I am at the point in my Business Associations class where we are discussing the landmark acquisition cases--Unocal, Revlon, Paramount/Time, etc.  Although it did not come up in class, I was tempted to note how not too much later Time-Warner would engage in what is one of the most value-destructive mergers ever--AOL Time-Warner.  A couple of years ago Steve Case, AOL's co-founder, essentially apologized for the merger : "Yes, I'm sorry I did it." 

Today I read another mea culpa over another merger--the merger of one of my former employers, Citibank, with Travelers.  I had left Citi's trading desk for law school a few months before the deal was announced, so I fortunately missed the apparently ugly attempt to combine Salomon's trading floor with Citi's (ex-Salomon/now Citigroup traders were rumored to be still answering their phones by saying "Solly" instead of "Citi" some months after the merger).

So what is the verdict on the Citigroup merger?  John Reed, Citi's CEO and (with Travelers' Sandy Weill) the driver of the deal, says in an interview that "the specific merger transaction clearly has to be seen to have been a mistake.  The stockholders have not benefited, the employees certainly have not benefited and I don’t think the customers have benefited because our franchises are weaker than they have been."  Reed attributed the failures to "a general weakening of the management fabric . . .. The core of what was happening was a lack of supervision and structure at the managerial level."  Sandy Weill, commenting on Reed's remarks, was quick to point out that any weakening occurred after his watch--in other words, while Chuck Prince led Citigroup.

Vikram Pandit, Citi's new CEO, has a difficult job ahead.  Citi's organizational problems would be daunting enough; however, they are now overshadowed by the larger debt crisis.  Reed and others think that Pandit should sell off some of the businesses, thereby producing needed liquidity and creating a more manageable organization.  We've been reminded for a couple of weeks now the crucial role that confidence plays in financial stocks (and now the SEC is investigating alleged efforts to bring Bear down through false rumors).  Perhaps, as has been speculated, Citi will need to restructure to restore the market's trust.

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Here we go ... the Wayne County Employees' Retirement System of Michigan and the Police and Fire Retirement System of the City of Detroit have filed an application for a TRO in the Delaware Court of Chancery. (Bloomberg) The Bear Stearns shareholders are trying to stop the sale of 95 million new voting shares to JP Morgan, which is projected to close on April 8.

We discussed this proposed sale here, and we mentioned Omnicare, Inc. v. NCS Healthcare. In that case, the Delaware Supreme Court invalidated a merger agreement and two voting agreements between an acquiring company and two shareholders of the target company. The two shareholders together controlled over 65% of the target company's votes, and the shareholders agreed to vote their shares in favor of the challenged transaction. In addition, the two companies had agreed that the target board would present the challenged transaction for a shareholder vote, even if the board received a better offer. The Delaware Supreme Court held that "the merger agreement and voting agreements, as they were combined to operate in concert in this case, are inconsistent with the NCS directors' fiduciary duties."

In doctrinal terms, the merger agreement and two voting agreements were treated as "defensive measures" under Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del.1985) and Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361 (Del.1995), which prohibit measures that are "preclusive" or "coercive." The Omnicare court reasoned:

Although the minority stockholders were not forced to vote for the [challenged] merger, they were required to accept it because it was a fait accompli. The record reflects that the defensive devices employed by the [target] board are preclusive and coercive in the sense that they accomplished a fait accompli. In this case, despite the fact that the [target] board has withdrawn its recommendation for the [challenged] transaction and recommended its rejection by the stockholders, the deal protection devices approved by the [target] board operated in concert to have a preclusive and coercive effect [because they] made it "mathematically impossible" and "realistically unattainable" for the [alternative] transaction or any other proposal to succeed, no matter how superior the proposal.

In the last section of the opinion, labeled "Effective Fiduciary Out Required," the Court went out of its way to provide an alternative basis for the ruling:

The defensive measures that protected the merger transaction are unenforceable not only because they are preclusive and coercive but, alternatively, they are unenforceable because they are invalid as they operate in this case. Given the specifically enforceable irrevocable voting agreements, the provision in the merger agreement requiring the board to submit the transaction for a stockholder vote and the omission of a fiduciary out clause in the merger agreement completely prevented the board from discharging its fiduciary responsibilities to the minority stockholders when Omnicare presented its superior transaction.
...
The NCS board could not abdicate its fiduciary duties to the minority by leaving it to the stockholders alone to approve or disapprove the merger agreement because two stockholders had already combined to establish a majority of the voting power that made the outcome of the stockholder vote a foregone conclusion.

Omnicare was a divided decision, with three justices in the majority and two in dissent. And post-decision commentary has been almost universally critical. But it serves as a nice base of comparison with the Bear Stearns-JP Morgan transaction. Which board of directors was more faithful to its obligations: the board that allowed existing majority shareholders to commit themselves to a transaction that they viewed as favorable (Omnicare), or the board that is planning to issue stock to the acquiring company to make approval of the transaction over the objections of the existing shareholders much more likely (Bear Stearns)?

That is not intended to be a difficult question. Nevertheless, the lawyers have structured the Bear Stearns-JP Morgan transaction in a manner that elides the obvious pitfalls in Omnicare. That is, it is not technically a fait accompli, and the Acquisition Agreement contains a fiduciary out.

Whatever the result of that line of analysis, the plaintiffs in this initial motion are not limiting themselves to the coercive-or-preclusive standard (aka Unocal/Unitrin). They are also arguing that the "lock up stock sale is designed primarily, if not solely, to eviscerate the voting franchise of the current Bear Stearns stockholders." Sound familiar? This is language designed to invoke the dreaded Blasius "compelling justification" standard.

The Delaware Supreme Court has limited Blasius to cases involving a "contested election for directors" (MM Companies, Inc. v. Liquid Audio, Inc.), but Vice-Chanceller Strine seems to have a more expansive view of the standard, suggesting that it might be applied to any "vote touching on matters of corporate control." Mercier v. Inter-Tel (Delaware), Inc. (2007).

If Blasius applied in this case, the Bear Stearns board would be required to show a "compelling justification" for its actions. According to Strine, "When directors act for the purpose of preserving what the directors believe in good faith to be a value-maximizing offer, they act for a compelling reason in the corporate context."

Could the Bear Stearns board meet that standard? Almost certainly, since they agreed to the lock-up as part of a negotiation to quintuple the price of the deal. A deal that was brokered by the Fed at a time when the prospects of the company looked bleak, to put things charitably. They may not have acted courageously or with all of the skill Bear Stearns' shareholders might have wanted, but this doesn't look like bad faith.

UPDATE: Writing with the benefit of the actual filing, Steve Davidoff analyzes the plaintiffs' claims. Lots of interesting insights, though Steve got a bit carried away at the end:

Here’s one thought. Delaware recently announced a procedure for the Delaware Chancery Court to accept certified questions from the Securities and Exchange Commission. The Delaware court could use this principle to turn the tables and certify a question to the Fed (or even perhaps the S.E.C.) asking this question: "If the share issuance and other lock-ups are knocked out on the usual grounds, would it endanger the financial system and therefore they should still be validated." You can fiddle with the wording but you get the idea.

If the Fed is actually going to orchestrate this deal, they and the Bush administration should bear the responsibility for pushing it through without upending Delaware and its well-reasoned doctrine and rules of law.

Permalink | Corporate Governance| Corporate Law| Delaware| M&A | Comments (8) | TrackBack (1)

By now you have heard about the new deal between Bear Stearns and JP Morgan, and you may have been puzzled by this line in the NYT: "Under a Delaware precedent, where the companies are incorporated, a company can sell up to 40 percent without shareholder approval."

Um, no.

This is what is known in the law biz as "wrong." There is no 40% cutoff under Delaware law. My immediate reaction to the story was that the author of the piece (Sorkin) must have been trying to convey one of the supposed lessons on Omnicare. Steve Davidoff confirms that reaction at Dealbook (emphasis added):

In Omnicare v. NCS HealthCare, a uniformly criticized opinion, the Delaware Supreme Court by a 3-2 vote struck down a locked-up deal. There, the court held that under the Unocal standard for testing defensive measures, the agreement of 65 percent of the shareholders to vote for a transaction, together with a force-the-vote provision requiring the company to hold a shareholder vote, was preclusive and coercive. The merger protections were both preclusive and coercive because “any stockholder vote would have been robbed of its effectiveness by … [the] predetermined outcome of the merger without regard to the merits of the Genesis transaction at the time the vote was scheduled to be taken.”

Thereafter, in the Chancery Court case of Cullen v. Orman, the court upheld an agreement for a controlling shareholder to vote in favor of the merger and for 18 months after termination of the agreement to vote against any other transaction. Notably, the shareholder vote was conditioned on approval of a majority of the minority and the judge relied on this fact — that it was not a fait accompli — to make this decision. Since Orman, takeover practitioners have generally advised that as long as a deal was theoretically possible, Omnicare wasn’t implicated. Delaware practitioners have settled on the “40 percent rule” to set a limit on [how] high you could go on a lock-up. Hence the 39.5 percent figure in Monday’s deal with Bear. Of course, none of this has been tested in court.

The bottom line is that JP Morgan is trying to lock up the acquisition of Bear, but it can't be too aggressive without triggering the wrath of the Delaware courts. 39.5% plus the shares of the Bear directors who "have indicated that they intend" to vote for the revised deal should get them to about 45%, and that may be enough to bring the deal home.

Lots of other issues, but that is one mystery solved ...

Permalink | Corporate Law| Delaware| M&A | Comments (0) | TrackBack (0)

Earlier today, Ashby Jones of the WSJ Law Blog called to talk about the Bear Stearns transaction, and we discussed the possibility of a challenge by shareholders (or a new bidder, as yet unknown) under Delaware law. You can see the results of our conversation here. The interview was pretty hasty, as I was on my way to class, but this post should clarify any lingering ambiguities.

When I first saw the news of this deal on Sunday night, I assumed Bear was being sold for cash. After all, it was only two bucks a share. So I made a snarky remark about how the directors of Bear Stearns should have been trying to get the "best value reasonably available to the stockholders." (Revlon)

The only problem is that Revlon doesn't apply to stock-for-stock transactions unless they result in a change of control. Under QVC, the challenged transaction would have resulted in a shift of control to Sumner Redstone, so that deal was subject to Revlon. In the Bear Stearns-JP Morgan transaction, on the other hand, shareholders would be part of a “fluid aggregation of unaffiliated shareholders” both before and after the deal. No change of control. So it would not be a Revlon case.

Does this line make sense? The usual justification for the line is that the target company shareholders have not been deprived of their ability to receive a control premium. As a result, the market still has the chance to compensate them adequately for their shares, even if the current compensation is not adequate.

The opposing view is that the sale of the company is so important that it should be subject to enhanced scrutiny, not the deferential business judgment rule. Leo Strine seems to endorse this view in a 2001 article, where he remarked on the different treatment of cash and stock sales: "What is striking is how trivial this economic difference is compared to the great difference in the nature of the judicial standard that some practitioners would contend applies to each."

So would the Bear Stearns-JP Morgan merger be subject to business judgment review? Probably not. The key here is whether the Delaware courts would treat the now-famous Section 6.10 as a deal protection device. (The provision is quoted here.) It sure looks like one, though I believe this provision would be new to Delaware. If Section 6.10 (and perhaps 6.11 -- Morgan's option to buy the Bear Stearns building) were treated as deal protection devices, the Delaware litigation would invoke the Unocal-Unitrin standard, as developed in Quickturn, Omnicare, and other cases. I offered some thoughts on those cases in yesterday's post.

Permalink | Corporate Governance| Corporate Law| Delaware | Comments (1) | TrackBack (0)

I recently ran across a 2007 study conducted by the Institute for Policy Studies, a progressive research center, which published figures on the pay disparities of various people in leadership positions. Based on 2005 and 2006 data, the study focused on the median salaries for the twenty highest paid individuals in various sectors. It found the following:

• Congress members: $171, 720
• Military leaders: $178, 542
• Federal executive branch: $198, 369
• Heads of non-profit organizations: $968, 698
• Heads of publicly held companies: $36.4 million

The study further pointed out that the median salary for the highest paid heads of hedge funds and private equity groups was $657.5 million. To be sure, it is no surprise that those in the nonprofit and public sector make less than their counterparts in the for-profit industry. It is also no surprise that those at the highest levels of corporate America make more than their highest paid counterparts in other fields.

Ultimately, the study probably would have been more interesting if it had compared figures from people in other fields such as those in medicine or law firm partners. Though I am sure even those figures would have underscored the study’s point that pay disparities are not just vertical, but horizontal as well. Again, while most people may be unaware of the extent of the gap, the fact of the gap seems unsurprising. Of course, given the current state of the markets, it would be interesting to see how this gap changes, if at all, in the next year.

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Steve Bainbridge and Larry Ribstein have differing suggestions on the most influential of all corporate law cases.  After Bainbridge first suggested Smith v. Van Gorkom, Ribstein replied by suggesting a federal securities case, Basic v. Levinson.  Bainbridge responded that even if one expands the set to include federal cases, Basic is less influential than Case v. Borak, since the latter makes possible private standing to sue to enforce the securities laws.  Hence, Levinson could not have occurred without Case.

This raises interesting questions of how one measures the influence of a case.  By the standard quantitative measures, Basic seems to win hands down.  Westlaw's citation service shows 9898 cases citing Basic, and just 3373 citing Case.  Looking to influence among academics, a search of Westlaw's JLR database yields 637 hits for "Basic /2 Levinson" compared to just 158 for "Case /2 Borak".  Basic also seems to get much more attention in Securities Law classes (it certainly does in mine).

And yet, Bainbridge's take on what makes a case influential certainly makes some sense.  He asks us to imagine the counterfactual of how the world would look if a case had been decided differently, and plausibly argues that more would have changed with a different decision in Case than in Basic.  Fair enough.  Of course, such counterfactuals are tricky.  If Case had been decided in the opposite way, for instance, would Congress have acted to create an explicit cause of action?  Perhaps.  The question is also complicated by the fact that Case dealt with causes of action under sect. 14 of the '34 Act, whereas the real action is under Rule 10b-5.  I doubt the latter point matters too much--had the Court denied a private cause under sect. 14, it would have been very hard to find a private cause under 10b-5.

FWIW, my own suggestion for other highly influential state law cases besides Van Gorkom, in the comments section, was Aronson v. Lewis.  Note how many significant Delaware cases that one might give in answer to this question come from the same time:  Van Gorkom (1985), Aronson (1984), Weinberger (1983), Zapata (1980), Unocal (1985), and Revlon (1986) are all way, way up there among state law cases.  Essentially, the contemporary contours of Delaware fiduciary duty were set in a 6 or so year period.  Obviously, the high M & A activity of the time, particularly hostile takeovers, played a big role in the development of the law.

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Steve Bainbridge provides excerpts from two recent papers examining this old chestnut, and Steve is kind enough to cite my contribution to the literature ... even though the primary purpose of quoting my piece is to showcase his disagreement with me.

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Many thanks to Gordon for his kind introduction and for inviting me on as a guest blogger. I'm a regular reader of Conglomerate and it's an honor to be asked to join in.

My research interest is in modern Chinese legal institutions generally and corporate governance in particular; recently I've been looking not at the substantive rules of corporate governance, but at the institutions that would make those substantive rules matter, and the extent to which they exist in China.

One can't spend much time studying Chinese law without being struck by the tremendous gap between what the rules say and what actually happens. This goes beyond the usual law-on-the-books versus law-in-practice gap that one can find in any jurisdiction, where the gap is attributable to obsolescence, resource constraints, and political factors such as government unwillingness to enforce certain types of laws. In China it seems to arise sometimes from a different view of law altogether:
essentially a kind of didactic text that regulated parties are supposed to read and obey. If obedience is not forthcoming, the response is to blame the regulated parties for their willfulness. An alternative response would, of course, be to look at the enforcement structure provided by the regulations in question: do regulated parties have any reason to obey? But this response is relatively rare.

Thus, for example, the Chinese Company Law provides that joint-stock companies (more or less the equivalent of the Delaware corporation) shall have both a board of directors and a board of supervisors. The latter is supposed to keep an eye on the former. But it is elected by exactly the same body that elects the board (i.e., the shareholders) and, while it can ask questions of the directors or request explanations of certain acts, it has no real power to do anything if the answers aren't satisfactory. A recent revision to the Company Law (in 2005) gave it the power to call a shareholders' meeting, but that's about it.

Another example is the director's duty of care and loyalty. This is stated in one provision of the 2005 revised Company Law, but there is no right of action clearly attached to it. Where the law does not very clearly provide you with a right of action (and even in some cases where it does), Chinese courts are typically very unwilling to give you one.

This in turn stems from another feature of Chinese law: that it often seems to make sense more as a set of instructions to officials than as a rights-granting instrument. For example, one type of company under the Company Law may dispense with a board of directors if it is "relatively small" and has a "relatively small" number of shareholders. But the law provides no clue as to how we are to know what counts as "relatively small" in each case. If we think of the law as a recipe for entrepreneurs, it's bad drafting. But if we think of it as instructions to officials in the bureaucracy that handles corporate registrations, then it's easier to understand: it's telling them to make a discretionary judgment. The same thinking is behind regulations that look like private law but say that something or other "should normally" be done or "should in principle" be done.

One might reasonably ask, "But is that so different from US (or other Western) law? Surely we have vague terms such as 'due process' and 'reasonable' that we happily give to judges, juries, or administrative agencies to interpret." This is not a bad point. I think the difference, though, is in the fact that in the US system, we now have a pretty good idea of who has the power to interpret what; when people draft legislation, they could probably readily tell you which body would be interpreting which term and under which principles. Very few of these matters are well worked out in the Chinese legal system. Legislation will always have problems, but the courts have very little power and prestige, and thus aren't a good institutional solution to these problems. As a result, while all legal systems generate uncertainty and contradiction, China's is unusual in not having well-understood techniques for resolving that uncertainty and contradiction.

The bottom line is that when one hears that Chinese corporate law requires such-and-such or imposes such-and-such a duty, one has to ask whether there's any reason to think that this alleged requirement or duty is at all meaningful. One doesn't have to be a card-carrying Holmesian realist to wonder whether a duty that is in substance wholly hortatory should really count, and be reported, as a legal duty just like the legal duty to drive carefully, refrain from embezzlement, etc.

Permalink | China| Comparative Law| Corporate Governance| Corporate Law| Law & Society | Comments (2) | TrackBack (0)

URI has lost its attempt to get Cerebus Capital to follow through with a merger that looked, at least to the acquirer, increasingly unfavorable.  Here's commentary from Steven Davidoff, Larry Ribstein, and Jeff Lipshaw.

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When I opened the Washington Post today, I must admit I was struck by the story indicating that Richard Parsons would be stepping down from his post as CEO of Time Warner.  I was struck not by the fact of his stepping down, but rather because his departure, coupled with the departure of Stanley O'Neal, means that the number of black people who serve as CEO of a Fortune 500 company would drop to four.   To my surprise, MSNBC also was struck by this phenomenon, and hence has a story on the impact of the departure of these two leaders, and the fact that it not only reflects a decline in the number of black CEOs, but also that it reflects the basic lack of such CEOs--so my musings were mirrored in the minds of some others.

To be sure, the fact that these two leaders are departing may simply reveal the difficulties of serving as CEO, regardless of race.  Moreover, these two CEOs are departing under dramatically different circumstances.  Then too, as the MSNBC story points out, studies indicate that there are many reasons why blacks have not advanced to the highest post in corporate America, some of which involve race and others of which are more nuanced.

Yet these two departures highlight the fact that the number of black CEOs is relatively small, and in the space of a couple of days, that number dropped by 30%.  And hence, even though the departures are unrelated and triggered by drastically different concerns, it is something that caught my attention.

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Over the weekend, Larry Ribstein posted two entries at Ideoblog that are well worth reading: first, he uses my "moral responsibility" post as a springboard to discuss corporate social responsibility, and second, he expands significantly on an older post of mine on Facebook, discussing "shelf LLCs," federal diversity jurisdiction, and choice of form. Over the past week, I have been updating my Business Organizations casebook, and in the process, I have had the chance to read several of Larry's articles on these latter subjects relating to LLCs. No one writes more meaningfully in the field, and if you don't have time to read the articles, at least do yourself the favor of reading the post.

Permalink | Corporate Law| Limited Liability | Comments (0) | TrackBack (0)

A study to be presented at the Academy of Management's annual meeting indicates that bad bosses get promoted rather than punished.  According to the study, nearly two-thirds or 64.2 percent of the 240 people surveyed said that their bad boss was either never censured or was promoted for domineering ways.  The three study authors from Bond University in Australia suggested that the promotion of such leaders has a negative impact on the corporate environment and the bottom-line.  Indeed, despite their apparent success in office, such leaders not only cause workplace strife, but also cause serious malaise for their subordinates including nightmares, insomnia, depression and exhaustion.  Bad bosses also lead to increased employee turnover, which can impact profit.  This is because not only do many employees eventually walk away from workplaces with spiteful supervisors, but such supervisors often develop a reputation that makes it difficult to recruit and retain employees.  The study's authors faulted senior managers for failing to recognize the signs of bad supervisors as well as the leaders above such managers who fail to intervene or otherwise elect to reward the behavior of spiteful bosses.

Permalink | Corporate Law| Employees | Comments (1) | TrackBack (0)

I have been traveling a bit lately and, as is apparently inevitable, my most recent flight was delayed.  However, the delay gave me the opportunity to speak with a fellow passenger who happened to own a mid-sized business.  Once he discovered that I was a Corporations professor at a law school, he at first lamented lawyers and the amount of money he had to pay in legal fees each year.  He then said that the fees (and the threat of lawsuits they often represented) were particularly annoying because he was, as he described himself, "one of the most accommodating bosses in the world."  When I guess I appeared skeptical, he explained that he made it a point to have a very flexible work schedule for his employees, and if people needed time off or to come in late to "watch their kids or whatever"--his answer was always that they should take the time, their job would be there when they returned.  He said the answer was the same if the time off was ten minutes or ten months.  When I asked him if he could really run a business with people taking ten months off at a time, he responded that the problem with most people in human resources was that they "forget that resources are things you build up, not something you constantly turn over."  I found the quote so interesting, that I knew I would share it.  The conversation reminded me that while many corporate scholars may debate the wisdom of whether or to what extent corporations should devote time and resources to employees, at least some business owners do not see it as a debate at all.  Thus, while I know that not all employers have the same philosophy as my fellow passenger, I found it refreshing to hear that some not only believe that focusing on employees and their welfare is an integral part of running a business, but also implement that belief through their employment policies.  Alas, I considered my flight delay time well spent.

Permalink | Corporate Law| Employees | Comments (2) | TrackBack (1)

In an entertaining post at Balkinization, Michael Stokes Paulsen describes his lab partner in high school chemistry, Cal Tillisch:

Cal had a distinctive, memorable methodology for doing lab experiment reports, which he inculcated in me at every turn: "First, draw the desired curve. Then, plot the data. If time permits, do the experiment."

Paulsen then likens this method to constitutional interpretation:

Teaching Con Law this year ... , I told my students the Cal Tillisch chem lab experiment story.... I used it as a parable about how not to do constitutional interpretation -- and as a description of how some interpreters (courts, law professors, certainly many first year law students) seem actually to do Constitutional Law, at least from time to time: Pick the desired result, choose an interpretive methodology to match, and then, time permitting, do some research to find supporting evidence.

One of the commenters observes, "We are all Cal Tillisches. There is no other way."

If that is true about constitutional interpretation, it is only true of hard cases. Lots of cases yield easy answers. And that is probably true of most areas of law. In law schools, we spend so much time talking about marginal cases that we sometimes forget that most cases are easy.

But corporate law is fundamentally different from constitutional law: when we confront hard issues in corporate law, courts are not the only means to the desired result. The Delaware legislature or the SEC can change the underlying law. As a result, we don't need a Brown to counter our Plessy. We have no Plessys.

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Gordon Gee, currently Chancellor and Professor of Law at Vanderbilt University, is returning to Columbus for a second stint as President of The Ohio State University. Gee may be the best-known Mormon law professor in the U.S., though his fame is not based primarily on his work in law.

He began his academic career as Assistant Dean for the University of Utah College of Law, and he later became Associate Dean and Professor at my new law school, the J. Reuben Clark Law School of Brigham Young University. After serving as Dean of the West Virginia University College of Law, Gee moved into the President's office, and he has worked in university administration ever since.

Though he has gained notoriety as a university president, some of you may know Gordon Gee for his important role in Delaware corporate law. The case of In re Limited, Inc. raised the issue of director independence with respect to Gee, who was a member of The Limited's board of directors when it approved a Contingent Stock Redemption Agreement that benefited CEO Leslie Wexner. You see, Wexner was an alum of Ohio State, and he had donated $25 million to establish The Wexner Center for the Arts during Gee's tenure as President. In response to the directors' motion to dismiss, Vice-Chancellor Noble addressed the following issue: "if a director is the head of a charitable or educational institution, under what circumstances may his independence be called into question by the charitable giving of the allegedly dominating person, in this instance, Mr. Wexner?"

VC Noble answered that question as follows:

The determination of whether a particular director is "beholden" to an allegedly controlling person is not limited to the power to affect the director in the future. One may feel "beholden" to someone for past acts as well. It may reasonably be inferred that Mr. Wexner's gift of $25 million to Ohio State was, even for a school of that size, a significant gift. While the gift was not to Gee personally, it was a positive reflection on him and his fundraising efforts as university president to have successfully solicited such a gift. In this context, even though there can be no "bright line" test, a gift of that magnitude can reasonably be considered as instilling in Gee a sense of "owingness" to Mr. Wexner. For that reason, I conclude that the plaintiffs have successfully alleged a reasonable doubt as to Gee's independence from Mr. Wexner's domination.

This decision is interesting for many reasons, but perhaps most importantly, it is interesting to note the behavioral assumption on which it is based, namely, that Gee might feel a sense of obligation to Wexner for a past gift to a university for which Gee was (then) no longer president. How does VC Noble know that Gee might have such feelings? Hmm.

The Delaware courts are required to make all sorts of behavioral assumptions with regard to corporate directors, but evidence about director behavior is largely anecdotal. If any young professors out there are looking for a research agenda, "director behavior studies" is ripe for the harvest.

By the way, Gee is still a member of The Limited board of directors, and Wexner is still the CEO.

Permalink | Corporate Law| Delaware| Law Schools & Lawyering | Comments (2) | TrackBack (0)

I read a story in the Wall Street Journal yesterday suggesting that the business world is still debating the merits of self-checkout. Given the proliferation of self-checkout machines in both grocery stores and airports I thought that debate had already been settled. However, to the extent it is still an open issue, I would like to weigh in against self-checkout, particularly to the extent that self-checkout is designed to displace most cashiers.

To be sure self-checkout appears like an ideal model for businesses to adopt because it promises efficiency and time saving, which should translate into increased sales. Yet more times than not, the self-checkout experience is not all it promises to be. Indeed, most people are lured to the self-checkout line in the hopes that they will save time, which means that any delay in line is more frustrating because they expected swiftness. Yet in my experience, delay is what occurs. That is become inevitably there is someone in line who encounters a problem. It then takes an inordinate amount of time for a store official to respond to the customer. And after that, it takes even more time for the first store official to find another official who actually knows how to resolve the customer’s problem. Meanwhile, everyone in line grows more frustrated, casting their eyes at lines with an actual cashier that appear to be moving more quickly. While this is not always the experience in the self-checkout line, it happens often enough to make me opt for the line with an actual cashier. Thus, I think businesses should do more to assess customer reaction to self-checkout before adopting a strategy designed to replace or significantly reduce the number of cashiers in favor of self-checkout.

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On Wednesday a federal judge sentenced the secretary accused of trying to sell Coke's trade secrets to eight years in prison, a sentence longer than that recommended by the sentencing guidelines.  Apparently the judge was not only concerned about the secretary's failure to acknowledge her conduct, but also about sending a message concerning the severity of these kinds of offenses.  Interestingly, of course, it was Pepsi that alerted Coke about the crime after receiving a letter offering to sell Coke's trade secrets to the highest bidder.  I was intrigued by this case not only because it is like a great spy novel, but also because I was trying to figure out how to assess Pepsi's actions.  To be sure, one could argue that this is an instance of Pepsi behaving in a responsible manner.  (It is here that I have to admit that I a Pepsi drinker, and from that perspective, I am relieved that Pepsi "did the right thing.") But there are other ways to view Pepsi's conduct.  A Forbes article has a great take on Pepsi's motives.  The article notes that while Pepsi may have been motivated by a sense of corporate responsibility and fairness, Pepsi has been gaining ground on Coke in many areas and hence Pepsi has no need to look to its competitor for new ideas.  Thus, there was no real tension between fairness and profit.  Regardless of its motive, I think it is fair to say that both Coke and Pepsi appreciate the sentiment behind the judge's sentencing because it seems to support companies' efforts to vigorously protect their trade secrets.

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Here is the new amendment to Delaware's Constitution (bold):

Section 11. The Supreme Court shall have jurisdiction as follows:

...

(8) To hear and determine questions of law certified to it by other Delaware courts, the Supreme Court of the United States, a Court of Appeals of the United States, a United States District Court, the United States Securities and Exchange Commission, or the highest appellate court of any other state, where it appears to the Supreme Court that there are important and urgent reasons for an immediate determination of such questions by it. The Supreme Court may, by rules, define generally the conditions under which questions may be certified to it and prescribe methods of certification.

This is huge! It could be the most important development in Delaware corporate law since Woodrow Wilson convinced the New Jersey Legislature to pass the Seven Sisters Acts. (See here.) By agreeing to entertain questions certified by the SEC, Delaware enables shareholders to frame specific questions about Delaware law without regard to an underlying dispute. So entrepreneurial corporate governance activists like Lucian Bebchuk can get answers to questions about the extent of the shareholders' bylaw amendment power. Among other things. (See my post about Bebchuck v. CA Inc. here.)

For more, see Francis Pileggi, Peter Lattman, and Steve Bainbridge.

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On Friday, in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, the Delaware Supreme Court cleared up some confusion about directors' fiduciary duties in distressed firms.  The most important thing to know about the case is that the court cited me in passing (JK), as well as fellow corporate law bloggers Steve Bainbridge and Larry Ribstein.      

In its principal holding, the court held that for a firm in the zone of insolvency (ZOI), its creditors have no direct breach of fiduciary duty claims against the firm's directors. 

Perhaps more interesting, language in the opinion also casts serious doubt about whether creditors can even bring ZOI derivative claims:

When a solvent corporation is navigating in the zone of insolvency, the focus for Delaware directors does not change:  directors must continue to discharge their fiduciary duties to the corporation and its shareholders by exercising their business judgment in the best interests of the corporation for the benefit of its shareholder owners.  (Emphasis supplied).

By contrast, discussing actually insolvent firms later in the opinion, the court confirms the long standing view that creditors replace shareholders as the firm's residual claimants:

Consequently, the creditors of an insolvent corporation have standing to maintain derivative claims against directors on behalf of the corporation for breaches of fiduciary duties.  (Emphasis in original).

The opinion suggests, therefore, that the ZOI concept famously described in Credit Lyonnais will no longer have any continuing relevance as a legal concept.  On balance, this is probably the right result.  It's hard for directors to know when they're in an ill-defined "zone" of insolvency.  So for purposes of "providing directors with definitive guidance," as the Gheewalla court attempts to do, doing away with ZOI is probably a good thing.

OTOH, drawing the line at insolvency seems somewhat arbitrary, and ZOI is not without some conceptual basis.  As I wrote in Gap Filling in the Zone of Insolvency,

Insolvency is not some magic event that triggers perverse incentives for managers that do not exist before insolvency. Instead, the agency cost of debt is increasing in the percentage of outside financing comprised of debt versus equity.

Insolvency, then, is just the extreme case of perverse managerial incentives to make inefficient investment decisions on behalf of equity.  What ZOI does--under any reasonable definition--is simply capture a larger share of those states of the world in which managers may have these perverse incentives.  For a legal rule, though, it's pretty vague.  Of course, one might suggest drawing a different line--say, when the debt-equity ratio hits 9:1.  The valuation issues are probably no worse at 9:1 than at insolvency (and the factual issues for equitable insolvency are likely to be even more intractible).  OTOH, the insolvency line may be defensible as a sort of focal point?

Finally, the court held that even for insolvent firms, creditors could not assert direct claims, but only derivative claims.  The court expressly overruled the Chancery Court's Production Resources decision in this regard.

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An individual shareholder has sued the board of Dow Jones:

The suit, which is seeking a class action against family members, said they "failed to exercise sound and proper business judgment" and "are not acting in good faith and have deliberately breached their fiduciary duties" toward public shareholders.

Dow Jones is a Delaware corporation, and this sort of claim would be governed by Delaware law. For reasons already discussed, this lawsuit is a loser.

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Over the past two days, I have seen a couple of commentators suggesting that the board of directors of Dow Jones might be forced to auction the company. For example, Elizabeth Nowicki poses the questions nicely here.

This is a question that has intrigued corporate law scholars (and courts!) for some time. Note this passage from Chancellor Allen's opinion in TW Services, Inc. v. SWT Acquisition Corp. (March 2, 1989):

But what of a situation in which the board resists a sale? May a board find itself thrust involuntarily into a Revlon mode in which it is required to take only steps designed to maximize current share value and in which it must desist from steps that would impede that goal, even if they might otherwise appear sustainable as an arguable step in the promotion of "long term" corporate or share values? Revlon did not address that subject but implied that a board might find itself in such a position when it said that the duty it spoke of arose "when the break-up of the company is inevitable."

More specifically for this case, what of a situation in which the holders of some 88% of the Company's stock in effect declare (by supporting the SWT tender offer either as offeror or as a tendering shareholder) that they do seek a current share value maximizing transaction now? Does a director's duty of loyalty to "the corporation and its shareholders" require a board, in the light of that fact alone, to enter a Revlon mode? In those Delaware cases that have factually involved preponderant shareholder acceptance of a hostile tender offer, boards have, responding to their own view of their duty, proposed an alternative transaction -- a management endorsed breakup transaction that, realistically viewed, constituted a functional alternative to the resisted sale. Those cases, however, offer no judicial opinion on the question when, if ever, will a board's duty to "the corporation and its shareholders" require it to abandon concerns for "long term" values (and other constituencies) and enter a current share value maximizing mode. This, however, is the question referred to above that is raised by this case but need not now be decided in light of the particularities of the circumstances the directors of TW face.

So tantalizingly close to getting an answer! Just months later, however, the Delaware Supreme Court decided Mills Acquisition Co. v. Macmillan, Inc. (May 3, 1989), stating:

Clearly not every offer or transaction affecting the corporate structure invokes the Revlon duties.   A refusal to entertain offers may comport with a valid exercise of business judgment. Circumstances may dictate that an offer be rebuffed, given the nature and timing of the offer; its legality, feasibility and effect on the corporation and the stockholders; the alternatives available and their effect on the various constituencies, particularly the stockholders; the company's long-term strategic plans; and any special factors bearing on stockholder and public interests.

Nevertheless, the Macmillan Court implied that "a subjective disinclination to sell the company will not prevent [the Revlon] duty from arising where an extraordinary transaction including, at a minimum, a change in corporate control is involved." Paramount Communications Inc. v. Time Inc. (Del. Ch. July 14, 1989). That last quotation is from Chancellor Allen's Time opinion, which has an interesting role in the question at hand. Chancellor Allen ultimately concluded that Revlon is triggered by the board's decision to pursue a change of control transaction. He rejected the plaintiff's argument that the Paramount bid triggered Revlon duties, observing, "Plaintiffs can cite no authority compelling or commanding this expansion, which would dramatically restrict the functioning of the board whenever an offer was made."

Allen's opinion was not immediately embraced by the Delaware Supreme Court. Whereas Chancellor Allen held that the Time-Warner merger did not constitute a "change of control," Justice Horsey  wrote, "we premise our rejection of plaintiffs' Revlon claim on different grounds, namely, the absence of any substantial evidence to conclude that Time's board, in negotiating with Warner, made the dissolution or break-up of the corporate entity inevitable." Of course, the Supreme Court backtracked on this formulation in QVC, embracing Allen's earlier opinion, but in Time the Court added, "we decline to extend Revlon 's application to corporate transactions simply because they might be construed as putting a corporation either 'in play' or 'up for sale.'"

Though Time might be read as an endorsement of "just say no," some commentators have suggested that it is not a pure test of that notion because Time's board of directors was pursuing a pre-existing merger with Warner. In other words, Time's board did not just say no to Paramount, but said no in furtherance of an alternative transaction. What if no alternative transaction exists, as with Dow Jones?

The usual citation here is Moore Corp. Ltd. v. Wallace Computer Services, Inc., 907 F.Supp. 1545 (D. Del. 1995), but that is a federal district court decision. And it involved the decision not to redeem a poison pill, which seems quite different from Dow Jones, where members of a single family, albeit with various strands, is resisting the bid.

You may have noticed that I did not refer to the Bancroft family as a "controlling" shareholder. This interesting background from the W$J should make it clear why such a designation is not inevitable in this case:

The company's board consists of 16 members, four of whom represent the Bancroft family. Michael Elefante, the Boston-based trustee who directly represents 46% of the family's voting power and influences even more, has played an active role in recent weeks as the intermediary between the family and the company, according to people familiar with the matter.

There are three branches of the Bancroft family. They come largely from the descendants of Jane Cook, Jessie Cox and Hugh Bancroft Jr. Ms. Cook's branch includes Martha Robes; her sister, Jean Stevenson; and Elizabeth Steele, who is a Dow Jones director. The second branch, descended from Ms. Cox, includes William Cox and his sister, Jane MacElree, and their children. The third branch, represented by Chris Bancroft, who also serves on the board, includes Elisabeth Goth, who voiced her opposition to Dow Jones's management a decade ago.

Within the three branches there are sub-branches and a number of trusts. Unlike the trusts controlling New York Times Co., the Bancroft family trusts are under no obligation to vote together. "This family can be split," said a person familiar with the family's history.

With all of that as background, let's conclude by considering Elizabeth's questions regarding Dow Jones:

What happens if the water starts churning with hungry bidders?  At what point does the Board need to say to the 52% block "you are walking away from a super deal"?  Does the Board ever need to say that?  What about the minority s/h?  Who, if anyone, needs to advocate for them?

The answers here probably do not depend on whether the Bancroft family is a "controlling shareholder." Note that this is not a case in which the controlling shareholder has proposed a self-interested transaction. Rejecting an unsolicited bid for the company is quite different from proposing a squeeze-out of minority shareholders. Thus, News Corp's proposal does not place the Bancroft family in a position of conflict vis-a-vis the minority shareholders. Nor does an unsolicited bid, without more, trigger Revlon duties, for the reasons discussed above. Therefore, in my view, the board of directors of Dow Jones could "just say no" to News Corp's proposal. And if the minority shareholders sued, the decision of the board of directors would be subject to review under business judgment rule.

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Larry Ribstein is slumming at the Harvard Corporate Governance Blog, where he examines the recently adopted North Dakota Publicly Traded Corporations Act. Larry describes the default rules of the Act as a "set of provisions that looks like a shareholder rights advocate's wish list," but he observes that "if corporations really want these provisions, they don't need to go to North Dakota." Given the relative paucity of such corporations on the modern landscape, Larry concludes that "the ND experiment is less interesting than it may seem."

I spoiled the punchline, but you really should read the whole post.

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Vice-Chancellor Strine's opinion in In re Netsmart Technologies, Inc. Shareholders Litigation was issued a month ago, and I have been pondering it ever since. This case has a lot of interesting features, and I hope to blog about some others later. For this post, however, I concentrate on Leo's attempt to distinguish the Revlon standard from the business judgment rule:

What is important and different about the Revlon standard is the intensity of judicial review that is applied to the directors' conduct. Unlike the bare rationality standard applicable to garden-variety decisions subject to the business judgment rule, the Revlon standard contemplates a judicial examination of the reasonableness of the board's decision-making process. Although linguistically not obvious, this reasonableness review is more searching than rationality review, and there is less tolerance for slack by the directors. Although the directors have a choice of means, they do not comply with their Revlon duties unless they undertake reasonable steps to get the best deal.

The distinction between rationality review and reasonableness review has been around for awhile. Vice-Chancellor Strine first articulated the difference in In re Toys 'R' Us, Inc. Shareholder Litigation (2005), and he took his cues in that case from Revlon itself and from QVC, both Delaware Supreme Court opinions.

The interesting part of the contrast between rationality and reasonableness is not what it says about the Revlon standard, but what it says about the business judgment rule. Outside of opinions by Vice-Chancellor Strine, it's hard to find Delaware cases that refer to the business judgment rule as a "rationality standard" or "rationality test." There is, of course, the oft-quoted statement from Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del.1971): "A board of directors enjoys a presumption of sound business judgment, and its decisions will not be disturbed if they can be attributed to any rational business purpose." But the reference to rationality in that context is pretty clearly a reference to the substance of the board decision, not the process by which the decision was made. The distinction between substance and process is evident in the Supreme Court's Unitrin opinion:

The effect of a proper invocation of the business judgment rule, as a standard of judicial review, is powerful because it operates deferentially. Unless the procedural presumption of the business judgment rule is rebutted, a "court will not substitute its judgment for that of the board if the [board's] decision can be 'attributed to any rational business purpose.'" (quoting Unocal, which was quoting Sinclair)

In my quick search of the Delaware cases, I found only one instance other than Vice-Chancellor Strine's opinions in which the courts has referred to the rationality of the process. That case was Chancellor Allen's Caremark opinion:

What should be understood, but may not widely be understood by courts or commentators who are not often required to face such questions, is that compliance with a director's duty of care can never appropriately be judicially determined by reference to the content of the board decision that leads to a corporate loss, apart from consideration of the good faith or rationality of the process employed. That is, whether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through "stupid" to "egregious" or "irrational", provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. To employ a different rule-one that permitted an "objective" evaluation of the decision-would expose directors to substantive second guessing by ill-equipped judges or juries, which would, in the long-run, be injurious to investor interests. Thus, the business judgment rule is process oriented and informed by a deep respect for all good faith board decisions. (emphasis added)

Chancellor Allen's dismissal of substance is only slightly hyperbolic, but the more important point is that even here, the business judgment rule is not a "bare rationality standard," but a standard predicated on the good faith of the board of directors.

I am curious to see whether Vice-Chancellor Strine's characterization of the business judgment rule as a rationality standard catches with the other Delaware judges. As with so many issues relating to the duties of directors, however, the exact formulation of the business judgment rule may not matter much because the important point is the directors are (almost) never liable.

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Can corporate law save the world? Kent Greenfield says yes. I say no. We decided to write up our views, and you can find my side of the debate in a paper called "The Dystopian Potential of Corporate Law," which is now available for download from SSRN.

I have a strong preference for simple titles, and I normally don't use ten-dollar words like "Dystopia." In this instance, however, I invoked Edward Bellamy's famous utopian novel, Looking Backward, which was written in 1887. (If you teach corporate law and you haven't read Looking Backward, you should put it on your summer reading list. You can find it online here or here.) Looking Backward presents a horrifying vision:

Early in the last century the evolution was completed by the final consolidation of the entire capital of the nation. The industry and commerce of the country, ceasing to be conducted by a set of irresponsible corporations and syndicates of private persons at their caprice and for their profit, were entrusted to a single syndicate representing the people, to be conducted for the common interest for the common profit. The nation, that is to say, organized as the one great business corporation in which all other corporations were absorbed; it became the one capitalist in the place of all other capitalists, the sole employer, the final monopoly in which all previous and lesser monopolies were swallowed up, a monopoly in the profits and economies of which all citizens shared.

My argument is that Kent's proposals for reforms are motivated by the same impulses that motivated Bellamy, and the results of implementing those proposals ... well, I think you can see why I used the word "dystopian."

Kent and I had live debates on this subject at the University of Chicago and Boston College. You can see a write-up from the latter event here.

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I was reading Usha's article tonight and I came across the word "acquirer" in a section on freezeout mergers in Delaware corporations. Normally, I expect people to use the alternate spelling ("acquiror") when discussing Delaware corporate law, even though "acquirer" is viewed in some circles as the proper form. (Indeed, Microsoft Word automatically changes "acquiror" to "acquirer.") So I wondered whether my expectation of "acquiror" was grounded in practice, and I turned to Westlaw.

"Acquiror" appears in exactly double the number of Delaware cases as "acquirer" (222 v. 111). In cases decided after 2000, however, the margin narrows (53 v. 47). In the JLR database, "acquirer" is more common than "acquiror," and the trend favors the latter. I searched documents published prior to 2001 (2558 v. 2740) and documents after 2000 (1384 v. 2172), and you can see the results.

Oh, in case you were wondering, the Delaware Code uses the term only once -- in Title 18 (Insurance) -- and it spells the word "acquirer."

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In a recently published article, David Rosenberg of the Zicklin School of Business at Baruch College cited this blog while noting that I had changed my mind about Disney. He's right, and I actually use that point to argue for the value of blogs and blogging in my forthcoming essay from the Bloggership Conference.

Here I go again.

In commenting on Stone v. Ritter, I expressed some confusion about the need to place the "fiduciary duty of good faith" under the duty of loyalty, but I didn't object to the notion that Caremark was essentially a "good faith" case, as that concept had been defined under Disney. Later, in a separate post on Caremark, I characterized the facts underlying a recent decision by Vice-Chancellor Strine (ATR-Kim Eng Financial Corp. v. Araneta) as a "model Caremark claim (failure of oversight)." I was wrong. Caremark has been distorted.

This is how Vice-Chancellor Strine described the standard of liability in Araneta:

Under Delaware law, it is fundamental that a director cannot act loyally towards the corporation unless she tries -- i.e., makes a genuine, good faith effort -- to do her job as a director. One cannot accept the important role of director in a Delaware corporation and thereafter consciously avoid any attempt to carry out one's duties.

That case was decided in December 2006, so it is no accident that the language at the end sounds like a combination of "bad faith" under Disney ("consciously and intentionally disregarded their responsibilities" (2003) or "intentional dereliction of duty, a conscious disregard for one's responsibilities" (2005)) and lack of oversight under Caremark ("only a sustained or systematic failure of the board to exercise oversight –- such as an utter failure to attempt to assure a reasonable information and reporting system exists –- will establish the lack of good faith that is a necessary condition to liability"). After all, Stone v. Ritter taught us the month before Vice-Chancellor Strine's opinion that Disney and Caremark were roughly equivalent standards: "a showing of bad faith conduct, in the sense described in Disney and Caremark, is essential to establish director oversight liability."

Here's the problem: the oversight duty described in Caremark did not require a conscious disregard of duty. Quite the opposite, in fact. This is what Chancellor Allen wrote in Caremark:

[This case belongs to a] class of cases in which director liability for inattention is theoretically possible [when] a loss eventuates not from a decision but, from unconsidered inaction.

I am fine with the notion that "consciously avoid[ing] any attempt to carry out one's duties" constitutes "bad faith," and if the Delaware courts are more comfortable treating "bad faith" as a form of disloyalty rather than as a separate breach of duty, that's ok, too. But why did they need to drag a distorted view of Caremark into this?

Do plaintiffs still have a Caremark claim under the duty of care for "unconsidered inaction"? Given the success rate of such claims (zero), maybe it doesn't matter.

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Harvard Law Students, apparently feeling deprived of "progressive corporate law" while learning at the feet of Lucian Bebchuk and John Coates, have invited Kent Greenfield, Larry Mitchell, and their own Jon Hanson to give a series of lectures on that topic. I suspect that I wouldn't agree with much that will be said in these lectures, but I would go if they were here. (Cue snarky comment from Kate!)

Anyway, I am almost ready to submit my long-promised article on contracts (new target date: Thursday!), and when that is done, I will turn to finishing my piece critiquing Kent Greenfield's new book. Look for that in a couple of weeks.

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We have had a few things to say about Chancellor Allen's well-known Caremark decision, but this post is about the new Caremark case, which is called Louisiana Municipal Police Employee Retirement System v. Crawford. If you are too busy to read the case, you might want to try the summary and critique from the Delaware law firm, Potter Andersen & Caroon.

Crawford involves the proposed "merger of equals" of Caremark and CVS. According to Chancellor Chandler, "Neither party would receive a premium. The board of directors would be evenly split between Caremark and CVS shareholders, and management positions would be divided between the two companies."

Unfortunately for the betrothed companies, Express Scripts wants to disrupt the union and has made an unsolicited offer for Caremark's shares. Express Scripts's offer values Caremark at about $26 billion -- more than $3 billion higher than the CVS merger valuation. Of course, the deals are not identical, and the CVS merger had some advantages, including the fact that it had received HSR clearance.

CVS responded to the Express Scripts' offer by proposing a modification of the merger agreement, which would allow Caremark to declare a special $2.00 dividend to be paid either at the time of or immediately after the merger. The Caremark board endorsed the amended merger agreement. Caremark and Express Scripts then proceeded to wage a proxy contest over their respective plans.

While the proxy contest was pending, CVS and Caremark agreed to increase the special dividend from $2.00 to $6.00 per share. That special dividend lies at the heart of the most interesting aspect of the opinion.

The plaintiffs in this case sued for an injunction, arguing that Caremark's board of directors breached their fiduciary duty of disclosure. Chancellor Chandler's opinion addresses each of the plaintiffs' disclosure claims, concluding that most of the disclosure defects were not material. Nevertheless, Chancellor Chandler enjoined the vote of the Caremark stockholders so that the Caremark's board of directors could "properly disclose to shareholders (a) their right to seek appraisal and (b) the structure of fees paid to Caremark’s bankers."

That may not seem very interesting, but embedded in the first part of that ruling is the judge's conclusion that the special dividend was part of the merger consideration to Caremark's stockholders. (Only if the special dividend were considered part of the merger consideration would the Caremark stockholders have appraisal rights. Otherwise, this stock-for-stock merger would be subject to the "market out" provisions of Section 262 of the DGCL.) According to Chancellor Chandler:

Plaintiffs contend the $6 special cash dividend triggers appraisal rights under 8 Del. C. § 262. Defendants respond that the special dividend has been approved and will be payable by Caremark and, thus, has independent legal significance preventing it from being recognized as merger consideration. Thus, according to defendants, dissenting Caremark shareholders will have no appraisal rights after the CVS/Caremark merger.

Section 262 of the DGCL grants appraisal rights to stockholders who are required, by the terms of the merger, to accept any consideration other than shares of stock in the surviving company, shares of stock listed on a national securities exchange, or cash received as payment for fractional shares. The $6 "special dividend," although issued by the Caremark board, is fundamentally cash consideration paid to Caremark shareholders on behalf of CVS.

Defendants are unsuccessful in their efforts to cloak this cash payment as a "special dividend." ... [D]efendants specifically condition payment of the $6 cash "special dividend" on shareholder approval of the merger agreement. Additionally, the payment becomes due upon or even after the effective time of the merger. These facts belie the claim that the special dividend has legal significance independent of the merger. CVS, by terms of the CVS/Caremark merger agreement, controls the value of the dividend. Defendants even warn in their public disclosures that the special cash dividend might be treated as merger consideration for tax purposes. In this case, the label "special dividend" is simply cash consideration dressed up in a none-too-convincing disguise. When merger consideration includes partial cash and stock payments, shareholders are entitled to appraisal rights. So long as payment of the special dividend remains conditioned upon shareholder approval of the merger, Caremark shareholders should not be denied their appraisal rights simply because their directors are willing to collude with a favored bidder to "launder" a cash payment. As Caremark failed to inform shareholders of their appraisal rights, the meeting must be enjoined for at least the statutorily required notice period of twenty days.

According to the lawyers at Potter Andersen & Caroon, "The Court’s ruling is a surprise to many practitioners and seems contrary to the well-settled Delaware corporate law doctrine of independent legal significance." They also assert that the decision was "startling to some practitioners."

Here are a few thoughts on this aspect of the decision. First, if you are interested in the doctrine of independent legal significance -- and who wouldn't be? -- you might check out my article on the subject, which you can download here.

Second, if you read that article, you will note that the doctrine has been used in only a few contexts. The most common is the "de facto merger," a concept that the doctrine of independent legal significance rejects by maintaining the distinction between a sale of assets and a merger. The doctrine also has been used to maintain the distinction between an amendment of the corporate charter and a merger. But I am reasonably certain that the doctrine of independent legal significance has never been used in a context like the one proposed in Crawford. (I did a quick check of Westlaw and didn't find anything close, but I can't claim to have done a thorough job of it.)

Third, what prevents a dividend from being treated as merger consideration? The defendants argue that the doctrine of independent legal significance should require the $6 payment to be treated as a dividend, not as merger consideration, but nothing in Section 262 of the DGCL precludes a "dividend" from being part of the merger consideration. So when Chancellor Chandler writes that the dividend was "fundamentally cash consideration," we could understand him to be saying that the payment is both a dividend (in form) and merger consideration (in substance).

The important point is that the doctrine of independent legal significance only matters when two characterizations of a transaction are mutually exclusive. A merger and a sale of assets are mutually exclusive because the statute provides different rights with respect to the two transactions, and the same goes for a chater amendment and a merger. Stated another way, the two transactions have different implications. But this is not true for a dividend and merger consideration. The $6 payment could be both.

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The AALS has posted podcasts from the Annual Meeting. You can browse the sessions from this page. If you would like to listen to the Section on Business Associations program on Disney, click here. By the way, I was the first speaker in that session.

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Francis Pileggi has blogged a recent decision by Vice-Chancellor Strine entitled Sample v. Morgan. The case involves the issuance of 200,000 shares of stock of Randall Bearings, Inc. to three senior officers of the company, who together comprised the majority of the company's five-member board of directors. The grant was made pursuant to a stock incentive plan (and accompanying charter amendment) that had been approved by the company's stockholders. The Compensation Committee that approved the grant was comprised of the two "independent" directors on Randall Bearings's board of directors. Perhaps the most important fact: the "200,000 shares represented a 46% increase in the number of shares that were issued and outstanding, from 431,680 as of the time the board approved the Charter Amendment and Incentive Plan, to 631,680 if all the Plan shares were issued."

Yikes!

Vice-Chancellor Strine's opinion denies the defendants' motion to dismiss -- a pretty easy call -- but it contains some interesting nuggets. Here are some quick takes on the case:

• Darian Ibrahim is writing a paper about individual v. collective liability of directors, and he discusses In re Emerging Communications, Inc. S'holders Litig., 2004 WL 1305745, *38 (Del. Ch.2004) at length. In Emerging Communications, then-Vice-Chancellor Jacobs wrote: "The liability of the directors must be determined on an individual basis because the nature of their breach of duty (if any), and whether they are exculpated from liability for that breach, can vary for each director." As Darian observes, Chancellor Chandler noted in his Disney opinion the tension between this view and the collective liability view espoused by Smith v. Van Gorkom. Vice-Chancellor Strine's new opinion comes down squarely on the side of individual liability: "Each director’s motivations and actions must be assessed individually before any finding of liability can be made." (citing Emerging Communications)

• Vice-Chancellor Strine uses the phrase "just ducky" (all of the directors of Randall Bearings "share the same counsel and have filed one brief taking the un-nuanced position that everything that was done was just ducky"). A Westlaw search reveals that this is the first use of this phrase in any opinion in the "allcases" database. It appears in three other cases, but in each case as a product or store name.

• Waste cases are almost as rare as Caremark cases, but just as Vice-Chancellor Strine found a viable Caremark claim in December, he has found what may be a viable waste claim in this case. His discussion is characteristically insightful:

Claims of waste are sometimes misunderstood as being founded on something other than a breach of fiduciary duty. Conceived more realistically, the doctrine of waste is a residual protection for stockholders that polices the outer boundaries of the broad field of discretion afforded directors by the business judgment rule. The wording of the test implies as much, as it condemns as wasteful a transaction that is on terms so disparate that no reasonable person acting in good faith could conclude the transaction was in the corporation’s best interest. When pled facts support an inference of waste, judicial nostrils smell something fishy and full discovery into the background of the transaction is permitted. In the end, most transactions that actually involve waste are almost found to have been inspired by some form of conflicting self-interest. The doctrine of waste, however, allows a plaintiff to pass go at the complaint stage even when the motivations for a transaction are unclear by pointing to economic terms so one-sided as to create an inference that no person acting in a good faith pursuit of the corporation’s interests could have approved the terms.

• Vice-Chancellor Strine refers to Santa Claus: "Even in an era when many scholars believe that compensation committees perhaps misunderstand the pertinence of Santa Claus to their work, the grants to the Insider Majority are extraordinary." This is the first reference to Santa Claus by a judge on the Court of Chancery (Vice-Chancellor Strine quotes a Texas court's reference to Santa Claus in Allied Capital Corp. v. GC-Sun Holdings, L.P., 910 A.2d 1020 (Del.Ch. 2006).) Could this signal a new line of cases in Delaware? Perhaps a law review article is in order.

• Vice-Chancellor Strine discusses the plaintiffs' "abdication" claim. This is not a Caremark/Stone claim (under which a director "consciously avoid[s] any attempt to carry out one's duties"), but a claim that the board has given away crucial powers. In this case, the plaintiffs claimed that the directors had abdicated their power to issue equity. Vice-Chancellor Strine wasn't buying that argument: "Although it is undoubtedly correct that a board of directors’ authority to issue equity is an important, statutorily-authorized power, that does not mean that a board cannot, for proper business reasons, enter into contracts limiting its ability to exercise that power." Again, that seems exactly right.

• Finally, Vice-Chancellor Strine offers a provocative footnote, re-interpreting a couple of famous Delaware Supreme Court opinions, Quickturn and Omnicare. Both opinions were authored by Justice Holland and suggested that certain actions of a board of directors were "invalid under Section 141(a)"  or "per se invalid," rather than breaches of fiduciary duty. Both of the opinions were adventurous and incoherent, and Vice-Chancellor Strine attempts to make sense of them by bringing them under the fiduciary umbrella:

I understand that certain S