In this second Conglomerate interview with a distinguished Delaware jurist, I am honored to welcome Supreme Court Justice Jack Jacobs to talk with us today.  For our last interview with Chief Justice Steele, see here.  Also, for more on how Delaware judges interact with the bar and the public, see my article with Chief Justice Steele here.

If you've taken or practice corporate law, you may recognize Justice Jacobs' many opinions from his service on the Court of Chancery and the Supreme Court.  To offer a few examples, he was the author of the recent AFSCME opinion on election bylaw legality and the Supreme Court's Disney opinion.  He was also one of the first judges to invalidate a poison pill in the Quickturn and Toll Brothers cases when he served as a Vice Chancellor. 

He has spoken and been published in forums around the world, including Tokyo, Hong Kong, and Stockholm.  The conventional wisdom among the Delaware bar is that his opinions are some of the deepest works of intellectual rigor in the corporate jurisprudence.

Verret: Welcome to the Conglomerate, Justice Jacobs.

Justice Jacobs: Thanks for the invitation.  It's a pleasure to be here.

Verret: What did you do before you became a Judge?

Justice Jacobs: From 1968-1985 I was in private practice at Young, Conaway, Stargatt & Taylor in Wilmington, Delaware, where I specialized in corporate, securities, and commercial litigation.

Verret: When did you first become interested in corporate law?

Justice Jacobs: Ironically, that subject bored me to death when I was a law student. At that time I vividly recall promising myself that I would have nothing to do with that area of the law. That attitude abruptly changed when, after graduating from law school, I became a law clerk for the Delaware Court of Chancery (and also Delaware’s Superior Court). That role afforded me the rare opportunity to see corporate cases actually tried, which brought otherwise dry appellate opinions to life.  I found them fascinating on both a human, and an intellectual, level. Moreover, these cases were usually presented and tried by exceptional lawyers from major city law firms. For these reasons I soon decided that litigating corporate cases was the area in which I wanted to specialize.

Verret: What made you decide to serve on the bench?

Justice Jacobs: My clerkship in the Delaware courts also enabled me to observe first hand what dedicated, excellent judges do, and afforded me the privilege to get to know many of them personally. It was that experience which formed my ambition to be (someday) a Delaware judge, if ever I were so fortunate as to be offered that opportunity.

Verret: How many former law clerks do you have?

Justice Jacobs: Because I have been a judge for almost 24 years, I have 23 former law clerks.

Verret: You first joined the bench in 1985, which seems to have been a watershed period for takeover law in Delaware.  It must have been an exciting time to be on the Court of Chancery?

Justice Jacobs: It was a very exciting time, for many reasons. First, the takeover cases were at the very cutting edge of Delaware corporate law. Although we could not know it at the time, they ultimately transformed Delaware corporate jurisprudence and made merger and acquisitions law a new and important sub-specialty. It was very heady to be at the center of many of these widely publicized cases. Second, those cases presented unique intellectual challenges, not only because each new takeover dispute pushed the envelope of corporate law doctrine out one more notch, but also because it forced the judges to do their best to reconcile the rulings in each new case consistently with the doctrine developed up to that point. That was more easily said than done, and in many cases the process took years to complete. This new doctrine was a moving target that was being developed at warp speed, rather than at the tortoise’s pace which characterized corporate doctrinal development during decades before. Third, and relatedly, these cases forced the judiciary to examine several of the basic premises and underpinnings of corporate law.

Our need to shape this law into a fabric that was coherent led the Court of Chancery judges to become a very collegial group. Although each trial judge is free to decide a case as he or she deems appropriate, unencumbered by the views of colleagues, nonetheless, we found it institutionally useful and beneficial to attempt to puzzle out collectively (where possible) the difficult issues that we confronted individually, in circumstances where the decision of one judge in any particular takeover case could bind other judges in future cases. This practice also helped to avoid inconsistent adjudications and to strengthen that court as an institution.
   
Verret: What is so unique about Delaware's approach to corporate law?

Justice Jacobs: That is a subject to which corporate law academics have devoted much time and law review space. In my opinion, the quality that is most unique is its effort to reconcile, in each specific case, the requirements of law (specifically, transactional predictability and giving practical guidance to corporate fiduciaries) with the commands of equity (to arrive at results that are fair and make sense in the business world). That is often more easily said than done, but over time I believe we have been successful in doing that.

Verret: How has the Delaware bar changed since you first started practice?

Justice Jacobs: When I became a Delaware lawyer, only about 500 lawyers were “enrolled” (admitted to practice) in Delaware, a state whose population was only about 700,000. That period was the high water mark of professional opportunities for lawyers. Also, the smallness of our Delaware bar enabled it to maintain somewhat effortlessly a high standard of professionalism based on informal constraints. In that legal world everyone knew everyone else, and if any lawyer cut corners, the word got out fast. The result was a culture where social, rather than formal controls, created strong incentives for lawyers to treat each other courteously and professionally. In addition, the small size of our bar made it easier for lawyers in both large and small firms to be mentored by more experienced lawyers, thus easing the transition from law school graduate to competent practitioner.

The situation is now different. Today, over 4000 lawyers are enrolled in the Delaware Bar--an 800 percent increase for a statewide population that has increased only about 25% during that same period. Those demographics are typical of what has occurred in other states—an overproduction of lawyers in relation to the opportunities for law-related jobs. That demographic has also changed the “face to face” quality that characterized the Delaware Bar four decades ago. One unavoidable result has been to weaken somewhat the social control-based legal culture possible only in a small size bar. To be sure, Delaware still remains a more personal, less anonymous place to practice than many major metropolitan centers. The increase in lawyer population has not reduced the quality or professionalism of those segments of the Delaware Bar that practice corporate, bankruptcy intellectual property, and many other specialty areas. But, it has made professional life more difficult for practitioners in solo or small firm practice who do not have the mentoring opportunities that were available to lawyers of the preceding generations. The organized bar, both in Delaware and elsewhere, needs to develop creative ways to address this problem.

Verret:  I understand you are working on a comparative work examining international governance issues, tell us more about that.

Justice Jacobs:  Last year I had the privilege of participating in a comparative mergers and acquisitions academic symposium in Tokyo, Japan, to which I was invited by Columbia Law Professor Curtis A. Milhaupt. Curtis and I found that we shared a common interest in trying to predict the future course of M&A regulation in Japan. That subject is new and relatively uncharted, because Japan has experienced hostile corporate takeovers only since 2000, and not until 2005 did Japan attempt to develop, in a systematic way, an institutional and substantive law framework to address this issue. That common interest has led us to collaborate on an article that would trace and compare the M&A regulatory institutional development in the United States and Japan, with a view to developing a framework that would enable scholars to predict the future course of Japanese legal regulation in this area. It soon became apparent that any such study would have to include the UK City Code as well, since the Japanese system has elements of both the City Code and the Delaware approaches. As a result, we were able to persuade Professor John Armour of Oxford University to join in our project, which is now only in its beginning stages.

Verret:  I understand you teach courses at NYU, Columbia, and Widener.  Do you find your experience as a jurist useful in the classroom?

Justice Jacobs:  Yes, I do find it useful, since my personal experience of having presided over several of the takeover and other complex corporate litigations, adds a somewhat unique perspective. That perspective enables me to communicate the meaning of the case materials on a “war story,” as well as a legal doctrinal level. That gives my students a reason to listen to what I am trying to say with real (as opposed to sometimes feigned) interest. Incidentally, I also find my experience as a teacher useful to my role as a judge, because it is a constant reminder of the burden of lawyers whose stock in trade is communicating their client’s position to judges. That requires them to give the judge reasons to give special attention to their presentation. A judge who takes on the role of a law professor now finds himself in the same position as the lawyers who appear before him—the judge-teacher must give his students a reason to listen to him, since, quite frankly,  the students could care less that their teacher’s day job is judging. All the students care about is whether what is coming out of their teacher’s mouth is worthy of their attention. It’s a humbling experience.

Verret:  Which of your opinions, either from serving on the Court of Chancery or the Supreme Court, do you think would be most useful in the classroom?

Justice Jacobs: There is no single right answer to that question, because the answer depends on the nature of the course being taught. For example, in a basic corporations class, appellate opinions may often be of more use, because the emphasis is more on doctrine than strategy or procedure, and appellate opinions are often clearer distillations of pure doctrine. On the other hand, where the course emphasizes procedure, litigation tactics and strategy, the trial court opinions are often more useful (or at least as useful) as the appellate opinions, since those dimensions of the litigation are often more apparent from the trial court opinion. I have taught both types of courses. This past semester, I taught (together with Professor John Coffee) a seminar at Columbia Law School that focused on litigation tactics and strategy in so-called “major” corporate litigation (not limited to pure corporate law, but including related areas, including bankruptcy and antitrust). In that course, the reading materials consisted more of trial court, than appellate court, opinions.

Verret:  Your recent AFSCME v. CA opinion has been in the news recently.  How was the Court able to turn the opinion around so quickly?

Justice Jacobs:  In that case, there was a need for expedition because there was a fixed date for the shareholders meeting to take place, which created a short-fuse deadline for the preparation and mailing of proxy materials. The form and content of the proxy materials would depend on how the issues in AFSCME v. CA were decided.  In cases where an expedited decision is required, it has long been the practice and the professional culture of both the Delaware Court of Chancery and the Supreme Court to respond quickly, by moving the expedited case to “the front of the line.” That is what happened here. And although I happened to be the judge who authored the AFSCME opinion for our court, the opinion it was a collaborative effort by all five Justices, who gave it the same high priority. That is what made it possible to expedite the matter as rapidly as we did.

Verret:  How do you see Delaware's role as a source of corporate law evolving into the 21st century?

Justice Jacobs:  In normal circumstances I would be better able to offer an informed opinion on this subject. In today’s political environment, however, legislation is being proposed that, if it became law, could federalize several different aspects of what has traditionally been the subject of state corporation law. Without knowing whether this will happen, and specifically what areas (if any) would be affected, any opinion that I proffered would be pure speculation.

Verret: Thanks so much for taking time out of your busy docket to join us today Your Honor, we sincerely appreciate it.

Justice Jacobs:  It was my pleasure.

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In 2007 Amylin Pharmaceuticals issued 3.00% convertible senior notes due 2014. The Note Indenture gives the noteholders the right to demand redemption of any or all of their notes at face value upon the occurrence of "Fundamental Change," which occurs, among other time, when “the Continuing Directors do not constitute a majority of the Company’s Board of Directors . . . .” The Indenture defines “Continuing Directors” as follows:

In a case issued today, Vice-Chancellor Lamb was asked to decide whether this provision "prevents the issuer’s board of directors from 'approving' as 'continuing directors' persons nominated by stockholders in opposition to the slate nominated by the incumbent directors." Certain stockholders -- including Carl Icahn and Eastbourne Capital Management, who together nominated five directors for election to Amylin's 12-person board of directors -- want the board to approve the directors to avoid the negative consequences associated with the change-of-control provision. The incumbent directors agreed to do this as part of a partial settlement of this litigation, but the Note Trustee believes that the board should be precluded from granting such approval.

This is a plain old contract interpretation case, but unfortunately for VC Lamb, the contract doesn't expressly address the issue, and the drafting history of the Indenture doesn't provide much guidance. He tries to make something of the word "approval": if the board opposes the election of the Icahn and Eastbourne nominees, can they really be said to approve those directors? VC Lamb:

That seems right. When you consider the negative consequences associated with the change-of-control provision, the narrow interpretation of "approval" would effectively prevent shareholders from electing a new majority of the board of directors, and VC Lamb suggests that this would raise public policy concerns regarding the enforceability of such a contract.

Thus, the Amylin board has the right to approve the dissident nominees, but it must exercise this right in good faith. Here's the decision rule: "the board may approve the stockholder nominees if the board determines in good faith that the election of one or more of the dissident nominees would not be materially adverse to the interests of the corporation or its stockholders."

Hmm.

The problem in applying this rule is that the incumbents made negative public statements about the dissidents. According to Lamb, "if taken at face value, these statements would suggest that the board has concluded that the dissidents would be harmful to the company, [but] such a reading would be inappropriate" because the statements are nothing more than "election puffery." The more important point is that approval was granted in exchange for a partial settlement of the litigation. That looks like it could be a good faith business judgment about the effect of approval on the corporation and its stockholders. Or a decision by the incumbent directors to serve their own selfish interests. Unfortunately, Lamb did not have enough evidence to draw any conclusions. And because the dissidents are seeking to elect less than a majority of the directors, the issue will not be ripe for adjudication until the dissidents gain control.

Case dismissed.

This is not a monumental case, but it reminded me how much I like reading Steve Lamb's opinions. His writing is economical, and he is always sophisticated about the implications of his opinions. I will miss him when he retires later this year.

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One of the hottest topics in corporate law scholarship over the past five years has been the relationship between good faith and loyalty, a topic we have discussed frequently on this blog. In our second week of discussions "Exploring the Connection between Religious Faith and Corporate Law," I thought a discussion of this topic might be in order, especially since Lyman Johnson has written an important piece on the subject entitled, "Faith and Faithfulness in Corporate Theory."

I hope that I can be excused for a gross oversimplification of Lyman's argument, but the essence of his position, it seems to me, is that directors and officers of corporations have sufficient discretion to "draw on and express themselves in ways influenced by faith." As a result, some corporate managers might discharge their legal obligation to be “faithful” fiduciaries by using biblical ideas:

This is a much more expansive notion of loyalty than generally assumed to be required of corporate managers, but it is not inconsistent with much of the recent rhetoric on loyalty in the Delaware courts. While Lyman is arguing merely for a "more prominent religious voice within corporate discourse," Andrew Gold has written an excellent new paper on "The New Concept of Loyalty in Corporate Law," 43 U.C. Davis. L. Rev. __ (2009) (not yet now available on SSRN) contending that a more expansive notion of loyalty is required to make sense of Disney + Stone. Andrew argues:

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North Dakota adopted a new "shareholder friendly" corporations statute in 2007, which ginned up enough attention to attract the W$J. At last month's Notre Dame conference, Chief Justice Myron Steele of the Delaware Supreme Court mentioned the North Dakota statute, but he didn't seem worried, given that less than a handful of public companies use North Dakota as their state of incorporation.

Despite the big yawn from most corporations scholars, the new statute is attracting some attention from shareholders (prompted by John Chevedden). According to Michelle Leder, the number of companies with reincorporation proposals on the ballot has now reached 11: Southwest Airlines, Exxon Mobil, Lowes, Marsh & McLennan, Amgen, Sempra Energy, and Qwest Communications, Oshkosh Corp., Hain Celestial, Whole Foods, and PG&E. These are precatory proposals, so even if they passed, which is highly unlikely, the corporations would not be required to reincorporate.

Steve Bainbridge has has written, "North Dakota is doomed to failure" in the race for corporate charters:

Steve's paper is a contribution to a symposium sponsored by the North Dakota Law Review. For a description of the program, see here.

Steve is right that North Dakota will not overtake Delaware with this new statute, but how should we think about "success" and "failure" with regard to this new statute? While North Dakota won't reap any financial benefits without actual reincorporations, my view is that the statute is already a success with shareholder activists. They have managed to place the statute on the ballots of 11 major corporations with more to follow. The North Dakota venture seems designed as a symbolic gesture, rather than as a real threat to Delaware, and it seems to me that it has already served that function.

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Notre Dame Law School is hosting a conference today on "The Future of Fiduciary Duties in Corporate Law." Julian Velasco has assembled a wonderful lineup of longtime friends, including fellow Glommer Lisa Fairfax, my co-author Bob Thompson, and Ideoblogger Larry Ribstein, as well as Chief Justice Myron Steele of the Delaware Supreme Court.

I will be presenting a new paper entitled "Unlimited Shareholder Power," which I hope to post on SSRN soon. Here is a glimpse:

By the way, this is my fourth trip to South Bend, twice on business and twice for football games. Every time I come here, I am more impressed with the University of Notre Dame.

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The Delaware Supreme Court finally issued its long-awaited opinion in Lyondell Chemical Company v. Ryan today. Remember, this is the case in which the directors of Lyondell Chemical Company were accused to breaching their fiduciary duties in connection with a sale of the company. The directors were admittedly independent and disinterested, but the plaintiff shareholders accused the directors of breaching their fiduciary duty of good faith by knowingly shirking their duties under Revlon. Vice-Chancellor Noble refused to grant the directors summary judgment because he wanted to know more facts about whether "the directors may have consciously disregarded their known fiduciary obligations in a sale scenario." (Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. 2008)).

In reference to that earlier decision, I expressed my frustration with the current state of Delaware law:

The problem with the decision is that [the defendants] can't get a lawsuit like this dismissed. But I don't see how you can pin that on Vice-Chancellor Noble. He is just taking direction from the Delaware Supreme Court.

Others, like Jeff Lipshaw, thought VC Noble was simply bootstrapping a duty of care claim into a non-exculpable duty of good faith claim. (Glom guest blogger Andrew Lund has written a paper about this possibility and how Delaware could more easily avoid it.) In its opinion today, the Delaware Supreme Court agreed with Jeff's assessment of the facts of this case: "At most, this record creates a triable issue of fact on the question of whether the directors exercised due care." (For Jeff's reaction to the opinion, see here.)

Importantly, this conclusion depends on a strikingly narrow understanding of "bad faith" in Delaware fiduciary law. In my first post on this case last August, I observed, "Disney and Stone now have defined 'bad faith' in a manner that does not require illegality or fraud (the traditional meanings of 'bad faith'), or disloyalty -- at least in the traditional sense of self-dealing. 'Bad faith' now has a more expansive meaning, that might include actions by directors who are admittedly independent and disinterested." While all of this remains true, it appears that the Delaware courts still have an extremely narrow view of bad faith. Steve Bainbridge described it this way earlier today: "Ryan ... goes a long way towards constricting the scope of bad faith claims to egregious and highly unusual sets of facts."

To understand how narrow "bad faith" has become, consider VC Noble's initial decision to deny summary judgment. That decision was motivated by a desire to gather more facts before determining that the directors here had not acted in bad faith. VC Noble was under the impression that directors could do something to fulfill their Revlon duties, but still knowingly fall short of doing enough. This is not an unreasonable view, though it would require a fair amount of precision to determine the difference between a care claim and a good faith claim. Chancellor Chandler made a similar point in a recent opinion in In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106 (Del.Ch. 2009):

The Delaware Supreme Court wants to draw a brighter line in its opinion issued today:

And again:

The influence of Caremark is apparent here, and we know from experience that Caremark liability is almost unheard of in Delaware. Of course, Vice-Chancellor Strine recently found support for Caremark claims with respect to the former senior vice chairman of general insurance and former vice chairman of investments and financial services of AIG. See In re American Intern. Group, Inc., 2009 WL 366613 (Del.Ch.2009). In denying a motion to dismiss on this issue, VC Strine observed:

This sort of behavior, if proved at trial, would easily support a finding of "bad faith" under the traditional standards. In other words, the Caremark version of bad faith would be unnecessary. And if the Delaware courts are serious about the standards articulated in Lyondell, I suspect plaintiffs will need facts like these to prevail on a claim of bad faith. So while boosters of the fiduciary duty of good faith had reason to rejoice after VC Noble's initial opinion, they will not be pleased with this latest directive from the Delaware Supreme Court.

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The ball has begun rolling toward amending the DGCL.  Of some note, proposed Section 112 would explicitly permit adoption of bylaws providing shareholder access to the corporation’s proxy for purposes of director elections.  The language in the proposal goes further and permits the bylaws to place restrictions on the access.  The language then goes even further and provides a non-exclusive list of restrictions that would be ok (minimum share ownership for nominators, indemnification by nominators, etc.).

The indispensable Jay Brown has a post up noting his concern that the proposed amendment would harm shareholder access, under the assumption that a shareholder access rule will be adopted by the SEC in short order.  His point is that boards might adopt bylaws under the Delaware rule that are more restrictive of that access than any forthcoming SEC rule would be.  In its summary of the proposal, RiskMetrics considers this a possible repercussion and gains comfort from Michael Barry's view that any federal rule could preempt more board-imposed limitations.  

It strikes me, however, that boards could adopt restrictive bylaws even without the explicit permission granted by the proposed Section 112.  They don’t do so currently, but that’s only because 14a-8(i)(8) makes any restrictions unnecessary.  Take away or amend 14a-8(i)(8) and there’s little to stop boards from imposing restrictions in the bylaws.  I understand that the explicit list of limitations would preclude a shareholder claiming that the board improperly restricted its “right” to proxy access, but is it clear that the Delaware courts would be all that friendly to such a claim even without the proposed statute?  In any event, wouldn’t the board-adopted bylaws would be “procedural” and thus subject to amendment by shareholders should they so choose (as they’d have to do anyway under any SEC-adopted access rule)?  That seems to be the real protection for access here - not the possibility of the federal rule preempting limitations in board-approved bylaws.

So what’s the point of the Delaware proposal?  Perhaps it’s just a case of Delaware getting in front of federal action, thereby demonstrating that it’s responsive to the corporate governance movement and perhaps "preempting" federal action in other areas.

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In my last post on Delaware's emergent good faith doctrine, I concluded that attempts to establish a usable test for distinguishing due care claims from conscious disregard claims are likely to fail.  These tests are laible to be either vague, underinclusive (so as to not capture cases of conscious disregard) or overinclusive (swallowing up simple due care claims).  The intractability of the problem assumes that there are reasons to value both due care exculpation as well as a knowledge-based culpability standard distinct from negligence or even gross negligence.  Suffice it to say, I think there are reasons to value both, though others may disagree.

So what to do?  Because of the uncertainty regarding the relative values of these competing considerations, there is a risk of regulatory error.  Ideally, the parties to each corporate contract would be allowed to make their own determinations about the appropriate level of accountability.  In this case, that would mean freeing up firms to exculpate directors for conscious disregard claims.  In that scenario, the Delaware courts would do best to establish a relatively determinate and potentially overinclusive standard for determining conscious disregard (perhaps Brett McDonnell and Claire Hill's "structural bias" idea).  Managers and shareholders would then determine whether to exculpate for care and the liberalized conscious disregard standard, care only or neither.

Of course, this solution is subject to concerns about the charter amendment process.  In my paper I try to demonstrate why that process should be reasonably trustworthy in the context of conscious disregard exculpation.  At the very least, anyone who wants to argue the other side would need to explain how conscious disregard exculpation is more problematic than due care exculpation (or else say that due care exculaption is not to be trusted either).

One final note: if the alternative is the Delaware Supreme Court adopting an underinclusive standard that truly protects due care exculpation, this solution may provide better optics for Delaware.  Those concerned about federal preemption responding to Delaware's perceived pro-director bias should feel better having to defend shareholder-approved measures rather than a court-adopted standard.

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As I posted yesterday, there’s a good chance that the Delaware Supreme Court’s opinion in Ryan v. Lyondell will turn on the application of Revlon and not the Chancery Court’s analysis of plaintiff’s good faith claim.  Clearly, though, something needs to be said about the relationship between due care and good faith.  The test for determining whether a breach of due care rises to the level of “conscious disregard” is significantly indeterminate at this point.  While Ryan indicated that almost any due care claim will state a conscious disregard claim at the pre-trial stages, Chancellor Chandler’s contemporaneous opinion in McPadden v. Sidhu (and recent opinion in the Citigroup litigation) suggests that it will be nearly impossible to state a conscious disregard claim for purposes of avoiding exculpation.

The indeterminacy is no surprise.  At least since Hillary Sale’s seminal article, everyone has recognized that the new good faith poses a serious line-drawing problem.  On the one hand, good faith can’t be too broad for fear of swallowing up due care exculpation clauses.  On the other, it can’t be too narrow or else become toothless.  Many have offered solutions – resort to a scienter analysis, requiring “plus” factors to exist, limiting conscious disregard to instances of non-deliberation, limiting it to non-transactional, monitoring cases (the recent AIG and Citigroup decisions suggest a further distinction within this approach: monitoring business decisions vs. monitoring criminal behavior), etc. 

In my most recent article I contend, uncontroversially, that we can’t be sure that any of these attempts to draw the line will get it right.  First, some line-drawing proposals (say, requiring some level of egregiousness) don’t provide much determinacy at all.  More importantly, the line drawing is bound to be problematic because we can’t be sure of the costs imposed by, and benefits gained from, the conscious disregard standard.  Accordingly, even those proposals described above that provide a clear standard may still not get the balance right.

If I were forced to hazard a guess, I’d expect that the Delaware Supreme Court will ultimately adopt a standard that errs on the side of protecting 102(b)(7) clauses and reject the approach taken in Ryan v. Lyondell.  That is, its best guess is that a robust conscious disregard standard is less valuable than due care exculpation, all things considered. And maybe that’s the right answer if we are limited, as the court is, to tweaking judicial doctrine. 

But, because it’s just a guess and might turn out to be the wrong one, we may want to consider an alternative to relying solely on the courts.  Along these lines, I suggest in my article that (1) Delaware courts adopt a more robust version of the conscious disregard standard and (2) the Delaware legislature amend 102(b)(7) to permit firms to opt out of conscious disregard liability.  Tomorrow I’ll post about the advantages of that approach and talk a bit about objections that might be raised.

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Back in January, the Delaware Supreme Court heard oral arguments on the interlocutory appeal in Ryan v. Lyondell.  It was somewhat surprising that the court agreed to hear the interlocutory appeal.  It’s perhaps more surprising that, after taking the case and hearing oral argument, it has taken the court almost two months to issue a ruling.

In Ryan, Vice Chancellor Noble denied summary judgment for the Lyondell board of directors with regard to a claim by former shareholders that the board violated its Revlon duties in agreeing to sell to Basell/Access.  More interestingly (maybe), the court denied summary judgment on the claim that the Revlon violation was “conscious”, and therefore counted as a non-exculpable violation of good faith.

When the Chancery Court denied summary judgment in Ryan, it generated a lot of commentary.  The opinion didn't distinguish pretrial analyses of care and good faith, thus making it easy for plaintiffs to bootstrap a due care claim into a non-exculpable good faith claim.  I’ve just posted an article to SSRN offering a way forward on that issue.  I’ll be posting some stuff related to my argument in that piece later this week.

But after listening to the oral argument in the case, I’m not sure the forthcoming opinion will say anything about the issue.  At oral argument, the discussion focused almost entirely on whether Revlon applied during the period between Basell/Access’ filing of the 13D and its offer two months later.  If the court finds that Revlon had no relevance for board inaction during that period, there’s presumably no due care violation under Revlon based on the board’s behavior post-offer.  The court might choose to talk about good faith in dicta (as it did in Disney), but it won’t have to reach the care/good faith distinction.

To be sure, a bidder’s credible statement of interest (whether via a 13D or not), by itself, doesn’t trigger Revlon duties.  The Chancery Court’s opinion doesn’t say differently exactly – the opinion would allow a board to go on its merry, Revlon-less, way after the statement of interest, under penalty of considering its post-statement behavior in a Revlon analysis should the board ultimately choose to sell.  During oral argument, one of the Justices referred to this argument as creating a “zone of Revlon”. 

I’m not sure that the “Revlon zone” would be such a bad idea.  The target board that (1) has reason to think a credible offer will be coming in that it might accept, (2) does no background work on a potential sale and then (3) accepts the deal under a tight deadline has done something qualitatively different than another board that gets blindsided by a blowout premium with a tight deadline.  It seems disingenuous for the first board to throw up its hands and say that it didn’t have time to go through a full sales process because of time pressure.  Of course, creating this contingent Revlon application would pose a number of problems, e.g., determining whether the board had received a credible indication that a bid would be coming down the pike (although a 13D would seem to be an easy case). 

A bigger issue for the Ryan plaintiffs, though, is that the Revlon zone would seem to be new law, making it difficult to show that directors knowingly failed to satisfy their enhanced duty of care after receiving the 13D.

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In my continuing effort to explore the connection between the financial crisis and fiduciary duty (see here and here for initial steps), I was interested to read David Rosenberg's paper, Supplying the Adverb: Corporate Risk-Taking and the Business Judgment Rule. In this paper, David explores the effect of judicial review of corporate decision making on the willingness of corporate managers to take risks, and he concludes that "courts are perfectly well-equipped to hear cases in which aggrieved shareholders claim that directors took improper risks in ways that ought to result in liability for those directors."

Note the key word in that sentence: improper.

The crux of David's argument is that the business judgment rule should not shield directors from liability for all risk taking, only appropriate risk taking. The Delaware courts routinely justify the business judgment rule on the ground that it is designed to encourage managerial risk taking, but David argues that the Delaware courts ignore their own standards if they insulate directors from liability for excessive risk taking. Obviously, the big question then becomes, what is "excessive risk taking"?

To answer that question, David turns to Stone v. Ritter, arguing that the standard of bad faith articulated there includes "knowing lack of care." David cites an excellent recent article by Claire Hill and Brett McDonnell on the subject, Stone v. Ritter and the Expanding Duty of Loyalty, 76 Fordham L. Rev. 1769 (2007). In that article, Claire and Brett imagine fiduciary duty cases as lying along a continuum of disloyalty. On the one end are classic loyalty cases, in which a director steals from the corporation. On the other end lie "classic duty of care cases[, which] also involve a director taking for herself something which should otherwise be the corporation’s: her attention and diligence." Under this version of Stone, loyalty has become an expansive concept that would permit a court to impose personal liability on directors in the following circumstances (quoting from David's paper):

Operating in an environment in which it is accepted that risky decisions often end in failure, corporate directors can still take those kinds of risks without fear that such failure will result in personal liability for them. What they plainly cannot do is choose a risky course of action knowing that the decision is a bad one or knowing they have not taken care to evaluate whether or not the risks involved will benefit the corporation.

This seems like a perfectly acceptable reading of Stone, though I suspect the number of cases in which directors would, as a factual matter, be found to have acted with a "knowing lack of care" is close to zero. This is not the sort of case in which Delaware courts seem inclined to lean toward the plaintiffs because the costs associated with a false positive -- chilling future boards from taking risks -- is much higher than the costs associated with a false negative -- failure to compensate plaintiffs in a particular case.

Returning to the issue that animates this series of posts, could we do better under a federal corporate law regime? I don't see how. David is calling for a very precise evaluation of board action, and the evaluation would not become easier just by transferring decision making power to a federal agency or court.

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Remember my September 14 post about the impending financial crisis leading to a reshaping our regulatory system? When I suggested that we would someday be comparing the regulatory reforms to the New Deal, some people scoffed. The same thing happened to me a month later (this time via email, so I can't link to it), when I was quoted in the National Law Journal with the following:

What Delaware should be most worried about is if people begin to associate the financial crisis with executive misconduct. If people really believe this crisis was caused by greed or failure of oversight, well, Delaware, by and large, regulates those through its fiduciary law.

A very prominent corporate lawyer emailed: "I think this angle on the crisis is ridiculous and trivial." He was speaking normatively, not descriptively, and as noted in my post on the subject, I agree. The case against Delaware is weak. Nevertheless, "I am not so sanguine about Congress' ability to craft an appropriate regulatory response or to refrain from messing with Delaware."

Now comes this from the W$J:

The lesson of Enron is, sadly, that there are no lessons.

Less than seven years ago, federal prosecutors began pouncing on the fallen energy company, eventually convicting 22 employees. When Chairman Kenneth Lay and Chief Executive Jeffrey Skilling were finally convicted in May 2006, House Financial Services Committee member Michael Oxley crowed that "justice has been served" and that the "entire debacle" had reinforced executives' duties to public corporations.

Today's financial crisis has shown what a real debacle looks like. And it has made clear that executives' duties to public companies have, if anything, been loosened, not reinforced. What is worse, the post-Enron crackdown appears not only to have failed to stop flagrant corporate risk-taking, but to have lulled Washington to sleep.

The article quotes Larry Ribstein, who certainly doesn't have it in for Delaware, but the larger point is the one I was making to the NLJ: the debate over the legacy of the financial crisis has begun, and fiduciary duties are on the table.

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Ryan v. Lyondell generated a whole lot of consternation in the blogosphere (some of which is collected here), but in my view, the commentary was largely overblown in this case, as Vice Chancellor Noble clarified today in his letter opinion denying an interlocutory appeal by the defendants. (See the letter opinion here and Francis Pileggi's helpful summary here.)

Of course, the defendants could have saved themselves the trouble if they had read my post on the initial opinion. My post on their memorandum in support of this motion of interlocutory appeal further showed why they were barking up the wrong tree, and Vice Chancellor Noble wrote as much in today's opinion, repeatedly emphasizing that his initial opinion did not eviscerate Section 102(b)(7), nor did it signal the revival of a "liability crisis" like the one that followed Smith v. Van Gorkom. (Of course, even that historical curiosity is more complicated than just that.) The court contrasted this case with Van Gorkom as follows:

The directors in this instance walked into a potential liability trap with their eyes wide open: they knew the Company was “in play,” they knew what the proper discharge of their fiduciary obligations in connection with a sale of control demanded, and yet they appear, on the limited record before the Court, to have done nothing to prepare for a possible sale.

That's the central point of the new opinion: on the summary judgment record, the defendants "did nothing (or virtually nothing)" to fulfill their Revlon duties. Thus, "the directors may have consciously disregarded their known fiduciary obligations in a sale scenario." In other words, the defendants may have acted in "bad faith." Thus, the court wants to see a more developed record. That is all.

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Steve Bainbridge has a long and important post on Section 102(b)(7) of the Delaware General Corporation Law. Steve is responding to my most recent post on Ryan v. Lyondell, in which I argued, "The problem with the decision is that [the defendants] can’t get a lawsuit like this dismissed." An excerpt from Steve's post:

I think Gordon’s got an excellent point. Ever since the Delaware supreme court held in Emerald Partners v. Berlin, 726 A.2d 1215, 1223-24 (Del. 1999), that a § 102(b)(7) provision is an affirmative defense, thereby imposing on defendant directors the burden of proving that they are entitled to exculpation under the statute, a § 102(b)(7) provision rarely entitles directors to a dismissal during the motions stage of the case. The legislative history of section 102(b)(7) is scant and thus does not allow confidence on this issue.

Regardless of whose fault the present state of the law is, however, the present state is most unfortunate. Because 102(b)(7) cannot reliably be invoked to result in a dismissal at the motions stage, plaintiffs will usually get to discovery, which some might call a fishing expedition, and the settlement value of shareholder claims will go up.

The time has come for the Delaware legislature to revisit the issues raised by section 102(b)(7). First, there is the broad issue of freedom of contract. Delaware has been a leader in allowing contractual limitations on fiduciary duty liability in public uncorporations such as LLCs. The legislature needs to start thinking about the extent to which those legal developments should carry over into the corporation law. Section 102(b)(7) would be a great place to start. In my view, it should be permissible for the articles to create a liability limitation provision that would entitle directors to get the case dismissed at the motions stage absent particularized allegations about a very narrow range of misconduct.

Second, although certainty and predictability long have been hallmarks of Delaware law, section 102(b)(7) was a botch job from the outset that has been made worse through judicial interpretation. It now wholly lacks certainy.... A coherent liability limitation provision would make clear whether it is intended to come into play pre- or post-trial, and identify with specificity the kinds of director misconduct for which monetary liability may still be recovered.

Ok, that was actually quite a bit of his post, but it was too good to cut. I agree with Steve that the time has come to revisit Section 102(b)(7). For his idea about fixing the problem, go read the rest ...

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If you are following the Ryan case, which I blogged about below, you will be interested to read the "Defendants' Memorandum of Law in Support of Their Application for Certification of Interlocutory Appeal and to Stay Proceedings Pending Appeal." (Whew!) The gist of the appeal is that  Vice-Chancellor Noble's decision would "eviscerate" section 102(b)(7) because it conflates the duty of care and the duty of good faith. The crux of the argument is that the defendants were "properly motivated, unconflicted and independent directors." As Meatloaf reminded us, two out of three ain't bad.

Vice-Chancellor Noble's opinion acknowledges that the defendants were unconflicted and independent, so he ends up focusing on motivation: "the Board’s failure to engage in a more proactive sale process may constitute a breach of the good faith component of the duty of loyalty as taught in Stone v. Ritter."

The only opening I see for the defendants here is the possibility that Vice-Chancellor Noble equates a breach of Revlon with a breach of the duty of good faith. Consider the following from footnote 11 of the opinion: "the Board’s apparent failure to make any effort to comply with the teachings of Revlon and its progeny implicates the directors' good faith and, thus, their duty of loyalty, thereby, at least for the moment, depriving them of the benefit of the exculpatory charter provision."

Necessarily implicates? Or may implicate? As noted in my first post on this case, the latter is the better view of Revlon because it implies that directors may violate their Revlon duties because they failed to act with due care, good faith, or loyalty. The Delaware cases do not seem crystal clear on this, but I think that is a fair reading.

But the defendants dont' take this path. Instead, they argue that Vice-Chancellor Noble's opinion conflates the duty of care and the duty of good faith because ... well, because there is no "record evidence that would support an inference that the Lyondell Directors intentionally breached their Revlon duties." Translated: we don't like the court's interpretation of the facts. That argument seems like a certain loser on an interlocutory appeal from a decision on a motion for summary judgment.

In the final analysis, however, the defendants have a bigger problem: nothing in Vice-Chancellor Noble's opinion would "eviscerate" 102(b)(7), as claimed by the defendants, because the Lyondell directors can still get the benefit of the exculpation provision if they are found after trial to have breached only their duty of care. The problem with the decision is that they can't get a lawsuit like this dismissed. But I don't see how you can pin that on Vice-Chancellor Noble. He is just taking direction from the Delaware Supreme Court.

Thanks to Steven Davidoff for the tip on the filing of the brief.

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