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How does one apply the medium form merger rule under DGCL 252(h) when there are multiple classes of stock

I got an email from a student that posed an interesting question: 

According to the DGCL 251(h): no vote of stockholders of a constituent corporation that has a class or series of stock that is listed on a national securities exchange or held of record by more than 2,000 holders immediately prior to the execution of the agreement of merger by such constituent corporation shall be necessary to authorize a merger if: ... (3)  Immediately following the consummation of the offer referred to in paragraph (h)(2) of this section, the stock irrevocably accepted for purchase or exchange pursuant to such offer and received by the depository prior to expiration of such offer, together with the stock otherwise owned by the consummating corporation or its affiliates and any rollover stock, equals at least such percentage of the shares of stock of such constituent corporation, and of each class or series thereof, that, absent this subsection, would be required to adopt the agreement of merger by this chapter and by the certificate of incorporation of such constituent corporation;

My question is if there is Class A, B, C voting stock, would this mean that the buyer would have to acquire the outstanding % of all three classes of voting stock? I would presume that the same rule would apply to a company that had common stock and preferred stock. Am I interpreting this part of the statute correctly?

Two points:  Section 251(h) applies to a target corporation with any class or series of stock that is listed on a national securities exchange or held of record by more than 2,000 stockholders.  In other words, not all classes or series of stock of the target corporation need to be listed on such exchange. 

Subsection (3) of Section 251(h) requires that subsequent to the close of the tender or exchange offer, the acquirer must own enough target stock as would be necessary to adopt the merger agreement, both under the terms of the Delaware General Corporation Law and the target’s certificate of incorporation, such that the acquirer could complete the merger, even if Section 251(h) was inapplicable.

The first question thus is what classes are eligible to vote. The articles of incorporation will tell you what voting rights each class of stock has. See Mariner LDC v. Stone Container Corp., 729 A.2d 267 (Del. Ch. 1998) (charter amendment giving non-voting preferred stock voting rights subsequent to merger did not confer right to vote on merger or right to vote on the non-adverse charter amendment itself).

The second question is whether the shareholders will vote as a single class or whether each class will vote separately. The default rule is that all shares of all classes vote as a single group unless the articles of incorporation provide to the contrary. This is implicitly confirmed by Section 251(c), which states that a merger must be approved by “a majority of the outstanding stock of the corporation entitled to vote thereon.”

So let’s say there is Class A common with 1 million shares outstanding and Class B common with 100,000 shares outstanding. Assuming both have 1 vote per share, you’d need to get a total of 550,001 shares in the first step tender offer. Any combination of A and B should work.

But what if the Class B has 10 votes per share. DGCL 212(a) provides that “If the certificate of incorporation provides for more or less than 1 vote for any share, on any matter, every reference in this chapter to a majority or other proportion of stock, voting stock or shares shall refer to such majority or other proportion of the votes of such stock, voting stock or shares.” Accordingly, the outstanding shares would have 2 million votes and you’d need some number of Class A and Class B shares totalling 1,000,001 votes.

In some cases, however, DGCL 242 may kick into play. It provides a for a class vote when an amendment to the articles would adversely affect the rights of that class. Compare Elliott Associates, L.P. v. Avatex Corp., 715 A.2d 843 (Del. 1998) (merger operated to repeal rights of preferred granted in the articles; vote by preferred required) with Warner Communications Inc. v. Chris-Craft Industries, Inc., 583 A.2d 962 (Del. Ch. 1989), order aff'd, 567 A.2d 419 (Del. 1989) (no class vote of preferred required in connection with merger where preferred was merely converted into common).

Guest Post from Andrew A. Schwartz: A Missing Piece in Regulation Crowdfunding

I write today to highlight a significant market failure in the field of investment crowdfunding, one that the current set of rules does not adequately address. At the end of the post, I will propose a simple rule that the SEC can adopt to resolve the problem.

Investment crowdfunding—the public offering of unregistered securities through an independent online platform—generally calls for a light-handed set of regulations, for a number of reasons, including: One, an issuer may only raise up to $5 million at a time, and so the regulatory cost must be minimal to make it work. Two, we already have a heavily regulated form of public offering, namely the traditional IPO; investment crowdfunding is meant to be a simpler method of public fundraising. Three, each issuance is at such a small scale that no single blowup can cause anything close to systemic harm.

Thus, in my recent book, Investment Crowdfunding, I advocate for a liberal regulatory system that eschews many of the traditional bulwarks of securities regulation, including mandatory disclosure. Even so, there are certain areas where the market, left to its own devices, will not produce an optimal result, and thoughtful regulation can help achieve a better outcome for all concerned.

As I discuss in my book, there is a problem with the ‘all-or-nothing’ model of crowdfunding. Under the JOBS Act, crowdfunding issuers must announce a target funding amount, and a time frame to reach it. If enough investors contribute within the relevant time to hit the target, the deal succeeds, the company gets the money, and the investors get securities. But if a project fails to meet its target, then the deal is off and no money changes hands. Hence, the issuer gets either ‘all or nothing.’ Companies must also announce a maximum amount they are willing to take.

This all-or-nothing model is a key governance mechanism for the investment crowdfunding market. Based on the ‘wisdom of the crowd,’ good companies will get funded and bad companies won’t. Moreover, any individual investor who selects a bad (unpopular) investment will be saved from his poor choice, because it won’t reach its target funding amount, and the deal will be cancelled. Rather than walk off the cliff alone, such an investor will be pulled back to safety by his fellows.

Consider, for example, a company that wants to raise money to develop a new type of electric car battery and sets a target of $2 million. If it only can get $20,000 worth of investments, it is much better for the deal to be canceled than for it to go through. The poor investors would have all their money eaten up by the costs of raising it, and the company has no chance of developing the battery with only $20,000. Furthermore, the founder now knows that the market is not receptive to his proposed idea, so he may pursue some other endeavor, or at least make drastic changes to this one.

All this shows the value of the all-or-nothing model. Unfortunately, the simple version enacted in the JOBS Act and Regulation Crowdfunding can be gamed by companies and platforms, because there is no minimum target in the law, and no relation between the minimum and the maximum. Thus, there is nothing to stop a company from setting its funding target at some absurdly low level, say $100, and the maximum at, say, $1 million. Once that low bar is cleared, the company is home free and will get the money regardless of how little or how much is ultimately raised—and the platform will receive its commission for hosting a ‘successful’ offer. Unfortunately, this is not at all merely hypothetical but appears to happen every day.

Rather than setting the funding target on an individual basis, the leading American platforms appear to impose uniform funding targets on all, or nearly all, of the companies they list. One leading platform sets the funding target at $50,000, another sets it at $25,000, and a third requires that every company on its site set a funding target of just $10,000. This practice defeats the purpose of the all-or-nothing rule, as it effectively ensures that every company will meet its target and thereby ‘succeed’ in its crowdfunding campaign.

But it is a bit silly for a company that really needed $2 million to call it a success to have raised $20,000. In fact, it’s worse than silly, since the whole $20,000 will go toward the costs of raising the funds (audit fees, for instance), harming the company and the investors at the same time. The platform, by contrast, might not mind, since it receives its commission (which it would not get if the offer were to fail).

Furthermore, because the rule allows for any minimum and maximum, companies routinely select a minimum of $10,000 and a maximum of $1 million. This is bonkers. A company that seeks to raise anywhere between $10,000 and $1 million clearly has no idea what amount of funding it actually needs.

An additional problem with the rule in Regulation Crowdfunding is that there is no legal limit on the deadline, so companies routinely give themselves many months, or even a year or more, to reach their funding target. This is a common occurrence on all platforms, as crowdfunding companies can close the offering ‘early,’ so long as they give the investors forty-eight hours to cancel.

The effect of such a long time-frame is to undermine the whole point of having a deadline in the first place, which is to test the crowd’s appetite for what the company has to offer. In addition, it may also harm the company by keeping its attention on the crowdfunding campaign for many months, rather than getting on with business.

In the end, the all-or-nothing model is a useful structure, but it is not presently working well. I accordingly would recommend that Regulation Crowdfunding be revised and tightened up to prevent the sort of gaming we have seen to date.

One way to address the low-target problem is to create a new rule that links the maximum to the funding target, such that a company is only legally allowed to raise a certain multiple (perhaps four times) of the funding target. For example, if a company announces a funding target of $20,000, it would only be legally allowed to raise up to a maximum of $80,000 (assuming a four-times multiple). If it announces a target of $250,000, it can raise up to $1 million.

A rule like this would effectively force a company to think carefully about how much funding it really needs and would rehabilitate the power of the all-or-nothing model in the United States. Were such a rule in effect, platforms would not have their listing companies all use a standard funding target like $10,000 or $25,000, as they commonly do now. This would be a big change from the current practice, but a good one, I think.

If my proposed rule were enacted, a crowdfunding company would have to analyze its individual circumstances and set its funding target at an amount that it actually needs to raise. Typical funding targets would likely be in the range of $100,000, $250,000, or even $1 million (as we see in other jurisdictions). Having to reach those lofty targets in order to get a penny would present a real test of the investors’ view of the company—which is exactly the point of the all-or-nothing regime.

In addition, there should be some regulatory guardrails on the deadline as well. Regulation Crowdfunding should be amended to include a legal limit on the length of time that a crowdfunding offer can remain open. Both Canada and Australia have done just that, imposing a legal limit of ninety days, which seems like a reasonable choice. This concentrates the discussion among the crowd and allows the company to raise money and then get back to its primary business, whatever it may be.

In conclusion, although I generally support a liberal and light-handed approach to investment crowdfunding regulation, I would call on the SEC to add a new rule that enhances the effectiveness of the all-or-nothing concept. My proposal is to add a rule that limits an issuer to raising four-times the target amount, and to impose a ninety-day time limit for crowdfunding offerings to remain open.

Andrew A. Schwartz, Professor of Law at the University of Colorado and Fulbright Scholar, is the author of Investment Crowdfunding (Oxford University Press 2023), from which this post was adapted.

Rallying Behind Coinbase: A Deep Dive into the Amicus Brief

Yours truly was privileged to co-sign an amicus brief in the SEC v. Coinbase litigation, along with:

• Tamar Frankel from Boston University
• Sean J. Griffith from Fordham Law School
• Lawrence Hamermesh from Widener University
• M. Todd Henderson from the University of Chicago Law School
• Jonathan R. Macey from Yale Law School

Crytopolitan takes a deep dive into the brief's core argument. The basic issue in the case is when cryptocurrency become a security, which focuses on whether it is an investment contract under the Howey test:

The Howey test, a cornerstone in securities law, has been a pivotal point of contention in the case. In their filing, the professors emphasized the importance of this test in determining what constitutes an “investment contract.”

According to the Howey test, for something to be deemed an investment contract, there must be an expectation of profits from the investment, which will be derived from the efforts of others. In simpler terms, an investor should anticipate returns based on the endeavors of the enterprise they’ve invested in.

The professors argued that federal cases, through the Howey test, have consistently recognized that “investment contracts” necessitate an expectation in the business’s income, profits, or assets. They stated, “An investor must be promised, by his or her investment, an ongoing contractual interest in the enterprise’s income, profits, or assets. In this section, we discuss some of these cases.” Their argument underscores the need for the Court to remain consistent with the established definition of ‘investment contract’ when interpreting it in this case.

 

The AMCAPES settlement is approved. But what about Blasius?

VC Zurn has issued her long awaited opinion in the $AMC #APES litigation. Bottom line? She approved the settlement. She also denied the request for a stay pending appeal. https://t.co/Hv1l0SOI1I HT: Chancery Daily #AMCAPES

— Steve Bainbridge (@PrawfBainbridge) August 11, 2023

A quick read suggests Zurn (1) thinks Blasius is still an independent standard, (2) thinks Blasius applies outside the context of director elections, but (3) Blasius now only requires defendants to "show their actions were reasonable in relation to their legitimate objective."

— Steve Bainbridge (@PrawfBainbridge) August 11, 2023

On Doing Legal Scholarship and Finding Your Scholarly Voice

I've been asked to participate in a faculty program offering "a broad discussion on scholarship, including the following:

• Finding your scholarly voice;
• When and how to engage multiple literatures (including when to stop reading and start
• writing);
• When and how to seek feedback on your work, both internally and externally;
• Conferences;
• Promoting your work (e.g., through social media); and
• Submissions."

Here's what I intend to say:

When I started out as a law professor I didn’t spend a lot of time thinking deep thoughts about what I was doing. I didn’t worry much about finding my scholarly voice. I was not very intentional about picking topics. I just sort of jumped into the pool and hoped for the best. And it worked out reasonably well.

Some years later, however, I encountered George Orwell’s essay Why I Write, and discovered that it was possible to be very intentional about the process.

Orwell says there are four primary motives for writing, all of which seem to me to be relevant to the scholarly enterprise.

“(i) Sheer egoism. Desire to seem clever, to be talked about, to be remembered after death . . ..” We are all guilty of it, but I think we need to be conscious of the errors that it can lead to. In particular, the desire to appear brilliant. Smarter than the average bear. Which leads to works like James Joyce’s Ulysses: impenetrable masses of jargon; choosing complexity over clarity; adopting tribal mores and memes so as to be accepted. 

“(ii) Aesthetic enthusiasm. Perception of beauty . . . in words and their right arrangement.” When I was a kid, I wanted to grow up to be a science fiction writer. As I got older, I realized two things: (1) I can’t write dialogue and (2) the vast majority of science fiction writers make almost no money. But I still think of myself as a writer. I enjoy the process of trying to find just the right word. Of trying to be clear. Turning a good phrase. Developing a flow and rhythm to the work. And I wanted to get better. So, I studied writing as a discipline. I found some excellent books on writing. I took some seminars on writing. “Craftsman-like” is a kiss of death in a tenure letter, but I think we should all aspire to a high level of craftsmanship.

I find it odd that a lot of law professors don’t seem to enjoy the writing process. They struggle. They view it as a chore. They labor endlessly over a project. I’ve got a friend who has been working on the same law review article for what seems like the last three years. I've read multiple drafts and it's very good. Yet, my friend can’t seem to cut the cord. My friend’s an editor, not a writer.

An analogy suggests itself. On my mother’s side, her father was a carpenter. Her three brothers were carpenters. My grandfather, in particular, was an exceptionally talented woodworker. He made beautifully crafted things. And then he sent them out into the world for others to enjoy. He got them to a stage at which they were the best work he could do and then he didn’t dither over trying to make them just a little bit better. So there’s a balance to be struck between creating a work of merit and deciding that’s it’s as good as it going to get. Or, as an older friend told me when I started out, you’re going to write a lot of juvenilia. We all do. You just have to be conscious of striving for maturity.

“(iii) Historical impulse. Desire to see things as they are, to find out true facts and store them up for the use of posterity.” When I started out at Illinois, my colleague John Novak used to say that the way to get tenure at a law school was to find an obscure legal issue and beat it to death in an article that has at least 300 footnotes. Rinse and repeat. Good advice at the time; probably not today. But it’s worth remembering that we are law professors. We teach in a professional school not a graduate school. Our students will go out into that profession. Our scholarship should be accessible and useful to them. We should see the law as it is and then share that insight with our profession.

“(iv) Political purpose – using the word ‘political’ in the widest possible sense. Desire to push the world in a certain direction, to alter other people’s idea of the kind of society that they should strive after.” Obviously, this is the reason and motivation most relevant to legal scholarship. As it should be. Yet, I think it is worth pondering the implications. We live in an increasingly tribal society. The legal profession is increasingly tribal. Even law schools show some tribalism, despite their tendency towards monoculture. Are you just writing for your tribe? Or are you trying to persuade people who reside in other tribes? Because they require different styles and choices.

Put another way, who is your audience? My scholarship got a lot better when I realized that I had a target audience and that I needed to adapt my work to reach them. So, for many years now, when I sit down to a new project, I have a specific audience in mind. It is the seven members of the Delaware Chancery Court and the five members of the Delaware Supreme Court. I see my job as writing them a letter that they will find useful and persuasive.

Find your audience and you’ll find your voice.

Tortellini and Sausage Soup

• 1 teaspoon olive oil
• 6 ounces bulk Italian sausage (sweet or hot, as you prefer)
• 2 garlic cloves sliced thin
• 1 small shallot, minced
• pinch red pepper flakes (optional)
• ½ cup dry white wine
• 3 cups low sodium chicken broth
• 1 14.5 ounce can diced tomatoes, drained
• ½ cup frozen spinach
• ½ cup frozen peas
• 6 ounces frozen cheese tortellini

Heat the olive oil in a large sauté pan (I use my All-Clad 3-quart sauté pan). If your sausage is in casings, remove and discard casings. Break the sausage into pieces. Cook over medium-high heat (I use the 7 setting) until lightly browned, breaking it up as you go. Remove sausage to a paper towel lined plate to drain. Leave a tablespoon or so of fat in the pan. Add garlic and sauté for a minute. Add shallot and sauté 2 minutes. Return sausage and stir to combine. Add white wine and raise heat to high. Bring to a boil, scraping up any browned bits. Add broth and return to the boil. Add tomatoes. Reduce heat to medium-low to simmer. Let cook for 10 minutes. Taste and add salt or pepper as needed. Add spinach, peas, and tortellini. Cook for five minutes. Serve in large bowls with crusty bread.

You can skew this soup in a slightly different direction by upping the tomato aspects. After you've sautéd the shallot for a minute and a half, add 1 tablespoon of tomato paste and sauté to a minute. Next, reduce the chicken broth to two cups. Next, add the tomatoes with their juice instead of draining them. Finally, season to taste with basil (fresh is better but dried works).

Since I decided at the last minute to go the tomato route, we drank a 2020 Marchese Antinori Chianti Classico Riserva instead of the white wine on which I had planned. It's a little heavy for a soup, but it worked reasonably well. On its own merits, it's a deep ruby color. Cherry, raspberry, and plum fruit associations. Well integrated oak provides vanilla, leather, and tobacco note. Excellent.

Martin Lipton's still peddling the bogus "New Paradigm"

Over on the Harvard Corporate Governance Forum, Martin Lipton and some of his Wachtell acolytes blithely brush off the rise of anti-woke capitalism investors and politicians and the growing resistance to ESG. Instead, he clings to the so-called "New Paradigm," which purports to offer "a  pragmatic and balanced approach to preserving open market capitalism, while also creating economic prosperity that will benefit all, not just a few," by embracing stakeholder capitalism. 

I'm deeply skeptical about all of this nonsense. I don't think Lipton is a woke capitalist. To the contrary, he's embraced ESG as the latest way of marketing his services to corporate managers. As I explain in my book, The Profit Motive: Defending Shareholder Value Maximization:

Martin Lipton rose to fame by defending Imperial CEOs from the raiders.  Lipton’s invention of what he called the shareholder rights plan—better known as the poison pill—was a major reason the brief hostile takeover era fizzled out by the early 1990s. . . .

Martin Lipton has morphed from anti-takeover warrior into a vigorous advocate of what he calls “the New Paradigm,” which “conceives of corporate governance as a collaboration among corporations, shareholders and other stakeholders working together to achieve long-term value ….” . . .

But it is difficult to take Lipton’s arguments at face value.

When you look closely at The New Paradigm it quickly becomes apparent that Lipton is still in the business of defending corporate managers. The only difference is that the corporate raiders of the 1980s have been replaced by hedge fund activists. Accordingly, one suspects that Lipton’s goal is not to empower his CEO clients to be more prosocial, but to use stakeholder capitalism as a lever for restoring the CEO’s former imperial powers.  Those suspicions find confirmation in Bebchuk’s study of deals negotiated during the COVID-19 pandemic. Lipton’s law firm, Wachtell, Lipton, Rosen & Katz, represented target companies in 15% of the studied deals. Despite Lipton’s frequent pronouncements about the need to embrace stakeholder capitalism, none of the Wachtell Lipton deals contained any contractual protections for labor, customers, creditors, or the environment.

Hypocrisy?

SEC Staff Continues to Allow Shareholder Proposals Amounting to Micromanagement of the Company

As I detailed at some length in my article, Revitalizing SEC Rule 14a-8’s Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705 (2016), the SEC shareholder proposal was never intended to allow shareholders to manage--let alone micro-manage--the corporations in which they invest. Yet, in recent decades, the SEC staff has basically eviscerated those safeguards. Skadden Arps lawyers Marc Gerber and Ryan Adams' review of the 2023 proxy season concludes that that trend continues:

The SEC Staff continues to grant no-action requests in some cases where companies argue that a shareholder proposal relates to ordinary business matters, would result in micromanagement or suffers from a procedural defect, among other things.

Nonetheless:

Companies were slightly more successful in excluding proposals under the micromanagement prong of the ordinary business exclusion in the 2023 season than in the previous season.

 

 

 

Smith-Madrone Chardonnay (Spring Mountain District) 2018

As longtime readers know, I'm a big fan of Smith-Madrone, which I think is one of the (what's the right word? small, boutique?) wineries in Napa. We've visited their facility on the top of Spring Mountain a couple of times and always enjoyed spending time with Chuck and Stu. We've drunk a lot of their wine over the years and have never had one that wasn't excellent. Their wines are usually drinkable on release but have the potential to age well. On top of which, they're very reasonably priced given the quality.

As it approaches its fifth birthday, the 2018 is drinking really well. This is a very well balanced wine. Buttery oak/rich fruit/good acidity all play well together with none dominating. The color is a rich yellow-gold. On the nose and palate, one notices toast, vanilla, oak, Meyer lemon, and peach. I served it with pan-seared scallops and pea risotto, for which it was a great match.

Highly recommended.

Guest Post from Jeffrey Lipshaw: Who owns the corporation?

[My friend and occasional sparring partner Jeff Lipshaw sends along a reaction to my post on “who owns the corporation?”]

Typical of most Quora questions, that one is slightly inane, because whether the shareholders "own" the corporation is at least worthy of a thoughtful response like yours, but before you explain to somebody that the CEO doesn't own it, you might need to disabuse them first of a couple Q-Anon theories on the deep state.

So I agree with your legal analysis of "ownership" of the corporation.  I agree, for example, that nobody other than a shareholder (not the union, not the government, not customers) has legal standing to complain about whether a board decision is in the best interest of the corporation.

Nevertheless, you ought to include a disclaimer when you say, "the corporation is an aggregation of people bound together by a complex web of contractual relationships."  In other words, "the web of contracts" concept is meaningful if you are looking at it through a legal lens.  And the legal lens itself imports what a sociologist might call a Gesellschaft view - a modern institution built on ownership rights embodied in law (per Ferdinand Tönnies, in contrast to the tribe or community Gemeinschaft).

Humor me with an analogy.  Who owns Detroit?  Residents?  Taxpayers?  Voters?  Is a city a thing? Ownership is as illusive a concept there as with the corporation.  One way of looking at the city is as an aggregation of people bound together by a complex web of constitutional, statutory, regulatory, and contractual relationships.  That is a pretty limited view.  There are myriad sociological, historical, political, psychological, anthropological relationships and norms that also have some explanation oomph in characterizing a city.  See, e.g., Susan Silbey on snow day placeholders.  I agree that most of them don't matter if, for example, the question is whether you are a resident for the purpose of the city income tax.

To hit closer to (your) home, who owns the Roman Catholic Church?  I actually litigated something like that years ago regarding some church property in Detroit.  Assume the deed to the church property says, “any transfer of this property to one not a true believer in the holy Roman Catholic catechism is void ab initio.” There is a schism in the congregation. The trustees sell the property to Group A.  Group B sues to void the transfer on the grounds that the members of Group A do not satisfy the condition.  The constitutional law principle is that the court will only look at legal title, and will not enforce a provision that would require it to decide a religious question.  So law will give a result, but is that really the right answer in light of all the norms that govern that community?

The same applies to a corporation, which I'd suggest is more than the sum of its legal contracts in the same way that a corporate acquisition is far more than the contracts that document it. (I speak from some personal experience. The lawyers think that they are running things because the funds don’t transfer or the certificate of merger doesn’t get filed until all the conditions of the contract get satisfied, but trust me when I say that the business unit and functional leaders responsible for deriving the synergies don’t see it that way. The documents are the metaphor skeleton of the transaction, but the business consists of organs, muscle, and tissue not reflected there.)  

I concede you didn’t take it that far, but I think the “web of contracts” approach makes easier for you to justify the shareholder wealth maximization principle, something about which we have had a nice debate.  The utilitarian approach only measures a certain kind of welfare in a certain kind of way and thus itself bespeaks the answer.  It’s not a given that it has to be that way:  compare European codetermined corporate governance. It’s fair to argue that the SWMP is normatively the way to go, but if you argue it purely from law and economics premises, you should be forthright about the implicit assumptions you’ve made.  And the corporation as “web of contracts” invokes those assumptions.

Who owns a company, the CEO or the shareholders?

I saw this question over on Quora and thought I'd offer an answer. It is one, of course, that long time readers know I've touched on often.

In the colloquial sense of the word “ownership,” shareholders own the corporation. In a technical legal sense, however, “[s]hareholders own neither the property nor the earnings of the corporation. Shareholders own only stock, from which their income is derived upon the liquidation of assets or the declaration of dividends by directors.” Nelson v. Anderson, 72 Cal. App. 4th 111, 126 (1999) (internal citations omitted).

The technical legal sense is conceptually more accurate. Ownership implies a thing capable of being owned. To be sure, we often talk about the corporation as though it were such a thing, but when we do so we engage in reification. While it may be necessary to reify the corporation for semantic convenience, it can mislead. Conceptually, the corporation is not a thing, but rather simply a set of contracts between various stakeholders pursuant to which services are provided and rights with respect to a set of assets are allocated.

Because shareholders are simply one of the inputs bound together by this web of voluntary agreements, ownership is not a meaningful concept. Someone owns each input, but no one owns the totality. Instead, the corporation is an aggregation of people bound together by a complex web of contractual relationships.

As I explain in detail in my article The Board of Directors as Nexus of Contracts, the shareholders' contract with the firm has some ownership-like features, including the right to vote and the fiduciary obligations of directors and officers.

Even so, however, shareholders lack most of the incidents of ownership, which we might define as the rights to possess, use, and manage corporate assets, and the rights to corporate income and assets. For example, shareholders have no right to use or possess corporate property. Cf. W. Clay Jackson Enterprises, Inc. v. Greyhound Leasing and Financial Corp., 463 F. Supp. 666, 670 (D. P.R. 1979) (stating that “even a sole shareholder has no independent right which is violated by trespass upon or conversion of the corporation’s property”). Management rights, of course, are assigned by statute solely to the board of directors and those officers to whom the board properly delegates such authority. Indeed, to the extent that possessory and control rights are the indicia of a property right, the board is a better candidate for identification as the corporation?s owner than are the shareholders. As an early New York opinion put it, “the directors in the performance of their duty possess [the corporation’s property], and act in every way as if they owned it.” Manson v. Curtis, 119 N.E. 559, 562 (N.Y. 1918).

Can shareholders replace a CEO or Chairman?

I saw the titular question over at Quora and thought I'd offer up an answer. Unless the bylaws so provide, shareholders have no right to remove a CEO. Delaware General Corporation Law sec. 142, for example, provides that: “Officers shall be chosen in such manner and shall hold their offices for such terms as are prescribed by the bylaws or determined by the board of directors ….”

In general, the practice is that the Chairman of the Board of Directors must be a member of the board of directors. In a few states (such as Ohio, if memory serves), this is statutorily required. In most, it is an understood best practice. At its first organizational meeting of a new year, the board will select one of its members to serve as Chairman. The chair serves at the pleasure of the board and can be removed from that position by the board at any time. But there is no provision under Delaware law for the board of directors to remove one of its members. Indeed, there is case law specifically holding that the board lacks power to remove one of its own members. See, e.g., Dillon v. Berg, 326 F. Supp. 1214 (D. Del. 1971). Hence, while the board may deprive the chairman of his position as chair, the removed chair will remain a member of the board.

Conversely, the shareholders may not remove a sitting chair from the chairman’s position they can remove a sitting chairman from the board. Under Delaware General Corporation Law § 141(k) shareholders are authorized to remove a board member. that right cannot be revoked in either the bylaws or articles.

VC Zurn rejects settlement in the AMC APEs litigation

I'm analyzing the opinion over on Twitter. Here's a link to the thread and the first tweet in the thread (which is now up to about 10+ tweets and growing): https://twitter.com/PrawfBainbridge/status/1682493057894350848

#AMCAPES #APES VC Zurn rejected the settlement in the @AMCTheatres $AMC litigation. https://t.co/GVr82eN00U

— Steve Bainbridge (@PrawfBainbridge) July 21, 2023

Stuff and Nonsense about Suing Woke Corporate Directors

From the website of an outfit called "The Association of Mature American Citizens" (it came up on the RCP news aggregator):

In early June, Elon Musk wrote on Twitter that it “won’t be long before there are class-action lawsuits by shareholders against the company and board of directors for destruction of shareholder value,” referencing the rise of corporate wokeism and so-called “environmental, social, and governance,” or ESG policies.

The prospect held out by Musk is one that, according to former Assistant Secretary of State and experienced litigator and congressional counsel Robert Charles, could indicate a coming flurry of lawsuits against individual board members and directors for breaching their fiduciary duty to shareholders. In an interview with AMAC Newsline, Charles said that the recent spate of boycotts against woke corporations such as Anheuser-Busch and Target are not enough on their own, and litigation should also be on the table.

Shareholders should “pierce the corporate veil,” Charles said, by taking aim at members of the corporate boards themselves—arguing that in some cases, board members should be held personally liable for violating their legal obligation to act in the best financial interests of their shareholders.

Let's start with the idea that piercing the corporate veil is somehow relevant to the fiduciary duties of directors (woke or otherwise). It isn't. Not even a little bit.

As Todd Henderson and I explained in our book Limited Liability: A Legal and Economic Analysis, piercing the corporate veil is an equitable doctrine pursuant to which creditors of the corporation may under some circumstances disregard the corporation's separate legal personality in order to hold the corporation's shareholders personally liable. The general rule, of course, is that shareholders have limited liability. If a corporation cannot pay its debts, the creditors cannot go to the shareholders and collect the debt out of the shareholders' personal assets. If the shareholders have used the corporation as their alter ego and respecting the limited liability rule would promote fraud or injustice, the creditors cqn pierce the vail to reach the shareholders' personal assets. Note, by the way, that in addition to being doctrinally irrelevant the empirical studies discussed in our book make clear that no one has ever pierced the corporate veil to hold public corporation shareholders liable.

Second, as I discuss in my book The Profit Motive: Defending Shareholder Value Maximization, while it is true that directors have a fiduciary obligation to maximize shareholder value it is also true that the law generally gives directors great discretion in how they pursue that goal. And that brings us to the business judgment rule, the central doctrine of corporate law and which makes no appearance in the column.

Let us therefore turn to one of my favorite corporate law cases: Shlensky v. Wrigley. 

Shlensky, a minority shareholder in the Chicago Cubs, challenged the decision by Wrigley, the majority shareholder, not to install lights at Wrigley Field. Shlensky claimed the Cubs were persistent money losers, which he attributed to poor home attendance, which in turn he attributed to the board’s refusal to install lights and play night baseball. According to Shlensky, Wrigley was indifferent to the effect of his continued intransigence on the team’s finances. Instead, Shlensky argued, Wrigley was motivated by his beliefs that baseball was a day-time sport and that night baseball might have a deteriorating effect on the neighborhood surrounding Wrigley Field.

Despite Shlensky’s apparently uncontested evidence that Wrigley was more concerned with interests other than those of the shareholders, the court did not even allow him to get up to bat. Instead, the court presumed that Wrigley’s decision was in the firm’s best interests. Indeed, the court basically invented reasons why a director might have made an honest decision against night baseball. The court opined, for example, “the effect on the surrounding neighborhood might well be considered by a director.” Again, the court said: “the long run interest” of the firm “might demand” protection of the neighborhood. Accordingly, Shlensky’s case was dismissed for failure to state a claim upon which relief could be granted.

So imagine a woke director who is accused of putting her personal political preferences ahead of shareholder value maximization. She will invoke the business judgment rule. She could defend her decision by arguing that business "have profit maximizing reasons for aligning themselves with woke coastal millennials, who are at the core of the supposedly most desirable marketing demographic." But she won't need to do so. The court will defer to the board's decision under the business judgment rule, absent evidence that a majority of the board (not an individual director) acted out of a conflict of interest.

Charles apparently thinks one could find such evidence:

Charles stressed that there are limits to a company’s freedom, comparing a company’s duty to its shareholders to a game of bowling.

“You can’t have a director bowl in the opposite direction or keep guttering the ball if the goal is to hit the pins. And so the bottom line here is if these directors—or any one of them—is vocal in board meeting minutes about the fact that they want to divert money to their personal political agenda, and this is not really being articulated to the investors, then I think you could make the [legal] argument that there’s been a breach of trust—that there’s been a breach of fiduciary duty.”'

I've been a corporate lawyer, consultant, and academic since 1986. In those 37-odd years, I have never seen a director so dumb as to put such a statement in the board minutes (or a corporate counsel so dumb as to include such a statement in the minutes). Remember that the minutes are not a word-by-word transcript of the meeting. They are carefully edited documents prepared in the knowledge that they could well be the subject of future litigation.

Also, notice Charles says you only need "any one of" the directors to make such a statement. As noted above, however, to rebut the business judgment rule you need to show that a majority of the board engaged in self-dealing, fraud, or some similar misconduct. See, e.g., Krasner v. Moffett, 826 A.2d 277, 287 (Del. 2003) ("when the majority of a board of directors is the ultimate decisionmaker and a majority of the board is interested in the transaction the presumption of the business judgment rule is rebutted").

In any case, even assuming that the tainted minutes exist and that they reflect the majority of the board laughing hysterically while spending money on woke causes their shareholders oppose, how does Charles think one would get one's hand on these tainted minutes? In Delaware (the home of most corporations that matter), you'd need to do a Section 220 books and records inspection. And our shareholder would thus bump up against the recent Disney decision.

In Simeone v. Walt Disney Co., 2022-1120-LWW, 2023 WL 4208481, at *1 (Del. Ch. June 27, 2023), a longtime Disney shareholder agreed to act as a nominal plaintiff so that some conservative activist lawyers could sue Disney's board of directors for opposing Florida's House Bill 1557, titled the “Parental Rights in Education” bill. Plaintiff's theory was that "that officers and directors of Disney may have breached their fiduciary duties to the Company and its stockholders by, inter alia, failing to appreciate the known risk that the Company's political stance would have on its financial position and the value of Disney stock.” (Sound familiar?)

Because (1) any lawsuit doubtless would have been derivative in nature, (2) the complainant in a derivative suit must allege facts with particularity, and (3) ine does not get pre-filing discovery in these cases, the plaintiff would have had to gather the requisite facts using what the Delaware courts call "the tools at hand." In other words, a shareholder request under DGCL 220 to inspect Disney's books and records. Which is what the plaintiff did.

(By the way, notice that I haven't even gotten into the problems that would be created for Charles' lawsuit by virtue of the suit being derivative in nature. It introduces a whole slew of procedural obstacles.)

The court began by observing that:

Delaware law vests directors with significant discretion to guide corporate strategy—including on social and political issues. Given the diversity of viewpoints held by directors, management, stockholders, and other stakeholders, corporate speech on external policy matters brings both risks and opportunities. The board is empowered to weigh these competing considerations and decide whether it is in the corporation's best interest to act (or not act).

This mattered because a Section 220 demand must state a proper purpose for inspecting the books and records. Shareholders are not allowed to paw through corporate files at will. They must get a judicial order and in order to do so they must demonstrate that they have a proper purpose for asking for the records in question, The court explained that:

The plaintiff's demand identifies four purposes; all center around the same desire to investigate wrongdoing. The second and fourth purposes—to determine whether Disney's opposition to HB 1557 was harmful to the company and to “explore possible remedial measures”—are derivative of and dependent upon whether there was mismanagement in the first place. ...

The plaintiff's theory is that Disney's “decision to express public opposition” to HB 1557 despite “the [G]overnor's warning” amounts to a possible breach of fiduciary duty by the Board and certain Disney officers.

But the problem was that:

The plaintiff is not describing potential wrongdoing. He is critiquing a business decision. “A stockholder cannot obtain books and records simply because the stockholder disagrees with a board decision, even if the decision turned out poorly in hindsight.” ...

At bottom, the plaintiff disagrees with Disney's opposition to HB 1557. He has every right to do so. But “disagreement with [a] business judgment” is not “evidence of wrongdoing” warranting a Section 220 inspection.Such an inspection would not be reasonably related to the plaintiff's interests as a Disney stockholder; it would intrude upon the “rights of directors to manage the business of the corporation without undue interference.”

Long time readers will recall that I've been accused of being a RINO as far back as the Gang of 14 filibuster deal. Maybe so. But this not about politics. It is about law. And the law is that suits claiming woke directors breached their fiduciary duties by their decisions about how the corporation behaves in the political arena are non-starters.

Delaware Merges Blasius and Unocal: Commentary on Coster v. UIP Cos., Inc.

In Coster v. UOP Cos., Inc., the Delaware Supreme Court finally addressed the longstanding debate over the validity of the Blasius doctrine. (The following is based in part on the discussion of Blasius and Unocal in my books Mergers and Acquisitions (Concepts and Insights) and Corporate Law (Concepts and Insights).)

In Unocal v. Mesa Petroleum,[1] the Delaware Supreme Court laid out what has been called an “intermediate” or “enhanced business judgment” standard of judicial review, but is perhaps best described as a “conditional business judgment rule,”[2] to govern target board of director actions taken in. response to an unsolicited takeover offer. In Unocal, the Delaware Supreme Court reaffirmed the target’s board general decision-making primacy, which includes an obligation to determine whether the offer is in the best interests of the shareholders. In light of the board’s potential conflict of interest vis-à-vis the shareholders, however, judicial review was to be somewhat more intrusive than under the traditional business judgment rule: “Because of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders, there is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred.”

The initial burden of proof is on the directors, who must first show that they had reasonable grounds for believing that a danger to corporate policy or effectiveness existed. The directors satisfy this burden by showing good faith and reasonable investigation. The good faith element requires a showing that the directors acted in response to a perceived threat to the corporation and not for the purpose of entrenching themselves in office. The reasonable investigation element requires a demonstration that the board was adequately informed, with the relevant standard being one of gross negligence.[3] Assuming the directors carry their initial burden, they next must prove that the defense was reasonable in relationship to the threat posed by the hostile bid.

Because unsolicited takeover bids often end up involving a shareholder vote, such as when the acquirer conducts a proxy contest to elect a new board of directors for the target in hopes that the new board will remove any takeover defenses that may be impeding the offer, there long was a question about how Unocal applied when the target board’s actions allegedly disenfranchised target shareholders.

The problem was that in that context Unocal bumped up into another line of cases arising out of Blasius Industries, Inc. v. Atlas Corp.[4] In Blasius, the Delaware Chancery Court held that where the board of directors takes actions for the “primary purpose” of interfering with the free exercise of the shareholder franchise, the board must demonstrate that it had a “compelling justification” for doing so. Taken by itself, Blasius proved to be “an unworkable standard of review, as once a court triggers Blasius, it would seem impossible for the directors to provide a compelling justification for disenfranchising their shareholders.”[5]

When a board action affecting the shareholder franchise takes place in other contexts, such as a simultaneous tender offer and proxy contest, Unocal provide the basic standard of review for the board’s actions. In applying Unocal’s proportionality prong, however, the courts treated board action that purposefully disenfranchises the shareholders as “strongly suspect.”[6] Attempting to merge the two created an even more untenable standard.

I have never been a fan of Blasius.[7] (See my post Professor Lipton asks "What about Blasius?" Well, what about it?) So I pleased to learn that the Delaware Supreme Court has finally more or less killed off Blasius by essentially merging it into Unocal. See Coster v. UIP Cos. Inc.

I’m going to skip over the facts and the case’s convoluted procedural history, as Ann Lipton has a great post on the Chancery Court opinion and an excellent post on the Supreme Court decision.

The key passage is at 31-32:

First, the court should review whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit.” The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interests of the stockholders.

Second, the court should review whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise. To guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control, a board that is properly motivated and has identified a legitimate threat must tailor its response to only what is necessary to counter the threat. The board’s response to the threat cannot deprive the stockholders of a vote or coerce the stockholders to vote a particular way.

Critics of Unocal have long complained that it is an essentially toothless standard.[8] Assuming arguendo that they are correct, does this mean that judicial review of shareholder disenfranchisement will now be reviewed with a lenient eye?

There are suggestions in the opinion that Unocal is to be applied contextually. See Coster at 31 (stating that “the court’s review is situationally specific and is independent of other standards of review”). There are also suggestions that, as applied to shareholder disenfranchisement, the standard may not be Unocal but rather what might be called Unocal+. See Coster at 31 (“Unocal can also be applied with the sensitivity Blasius review brings to protect the fundamental interests at stake – the free exercise of the stockholder vote as an essential element of corporate democracy.”); id. at 33 (“Applying Unocal review in this case with sensitivity to the stockholder franchise is no stretch for our law.”). In other words, it is at least possible that Unocal will be applied in this context with a more skeptical eye than it is in other situations.[9]

There are also suggestions that the new Unocal/Blasius standard and the sensitivity it supposedly demands will be more limited in scope than early Blasius decisions suggested. Some 15 years ago, a New York court suggested that Blasius is now limited to proxy contests involving director elections:

Blasius has been largely limited to disputes over the election of directors. Accordingly, “courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.” Of particular significance here, “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office.”[10]

There are a few passages in the Supreme Court decision suggesting that the new standard is in fact limited to proxy contests over the election of directors and similar situations:

• Describing the standard as calling for “enhanced judicial scrutiny of board action that interferes with a corporate election or a stockholder’s voting rights in contests for control.” Coster at 30.
• “When a stockholder challenges board action that interferes with the election of directors or a stockholder vote in a contest for corporate control, the board bears the burden of proof.” at 31.
• Noting the need “[t]o guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control . . ..” at 32.

The key question here is whether by “corporate elections” the court meant all proxy contests or only proxy contests involving election of directors. If Unocal/Blasius is in fact now so limited, it will have important implications for cases like the current litigation involving the AMC APES shares, in which the AMC board allegedly interfered with the shareholder vote but not in the context of a proxy contest for electing directors. If so, is the standard of review now applicable to such matters the business judgment rule?

Finally, on a personal note, let me vigorously object to the Supreme Court’s claim that there are “fundamental interests at stake”; i.e., “the free exercise of the stockholder vote as an essential element of corporate democracy.” As regular readers know, much of my scholarly output over the last several decades has been devoted to the proposition that corporations are not democracies.[11] And I am not alone in saying that corporations are not democracies.[12]