Jay Brown has a series of posts, starting on July 1, covering many aspects of the SEC's decision to certify a question of law to the Delaware Supreme Court. Jay has helpfully posted all of the relevant documents on his law school's website.

The question in this first certification case is whether CA, Inc. may exclude a proposal for a shareholder-adopted bylaw from its proxy statement on the ground that the proposed bylaw would be an improper subject for shareholder action under Delaware law or, alternatively, that the bylaw would cause CA to violate Delaware law. The proposal seeks to amend CA's bylaws so that the company would be required to reimburse the reasonable expenses of a stockholder or group stockholders who run a short slate of director candidates, as long as one of their nominees were elected to the board. As a legal matter, this case implicates the infinite loop of Sections 109 and 141(a) of the Delaware General Corporation Law, which I describe in a prior post on CA.

Jay thinks the whole certification process is misguided. He argues:

With two democrats on the Commission, they should insist on an immediate review of this policy and frankly order the staff to withdraw the request.  Let the proposal go forward and leave it to the parties to sort it out in the Delaware courts if they think it appropriate.

Recognizing the (at least temporary) inevitability of the process, however, Jay makes a prediction:

The Delaware Supreme Court will agree with CA and find the bylaw a violation of state law or as improper interference in the role of the board.  This can be predicted based upon the race to the bottom.  The race to the bottom predicts that states will alter their law to attract (or retain) companies.... Because it is the board that must decide to reincorporate in the first instance, companies will change their state of incorporation if the law becomes more favorable to management in a significant way.

Even if Jay's behavioral assumption about the Delaware courts were true, the implications of that assumption would be more opaque than he implies. Jay contends that the proposal in this case "threatens job retention" of corporate managers. If the Delaware courts approved the bylaw, his reasoning goes, other states would adopt a contrary rule, and this might entice managers to pursue reincorporation.

This is as caricatured a version of the "race to the bottom" argument as you are likely to read, though it is not a frivolous argument. The issue in CA is potentially enormous, as it could change the power distribution between boards and shareholders rather dramatically.

In his most recent post, earlier today, Jay quotes from the oral argument. One of the Delaware justices (not identified) characterizes CA's position as follows:

So if the shareholders acting alone that is without concurrent director approval adopt this bylaw your position is that contravenes Delaware law. Similarly, if the directors were to do the same thing that would contravene Delaware law. But if the directors and the shareholders acting together voted to adopt this bylaw but as part of the certificate of incorporation that would be alright.

Jay takes CA's counsel to task for embracing this position: "management entirely dominates the process of drafting and amending the certificate. Amendments cannot be introduced by shareholders, only managers." True enough, but the argument from CA carries the seeds of a more pernicious problem: it implies that shareholders can receive power from directors that shareholders do not possess on their own.

Treating directors as a source of power to shareholders inverts their relationship and would constitute a revolutionary departure from traditional corporate norms. Jay implies that some of the Delaware justices were drawn to CA's argument, but for the sake of Delaware corporate law, I hope they see the embedded problem with this position.

Corporate Law, Delaware | Bookmark

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