Delaware's Top Five Worst Shareholder Decisions for 2010 (#4: City of Westland Police v. Axcelis Technologies)

Majority vote provisions have been trumpeted as a source of shareholder rights.  They give shareholders the right, in the absence of a proxy contest, to defeat directors nominated by management.  As we have noted, however, these rights are a myth.  Under Delaware law, the most that can happen if a director does not get the percentage dictated by a bylaw or governance policy is that the director must submit a letter of resignation to the board. 

As we have noted, this merely increases the discretion of incumbent directors.  Directors in general cannot remove those elected by shareholders, a relatively ancient but recently reaffirmed principle.  Majority vote provisions amount to an exception to this general rule.  By not providing majority support, shareholders merely transfer to the board the authority to remove the otherwise properly elected nominees.  Moreover, the pattern emerging already (and that was entirely predictable) is that the boards will routinely decline to accept the resignations of the defeated directors. 

The Delaware Supreme Court in City of Westland Police v. Axcelis Technologies, 1 A.3d 281 (Del. 2010) confirmed the mythical nature of majority vote provisions.  We posted on this case back in August.  Posts on the Chancery Court opinion date back to 2009.

In Axcelis, three directors on a staggered board did not get a majority of the votes cast.  They dutifully submitted their letters of resignation.  The Board declined to accept the resignations, mostly noting that it needed the experience and expertise of the defeated directors.  Thereafter, shareholders sought to inspect the records used by the board in rendering that determination.  The request was narrowly drawn.  Shareholders mostly sought agendas of meetings where the resignations were considered and documents distributed to the Board on the matter. 

The Chancery Court denied access to the documents.  Under prevailing law, plaintiffs were obligated to allege some type of mismanagement or improper behavior and produce credible evidence to support the allegations.  In other words, they had no automatic right to information about  board decisions that overturned the will of shareholders. 

The case effectively laid bare the use of pleading standards by the Delaware courts to deny shareholders access to information pursuant to their inspection rights.  The Chancery Court's decision, while philosophically inconsistent with the notion that shareholders have rights to information relative to their status as owners of the country, was faithful to the law created by the Supreme Court (see Seinfeld).   This use of pleading standards to deny shareholders access to information is discussed to some degree in Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty. 

Nonetheless, the lower court opinion was too much even for the Delaware Supreme Court.  Although affirming the decision to deny access, the Court did what it was asked to do in Seinfeld and did away with the credible basis standard, at least with respect to majority vote provisions.  In effect, the Court held that shareholders could get the underlying documents whenever directors refused to accept letters of resignation pursuant to a majority vote provision.

What the Court gave with one hand, however, it took away with the other.  The opinion made absolutely clear that the standard of review for board decisions to decline to accept resignations was the process driven, impossible to overturn, business judgment rule.  In doing so, the Court rejected application of the Blasius standard, somehow reaching the mystifying conclusion that refusing to accept the decision of shareholders was not a disenfranching act that required application of the compelling justification standard. 

The case makes clear that boards seeking to overturn the will of shareholders under a majority vote provision may do so for any rational reason (their experience is needed on the board).  Future inspection requests will produce evidence of a single meeting and documents that attest to the experience of the resigning directors. 

Axcelis made clear what many have suspected.  While shareholders can vote against an incumbent director under a majority vote provision, the board may (and will) ignore the message.  In other words, the decision confirms that any notion that a majority vote provision gives meaningful authority to shareholders is a myth. 

Delaware's Top Five Worst Shareholder Decisions for 2010 (#5: In re Revlon)

VC Laster is the newest member of the Chancery Court.  He has made a number of bold decisions and will be an interesting figure to watch.  It remains to be seen whether his decision making flair will gradually dim as he incurs reversals by the less colorful approach of the Delaware Supreme Court.

But one of his opinions makes the list this year, In re Revlon, 990 A.2d 940 (Del. Ch. 2010).  We blogged on this case back in April. 

In many ways, Revlonreflects the bold nature of VC Laster's decision making.   He dealt with what he saw as lawyers not adequately representing the interests of shareholders.  Rather than ignore the situation, he weighed in and took action.  

• I find that Old Counsel has not provided adequate representation in this case. After the initial skirmish over consolidation and lead counsel status, Old Counsel fell blithely into Cox Communications mode. They literally did nothing.  To put the best spin on it, Old Counsel seemingly recognized that they filed their complaints prematurely and that the consolidated case was subject to a motion to dismiss. I infer that the defendants did not challenge the premature litigation because they wanted the case to stay alive to support a settlement. Everyone knew their parts.

More than criticize, he took action, replacing Old Counsel with New. 

Had that been the extent of the opinion, VC Laster would have sent a firm message to counsel that in his court this type of representation would not be tolerated. 

But the message was obscured by two actions that betrayed hostility towards counsel for plaintiffs in general.  The first was his decision to describe counsel for shareholders in pejorative terms.  As he described:  "Firms who are early filers are frequently early settlers, leading some wags in the defense bar to label them 'Pilgrims.'"  Later in the opinion, he would note that he had "no desire to replace Pilgrims with Puritans."

The term had, until its exposure in the opinion, represented an example of inside baseball.  VC Laster was apparently repeating an adage commonly spoken among the defense bar.  The term (as a pejorative label) appears in no other Delaware case nor in any federal case.  One can find a mention of the term in an article by Professor Coffee.  He provides no citation for the origin of the term but notes that it is derisive.  See ACCOUNTABILITY AND COMPETITION IN SECURITIES CLASS ACTIONS: WHY "EXIT" WORKS BETTER THAN "VOICE", 30 Cardozo L. Rev. 407, 413 n. 15 (2008). 

Future articles and opinions need not use the term in an unattributed manner.  Revlon provides the requisite citation.  The derisive term should have remained a part of the sotto voce conversations of defense lawyers, without bleeding into the judicial lexicon. 

Moreover, the unfortunate terminology could be juxtaposed against his characterization of independent directors.  They were described as "courageous."  This was the case even though, as we noted, their behavior seemed anything but. 

The second unfortunate step was, that in replacing Old Counsel, he faced three firms seeking to intervene, two from New York and one from Delaware.  The three firms had already cobbled together an arrangement.  The two New York firms would act as lead counsel, the Delaware firm was liaison counsel.  Although these firms had no role in the concerns expressed about Old Counsel, VC Laster largely treated them with equal disdain.  As he reasoned:  

• I therefore find that New Counsel can take over as lead counsel in the case. I will not, however, adopt the leadership structure that New Counsel proposed, in which the Harwood Feffer firm and the Trinko firm would serve as co-lead counsel with Smith Katzenstein as Delaware liaison counsel. The qualifications and modus operandiof the Harwood Feffer and Trinko firms closely resemble those of Old Counsel. As relatively small firms managing a portfolio of representative litigation, the Harwood Feffer and Trinko firms have similar economic incentives to settle early to maximize the net benefit to themselves, rather than expending resources to press litigation further for the benefit of the class. I have no desire to replace Pilgrims with Puritans.

Instead, he appointed liaison counsel as lead counsel.  The basis for the decision?  The reputational capital that liaison counsel had built up with the new Vice Chancellor.

• The Smith Katzenstein firm, by contrast, is a Delaware law firm that is well-known to the Court. The firm frequently represents paying clients and does not appear to litigate plaintiffs' cases using a portfolio strategy. The members of that firm, including the lead lawyer in this case, have built up reputational capital with the Court and have proven willing to engage in the hard work of actual litigation.

Given the local nature of liaison counsel, VC Laster was in effect announcing that Delaware firms would have greater credibility in his courtroom.  Moreover, his attitudes about Old Counsel was allowed to bleed over into New Counsel, despite any significant evidence of similar concerns.  Whatever reasons VC Laster had in replacing Old Counsel, he lacked similar evidence to disrupt the arrangement worked out by New Counsel. 

We hope that this case does not reflect VC Laster's general views on counsel for shareholders.  We also hope that VC Laster will continue to decide cases in a bold fashion but will avoid the type of actions and language in Revlon that otherwise obscure important and necessary analysis. 

Delaware's Top Five Worst Shareholder Decisions for 2010 (Introduction)

We like to bring in the new year with our own countdown. 

For the fourth year in a row (for prior listings, see 2009, 2008, and 2007), we conduct a retrospective on the decisions that emerged from the Delaware courts over the last year and rank the five most anti-shareholder in analysis and result.  There are plenty to choose from.  The courts in Delaware make what can only be described as consistently "management friendly" decisions, often at the expense of shareholders. 

The last four years have seen some evolution.  Overt anti-shareholder rehtoric has decreased, although we will set out a noticeable exception in our countdown.  The Supreme Court hasn't described plaintiffs (aka shareholders) as "prolix" since Wood v. Baum, 953 A.2d 136 (Del. 2008); the Chancery Court since In re Citigroup, 964 A.2d 106 (Del. Chan. 2009).  Prolix is, as we have noted, a term reserved exclusively to describe pleadings submitted by plaintiff/shareholders; never by management. 

In terms of outcomes, however, this has been a very bad year for shareholders.  If there is a trend, it is that this type of outcome is far more common than in the past.  In the 1980s, the Delaware courts occasionally sided with shareholders (Van Gorkom comes to mind; in some ways, Unocal was at least a partial victory for shareholders).   In the new millennium, these sorts of victories are largely nonexistent. 

Anyway, on to the countdown of the five worst shareholder decisions by the Delaware courts for 2010.

Top Top 10 Reasons Why “Independent” Directors Are Not Independent Under Delaware Law

Delaware law provides substantial benefits to companies with boards consisting of a majority of independent directors.  In the case of transactions not involving a controlling shareholder, courts analyze conflict of interest transactions under the duty of care and the business judgment rule.  In demand excusal cases, demand will not be excused where the board has a majority of independent directors.  Yet despite providing these advantages, an analysis of Delaware decisions indicates that, in practice, the test (and the application of the test) for independence does not ensure that directors are in fact independent.  This issue is discussed at length here.   

The topic is a large one and will be addressed throughout the life of this Blog.  Still, we start today with a list of the top reasons why directors treated as independent under Delaware Law are in fact often not independent. 

1. Delaware courts use a subjective test for defining director independence then disregard it when convenient (such as the categorical exclusion of fees);

2. Delaware courts effectively exclude from the analysis of independence personal relationships (other than those arising from family bonds);

3. Delaware courts largely treat as independent directors employed by non-profit organizations where the non-profit receives substantial contributions from the company (or its employees);

4. Delaware courts impose unreasonable pleading standards, frequently terminating the analysis of independence at the motion to dismiss stage, precluding the use of discovery as a means of uncovering a director’s actual relationship with the company or CEO;

5. Delaware courts typically examine each allegation of non-independence in isolation, without weighing all of the factors together;

6. Delaware courts make factual determinations in connection with the analysis of independent directors on motions to dismiss;

7. Delaware courts discourage challenges to independence by all but requiring plaintiffs to first invoke their inspection rights, a step that adds costs and delay without yielding appreciable benefits;

8. Delaware courts rely on the standards employed by the stock exchanges to justify findings of independence, without discussing the differences in the standards;

9. Delaware courts routinely disregard information suggesting a lack of independence at the motion to dismiss stage; and

10. Delaware courts routinely require, on a motion to dismiss, that plaintiffs produce information about independence that cannot be obtained in the public domain.

Top 10 Benefits Resulting from the Adoption of SOX

1. SOX has improved investor confidence in the financial disclosure of public companies (perhaps there's a relationship between investor confidence and the record high set by the Dow Jones Average last Wednesday, Jan. 24);  see also the student post below this one;  

2. SOX has resulted in the uncovering of a considerable amount of dodgy accounting. A record number of companies have restated their financial statements, with the GAO estimating that the market capitalization of companies announcing restatements between July 2002 and Sept. 2005 "decreased by $63 billion when adjusted for market movement."  GAO Report 6-678 (July 2006).

3. SOX (and the fear of liability) has contributed to the transformation of accounting firms into true gatekeepers against fraud and sloppy financial statements;

4. SOX has resulted in the Audit Committee of the Board of Directors becoming a real watchdog over the accuracy of the financial statements;

5. SOX and the certification requirement has largely eliminated the Bernie Ebbers defense (aka the Ostrich defense) that the financial statements were not the responsibility of the CEO; 

6. SOX, by requiring the attestation of internal controls by independent auditors, has significantly improved the ability of the board to monitor the company’s activities, correcting one of the most serious weaknesses in fiduciary obligations under Delaware law;

7. SOX, by requiring changes of beneficial ownership within two days, has made the practice of backdating more obvious and more difficult;

8. SOX has provided in house counsel with greater leverage to ensure legal and ethical business practices;

9. SOX has provided a greater role for the SEC in the corporate governance process, undoing some of the harm caused by Business Roundtable v. SEC, 905 F.2d 406 (DC Cir. 1990) (see for example the use of the case by Roberta Karmel at Brooklyn Law School citing the case in a letter to the Commission questioning the agency's rule making authority to give shareholders access to management's proxy statement for their director nominees); 

10. SOX has resulted in the widespread use of disclosure committees inside corporate america, broadening the voices involved in the disclosure process; and (I know I said only 10, but its hard to be so limiting when it comes to the benefits of SOX);

11. SOX has encouraged employees to come forward with concerns about financial reporting, through both whistle blowing protections and mechanism that provide mandatory access to the board of directors.