December 21, 2005
Shareholder Power & News Corporation
Posted by Gordon Smith

Yesterday, Chancellor William Chandler issued his opinion in Unisuper Ltd. v. News Corporation, which is an important new data point in the ongoing debate about shareholder power.

Several institutional shareholders in Rupert Murdoch's News Corporation are challenging a decision by the board of directors to extend the life of the company's poison pill. Among other things, the shareholders claim that the board of directors entered into a contract with the shareholders in the midst of negotiations regarding the company's reincorporation from Australia to Delaware. According to the shareholders, the contract allowed the board of directors of News Corporation to adopt a poison pill for one year, but required shareholder approval for any extension of the pill.

The reincorporation decision was the impetus for this contract because Australian law requires shareholder approval of poison pills while Delaware law allows boards of directors to institute poison pills unilaterally. The shareholders initially attempted to impose a limitation on the board's power via charter amendment, but that attempt was abandoned when the General Counsel of News Corporation told the shareholders that it would be too difficult to draft and finalize an amendment prior to the target date for reincorporation. Instead, News Corporation proposed the adoption of a board policy, which was described in a press release:

The [News Corp.] Board has adopted a policy that if a shareholder rights plan is adopted by the Company following reincorporation, the plan would have a one year sunset clause unless shareholder approval is obtained for an extension. The policy also provides that if shareholder approval is not obtained, the Company will not adopt a successor shareholder rights plan having substantially the same terms and conditions.

The shareholders subsequently approved the reincorporation, allegedly in reliance on this press release and other assurances from the company. Shortly after the reincorporation vote, Liberty Media appeared on the scene as a potential hostile acquiror of News Corporation, and the board of directors of News Corporation adopted a one-year poison pill. A year later, on November 8, 2005, the board of directors voted to extend the pill. They did not seek shareholder approval for this action, and the shareholders sued for breach of contract.

The contract claim looks weak. As noted by Chancellor Chandler:

Plaintiffs are sophisticated investors capable of negotiating enforceable agreements to protect their interests... [I]t is not entirely clear why ... plaintiffs accepted a promise to adopt a board policy, which is a more transitory right than a charter provision, especially when sophisticated parties such as these must have understood the significant difference between a charter provision and a board policy.

Despite the apparent weakness of the contract claim, Chancellor Chandler's reasoning is provocative. The most interesting part of the opinion falls under the heading "Unenforceability." The defendants argued that even if a contract existed, it would be unenforceable because it purports to limit the board's discretion without using a charter amendment. (Section 141(a) of the Delaware code grants managerial power to the board of directors, subject to limitations imposed in the corporate charter.) This seems like a very strong argument to me, but Chancellor Chandler rejected it:

By definition, any contract a board could enter into binds the board and thereby limits its power. Section 141(a) does not say the board cannot enter into contracts. It simply describes who will manage the affairs of the corporation and it precludes a board of directors from ceding that power to outside groups or individuals.

The fact that the alleged contract in this case gives power to the shareholders saves it from invalidation under Section 141(a). The alleged contract with ACSI did not cede power over poison pills to an outside group; rather, it ceded that power to shareholders. In effect, defendants’ argument is that the board impermissibly ceded power to the shareholders. Defendants’ argument is that the contract impermissibly restricted the board’s power by granting shareholders an irrevocable veto right over a question of corporate control.

Delaware’s corporation law vests managerial power in the board of directors because it is not feasible for shareholders, the owners of the corporation, to exercise day-to-day power over the company’s business and affairs. Nonetheless, when shareholders exercise their right to vote in order to assert control over the business and affairs of the corporation the board must give way. This is because the board’s power – which is that of an agent’s with regard to its principal – derives from the shareholders, who are the ultimate holders of power under Delaware law.

Wow! If this reasoning holds up, it would effectively settle the debate about shareholder bylaws in Delaware, including the debate that we had here the other day re Bally Total Fitness. In that context, I argued that the shareholders of Bally would not be entitled to adopt a bylaw giving themselves the power to terminate Bally's CEO, but my argument would collapse in the face of this new decision.

Chancellor Chandler also addressed the defendant's claim that the directors' fiduciary duties required board control over the decision to extend the poison pill. He distinguished two famous takeover cases -- QVC and Quickturn -- on grounds that they involved "defensive measures that took power out of the hands of shareholders" rather than a "contract [that] put the power to block or permit a transaction directly into the hands of shareholders." He also used a version of this "empowerment of shareholders" rationale to distinguish Omnicare. On the relationship between fiduciary duties and shareholder power, he again relied on principles of agency law:

To the extent defendants argue that the board’s fiduciary duties would be disabled after a hypothetical shareholder vote, this argument also misconceives the nature and purpose of fiduciary duties. Once the corporate contract is made explicit on a particular issue, the directors must act in accordance with the amended corporate contract. There is no more need for the gap-filling role performed by fiduciary duty analysis. Again, the same point can be made by reference to principles of agency law: Where the principal makes known to the agent exactly which actions the principal wishes to be taken, the agent must act in accordance with those instructions.

I would be interested in hearing others' views on this case, but my initial reaction is Chancellor Chandler made a fundamental error in his use of agency law. Simply stated, agency law does not govern the relationship between shareholders and directors. Agency law is a metaphor in this context, and like all metaphors, it breaks down when stretched too thin. By suggesting that shareholders potentially have direct power over any decision ordinarily made by the board of directors, Chancellor Chandler snapped! the the agency metaphor and ignored the teaching of many prior Delaware cases, which recognize an important role for the board of directors, even when they resist shareholders.

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