Corporate Governance

Shareholder Access and the Advocacy Role of Delaware in the Corporate Governance Debate: The Enabling Approach to Management Friendly Governance (Part 2)

By J Robert Brown Jr.

We are examining the Amicus Brief submitted by the State of Delaware in Business Roundtable v. SEC, the case challenging the SEC's rule providing certain shareholders with access for their nominees to the proxy statement. 

The Brief characterizes the law in Delaware as "enabling."  The law, therefore, "grants corporations and their stockholders broad latitude to privately order their corporate governance structure."  Brief, at 3.  The characterization is designed to contrast with shareholder access, which is labeled as a one size fits all provision.

To the extent the concept of "enabling" is used as a sub text to suggest bargaining among shareholders and management to achieve economic efficiency (in this context, profit maximization), the characterization is flawed.  First, as we have shown, terms like "enabling" and "private ordering" are really concepts synonymous with a management friendly approach to regulation.  Thus, when Delaware adopted Section 102(b)(7) to allow for waiver of liability provisions, the idea was to permit private ordering.  The provision had to be proposed by management and adopted by shareholders as part of the articles of incorporation. 

This is because Delaware has a particularly unfavorable environment for private ordering.  For example, only management can propose charter amendments.  Moreover, as the ones proposing the provision, management controls the drafting.  Once in place, shareholders cannot initiate revisions.  As a result, the largest companies (save for some reason Pepsi) all have waiver of liability provisions and all waive liability to the fullest extent permitted by law.  See Opting Only in: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom.  In other words, under the rubric of private ordering and enabling, Delaware effectively eliminated one categorical rule (liability of directors for breach of the duty of care) and replaced it with another management friendly categorical rule (no liability for management in the event of breach of the duty of care). 

Staggered boards are another provision that commonly appears in the articles and is, therefore, beyond the reach of shareholders to change.  Thus, whole swathes of corporate governance matters are outside the control of shareholders.  They can try to force management to initiate a change but this is a very cramped notion of private ordering.  It would equate unilateral authority for management with private ordering since management could always be pressured not to use the authority.

There are many other ways in which Delaware makes private ordering difficult for shareholders.  Shareholders cannot adopt bylaws that "interfere" with the day to day management of the company, see Bebchuk v. CA, Inc., 902 A.2d 737, 743 (Del. Ch. 2006) ("the question of whether a bylaw unduly restricts the ability of a board of directors to exercise its fiduciary duties can only be examined in the context of an enacted bylaw that is said to actually threaten the board's ability to discharge its obligations to the corporation and its stockholders."), a restriction that has been broadly read to include almost any bylaw that triggers some type of mandatory corporate expenditure.  See CA v. AFSCME, 953 A.2d 227 (Del. 2008).

Moreover, even if shareholders manage to adopt a bylaw that will not be invalidated because of this interference (see CA v. AFSME, at 240, to see how difficult this can be), management in Delaware arguably has the authority to repeal it, even if shareholders include language that prohbits the action.  The uncertainty is particularly noticeable given the clarity of MBCA jurisdictions on the issue.  See Brett H. McDonnell, Shareholder Bylaws, Shareholder Nominations, and Poison Pills, 3 Berkeley Bus. L.J. 205, 261 (2005) ("It is an open, and rather puzzling, question in Delaware whether the board may amend a shareholder-passed bylaw where the bylaw on its own terms states that the board may not do so. In states that follow the Model Business Corporation Act, the Act clearly provides that the board may not do so.").  

Shareholders in Delaware cannot put in place true majority vote provisions (Delaware provides for election by plurality but allows for a mandatory letter of resignation should a director not receive the required percentage).  Again, this contrasts with the MBCA that allows bylaws to shorten the terms of directors who did not receive majority support to 90 days, with no discretionary actions by the board. 

Moreover, when the resignation letters are submitted under a majority vote provision and the board declines to accept them (which has occurred and likely to be the norm), the courts have held that the decision will be reviewed under the duty of care and business judgment rule (see Axcelis), effectively making the decision unreviewable (the duty of care is a process standard). Thus, shareholders have no authority even under majority vote provisions to compel a director to step down. 

An enabling approach sounds good but the right has to be meaningful.  In Delaware, for most matters of corporate governance, it is not.  Indeed, the one sided nature of the "enabling" approach employed by Delaware is what has generated the need for shareholder access. 

For a history of the SEC's efforts to provide for shareholder access (a process that dates back to 1942), see The SEC, Corporate Governance, and Shareholder Access to the Board Room.  Assorted briefs and motions in this case can be found at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on February 01, 2011 (boomark / email).