Corporate Governance

Delaware's Top Five Worst Shareholder Decisions for 2010 (#4: City of Westland Police v. Axcelis Technologies)

By J Robert Brown Jr.

Majority vote provisions have been trumpeted as a source of shareholder rights.  They give shareholders the right, in the absence of a proxy contest, to defeat directors nominated by management.  As we have noted, however, these rights are a myth.  Under Delaware law, the most that can happen if a director does not get the percentage dictated by a bylaw or governance policy is that the director must submit a letter of resignation to the board. 

As we have noted, this merely increases the discretion of incumbent directors.  Directors in general cannot remove those elected by shareholders, a relatively ancient but recently reaffirmed principle.  Majority vote provisions amount to an exception to this general rule.  By not providing majority support, shareholders merely transfer to the board the authority to remove the otherwise properly elected nominees.  Moreover, the pattern emerging already (and that was entirely predictable) is that the boards will routinely decline to accept the resignations of the defeated directors. 

The Delaware Supreme Court in City of Westland Police v. Axcelis Technologies, 1 A.3d 281 (Del. 2010) confirmed the mythical nature of majority vote provisions.  We posted on this case back in August.  Posts on the Chancery Court opinion date back to 2009.

In Axcelis, three directors on a staggered board did not get a majority of the votes cast.  They dutifully submitted their letters of resignation.  The Board declined to accept the resignations, mostly noting that it needed the experience and expertise of the defeated directors.  Thereafter, shareholders sought to inspect the records used by the board in rendering that determination.  The request was narrowly drawn.  Shareholders mostly sought agendas of meetings where the resignations were considered and documents distributed to the Board on the matter. 

The Chancery Court denied access to the documents.  Under prevailing law, plaintiffs were obligated to allege some type of mismanagement or improper behavior and produce credible evidence to support the allegations.  In other words, they had no automatic right to information about  board decisions that overturned the will of shareholders. 

The case effectively laid bare the use of pleading standards by the Delaware courts to deny shareholders access to information pursuant to their inspection rights.  The Chancery Court's decision, while philosophically inconsistent with the notion that shareholders have rights to information relative to their status as owners of the country, was faithful to the law created by the Supreme Court (see Seinfeld).   This use of pleading standards to deny shareholders access to information is discussed to some degree in Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty. 

Nonetheless, the lower court opinion was too much even for the Delaware Supreme Court.  Although affirming the decision to deny access, the Court did what it was asked to do in Seinfeld and did away with the credible basis standard, at least with respect to majority vote provisions.  In effect, the Court held that shareholders could get the underlying documents whenever directors refused to accept letters of resignation pursuant to a majority vote provision.

What the Court gave with one hand, however, it took away with the other.  The opinion made absolutely clear that the standard of review for board decisions to decline to accept resignations was the process driven, impossible to overturn, business judgment rule.  In doing so, the Court rejected application of the Blasius standard, somehow reaching the mystifying conclusion that refusing to accept the decision of shareholders was not a disenfranching act that required application of the compelling justification standard. 

The case makes clear that boards seeking to overturn the will of shareholders under a majority vote provision may do so for any rational reason (their experience is needed on the board).  Future inspection requests will produce evidence of a single meeting and documents that attest to the experience of the resigning directors. 

Axcelis made clear what many have suspected.  While shareholders can vote against an incumbent director under a majority vote provision, the board may (and will) ignore the message.  In other words, the decision confirms that any notion that a majority vote provision gives meaningful authority to shareholders is a myth. 

Full post as published by The Race to the Bottom on January 04, 2011 (boomark / email).