Corporations:
A Contemporary Approach
Chapter 16
Public Shareholder Activism
Slide 1
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Henry Matisse, “Dance I” (1909) – MOMA, NYC
Module VII – Fiduciary Duties
Chapter 18
Board Decision Making
• Business judgment rule
Bar
exam
Corporate
practice
Law
profession
– Wrigley case: judicial abstention
– Reasons for BJR
– Exceptions to rule: fraud, illegality, conflicts (and
waste / gross negligence)
• Informed decision making
– Smith v. Van Gorkom
• background of case: company situation
• surprising result: explain?
– Causation and reliance
• Avoiding director liability
Citizen of
world
Corporations:
A Contemporary Approach
– Exculpation: § 102(b)(7)
– Indemnification: mandatory / permissive
– D&O insurance (who pays?)
Chapter 18
Board Decision Making
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1.
Fundamentals
–
–
2.
Corporations and policy
–
–
–
3.
Chapter 29
Planning in Close Corporation
Sale of control
Antitakeover devices
Deal protection
Close corporations
–
–
Corporations:
A Contemporary Approach
Securities markets
Planning
Securities fraud class actions
Oppression
Insider trading
Corporate deals
–
–
–
10.
Shareholder litigation
Board decision making
Board oversight
Director conflicts
Executive compensation
Corporate groups
Stock corporations
trading
Close
–
–
–
9.
Shareholder voting
Shareholder information rights
Public shareholder activism
Fiduciary duties
–
–
–
–
–
–
8.
10.
Piercing corporate veil
Corporate environmental liability
Corporate criminal liability
Corporate governance
–
–
–
7.
Numeracy for corporate lawyers
Capital structure
Corporate externalities
–
–
–
6.
Organizational choices
Incorporation
Locating corporate authority
Corporate finance
–
–
5.
Corporate federalism
Corporate social responsibility
Corporate political action
Corporate form
–
–
–
4.
Introduction to firm
Corporate basics
Planning
Oppression
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Business Judgment Rule
Procedural / substantive presumption
“Rule” vs. “doctrine”?
Source / justifications for BJR?
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Night baseball at Wrigley Field?
[you’re on the Cubs board]
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Night baseball at Wrigley Field?
BASEBALL TRIVIA (as of 1968)
1.How many teams play all of their
home games during the daytime,
no night baseball?
1.What percentage of major league
games are played at night?
1.What is Cub attendance,
compared to White Sox's?
1.What is Cub attendance on the
road, compared to home games?
1.Why did the Cubs' board adopt a
"daytime baseball" policy?
1.Can the Cubs afford lights for
night baseball?
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
1 – NONE
2 - 57.5%
3 - White Sox weekday higher
4 - higher on road
5 – Philip K Wrigley
6 – all others do!
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Return to lights in Wrigley Field …
Plaintiff’s allegations
Defendant’s response
"It is charged that ... such
arbitrary and capricious acts
constitute mismanagement and
waste of corporate assets, and
that the directors have been
negligent in failing to exercise
reasonable care and prudence
in management of corporate
affairs."
"... the courts will not step in
and interfere with honest
business judgment of the
directors unless there is a
showing of fraud, illegality or
conflict of interest ..."
Philip K Wrigley
“baseball is a daytime sport”
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Court’s dismissal –
"... it appears to us that the effect on the
surrounding neighborhood might well be
considered by a directors who was considering
the patrons who would or would not attend the
games ... the long run interest of the
corporation in its property value at Wrigley
Field might demand all efforts to keep the
neighborhood from deteriorating ...
"There ... is no allegation that there will be a
benefit to the corporation from [night baseball]
considering all increased costs ..."
"No mention was made of operation and
maintenance of the lights .. and we cannot
speculate as to what other factors might
influence the increase or decrease of profits if
the Cubs were to play night home games ...
Are these points
appropriate for
dismissal of complaint?
Shlensky v. Wrigley
(Ill. App. 1968)
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A Contemporary Approach
Chapter 18
Board Decision Making
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Compare to other duties …
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Duties
TORT LAW
ADMINISTRATIVE LAW
Phillip, an automobile driver drives
at night without headlights to save
money, even though 99.9% of
other drivers use theirs. Phillip
externalizes the costs of his
driving penchant – hurting many
pedestrian-strangers and other
roadway objects.
The Public Works Administration
(PW) is charged with bringing
modern infrastructure to as many
people in the valley as is
feasible. PW wires none of the
houses, even though power
administrations in other valleys
have wired 97.5% of their
houses.
Is he liable to those he hurts by
driving without "reasonable care
and prudence"?
Corporations:
A Contemporary Approach
Can a court enjoin PW for acting
in a way that is "arbitrary and
capricious"?
Chapter 18
Board Decision Making
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Justifications for BJR …
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Likely
outcomes
Option A
Option B
10%
$60
$1000
80%
$50
$0
10%
$40
($400)
Expected
value
$50
$60
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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"Hopefully, it's not a business
move gone wrong. We'll have to
wait and see what happens.
If it doesn't backfire, I won't have
a lot to say. If it does backfire, I
will have a lot to say."
Shaquille O'Neal
(on trade of teammate)
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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1977:
1981:
1988:
Corporations:
A Contemporary Approach
Philip K Wrigley dies – on deathbed, “never sell”
Son sells team to Chicago Tribune
Chicago ordinance banning night baseball rescinded
August 9 - First night game
Chapter 18
Board Decision Making
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1. The BJR is …
a. A substantive rule that protects
directors from liability
b. A procedural rule that protects
directors from liability
c. Both substantive and procedural
4. If claiming the BJR for a board decision,
Ds must show …
a. there was no corporate waste
b. They had no conflicting, financial
personal interest in the decision
c. Nothing – the burden is on the plaintiff
2. The BJR ensures …
a. Courts do not interfere with goodfaith board decisions
b. Directors feel confident to take
risks, even when uncertain
c. Shareholders do not interfere with
centralized management
5. Bad decisions by the board …
a. Can be challenged if they prove
harmful to corporation
b. Can always be reversed if Shs vote in
new Ds
c. Eventually will be “corrected” by the
product/services market
3. There are exceptions to the BJR …
a. If Ds were negligent in gathering
information
b. If Ds had a personal interest in a
board decision
c. If Ds were careful + disinterested,
but approved illegal corporate
conduct in best interests of corp
6. In Shlensky v. Wrigley, the suit was
brought as …
a. A derivative suit seeking damages
and injunction against Ds
b. A class action seeking damages from
Ds and injunction against corporation
c. A direct suit against Philip Wrigley, for
not being more sensitive to Shs
Answers: 1-c / 2-abc / 3-c / 4-c / 5-c / 6-a
Corporations:
A Contemporary Approach
Chapter 29
Planning in CHC
Slide 15
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Smith v. Van Gorkom
Trans Union board decision?
What did court say was wrong?
Can you explain Trans Union?
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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A nagging tax problem
Trans Union owns and leases rail cars
-- a great business in the 1970s.
The company garners 20% return on
equity, with cash flow of 3 times
earnings.
Too much of good thing: Trans Union
has more depreciation than it can
use. Moreover, the company can't
use its investment tax credits since
it has no taxable income to offset.
Some competitors (with less cash flow
than Trans Union) can take all the
tax breaks. What are the options?
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Problems / Solutions
• Get Congress to pay for
unused investment tax credits
Revenues
Business is
good
Cash flow
Could handle
more debt
Tax deductions
Too high
to use
Taxable income Too low
Inv tax credits
Corporations:
A Contemporary Approach
Can’t use
fully
• Acquire businesses to
generate taxable income
• Sell to a public company that
wants tax benefits
• Sell to a private company that
wants tax benefits
• Sell in a management buyout
(management borrows to buy
the company)
Chapter 18
Board Decision Making
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September 20, 1980
Board meeting
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Jerome W. Van Gorkom
• Born: 1918 (age 62) raised in
Depression by mother on
welfare
• 1939 - Univ.. of Illinois (BS,
business)
• 1941 - Univ. of Illinois (law
degree)
• 1941-1945 - Navy
(engineering officer)
• 1945-1947 - private law
practice
• 1947-1955 - Arthur Andersen
(tax lawyer, CPA)
• 1955-1963 - Union Tank Car
(controller)
• 1963-present - Trans Union
(CEO and director)
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Jerry Van Gorkom :
"Thank you, gentlemen, for making it to this
special Saturday board meeting on such
short notice.
We just got an offer to sell the company for
$55 per share. This is a 50% premium over
the current trading price of $38.75.
And it's 62% better than the average of our
high and low prices this year. The offer
comes from Jay and Tom Pritzker -- the
Hyatt Billionaires. They're serious. We have
until tomorrow PM to say yes or no.“
Jay Pritzker
I negotiated Jay down on a stock lock-up – he
wanted 1.75 million shares, I got him to
accept one million.
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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What do you want to know?
Outside directors:
• A.W. Wallis: Economist; Dean Chicago MBA; Chanc - Univ.
Rochester (director since 1962).
• William B. Johnson: Law degree;
CEO - IC Industries (director since
1968)
• Joseph Lanterman: CPA; CEO American Steel (director since
1976)
• Graham Morgan: Chemist; CEO US Gypsum (31 corporate
takeovers)
• Robert Reneker: Harvard MBA;
CEO - Swift & Co (director since
1971)
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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How did the board fail?
[what are the lessons?]
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Delaware Supreme Court
"... the party attacking a board
decision as uninformed must
rebut the presumption that its
business judgment was an
informed one. … The concept
of gross negligence is the
proper standard”
"... in the merger context, a
director may not [leave] to the
shareholders alone the
decision to approve or
disapprove the agreement."
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Delaware Supreme Court
"On the record before us, we must
conclude that the Board of
Directors did not reach an
informed business judgment on
September 20, 1980 in voting to
“sell” the Company at $55 per
share. ...
The directors did not adequately
inform themselves -(1) Van Gorkom's role in "sale"
(2) Intrinsic "value" of company
(3) Details of deal (two hour
meeting, without prior notice and
without crisis)
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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What about BJR deference?
1.
50% premium over market price – this was a
great price (in hindsight)
2.
Test market period for 90 days – GE Capital
and KKR showed interest, but backed off
3.
Collective experience of directors – these folks
understood takeover “game” and its risks
4.
Legal opinion that no need “fairness opinion” –
in any event, Boston Consulting study said
Trans Union = $55
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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A bad dream …
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Directors pay!!
Nine blue-chip directors were ordered
personally to pay the difference
between the selling price and the
"real" market value of the company.
They later settled at $23.5 million -- $10
million paid by D&O insurance and
the remainder by Pritzker (on the
condition directors would contribute
$1.35 million to charities)
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Meaning of case
1. Judicial second-guessing: a new development in corporate common
law and level of judicial review
1. New board procedures (rather than substance): courtroom process
brought into boardroom
2. New role for outside directors (and lawyers): new definition of “good”
corporate governance
3. Court reacts to “fast shuffle”: Van Gorkom (conflicted) bamboozled
board
4. Delaware gives plaintiff’s bar some meat: Delaware continues
corporate law preeminence
5. Delaware, looking at Washington, DC, puts itself in driver’s seat of
corporate law: answers “wings effects” of threatened federalization
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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The year is 1985, the month is January.
You are a prestigious corporate
lawyer in Delaware.
Group hypo
The Council of the Corporate Law
Section - the Delaware bar
association’s special drafting
committee for corporate law reforms
– has asked for your advice.
The Trans Union decision has just
come out, and you like many others
are surprised. Some on the Council
think the Council should respond;
others not.
(1) What is your view on theTrans
Union case?
(2) What would you recommend to the
Council?
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Group answers
Meaning of Smith v. Van Gorkum?
•
•
•
•
•
Court responds to facts, not new law (board lapse of attention) – 3
Court requires more process (deliberation, disclosure to Shs) – 8
Court creates new law and exposes Ds to liability – 4
Court responds to “fast shuffle” / disloyalty of Van Gorkum - 2
Court sends message to DC that Delaware will oversee corps - 2
What should Council do?
•
•
•
•
•
•
Do nothing (let court define BJR, fiduciary duties) – 7
Propose comment to DGCL that Ds must be informed – 1
Propose statutory definition of “gross negligence” - 1
Propose statutory procedures for boardrooms – 4*
Propose adoption of MBCA S 8.30 (standards of conduct) - 1
Propose charter exculpation of directors – 3
* With an attorney at all board meetings
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Avoiding Director Liability
1.
2.
3.
4.
Corporations:
A Contemporary Approach
Proximate cause and BJR
Exculpation clause
Indemnification
D&O insurance
Chapter 18
Board Decision Making
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Director liability?
"Nothing in the history of development of
corporations or corporation law
suggests that the personal assets of
directors were intended to constitute a
financial safety net for stockholder or
others willing to second-guess
directors' decisions.“
James J. Hanks,
True or false?
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
leading practitioner on
director liability avoidance
(survivor of Flight 1549
(“Miracle on Hudson”)
Slide 33
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Protect Your Board
Attend the Delaware Law Issues Update
Learn the latest on:
• state and federal corporate and securities
class action practice and derivative litigation
• boards' fiduciary duties relating to executive
and director compensation
• books and records demands under Delaware
law, shareholder demands that boards bring
action against alleged wrongdoers
• M&A trends and developments in
nondisclosure agreements and standstill
agreements
• recent shareholder activism, including at
companies like Dell, Herbalife, Agrium, Hess,
Yahoo!, Sony and others
• minute taking, post-meeting follow-up and
Board and committee presentations
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Four-legged stool
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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(1) BJR and causation
Remember Trans Union
Even if the directors had
been properly attentive
would they have
necessarily gotten a better
price?
Some caselaw:
•
•
•
Barnes v. Andrews
(SDNY 1924)
Francis v. United Jersey
Bank (NJ 1981)
Cinerama v. Technicolor
(Del 1993)
What’s the harm they
caused?
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Four-legged stool
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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(2) Exculpation
Del. GCL § 102 Contents of certificate of
incorporation.
(b) ... the certificate of incorporation may
also contain ...
Go back again to
Trans Union facts.
Would the directors
have been liable if
corporation had
102(b)(7) clause?
Corporations:
A Contemporary Approach
(7) A provision eliminating or limiting the
personal liability of a director to the
corporation or its stockholders for
monetary damages for breach of
fiduciary duty as a director, ... provided
that such provision shall not eliminate
or limit the liability of a director:
(i) For any breach of the director's
duty of loyalty to the corporation or
its stockholders;
(ii) for acts or omissions not in
good faith or which involve
intentional misconduct or a knowing
violation of law;
(iii) under § 174 of this title; or
(iv) for any transaction from which
the director derived an improper
personal benefit.
Chapter 18
Board Decision Making
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How do shareholders respond to
“grossly negligent” directors
getting a free pass?
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Event Study
Bradley & Schiapani, 75 Iowa 1 (1989)
• After Trans Union D&O premiums go up for $1MM coverage $3200 premium goes
to $23,000 (from 2nd qtr to 3rd qtr 1985)
• Compare DE corporations vs others:
1. Trans Union -- no statistical effect on
Delaware corporation stock prices
2. Delaware's adoption of 102(b)(7) -negative effect (minus 2.67%) on Delaware
corporation stock prices
3. Firm-specific adoption of exculpation
clauses -- negative effect (minus 0.56% )
on specific company’s stock prices
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Pleading “exculpation” clause
Complaint
Direct suit
Derivative suit
Demand excused
No demand required
Motion to dismiss – no BJR protection
Lack due care
Lack loyalty / good faith
Dismiss 102(b)(7)
Merits !!
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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Four-legged stool
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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(3) Indemnification
Go back again to Trans
Union facts.
(1) Could directors have
insisted that corporation
indemnify them?
(after all they were trying to do the
right thing!)
(2) What about advancing
their litigation expenses?
Corporations:
A Contemporary Approach
NC Bus Corp Act § 55-8-52
Mandatory indemnification
Unless limited by its articles of
incorporation, a corporation shall
indemnify a director who was wholly
successful, on the merits or otherwise, in
the defense of any proceeding to which he
was a party because he is or was a
director of the corporation against
reasonable expenses incurred by him in
connection with the proceeding.
NC Bus Corp Act § 55-8-51
Authority to indemnify
(a) ... a corporation may indemnify an
individual made a party to a proceeding
because he is or was a director against
liability incurred in the proceeding if:
(1) He conducted himself in good faith; and
(2) He reasonably believed ... that his
conduct was in [the corporation's] best
interests ...
Chapter 18
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(3) Indemnification
Go back again to Trans
Union facts.
(1) Could directors have
insisted that corporation
indemnify them?
(after all they were trying to do the
right thing!)
(2) What about advancing
their litigation expenses?
Corporations:
A Contemporary Approach
NC Bus Corp Act § 55-8-53
Advance for expenses.
Expenses incurred by a director in
defending a proceeding may be paid
by the corporation in advance of the
final disposition of the proceeding
as authorized by the board of
directors in the specific case or as
authorized or required under any
provision in the articles of
incorporation or bylaws or by any
applicable resolution or contract
upon receipt of an undertaking by
or on behalf of the director to repay
such amount unless it shall ultimately
be determined that he is entitled to be
indemnified by the corporation against
such expenses.
Chapter 18
Board Decision Making
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(3) Indemnification
NC BCA § 55-8-51
Authority to indemnify
Shareholders
(d) A corporation may
not indemnify a director
under this section:
(1) In connection
with a proceeding by
or in the right of the
corporation in which
the director was
adjudged liable to
the corporation;
Corporations:
A Contemporary Approach
“on behalf of
corporation”
“direct”
liable
liable
cannot
indemnify
Chapter 18
Board Decision Making
Board
Corporation
indemnify
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(3) Indemnification
NC BCA § 55-8-51
Authority to indemnify
Shareholders
(d) A corporation may
not indemnify a director
under this section:
(1) In connection
with a proceeding by
or in the right of the
corporation in which
the director was
adjudged liable to
the corporation;
Corporations:
A Contemporary Approach
“on behalf of
corporation”
“direct”
liable
liable
cannot
indemnify
Chapter 18
Board Decision Making
Board
Corporation
indemnify
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Four-legged stool
Corporations:
A Contemporary Approach
Chapter 18
Board Decision Making
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(4) D & O Insurance
NC Bus Corp § 55-8-57
Additional indemnification and
insurance
Remember Trans Union.
(1) After the case was
remanded the D&O
policy paid its limit of
$10 million?
(2) Why can corporation pay
for D&O premiums but
not be allowed to
indemnify?
(c) A corporation may purchase and
maintain insurance on behalf of an
individual who is or was a director
... against liability asserted against
or incurred by him in that capacity
or arising from his status as a
director ... whether or not the
corporation would have power to
indemnify him against the same
liability under any provision of this
Chapter.
In 2007, GE paid $20.7 million for D&O insurance.
In 2013 only $8.7 million. Hmm, wonder what’s up?
Corporations:
A Contemporary Approach
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Board Decision Making
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1. In a suit in Delaware claiming Ds
breached fiduciary duties …
a. Shs must prove Ds’ action was
prox cause of harm
b. Once Shs proves breach, Ds’
burden to show no prox cause
c. Shs must only prove breach; prox
cause not issue
2. In Delaware legislative adoption of
102(b)(7) led to …
a. Relative decline in market value of
DE corporations
b. No market price effects
c. Few DE corps adopting
exculpation clauses
3. Assume TransUnion had 102(b)(7)
clause in articles …
a. Merger couldn’t be challenged
b. Ds have no personal liability for
gross negligence
c. Ds only liable if merger illegal
4. If Trans Union came up in MBCA
jurisdiction, indemnification …
a. Available to Ds as of right
b. Available to Ds permissively
c. Not available because case was
derivative suit
5. If Trans Union facts came up in an MBCA
jurisdiction, Ds can …
a. Get advancement of litigation
expenses, only if successful
b. Get advancement of litigation
expenses, if agree to repay
c. Cannot get advancement because
derivative suit
6. In MBCA, D&O insurance …
a. Can cover corporation’s
indemnification of Ds
b. Cannot be paid by corporation, but
instead only by individual D/Os
c. Cannot cover liability for which
indemnification is not available
Answers:
Corporations:
A Contemporary Approach
Chapter 29
Planning in CHC
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The end
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A Contemporary Approach
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Board Decision Making
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What if business decision is illegal …
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BJR and Illegality
Second Circuit:
“BJR eschews intervention in
corporate decision-making
“When decision not to collect a
debt [to DNC] … is itself an
illegal act, different rules apply.
“For reasons for public policy,
[corporate activity] must be
condemned.”
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A Contemporary Approach
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