Delaware and the Consequences of an Excessively Management Friendly Approach to Corporate Governance (Part 1)
As we have noted before on this Blog, there was a time when the Delaware courts, albeit always management friendly, occasionally made decisions favorable to shareholders. Van Gorkom and Unocal are two examples. Those days are over.
A bylaw friendly to shareholders that sought reimbursement for shareholders who successfully elected a director? Struck down. A bylaw favorable to management forcing shareholders to litigate cases in a designated forum (mostly Delaware), upheld. Inspection rights denied because documents were going to be used in litigation (see the lower court case in Central Laborers Pension Fund v. News Corp); inspection rights denied because documents could not be used in litigation (due to the statute of limitations) (Wolst v. Monster Beverage).
Cases that benefited shareholders in the past (Blasius) are under attack and not likely to survive much longer. Standards in mergers with controlling shareholders have been weakened, with entire fairness replaced in some cases by the business judgment rule. Process continues to replace substance yet the process is given little meaning (except perhaps in Vice Chancellor Laster's courtroom).
The most obvious consequence of this approach has been efforts by shareholders and investors to seek reform in other forums. For the most part, this has meant appeals to, and preemption by, Congress. Congress intervened and set standards for audit and compensation committees of the board. Congress intervened and required a shareholder vote on compensation (say on pay) and mandated that boards seek clawbacks of certain performance based compensation in the event of restatements. Congress has begun to impose qualifications on directors, essentially requiring the presence of a financial expert.
In preempting state law, Congress has used a variety of methods. In the case of say on pay, the requirement was imposed on all public companies (those registered under Section 12(g) of the Exchange Act). In the case of audit and compensation committees, Congress did so through the imposition of mandatory listing standards.
All of these areas were traditionally matters of state law. No longer. Which brings us to bylaws designed to limit judicial process. Bylaws in general regulate the internal affairs of a corporation. They can adjust the relationship between shareholders and managers. Fee shifting bylaws, however, do not fall into this category. First, they are not limited to cases arising out of the internal affairs of a corporation but generally apply to any action against the company or the board. Second, they are not limited in application to shareholders but generally apply to a broader category of plaintiffs.
Yet in addressing these provisions, the Delaware Supreme Court engaged in a simplistic, management friendly analysis of Section 109. The Section permits bylaws that are "not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees". From the Court's perspective, nothing in the language prohibited a bylaw that regulated judicial process.
As we will see in the next post, the door opened by the Delaware court is quite wide. It has the potential to alter the rights of shareholders and investors by limiting their rights to challenge behavior in court. We will discuss the implications of this approach and an example of the door being pushed open even wider in the next post.