Corporate Governance

Delaware's Top Five Worst Shareholder Decisions of 2007

By J. Robert Brown

As the year comes to an end, we review the decisions issued by the Delaware courts.  These are the decisions that most show the anti-shareholder, anti-plaintiff nature of the Delaware courts and reflect the race to the bottom.  We have many choices, but the five that most fit this criteria are discussed below.  We encourage readers to submit comments on cases that they believe ought to go into the top 5.

#5  Openwave Systems v. Harbinger Capital Partners, 924 A.2d 228 (Del. Ch. 2007).  The case illustrates just how difficult it is for shareholders to put someone on the board over the opposition of management.  For a post on the decision, go here.   

In this case, shareholders succeeded in electing a director over management's opposition.  The Chancery Court overturned the election, finding that the shareholder (labeled a hedge fund, never a good sign for plaintiff) violated an advance notice bylaw.  The bylaws, however, were poorly drafted and conflicted with each other.  Moreover, the meeting date (Jan. 17) was only announced on December 1, with plaintiff submitting the nominees on December 28.  The relatively short time for scheduling the meeting, the confusion in the bylaws, and the fact that one of the nominees got the most votes of all candidates, made no difference to the court.    

#4  Highland Select Equity Fund, L.P. v. Motient Corp., 2007 Del. Ch. LEXIS 37 (Del. Ch. March 14, 2007), aff'd, 2007 Del. Lexis 157 (Del. Apr. 4, 2007).  The case illustrates the many barriers thrown up by the Delaware courts to the exercise of inspection rights. 

In this case, plaintiff, a large shareholder, sought to invoke its inspection rights.  The shareholder wanted to investigate mismanagement, an obvious proper purpose.  The court acknowledged that the shareholder had provided "credible evidence at trial" to support the purpose but nonetheless denied the right to inspect, finding that the shareholder in fact had an improper purpose.  The decision was remanded by the Supreme Court questioning the reasoning of the decision. 

On remand, the Chancery Court again found that the shareholder had an improper purpose.  The evidence?  Primarily the length of the demand letter.  "The starting point of this analysis is a demand letter that suffers from such extreme overbreadth that it is impossible to conclude that it was drawn in a good faith effort to comply with the clear, controlling authority of the Delaware Supreme Court. That letter spanned 25 single-spaced pages and included 47 categories requiring the production of 'all books, records, documents, and correspondence in the Company's possession, custody, or control that constitute, identify, analyze, discuss, evaluate, consider or address' a wide variety of issues."  There were other reasons, none any more valid.  The case illustrates that even when a shareholder agrees to submit to the costs associated with inspection rights, the time delay involved, and has a proper purpose, Delaware courts can still find a way to deny it the right to inspect.   

#3  Mercier v. Inter-Tel, 929 A.2d 786 (Del. Ch. 2007), a decision providing directors almost carte blanche to reschedule a meeting whenever they are losing.  Posts on this case can be found here andhere. 

The case arose where management submitted to shareholders a proposed merger.  As the proxies came in, management could tell that the merger would be defeated.  A committee of the board opted to reschedule the meeting and change the record date.  They did so even though shareholders were voting against any adjournment in the event that the merger lacked sufficient votes for approval.  See 929 A.2d at 804 ("As an initial matter, I acknowledge the fact that, at the SEC's prodding, Inter-Tel included on its proxy ballot a proposal regarding whether or not to adjourn the special meeting if there were not sufficient votes to approve the Merger and that a majority of Inter-Tel's stockholders voted against an adjournment."). 

The change in the meeting date allowed management more time to lobby shareholders.  The change in the record date allowed arbitrageurs and other short term investors to have a vote in the ultimate outcome.  Without separating the two issues, the court concluded that management merely needed to show that its decision was reasonable.  Reasonable meant that management believed approval of the merger was in the best interests of shareholders.  Of course, the mere fact that the directors submitted the matter to shareholders was evidence that they believed it was in the best interests of shareholders.  The case, therefore, stands for the proposition that anytime management is losing a vote on something it submitted to shareholders, it will invariably be "reasonable" to reschedule the meeting.  This places in the hands of management enormous authority to manipulate the voting process.  

#2     Desimone v. Barrows, 924 A.2d 908 (Del Ch 2007).  This decision is a poor one for many reasons, both on the merits and for its efforts to make backdating just another form of executive compensation. 

This decision refused to allow a backdating case to go forward despite statistical evidence indicating that the practice had occurred.  The vice chancellor writing the opinion engaged in shameless dicta setting out potential justifications for backdating and the use of spring loaded options.  The case is full of hypotheticals, none of which are directly relevant to the case.  Fortunately, the opinion has not been followed in subsequent chancery court decisions.  For posts on the case, go here, here, here, andhere. 

#1   While we could have come up with a number of other cases in our ranking, the worst offender goes to the use by the members of the Delaware judiciary of opinions and external speeches to expound upon matters of corporate governance that could appear before the courts or reflect a judicial predisposition.  We note as an example VC Strine's willingness to comment on multiple aspects of corporate governance, including his views onshareholder activists and his use of dictum in Desimone to comment on backdating, including the use of hypotheticals.  It is clear that some members of the judiciary enjoy the spotlight.  Nonetheless, as we have noted, this involves an inappropriate judicial disposition and transforms them into another interest group involved in the corporate governance debate, something that will ultimately make federal preemption of state law principles easier. 

Full post as published by The Race to the Bottom on January 03, 2008 (boomark / email).