In Totta v. CCSB Financial, (Del. Ch.; 6/22), the Delaware Chancery Court held that language in an antitakeover charter provision giving the board broad authority to construe its terms and providing that the board’s informed, good faith decisions would be “conclusive and binding” did not alter the standard of review applicable to fiduciary duty claims arising out of those decisions.
The case arose out of a proxy contest in which an insurgent stockholder sought to obtain two out of seven seats on the company’s board. In response to that contest, the board invoked a provision in the company’s certificate of incorporation prohibiting a stockholder from exercising more than 10% of its voting power. The board also adopted an interpretation of its language that permitted aggregating the ownership of multiple stockholders if the board decided they were acting in concert. Accordingly, the board instructed the inspector of elections not to count any votes above the limit submitted by the insurgent stockholder, his nominees, and an entity affiliated with one of the nominees.
This instruction turned out to be outcome determinative, and the insurgents sued to invalidate the board’s instruction. The company pointed to the language of the charter provision, which purported to render “conclusive and binding” on the company and its stockholders “any constructions, applications, or determinations made by the Board of Directors pursuant to this section in good faith and on the basis of such information and assistance as was then reasonably available.” It argued that this language compelled the Court to apply the business judgment standard of review to the challenged actions.
Chancellor McCormick disagreed. She noted that the entity in question was a corporation, not an alternative entity, and that as such, it didn’t have the authority to establish or alter the standard of review that a court would apply to the fiduciary obligations of its directors:
The Company’s argument contravenes fundamental principles of Delaware corporate law. In essence, the Company asks the court to hold that a corporate charter may alter the directors’ fiduciary obligations and the attendant equitable standards a court will apply when enforcing those obligations. The Company would treat a corporate charter like the constitutive agreement that governs an alternative entity.
Fiduciary duties arise in equity and are a fundamental aspect of Delaware law. The constitutive agreements that govern an entity can only eliminate or modify fiduciary duties and the attendant judicial standards of review to the extent expressly permitted by an affirmative act of the Delaware General Assembly. The General Assembly has granted broad authorization to modify or eliminate fiduciary duties and attendant standards of review in some types of entities. The General Assembly has granted only limited authority to corporations.
The Chancellor ultimately concluded that because the voting limitation interfered with the exercise of the franchise, the board’s actions in issuing the challenged instruction to the inspector of elections should be evaluated under the Blasius standard of review, which required the directors to establish a “compelling justification” for their actions. She held that the board did not carry this burden.
Chancellor McCormick also concluded that the board’s interpretation of when stockholders are “acting in concert” was inappropriate. In the course of making this latter determination, she engaged in an extended discussion of what it means to “act in concert” under Delaware law, so this case is worth bookmarking on that point as well.
Earlier this year, I blogged about the Delaware Chancery Court’s decision in Lockton v. Rogers, (Del. Ch.; 3/22), in which the Vice Chancellor Glasscock refused to dismiss breach of fiduciary duty allegations against a director despite the fact that he abstained from voting on the proposed transaction that gave rise to the claims. More recently, in Harris v. Junger, (Del. Ch.; 5/22), another director gave that defense a try in a motion to dismiss. Vice Chancellor Glasscock once again promptly shot it down:
Junger argues that he should be dismissed because he was not a member of the Special Committee that negotiated the Merger, and because he abstained from voting on the Merger. However, it is reasonable to infer from the allegations of the Complaint that Junger played a role in negotiating the
Merger. Notably, Junger was a member of the initial special committee formed to consider a merger of Fat Brands and Fog Capital. Although that special committee disbanded in May 2020, the Board, including Junger, continued to discuss the Merger, with no special committee in place, between June and August 2020. Even after the Board approved the Special Committee’s charter in September 2020, the Board, including Junger, continued to discuss the Merger at regular Board meetings.
Together, these facts give rise to a reasonable inference that Junger was involved in the Merger negotiations, even if he did not participate in Special Committee meetings or vote to approve the Merger.
Citing both In re Tri-Star Pictures, Inc., Litig. (Del. Ch.; 3/95) and his own recent opinion in Lockton v. Rogers, the Vice Chancellor said that directors involved in negotiating a deal can’t “shield themselves from any exposure to liability” by “deliberately absent[ing] themselves from the directors’ meeting at
which the proposal is to be voted upon.”
The 1974 classic “Chinatown” contains one of the most memorably bleak closing scenes in film history. After witnessing the film’s villain – a proverbial “malefactor of great wealth” – get away with a murder, Jack Nicholson’s character Jake Gittes is hustled away from the crime scene by his colleagues, who simply tell him to “Forget it, Jake. It’s Chinatown.” In that last line “Chinatown” isn’t just a place, but a metaphor for the idea that the world’s a venal place, where the wealthy and powerful are above the law.
For me, it’s hard not to think of that line when I ponder Elon Musk’s encounters with the SEC and the courts and his erratic behavior surrounding his proposed acquisition of Twitter. It sounds like I’m not the only one. Here’s what Ann Lipton recently had to say on the Business Law Prof Blog about Musk & his Twitter shenanigans:
I mean, sure, you kind of know in a cynical way that rich people play by their own rules, but there’s a difference between believing that intellectually and viscerally experiencing it, day by day, as it plays out in Twitter.
And maybe that perception is misguided in this case – as I just said, there really isn’t a basis for any regulatory authority to get involved here, though the SEC could create headaches by demanding more disclosures in the proxy – but Musk’s brazen disregard of his contractual obligations almost certainly flows from his history of ignoring rules and experiencing no meaningful consequences. And of course, the more he does it, the more he develops an army of admirers who become less likely to hold him to account in the next iteration of the game.
And that’s the danger of each individual player – a Delaware court, a particular regulatory agency, a merger partner – each deciding that Musk is too irascible, too smart, too wealthy, too talented, to rein in. It collectively communicates a very specific lesson about who has to comply with the law, and who doesn’t. That harms everyone, but no one actor has an incentive or even the jurisdiction to address it.
Elon Musk is a sometimes dazzlingly brilliant entrepreneur who has earned an immense fortune with his vast talent. He also believes that the rules don’t apply to him, and so he doesn’t follow them. If institutions from the Tesla board to the SEC to the federal courts won’t step up and make him, then “Forget it Jake. It’s Chinatown.”
Yesterday, in Goldstein v. Denner, (Del. Ch.; 5/22), the Delaware Chancery Court refused to dismiss breach of fiduciary duty claims against the officers and directors of Bioverativ arising out of the company’s 2018 sale for Sanofi. This is another one of Vice Chancellor Laster’s 100+ page opinions, so there’s certainly a lot I could talk about. But one aspect of the case that I thought would grab your attention right before a long holiday weekend was the Vice Chancellor’s refusal to dismiss claims against the company’s Chief Legal Officer based on her alleged “embellishment” of board minutes approving the sale of the company.
The complaint alleges some pretty sketchy conduct by several members of the board, including violations of the company’s insider trading policy & non-disclosure of key facts to other board members. While some duty of care claims were made against the company’s officers, most of the complaint’s allegations alleged breaches of the duty of loyalty arising out of lucrative severance benefits that they would receive in the event of a sale. When it came to the CLO, the complaint alleged that those conflicts prompted her to prepare board minutes in a way that did not reflect reality. Here’s an excerpt from Vice Chancellor Laster’s opinion:
The complaint alleges that [the CLO] took steps to create a record that would enable the Transaction to close. But rather than creating a record in the sense of creating documents that accurately reflected what had taken place, [the CLO] created a record in the sense of engaging in acts of creativity. The plaintiff alleges that [the CLO] documented events that did not occur and described other events in a manner that made the process seem better than it was.
In making these allegations, the plaintiffs pointed to discrepancies between the language of the minutes and internal emails produced in response to a books & records demand. Although acknowledging that there were “defendant-friendly” ways to reconcile the emails to the minutes, the Vice Chancellor concluded that it was inappropriate for the Court to “find facts or weigh competing inferences” at this stage of the proceeding. Accordingly, he concluded that the plaintiff had advanced a possible account in which the CLO created “an embellished description of the Board’s deliberative process,” and declined to dismiss the breach of fiduciary duty claim against her.
If you’re looking for more on this case, check out Ann Lipton’s Twitter thread on VC Laster’s holding that directors who expect repeat board positions from activists may not be viewed as independent.
This Wilson Sonsini memo highlights recent statements by senior DOJ & FTC officials that suggest that antitrust regulators are increasing their scrutiny of the private equity industry. In particular, director interlocks, roll-ups and issues surrounding private equity funds as divestiture buyers are getting a lot of attention. Here’s an excerpt on what’s caught the regulators attention about divestitures to PE buyers:
Private equity firms are often ideal buyers of assets in the context of agency-mandated merger divestitures. However, AAG Kanter recently stated that the DOJ would pay closer attention to private equity firms as divesture buyers, reasoning that “[v]ery often settlement divestitures [involve] private equity firms [often] motivated by either reducing costs at a company, which will make it less competitive, or squeezing out value by concentrating [the] industry in a roll-up.”
He added that “[i]n many instances, divestitures that were supposed to address a competitive problem have ended up fueling additional competitive problems.” Further the agencies have already made private equity purchases of divestiture assets more difficult; in November 2021, the FTC announced a rule change that requires divestiture buyers to obtain prior agency approval for at least 10 years before reselling the acquired assets, making these acquisitions less practical for private equity firms.
The memo provides some key takeaways for private equity sponsors & their lawyers when confronting these issues. It recommends that private equity firms & portfolio companies develop a compliance program to assess antitrust risk associated with potential interlocks. The added scrutiny being applied to roll-ups is a reason to involve antitrust counsel early on when assessing whether a transaction or series of transactions would be problematic. Finally, PE divestiture buyers face an uphill battle, and must be able to demonstrate the ability to operate a competitive standalone business.
One of the things that sometimes drives businesspeople up a wall about lawyers is our obsession with recordkeeping. Minutes, board and stockholder resolutions, documentation of share issuances and preparation of other corporate records loom large in most lawyers’ priorities, but for business folks, that’s often not the case. Well, the next time somebody from the business side rolls their eyes when you shove a bunch of organizational minutes for a new Norwegian subsidiary under their nose, be sure to point them in the direction of this Deloitte study, which says that failing to pay due attention to legal entity management can be very costly when it comes to M&A. Here’s an excerpt:
A company with immaculately managed books conveys a sense of order and trustworthiness. Buyers don’t have reason to question general counsel or the management team; they can see that everything is as it should be. “Better entity management gives the buyer more confidence in the organization,” according to John Easterday, a partner at Deloitte Tax LLP. If, on the other hand, a business hasn’t exercised care in maintaining its entities’ corporate records, buyers may start to wonder what else has escaped the management team’s focus—and what other problems they may be buying with this deal. In our research, 59% of respondents said that poor entity management causes buyers to question whether subsidiaries are, in fact, wholly owned by sellers.
Sloppy LEM can lead to questions that ultimately decrease confidence and trust. That’s what we heard about in the cautionary tale of a private equity firm that initially offered $47 million to buy a company. But when the private equity firm inspected the seller’s records, it found that leases hadn’t been executed properly and only half of the stock option agreements were signed. These shortcomings caused the private equity firm to question the seller so much that it ended up discounting its price.
The study says that when a buyer encounters sloppy corporate recordkeeping, it reaches one of two conclusions: either the seller’s legal team is inept, or the seller is hiding something. Neither conclusion is conducive to a successful transaction.
Earlier this month, I blogged about Chancellor McCormick’s decision in Coster v. UIP, (Del. Ch.; 5/22), in which she held that a board satisfied the Blasius standard by demonstrating a “compelling justification” to issue shares in order to resolve a shareholder deadlock. Weil’s Glenn West recently blogged about the same case, and he closed with a point that’s worth remembering:
How much easier would this have been if there had been a stockholders’ agreement in place that dictated a process for a buyout in the case of the death or divorce of a stockholder or otherwise provided for a buy-sell arrangement in the case of a deadlock. In the private equity world, the idea that there was no pre-agreed exit mechanic or a specific means of resolving deadlocks is almost inconceivable. But it does happen. Planning for death, divorce or changed business plans of your founder, who is retaining significant ownership in a portfolio company, should always be front of mind.
That’s good advice, and in hindsight, I think the parties to this lawsuit, who have been litigating the share issuance since 2018, would agree.
I’ve blogged a couple of times about some of the potential implications of the SEC’s proposed SPAC rules on the investment banks involved in SPAC IPOs & de-SPACs. Now Bloomberg Law’s Preston Brewer has published an analysis indicating that although the rule proposal hasn’t yet been acted upon by the SEC, it’s already driving many banks out of the SPAC business:
Of the many proposed rules addressing special purpose acquisition companies, Securities Act Rule 140a may prove the most problematic for SPACs. It would make an underwriter for a SPAC’s IPO also liable as an underwriter for the de-SPAC transaction if certain conditions are met—generally, if the underwriter does anything that might be construed as facilitating the de-SPAC transaction or any related financing transaction.
The proposal is causing investment banks such as Goldman Sachs, Bank of America, and Citigroup, which underwrite securities offerings, to rethink their SPAC business. Those underwriters are balking at the prospect of their potential liability—already significant—being extended beyond a SPAC’s initial IPO to subsequent financings conducted by a SPAC, including the de-SPAC merger, even if their later involvement was minimal.
Preston goes on to observe that this reticence on the part of investment banks to sign-up for the new liability scheme isn’t a bug, but likely a feature of the SEC’s SPAC proposal. That conclusion won’t come as a surprise to anyone who’s been keeping an eye on the SEC’s increasingly skeptical view of SPAC deals over the past couple of years.
In Wong v. Restoration Robotics, (Cal. App.; 4/22), a California appellate court upheld a federal forum provision in a company’s certificate of incorporation that required Securities Act claims to be filed in federal court. Although other California courts have previously upheld exclusive forum provisions, this is the first California appellate court case addressing the issue. This excerpt from a DLA Piper memo on the case reviews the Court’s reasoning:
The Court of Appeal first addressed whether federal forum provisions as a category are impermissible under the concurrent jurisdiction provision of the Securities Act or under various sections of the United States Constitution. The court ruled for defendants across the board on those issues. It held that such corporate provisions do not implicate the Securities Act’s prohibition on removal because they do not themselves remove cases to federal court; the Securities Act does not create an unwaivable right for plaintiffs to have claims adjudicated in state court; and the Delaware statutes authorizing corporations to adopt federal forum provisions do not purport to shut the doors of any state court to Securities Act cases.
The Court of Appeal then found the trial court did not abuse its discretion in finding that the federal forum provision adopted by Restoration Robotics was valid and enforceable. Applying Delaware law, the court concluded that Salzberg had settled the question of validity in the defendants’ favor. It found that plaintiff had not shown that the enforcement of the provision would be outside the reasonable expectations of the company’s stockholders, due in part to the fact that the provision “was made public in an amendment to the registration statement several weeks before the IPO, when it became effective.” For the same reasons, the federal forum provision was neither substantively unconscionable nor a contract of adhesion.
The memo goes on to point out that the most important aspect of the Court’s decision is that it has been certified for publication, and thus may be cited as precedent in other cases in California courts.
Harvard Law School profs Caley Petrucci & Guhan Subramanian recently posted an article in which they suggest some updating of the ground rules governing pills to address the challenges of sophisticated shareholder activism and the broader set of constituencies corporate boards are being asked to consider. As law review articles go, this one’s pretty short at 21 pages, and it’s definitely worth reading. Some specific recommendations include:
– Giving larger companies more tolerance on the trigger percentage for poison pills because the toehold stake is so much larger; in today’s world, what is relevant is the dollar stake an activist can acquire, not the threshold percentage (e.g., a 5% trigger in a $30 billion market cap company is probably more activist-friendly than a 10% threshold at a $5 billion market cap company).
– Third generation “parallel conduct” acting in concert provisions that include a board determination “guardrail” are not just an appropriate response to increasingly sophisticated activist attacks, but a best practice.
– “Daisy chain” language providing that stockholders are acting in concert with one another when they separately act in concert with the same third party. Without such a provision, large shareholders could evade the pill by coordinating their activities through a middleman who holds a trivially small percentage of the company.
– Definitions of beneficial ownership that address synthetic equity positions, because a pill that does not capture synthetic equity (at least with regards to synthetic equity that is morphable into shares with voting rights) would provide a yet another loophole that weakens the pill, if not rendering it virtually illusory.
The authors’ argue that these recommendations reflect an effort to balance concerns about the need to deal with sophisticated activism and multiple constituencies against the need for all shareholders, including activists, to be able to solicit support for their ideas or attempt to gain control of the company. Whatever the motivation, the article offers a spirited defense of many of the same pill features that Chancellor McCormick found objectionable in her decision in The Williams Companies case. (H/T The Activist Investor).