In Strougo v. Hollander, the Delaware Court of Chancery held that a fee-shifting bylaw did not apply to a former stockholder’s challenge to the fairness of a 10,000-to-1 reverse stock split that the corporation undertook in connection with a going-private transaction because (i) the bylaw was adopted after the stockholder’s interest in the corporation ceased to exist due to the reverse stock split and (ii) Delaware law does not authorize a bylaw that regulates the rights or powers of former stockholders. While the proposed 2015 amendments to the Delaware General Corporation Law, if adopted, would themselves invalidate fee-shifting provisions in corporate charters and bylaws, Delaware corporations should consider the implications of this opinion’s holding that former stockholders are not bound by bylaws (or, by implication, charter provisions) adopted after their interests as stockholders cease to exist.
Posts Tagged ‘Delaware law’
Even as the Delaware appraisal rights landscape continues to evolve, dealmakers should not assume that the issues and outcomes will be the same in transactions involving companies incorporated in other states. Although once an afterthought on the M&A landscape, in recent years appraisal rights have become a prominent topic of discussion among dealmakers. In an earlier M&A Update (discussed on the Forum here) we discussed a number of factors driving the recent uptick in shareholders exercising statutory appraisal remedies available in cash-out mergers. With the recent Delaware Supreme Court decision in CKx and Chancery Court opinion in Ancestry.com, both determining that the deal price was the best measure of fair price for appraisal purposes, and the upcoming appraisal trials for the Dell and Dole going-private transactions, the contours of the modern appraisal remedy, and the future prospects of the appraisal arbitrage strategy, are being decided in real-time. These and almost all of the other recent high-profile appraisal claims have one thing in common—the targets in question were all Delaware corporations and the parties have the benefit of a well-known statutory scheme and experienced judges relying on extensive (but evolving) case law. But, what if the target is not in Delaware?
On March 11, 2015, the Delaware State Bar Association gave its formal approval to HB 49, which was filed yesterday in the Delaware Legislature. If passed by the Legislature, the bill, which bears the title the Delaware Rapid Arbitration Act, will establish Delaware as a cutting-edge seat for business arbitrations. Building on the best of the state’s earlier experiment with judicially annexed arbitration, the new legislation was crafted with extensive consultation and input from constituencies around the US and internationally. One thing became clear as a result of those consultations: businesses and their advisors are alarmed at the marked drift in arbitration practice away from timely, efficient dispute resolution.
Sometimes the remedy is worse than the disease. This, it seems, is the implicit view of the Delaware State Bar Association’s Corporation Law Council (the “Council”) with regard to fee-shifting in shareholder litigation. The Council’s second proposal on fee-shifting, circulated in early March 2015,  is much like their first, circulated in May 2014 in the wake of ATP Tour v. Deutscher Tennis Bund.  Both would prevent corporations from seeking to saddle shareholders with the cost of shareholder litigation by means of a fee-shifting provision, whether adopted in the charter or the bylaws.
In Halpin v. Riverstone National, Inc., a controlling stockholder caused the company to complete a merger, but did so without exercising drag-along rights that would have compelled the minority stockholders to vote in favor of the merger and thereby waive their statutory rights to judicial appraisal. After receiving notification of the merger, the minority stockholders filed an action for statutory appraisal of their shares, and in response the company sought an order requiring the minority stockholders to vote in favor of the merger so that the company could avail itself of the benefits of the drag-along rights. The Delaware Court of Chancery held that because the company failed to properly exercise its drag-along rights in advance of the merger, the minority stockholders were not required to vote in favor of the merger and thus could pursue their appraisal rights.
As part of the annual update cycle for Delaware’s General Corporations Law (DGCL), the Delaware Bar has returned to last year’s controversy on fee-shifting provisions in bylaws and certificates of incorporation to propose, yet again, destroying the ability of Delaware corporations to, in their organizing documents, have the losing party in an intra-company (i.e. fiduciary duty) lawsuit pay the prevailing party’s legal fees.
The proposal is among several 2015 legislative changes to the DGCL proposed by the Council of the Corporation Law Section of the Delaware State Bar Association, which is the working-level body that, historically through consensus, creates changes to the DGCL.
Vice Chancellor Laster has been writing for several years about the fiduciary duties of directors who represent the interests of a particular block of stockholders. In his opinion in the Trados Shareholder Litigation he found that directors, elected by the venture capital investors who held Trados’s preferred stock, had a conflict of interest in deciding on a sale of the corporation in which all the proceeds would be absorbed by the liquidation preference of the preferred and nothing would go to the common.  As a result of this finding, Vice Chancellor Laster applied the entire fairness standard of review to the Trados board’s decision. He concluded that while the directors failed to follow a fair process, the transaction was fair because the common stock had no economic value before the sale and so it was fair for the common stock to receive nothing from the sale.  In a recent Business Lawyer article which he co-authored with Delaware practitioner John Mark Zeberkiewicz,  Vice Chancellor Laster extended his Trados conflict of interest analysis to other situations in which directors represent stockholder constituencies with short-term investment horizons, including directors elected by activist stockholders seeking immediate steps to increase the near term stock price of the corporation. He states that such directors can face a conflict of interest between their duties to the corporation and their duties to the activists.
Delaware corporations and their advisers have been eagerly awaiting the response of the Delaware legislature to the recent surge in appraisal arbitrage and judicial pronouncements allowing this activity and suggesting that lawmakers should step in if they perceive a problem. It now appears based on a proposal released by the Delaware Corporation Law Council that the legislature may act as soon as this week. If the lawmakers follow the recommendations of the Council (which they usually do) the changes will likely disappoint Delaware corporations, make mergers and acquisitions in that important state more difficult, reduce deal flow, and lead to lower prices being paid to selling shareholders. The beneficiaries of this legislation will be the small (but growing) group of short term speculators specializing in appraisal arbitrage and the advisors who support that industry. Some of the problems created by appraisal arbitrage are described in my post on this subject a few weeks ago.
For at least 40 years, a large body of literature has debated the effects of state competition for corporate charters and the value of state corporate laws. The common assumption of these studies is that interstate competition affects the way state corporate laws respond to managerial moral hazard, i.e., the agency problem arising between shareholders and managers out of the separation of ownership from control (Jensen and Meckling, 1976). Nevertheless, scholars have been sharply divided about the importance of interstate competition, and particularly whether interstate competition fosters a “race to the top” that maximizes firm value (Winter, 1977; Easterbrook and Fischel, 1991; Romano, 1985, 1993) or a “race to the bottom” that pushes states to cater to managers at the expense of shareholders (Cary, 1974; Bebchuk, 1992; Bebchuk and Ferrell, 1999, 2001).
A foundational premise of Delaware jurisprudence has been the courts’ deference to decisions made by independent and disinterested directors. Over the last year, the Delaware courts have continued a trend in their opinions toward increased judicial deference to the decisions of independent and disinterested directors. Thus, for example, the Delaware Supreme Court’s seminal MFW decision provides a roadmap to business judgment review even of controller transactions (which used to be reviewed under an entire fairness standard).
Other than MFW, however, the courts have not changed the fundamental ground rules for review of a sale process. Thus, as in the past: