Delaware's Top Five Worst Shareholder Decisions for 2014 (#2: The Radicalization of Corporate Law by the Delaware Supreme Court)
Delaware is a management friendly state. The courts are management friendly in their decisions. We have written on these themes often. Management friendly, however, represents a leaning. It does not mean that shareholders always lose. In the Chancery Court, in particular, 2014 saw a number of cases that, while operating within a management friendly set of legal principles, applied them with appropriate rigor.
Thus, in In re Orchard, the Chancery Court for the first time found a set of facts that warranted a trial over whether non-family personal relationships resulted in a loss of director independence. In In re Rural Metro, the court provided additional content to the duty of care, essentially requiring boards to take a more active role in hiring and supervising financial advisors. In In re Hershey, the court overturned recommendations from a Master indicating that shareholders could not inspect records relating to information about possible violations of child labor restrictions in the cocoa market.
While the Chancery Court was making these decisions, the Delaware Supreme Court swung sharply in the opposite direction, radically revising corporat law. In the three cases discussed in this series of posts (C&J, ATP & Kahn), the Supreme Court either rewrote statutes or effectively abrogated longstanding principles of common law, all in a shareholder unfriendly fashion.
ATP is perhaps the most radical departure, rewriting the DGCL and eliminating any effective ability to facially challenge management adopted bylaws. The decision eliminated any need for a connection to the company's internal affairs, allowing bylaws that, for example, applied to actions brought under the federal securities laws.
To get there, the Court had to ignore explicit language in the DGCL indicating that limits on the rights of shareholders were to be in the certificate of incorporation. See DGCL 102. The bylaws also threatened statutory rights that had long been viewed as incidents of ownership. Thus, fee shifting bylaws arguably apply to inspection and appraisal right actions filed by shareholders, thereby throwing up non-statutory barriers to the exercise of these basic rights.
The decision did not, however, just rewrite the statute. It effectively gave the courts enormous additional authority. By eliminating facial challenges to most bylaws, the decision left courts as the arbiter of bylaws through the application of equity.
For a more detailed discussion of the case, see Shifting Back the Focus: Fee Shifting Bylaws and a Need to Return to Legislative Intent.
C&J and Kahn both rewrote the common law, eliminating shareholder friendly vestiges that had been in place since the 1980s. Revlon is gone, at least to the extent it required boards to actually act as an auctioneer and ensure that shareholder received the best price when selling the company. Also gone, for the most part, is the ability to test for fairness of transactions with controlling shareholders. As long as there is enough process (process on top of process), the business judgment rule is the applicable standard and the terms of the transaction no longer matter.
We shall see what other positions that benefit shareholders are rewritten in 2015. The Blasius standard is presumably at risk, with the possibility that the shareholder friendly "compelling justification" standard will be replaced by a management friendly standard of reasonableness.
As the Court rewrites the law and the shareholder unfriendly nature of the positions become more apparent, responses designed to minimize the role of Delaware in the corporate governance process become more viable. Federal preemption is one possibility.
There is also, arguably, room for a race to the top. The primary limit in the past on states that attempted to impose stricter requirements on corporations was the ability to reincorporate in management friendly jurisdictions, effectively neutering any such standards. But Delaware, through the allowance of bylaws not limited by the internal affairs doctrine, has provided other states with an opening.
States can now adopt a different interpretation of management's authority and apply it to domestic and foreign companies. Oklahoma has already done this. New York or California could easily provide that fee shifting bylaws are invalid for actions filed in the state (by any company, whether or not incorporated in the state). The ability of a company to reincorporate in Delaware wouldn't change that result. If that happened, New York and California would be the main site of derivative suits and their courts, not the Delaware courts, would determine national corporate law.