Delaware Courts: The Best Alternative For Business

Monday, May 2, 2011 - 11:00

Editor: Delaware's Complex Commercial Litigation Division (CCLD) now offers a fast track, court-based resolution for qualified commercial disputes. Tell us about this development. Where does it fit into the traditional spectrum from arbitration to full-scale litigation?

Steele: CCLD has garnered significant interest. I attended a recent ABA Business Law Section meeting, and there was considerable talk among the business and corporation litigation committee attendees about the efficacy of this new division. While initial growth is slow, most litigators believe that CCLD is of great use, and I expect it to grow quickly as the legal community acclimates.

Where does it fit in the traditional spectrum? It is an attractive, non-traditional option that merges the best of ADR with the best of judicial fact-finding and opinion-writing. CCLD is meant to be fast track, which appeals to ADR advocates. Further, it resolves what many litigators dislike about ADR, in that it preserves the expansion of the common law to offer perspective and predictability to the Law.

ADR decisions cannot be cited or relied upon to generate predictable results for future cases with similar fact situations. Predictable results produce more dispute resolution. If parties can refer to written case law and make a value judgment about what the result might be when applied to their facts, cases tend to go away.

Editor: Has CCLD become more popular?

Steele: Yes. When cases arise, parties should consider CCLD an attractive option - if they are aware it exists. Right now, growth is represented in increasing awareness and interest more than in actual filings. Further growth may be generated if parties opt to specify CCLD in forum selection clauses for dispute resolution within contracts.

Conceived by our Superior Court judges, CCLD combines efficiency and quick results within a court system that both engages judges who understand business law and provides an ongoing basis for predictability. CCLD preserves the best of both worlds and shows promise of being successful.

Editor: To what extent has federal legislation intruded on issues normally left to state courts? What are your concerns with respect to Dodd-Frank?

Steele: There are many perspectives. To start, federal legislation tends to be crisis driven and rarely adds anything of enduring quality, as certainly was the case with Dodd-Frank (the Bill). Unfortunately, Dodd Frank and similar initiatives are rarely revisited, after the crisis subsides, to adjust for unintended consequences.

Of the Bill's 2,300 pages, 24 purportedly relate to corporate governance, which is a matter of state law. Traditionally, corporations decide where to charter based on the extent to which a state's legislative and judicial services fit their needs. Any sweeping federal legislation should incorporate sufficient data to convince all constituencies that those changes will result in better performance. Because it is not based on such empirical data, the Bill serves mainly as a sop to certain political constituencies.

Specifically, the Bill is politicized because the proposed changes are skewed in favor of institutional shareholders, many of whom contribute generously to political campaigns of legislators. These shareholders capitalized on what was a brief window of opportunity for sympathetic views by substantial majorities in both houses of Congress and by the President. In merging what had been six individual bills, Dodd-Frank may be less intrusive than would have been the combined legislation, had all six passed. Congress wisely declined to mandate majority voting and did not proscribe staggered boards in exchange for say-on-pay and proxy access.

In theory, requiring expanded shareholder communication about company operations is a positive step; however, broad-based federal requirements are unnecessary and certainly impose additional expense on business operations. When politics drives legislation, we are left to ponder the wisdom of subverting traditional state schemes for the unknown where interested parties in the state can explore legislation alternatives and empirically assess what change actually results in better performance - an option lost when the feds mandate a one-size-fits-all regime.

Editor: Are Delaware law and Delaware state court decisions still the most influential sources of authority with respect to Delaware law?

Steele: Yes. Delaware courts are the ultimate authority with respect to Delaware General Corporation Law (DGCL) and persuasive authority with respect to the ABA's Model Business Corporation Act. In general, state and federal courts strive to interpret Delaware law consistent with what they believe Delaware's Court of Chancery and Supreme Court would hold.

Absent extraordinary circumstances, when confronted with a venue issue in multi-jurisdictional litigation, cases involving Delaware corporations or interpretation of Delaware law we follow a first-filed rule. For years, we've maintained that other jurisdictions can apply Delaware law effectively. Only when there's a fundamental issue - a case of first impression - would we ignore the first-to-file rule and take the case ourselves. Otherwise, we'll either grant a motion to stay or dismiss it, depending on the nature of the case.

So I'm not troubled at all by the fact that there are other state and federal courts deciding cases based on Delaware law. I don't see any widespread misapplication of the law, and I do see widespread respect for the way in which Delaware courts would interpret it.

There's also an option for the U.S. courts, high courts in other jurisdictions and the SEC to certify questions of law and seek assistance from Delaware courts - when it's a close question or one of first impression. Recently U.S. District Court Judge Jed S. Rakoff of the Southern District of New York certified to us a question about the implications of a double derivative suit in the context of the Bank of America takeover of Merrill Lynch.

We take on these issues in aid of other courts when the facts are not in dispute, and those courts seek our advice on Delaware law.

Editor: To what extent does Delaware continue to lead the nation in being the incorporating jurisdiction of choice? What advantages does it offer?

Steele: Delaware still leads the nation with 61 percent of the Fortune 500 and with 51 percent of all publicly traded corporations - despite the alternatives. For example, if a corporation wanted governance changes that were proposed in the original six federal bills, mentioned above, they could incorporate in North Dakota - where all six bills changes are mandated. Only two corporations have reincorporated in North Dakota since that state enacted a governance mandate two years ago.

Incorporating in Delaware still offers all the advantages of our basic enabling statute (the DGCL), a knowledgeable court system, a substantial body of case law, predictability and an efficient system that includes the CCLD.

Editor: What are the key considerations for international corporations that want to incorporate in the U.S.? Are they tending to select Delaware?

Steele: It's a difficult question because international corporations have varying ideas about the advantages of incorporating anywhere in the U.S., much less in Delaware specifically. For many, it's the "tax tail that wags the dog." Sadly, because of Sarbanes-Oxley, Dodd-Frank and the cost of largely federal regulations, international corporations choose Hong Kong, London or London-related jurisdictions like the Cayman Islands, British Virgin Islands or Channel Islands.

These choices are driven by perceptions of federal impairments to doing business as a U.S. corporation, Delaware or otherwise. Traditional business activities constituting reasons to incorporate in the U.S., such as raising equity, are easier in China and Hong Kong, which have substantial cash and liquidity and less onerous regulatory restrictions.

When international companies have a valid business reason to incorporate in the U.S. - despite tax disadvantages and regulatory costs - they tend to choose Delaware for the same reasons as would U.S. corporations. Overall, Delaware does not offer special incentives to international business.

Editor: Why has the Delaware Supreme Court decision in Airgas, Inc. v. Air Products and Chemicals, Inc . received much attention?

Steele: There are two reasons. First, one of the three chancellor opinions suggested a difference of opinion between the Court of Chancery and the Supreme Court on the fundamental issues in the case. Judicial disagreement always draws attention.

Second, Airgas teed up a core issue, particularly among academics, institutional shareholders and organizations like the National Association of Corporate Directors (NACD). Specifically, is Delaware still a director primacy state, or have we moved toward the trendier shareholder democracy regime?

Airgas focuses on the relative authority of the board and the shareholder base when they may be at odds over a hostile acquisition. Who should prevail and under what circumstances, and who has the last word on whether an acquirer's offer is sufficient?

We all know the board has fiduciary duties to act in the best interest of the corporation and its shareholders. The Delaware statute authorized Airgas to have a staggered board. As a potential acquirer, Air Products sought to unseat staggered board members, and, in fact, elected three of its own in a proxy contest.

The question then centered on how quickly Air Products could force an election for the next three of the "three-three-three" staggered board by passing a bylaw that alters the annual meeting schedule. Under dispute was whether a 51 percent shareholder vote could override a concurring opinion - by both the board and Institutional Shareholder Services (ISS) - that the offer was too low.

Air Products responded by passing a bylaw that rescheduled the annual meeting within months of the election of its own three-member slate - meaning that, potentially, well within one year, Air Products could elect six out of the nine board members. From there, Air Products' majority would pull the poison pill that in conjunction with the staggered board thwarted, or at least slowed, their takeover attempt.

The Airgas parties asked the court to determine the extent of board authority to frustrate a premium-to-market acquisition, particularly when many shareholders wanted to accept the premium. Under what circumstances should the law allow the board's exercise of its fiduciary duty to frustrate a shareholder vote on the tender offer?

From a lawyer's point of view, this case is a dream. You interpret the bylaw, determine if it is consistent with the charter, determine whether the charter is consistent with the Delaware code and then find an ambiguity. Both the Court of Chancery and the Supreme Court concluded that the language is ambiguous.

The Chancellor found that ambiguity should be resolved in favor of the shareholders through a policy default mechanism. The Supreme Court disagreed, maintaining that a charter is a contract and that a decision must be rendered in the same way as with language disputes among parties to a contract.

We affirmed the need to look at both the extrinsic evidence and the demonstrated history of the parties' conduct. Instead of saying the annual meeting could be held at any time during the next year, we maintained that, in order for the staggered board to be effective, the only rational interpretation of "annual" means nearly 12 months. Otherwise, the directors would not have served a full three-year term if they could be eliminated during the first month of the next calendar year.

Here, the annual meeting, during which the three Air Products members were elected, was held on September 15, and their own new bylaw provided that the next annual meeting would be January 15 - just two weeks into the following calendar year.

All courts agreed that the language was ambiguous, but the Chancellor maintained that resolution must default in favor of the shareholders. If upheld, this decision would allow an annual meeting within four months, frustrate the staggered board, enable the pill to be pulled and make the offer available for a shareholder vote. At bottom, this is a reasonable position with which we simply disagreed.

We looked at communications from the company through its proxies to its shareholders and the SEC. Consistently, for the last ten years, the board met annually in the July-August time frame. In this case, while the meeting occurred slightly later - on September 15 - it remained within the spirit of a charter that mandated a staggered board and annual meetings (approximately 12 months apart). We couldn't justify a four-month time frame interpretation in light of company history.

Interestingly, the three Air Products board members elected on the Air Products case voted with the Airgas board majority to reject the tender offer. It seems, once they got involved, they agreed that the offer was too low, which frustrated those who wanted a shareholder vote. Our final view is consistent with the idea that directors run the company, and, in order to carry out their fiduciary duty, they have to act in the best interest of the entire diverse shareholder base.

When directors conscientiously believe that an offer is too low, it would be inconsistent with their fiduciary duty to disappear and let the shareholders decide. Mom and Pop shareholders might take an overly simplistic view that 70 dollars was enough for stock the board thought to be worth 78 dollars, or they might simply adopt the board's long-term strategy. On the other hand, institutional shareholders have to satisfy the people for whom they act as fiduciaries in the short term and who have not necessarily aligned with the long-term interest of the corporation.

Airgas attracted so much attention because it involved a fundamental, philosophical difference between the view that the board has to exercise its fiduciary duty for the entire shareholder base and the view that boards should step out of the picture and let the shareholders vote.

After our finding, the Chancellor's ultimate decision was consistent with ours, but his language was very critical of our opinion and took the opposite philosophical view. While there's nothing wrong with reasonable people disagreeing, we think the way to solve this problem is either to amend an individual corporate charter, eliminating the staggered board, or to ban staggered boards through state legislation. Both are options.

Because I believe that a charter is a contract between the shareholders, management and the board, my only job was to interpret the contract - not to make Olympian determinations about what is in the best interest of corporate America.

Editor: What lessons are to be drawn from decisions with respect to Delaware LLC law? Please discuss Related Westpac LLC v. JER Snowmass LLC.

 

Steele : Westpac is a fundamentally important case. Since February of 2004, the majority of business entities chartered in Delaware has been shifting from the corporate form to alternative business organization form (ABO) - LLCs, LLPs and LPs - and this trend has increased ever since. The body of case law for corporations is far more developed than it is for ABOs; thus, any case involving ABOs, including the relationship between financial owners and management, is an important case.

Westpac focuses on a fundamental ABO issue - allocation of authority. Delaware's statute that authorizes the chartering of ABOs uniformly mandates that we recognize freedom of contract. Parties are allowed to adopt traditional corporate law fiduciary duties in the relationship between management and the owners, or they're authorized to eliminate fiduciary duties. This case affirms the principle of freedom of contract.

In Westpac, one member of an LLC was frustrated with other members' refusal to grant consents, to provide additional finances and, in effect, to manage the corporation consistent with these desires. The Court was asked to imply fiduciary duties or look to implied covenants of good faith and fair dealing.

In refusing to imply such duties, the Court affirmed the primacy of the contract and the need to interpret the contract consistent with its plain meaning. In essence, the Court said that it will not imply duties that the contract makes clear were never accepted by the parties.

The lesson for lawyers is to sit down with your client, be careful to understand the client's needs and views about how the ABO should be managed, and communicate the costs and benefits of restrictions on management - balance those carefully and make sure you clearly describe its relationship in the contract.

I like this case because I am a contractarian who believes that parties should be able to strike any bargain that's not based upon fraud or misrepresentation, and the court should respect what they express in their contract. This case stands for the proposition that courts should respect the right of contract.

Editor: It's very important in terms of certainty.

Steele: I would think so. Obviously it begins to break down when you have ambiguities, and, over the years, I have seen what can be referred to as conscious ambiguities (a term of art). Here, the parties get right down to the last Gordian knot before they enter into the contract. There may be a provision on which they can't expressly and precisely agree, so they insert language that amounts to conscious ambiguity.

In these cases, it's clear that the parties could have agreed to go one way or another; therefore, there must have been some reason for opting to keep the language ambiguous. Certainly, the parties retained qualified counsel who knew this was ambiguous language and still included it in the contract. Those are the most difficult cases to decide.

On the other hand, our analysis is clearer and easier when the language is plain and not susceptible to different reasonable interpretations. In these cases, we're going to honor the contract language as is.

Editor: That's another plus for Delaware.

Steele: I hope so; however, whether or not this approach enhances chartering in Delaware, I definitely think it's the right approach.