Corporate Governance

Delaware Courts and the Influence of Federal Preemption (part 1)

By J. Robert Brown

Many who pay attention to the Delaware courts noted that, in the aftermath of Enron (and, more importantly, federal intervention in the form of SOX), that the decisions seemed to have a somewhat less pro-management bias.  It was during this period that Disney for the first time gave content to the concept of "good faith," largely defining the standard as "conscious disregard."  It was arguably an important step since decisions that violated the good faith standard were not subject to the ubiquitous waiver of liability provisions.  Similarly, the court seemed a bit more reasonable on the standards for independent directors, as the decision in Krasner v. Moffett, 826 A.2d 277 (Del. 2003) suggested.

There were some who were suspicious that the shift was designed to prevent further encroachment by Congress into the Delaware reserved area of corporate governance.  (Take a look at footnote 382 in The Irrelevance of State Corporate Law in the Governance of Public Companies).  To the extent true, the cases represented an expediency rather than a genuine shift in approach.  And, in fact, the trend (if it really was one) didn't last.  When congressional interest in governance reform receded, the Delaware decisions returned to their more traditional, pro-management approach.

The question is whether we are about to see (or are seeing) a repeat performance.  Considerable criticism has been heaped on CEO compensation.  Congress included substantive limits on executive compensation in TARP and had them in the proposed auto bailout bill.  These are a direct result of the amounts paid to CEOs, particularly in connection with bonuses and golden parachutes.  While the efforts have (unfortunately) not taken the standards used by the Delaware courts to task by name, the reality is that the "excessive" payments to CEOs were invariably approved by the standards developed by the Delaware courts. 

Pressure is, therefore, building for reform of the method of determining executive compensation.  This would generally require preemption of Delaware law.  The question is whether there will be a noticeable shift in the Delaware decisions that are designed to tighten the fiduciary obligations of management (particularly in the area of executive compensation) in an effort to head off any effort at federal preemption.  We suggest that this may in fact be taking place.  The next few posts will give some possible examples.

Full post as published by The Race to the Bottom on December 15, 2008 (boomark / email).