Corporate Governance

Portnoy v. Cryo-Cell: Vote Buying, Manipulation of the Voting Process, and the Race to the Bottom (Part 6)

By J. Robert Brown

We are discussing Portnoy v. Cryo-Cell, CA No. 3142-VCS, Del. Ch., Jan. 15, 2008, a 73 page tome issued by the Delaware Chancery Court.  Primary materials, including the case, can be found at the DU Corporate Governance web site.

Plaintiff challenged a number of practices used by management to succeed in a proxy contest. The court agreed that a number of practices were improper, including the failure to disclose that a seat on the board had been bargained away to a large shareholder supporting management, the use of coercion by management to induce a shareholder to support its slate and conduct at the meeting itself. As the opinion noted:

• "In this case, unlike in Inter-Tel, [the CEO] gave the assembled stockholders false reasons for delay and was not acting in good faith to ensure that stockholders had more time to consider an arms-length transaction that was at danger in a time of economic tumult. Rather, she misled the meeting attendees about the reasons for delay, did not use the period of delay to release a quarterly report that was adverse, and closed the polls as soon as she knew her side would win."

With such behavior, what was the remedy? The court agreed to set aside the election, returning the board to its preelection state, requiring the shareholder who had sided with management and obtained a position on the board to step down.  Id.  (shareholder's "claim to office has no pre-existing legitimacy and he shall leave the board until he is elected by the stockholders.").  There would need to be a "prompt special meeting" for a new election, rather than wait until the next annual meeting.  Moreover, in a highly unusual move, the court imposed on management the costs associated with the new election.  Id.  ("A more fitting way to address the cost concerns is to require the Management Slate to bear the costs of their own proxy solicitation efforts, the costs to the corporation of holding the meeting, and the costs of a special master to conduct the meeting."). 

At first blush, it looks like a victory for the Plaintiff.  But it was anything but that.  The Defendant CEO who was responsible for most of the challenged behavior was allowed to remain on the board.  Only the shareholder siding with management was removed, a result management probably favored.  Moreover, while requiring management to pay its own solicitation expenses for the upcoming meeting, the remedy did nothing to defray the already significant costs incurred by Plaintiff. 

Still without board representation, he had paid the costs of the initial solicitation, one that he arguably would have won but for the behavior of management.  In challenging the actions of management, he had to pay his own attorneys fees.  None of these costs were ordered repayed by the court.  Instead, as a result of the court's order, there would be yet another shareholder election, with Plaintiff having to pay his own costs.  Presumably if management again engaged in questionable behavior, Plaintiff's reward would be continued exclusion from the board and additional litigation expenses.

And why did Plaintiff not get his fees or election costs reimbursed?  Because he had the temerity to talk with a former employee who had signed a confidentiality agreement.  As the court noted, there would be no fees awarded "as a fitting consequence for [Plaintiff's] dalliance with [the former employee], a course of conduct that I do not believe disentitles him to a remedy but that ought to have some consequence."   This was true despite the court's acknowledgement that the Plaintiff had done nothing improper with the information and that the confidentiality agreement may have been put in place to prevent others from discovering potentially inappropriate behavior by management.

This case sends a strong message.  Shareholders wanting to challenge management will get little reasonable relief, even when they establish improper actions by management.  This is also an area ripe for federal preemption.  Had management not known in advance that it was losing the tally, the CEO might not have embarked on such an aggressive program to defeat Plaintiff.  Perhaps Congress should step in and give the Commission greater authority to oversee the election process, including insuring the integrity of the voting process.

Full post as published by The Race to the Bottom on February 13, 2008 (boomark / email).