Corporations: A Contemporary Approach Chapter 16 Public Shareholder Activism Slide 1 of 65 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 Slide 2 of 54 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 Slide 3 of 59 Business Judgment Rule Procedural / substantive presumption “Rule” vs. “doctrine”? Source / justifications for BJR? Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 4 of 54 Night baseball at Wrigley Field? [you’re on the Cubs board] Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 5 of 54 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! Slide 6 of 54 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 Slide 7 of 54 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) Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 8 of 54 Compare to other duties … Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 9 of 54 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 Slide 10 of 54 Justifications for BJR … Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 11 of 54 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 Slide 12 of 54 "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 Slide 13 of 54 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 Slide 14 of 54 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 of 59 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 Slide 16 of 54 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 Slide 17 of 54 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 Slide 18 of 54 September 20, 1980 Board meeting Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 19 of 54 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 Slide 20 of 54 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 Slide 21 of 54 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 Slide 22 of 54 How did the board fail? [what are the lessons?] Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 23 of 54 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 Slide 24 of 54 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 Slide 25 of 54 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 Slide 26 of 54 A bad dream … Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 27 of 54 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 Slide 28 of 54 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 Slide 29 of 54 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 Slide 30 of 54 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 Slide 31 of 54 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 Slide 32 of 54 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 of 54 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 Slide 34 of 54 Four-legged stool Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 35 of 54 (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 Slide 36 of 54 Four-legged stool Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 37 of 54 (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 Slide 38 of 54 How do shareholders respond to “grossly negligent” directors getting a free pass? Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 39 of 54 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 Slide 40 of 54 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 Slide 41 of 54 Four-legged stool Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 42 of 54 (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 Board Decision Making Slide 43 of 54 (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 Slide 44 of 54 (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 Slide 45 of 54 (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 Slide 46 of 54 Four-legged stool Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 47 of 54 (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 Chapter 18 Board Decision Making Slide 48 of 54 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 Slide 49 of 59 The end Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 50 of 54 What if business decision is illegal … Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 51 of 54 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.” Corporations: A Contemporary Approach Chapter 18 Board Decision Making Slide 52 of 54