Delaware Case Research Articles

Trenwalla: A Call for Rationalizing Fiduciary Duties to Creditors in Delaware

In 2007, the Delaware Supreme Court considers two cases: North American Catholic Educational Programming Foundation, Inc. v. Gheewalla and Trenwick America Litigation Trust v. Ernst and Young, et al., both involving fiduciary duties to creditors. Not since Bovay v. H.M. Byllesby & Co., a 1944 corporate insolvency case decided upon the historical trust fund doctrine, has the Delaware Supreme Court had the opportunity to reexamine the state of Delaware case law on directorial duties to at insolvency or the vicinity of insolvency. On May 18, 2007, the Court held that individual of an insolvent corporation have no right to assert [direct] claims for breach of fiduciary against corporate directors. Given that these issues are equally applicable to direct or derivative fiduciary duties to creditors, will the Delaware Supreme Court will take the opportunity presented in Trenwick to eliminate the troublesome fiduciary derivative to in favor of more rational, creditor-particular remedies. The Delaware Supreme Court stands at a divide and thus should adopt a rational approach to the law of creditor rights by eliminating all derivative fiduciary duties in whatever context. This rational approach is dictated by: 1) the need for corporate management to be able to engage in vigorous and good faith negotiations with in or near insolvency; 2) creditors' inability to meet the exacting legal standards required to bring a derivative suit; 3) the unfair exposure that advisors to corporate directors suffer under the Delaware regime after Gheewalla; and 4) the lack of rationality of the present day duty to creditors to its historical underpinnings (the trust fund doctrine) which required unjust enrichment of corporate management at the expense of the corporate enterprise.

A Board's Duty to Monitor

One of most difficult questions in corporate law is what is the board’s duty to prevent harm to the corporation? Delaware courts currently excuse boards from responsibility for harmful outcomes not involving wrongful or illegal acts. By doing so, however, Delaware courts have encouraged boards either to be ignorant or unquestioning of aggressive risk-taking by officers. The Delaware conception of the duty to monitor is in notable contrast to calls by regulators, shareholder groups and, most recently, Congress for boards to play a more active and participatory role in the management of risks affecting the corporation. As part of a larger study of the board’s duty to monitor, this particular paper examines in detail Delaware case law defining the scope and application of the duty to monitor and considers why Delaware courts have decided that boards should not be held responsible for monitoring business risks, even if the taking of such risks results in catastrophic losses. As will be more fully argued in a separate article (38 Fla. St. U. L. Rev. (forthcoming 2011)), the current Delaware position is inconsistent with the optimal role of the board in the modern corporation. Consequently, Delaware courts should expand the scope and application of the duty to monitor.

Match That!: An Empirical Assessment of Rights of First Refusal in Merger Agreements

This short paper provides an overview of rights of first refusal (match rights) in merger agreements. Match rights are common in merger agreements, nearly universal. Even though these preemptive rights can be a strong economic deterrent to topping bids, there is little, if any, Delaware case law limiting their use. In fact, one recent chancery court decision endorsed the use of rights of first refusal in order to end an auction where Revlon duties applied. With the Toys r Us case as a backdrop, this paper will attempt to evaluate the competitive effects of rights of first refusal, specifically their impact on the deal premia, number of bidders and the prevalence of “deal jumping.” If the data provide evidence that rights of first refusal are anti-competitive, this paper will make arguments in favor of adopting a rule to limit reliance on match rights when Revlon duties apply.

Rethinking Delaware's Corporate Opportunity Doctrine

Although the prohibition on taking of organizational opportunities is well established, the standards applied to this problem in corporate law disputes are vague and imprecise. Corporate directors and officers lack clear guidance as to when a particular business venture may be taken for themselves or must first be offered to the corporation. In this article, I review the relevant Delaware case law, focusing on the ambiguities inherent therein. I then offer a proposed alternative regime, providing greater certainty and predictability.

Trans Union Unreconsidered

In a Yale Law Journal article Jonathan R. Macey and Geoffrey P. Miller argue that Smith v. Van Gorkom, commonly referred to as the Trans Union case, should be considered as a takeover case rather than as a Business Judgment Rule Case. As it is currently construed, Smith is broadly applicable as a corporate duty of care case based on the common sense supposition that boards of directors must obtain all reasonably available information before making decisions. Thus, while Macey and Miller claim that their articulated position will result in more easily squaring Smith with other Delaware case law, their position is a radical departure from the views of other commentators. This article argues that none of the reasoning behind the arguments presented by Macey and Miller makes sense. The consequences of overruling Smith are astounding: investor confidence would decrease; market economics would be less efficient; the corporate law doctrine would be less rational; and there would be a loss of corporate accountability. As a result, this article takes the position directly contrary to that of Macey and Miller; Smith v. Gorkom should be reaffirmed not reconsidered.

Post‐Siliconix Freeze‐Outs: Theory and Evidence

At approximately the same time that the Sarbanes‐Oxley Act increased the costs associated with being a public company, important Delaware case law created a difference in the standard of judicial review for the two basic methods of freezing out minority shareholders. While a freeze‐out executed as a statutory merger is subject to stringent “entire‐fairness” review, the Delaware Chancery Court held in In re Siliconix Shareholders Litigation that a freeze‐out executed as a tender offer is not. This paper presents the first systematic empirical evidence on post‐Siliconix freeze‐outs. Using a new database of all Delaware freeze‐outs executed in the 4 years after Siliconix was decided, I find that minority shareholders achieve significantly lower abnormal returns, on average, in tender‐offer freeze‐outs relative to merger freeze‐outs. I discuss the doctrinal and policy implications of these findings in a companion paper.

Recent developments in Delaware case law

The Disney, Toys ‘R’ Us and LNR cases confirm that the Delaware Chancery Court will provide broad — but not unlimited — latitude to corporate boards in the exercise of their business judgment, provided that they act in good faith and on at least a minimally informed basis. The Chancery Court reaffirmed that a board's fiduciary duties are immutable and that the standards of corporate governance do not shift with the winds of public opinion and perception. In an era when executive compensation and directorial misfeasance or non-feasance animate sweeping federal legislation and blockbuster settlements of federal securities litigations, the Delaware Court refused to second-guess the Disney board's decision to hire, lavishly compensate and quickly terminate Michael Ovitz, despite noting significant failings in both the composition of Disney's board and its performance. Even in the context of mergers and corporate control changes, the Chancery Court made clear through Toys ‘R’ Us and LNR that the board or a special committee's decisions will be given the traditional deference afforded by the business judgment rule so long as their actions demonstrate adherence to the substance of the business judgment rule and not just a perfunctory nod to its formalities alone. Thus, Delaware law continues to remain constant in its support for what it calls ‘the risk taking, innovative, wealth-creating engine that is the Delaware corporation’.

Audit committee membership: The interplay with general corporate law

In the authors' last paper, 1 the audit committee membership requirements imposed by the Sarbanes—Oxley Act of 2002, the Securities and Exchange Commission and the US securities markets were discussed. In particular, the authors discussed these rules and their interaction with one another, focusing primarily on the rules requiring each audit committee member to be independent of management and financially literate, and at least one member of the audit committee to qualify as a financial expert. This paper highlights the added complexities audit committee members face as a result of the interplay between the audit committee membership requirements and general corporate law. In this regard, the authors take particular note of recent Delaware case law that potentially bears on the audit committee membership requirements of independence and financial expertise, including case law in which apparently independent directors were disqualified from serving on an independence committee based on alleged conflicts of interest and case law in which the court focused on a director's financial expertise in concluding that the director should be personally liable for approving a particular transaction. While it is important to understand the implications of these cases, directors, including audit committee members, need not overreact. The Delaware Supreme Court, perhaps the most influential court in the US with respect to business cases, has provided welcome guidance and has done so by reaffirming the primacy and vitality of the business judgment rule and in specifically addressing the persuasiveness of arguments that social connections and personal friendships can result in disqualification.

The Duty of Good Faith in American Corporate Law

An important development in American corporate law is the recent explicit recognition, in a series of Delaware cases, that corporate managers owe a fiduciary duty of good faith in addition to their traditional duties of care and loyality. The duty of good faith was not created by those cases. On the contrary, the duty has long been explicit under the statutes and has also long existed implicitly in the case law. Nevertheless, the explicit recognition of the duty of good faith in recent Delaware cases shines a spotlight on that duty, and therefore makes it especially important to develop the contours of the duty and to examine the duty from a normative perspective. Briefly, the duty of good faith in American corporate law is comprised of a general baseline conception and specific obligations that instantiate that conception. The baseline conception consists of four elements: subjective honesty, or sincerity; nonviolation of generally accepted standards of decency applicable to the conduct of business; nonviolation of generally accepted basic corporate norms; and fidelity to office. Among the specific obligations that instantiate the baseline conception are the obligation not to knowingly cause the corporation to disobey the law and the obligation of candor even in non-self-interested contexts. Turning to the normative issue, there are several basic reasons why the duty of good faith is desirable. To begin with, the duties of care and loyalty do not cover all types of improper conduct by managers, because certain kinds of improper managerial conduct fall outside the spheres of those duties. Most of these types of conduct fall within the duty of good faith. Furthermore, various rules limit a manager's accountability under the duties of care and loyalty, and these limiting rules should be and are inapplicable to conduct that violates the duty of good faith. Moreover, the duties of care and loyalty characteristically (although not invariably) function as platforms for liability rules, while the duty of good faith characteristically (although not invariably) functions as a condition to the application of rules that do not in themselves impose liability. This difference in characteristic function makes it desirable to treat good faith separately from care and loyalty. Finally, the duty of good faith provides a principled basis for the courts to develop new specific fiduciary obligations that come to be seen as appropriate in response to changes in social and business norms, and in the general understanding of efficiency and other policy considerations that are applicable to corporate law, but cannot be easily accommodated within the duties of care or loyalty.

Post-Siliconix Freeze-Outs: Theory, Evidence & Policy

At approximately the same time that the Sarbanes-Oxley Act increased the costs associated with being a public company, important Delaware case law created a difference in the standard of judicial review for the two basic methods of freezing out minority shareholders. While a freeze-out executed as a statutory merger is subject to stringent entire fairness review, the Delaware Chancery Court held in In re Siliconix Shareholders' Litigation that a freeze-out executed as a tender offer is not. This paper presents the first systematic empirical evidence on post-Siliconix freeze-outs. Using a new database of all freeze-outs executed during the current doctrinal regime, I find that a controlling shareholder pays less to the minority shareholders, on average, when it uses a tender offer compared to a merger. This difference between tender offers and mergers seems to increase with the size of the controller's pre-deal stake. These findings introduce a puzzle as to why more than two-thirds of post-Siliconix freeze-outs still proceed through the traditional merger route. I present some evidence that controllers are more likely to choose a merger when they hold a relatively small controlling stake, in order to avoid supermajority approval from the minority that would be required in a tender offer. I also present some evidence that a freeze-out is more likely to be executed as a tender offer when the controller's outside counsel has substantial M&A experience. These findings bolster arguments for convergence in judicial standards of review between tender offer and merger freeze-outs, and provide guidance on how such convergence might best be achieved.

Shareholders as Principals

Academic writing about corporate law often characterizes directors as the of shareholders. This characterization carries substantive consequences for the relative and residual powers of shareholders and directors. In particular, a principal in a relationship of common-law agency has power to give binding instructions to the agent, even when the principal has previously agreed not to do so. This paper examines the shareholder-director relationship in the context of contemporary corporation statutes, focusing on the United States, the United Kingdom, and Australia. In all three countries - and most strongly so in the United States - it is not accurate to characterize directors in most instances as the agents of shareholders. The paper explores the implications of this point for the current and controversial question whether shareholders have power to instruct directors to redeem a poison pill by adopting a bylaw. The paper examines this question from a comparative perspective by contrasting Delaware cases dealing with defenses to hostile take-overs with regulation in the United Kingdom.

A Brief Roadmap to Going Private

In the midst of increasing regulatory burdens and a shaken economy that is slow to recover, more and more U.S. companies are choosing to forego their public status through “going private” transactions. “Through the end of August, sixty public companies had already [gone] private in 2003, . . . up from forty-nine during the same period in 2002 and thirty-two in 2001.” The number of companies going private in the sixteen-month period following the passage of the Sarbanes-Oxley Act numbered 120, 30% more than in the sixteen-month period prior to its July 30, 2002 enactment. Experts expect that with the sluggish economic recovery and increased regulatory compliance costs, the going private trend will continue to pick up speed. The purpose of this paper is to offer the reader a basic roadmap to going private, introducing and bridging the major considerations involved in the typical going private transaction. Part Two provides an overview of going private, beginning by defining “going private” and highlighting the major reasons companies go private, including the effective closure of capital markets, avoidance of regulatory expenses, long-term value maximization, and decreasing agency costs. It continues by pointing out current sources of these reasons, such as market downturns and the passage of the Sarbanes-Oxley Act, which combine to make an environment highly favorable to going private transactions. The section then presents barriers that may prevent a company considering going private from making the move and introduces the key players in a going private transaction. Part Two closes by analyzing the popular means by which to finance a going private transaction and the current climate in which such financing may be procured. Part Three presents the legal considerations that come into play when a company chooses to go private, including federal disclosure rules and state compliance laws. These considerations may affect both the choice of whether to take a company private and the optimal transaction structure chosen once such a decision has been made. The section begins by examining Rule 13e-3, the federal disclosure standard that governs going private transactions, describing its mechanics and disclosure requirements. Relevant state law issues are then introduced, with particular attention being given to legally enforceable standards of review, including the well-known “entire-fairness” test. Finally, Part Four details the possible means of structuring the going private transaction, which include the long-form merger, the tender offer, the reverse stock split, and the asset sale and dissolution. Advantages and disadvantages of each structure are compared, and reflect timing, financing, tax, and legal considerations, including recent Delaware case law that makes the tender offer the transaction of choice for controlling shareholders taking a company private.

Delaware's Good Faith

In the post-Enron era, there has been considerable discussion about what went wrong at Enron and elsewhere and how to fix it. Congress passed the Sarbanes-Oxley Act, the New York Stock Exchange adopted new corporate governance regulations designed to create better checks and balances, and other self-regulatory organizations followed suit. In addition, the Securities and Exchange Commission, both before and after the Sarbanes-Oxley Act, promulgated many new regulations. One voice, however, has been fairly quiet. The State of Delaware, the mother of all corporate law, has been largely absent from the debate. The Delaware judiciary, however, has issued several opinions that indicate movement may be afoot. In this Article, I raise some questions about Delaware's (declining) role in corporate law, and discuss the emerging duty of good faith and its potential for curbing abuses like those seen in the past few years. To do so, I examine several key cases from Smith v. Van Gorkom, to Caremark, to the Disney cases. In these, and other cases, I argue, the judiciary has put forth a set of guiding principles for fiduciary good faith. I argue that this duty is appropriately a separate duty, not an obligation on the other two key fiduciary duties of due care and loyalty. I compare the Delaware cases and the standards within them to the standard for pleading and proving scienter under the federal securities laws. Using the federal standard as a jumping off point, I argue that the duty of good faith can be analogized to the types of situations involving scienter and, thereby, limited in a meaningful manner. As a result, good faith can help to fill the gap in fiduciary duties without becoming excessively capacious.

The Determinants of Professional Fees in Large Bankruptcy Reorganization Cases

This article presents the findings of an empirical study of professional fee and expense awards by United States Bankruptcy Courts in 48 large public company bankruptcy cases concluded from 1998 through the first half of 2002. Data was gathered from fee applications and orders in the courts files. Using that data together with case and company data from the Bankruptcy Research Database, the authors constructed regression models of the determinants of (1) the amounts of professional fees and expenses awarded by case and (2) the amounts of debtor-in-possession bankruptcy attorneys fees awarded by case. Two determinants dominate both models: the value of the reorganizing firm's assets and the length of time the case remains pending. Two additional factors contribute to determining the amount of professional fees and expenses, but not debtor in possession bankruptcy attorneys fees: the number of professional firms working in the bankruptcy case and whether the case was in the Delaware bankruptcy court. The ratio of fees and expenses to firm size was subject to a scale effect. As the size of the case increased, the ratio of fees to expenses declined. For the 48 cases studied, total fees and expenses were 1.4% of assets reported on the bankruptcy petition. The average ratio of fees and expenses to assets was 2.2%, but removal of a single outlier reduced it to 1.9%. Controlling for firm size, case duration, and the number of professional firms working, fees were 32% higher in Delaware cases. But controlling only for firm size, the significance of this finding disappeared. Fee cuts were generally small - exceeding 4% of the amounts applied for in only 11% of the cases. The mean fee cut varied significantly by court. Delaware cuts averaged 0.7%, New York 4.5%, and Other Courts 2.3%. The differences in fee cuts among courts was significant, but fees were not significantly lower in cases with larger fee cuts. Based on a comparison of the data gathered in this study with the data gathered by Weiss, inflation-adjusted professional fees and expenses awarded in large, public company reorganizations have fallen by about 57% since the 1980s. Controlling only for firm size, the difference is statistically significant. The decline in fees appears to be associated with the decline in case duration that occurred during the period.

Recent Delaware Decisions May Prove to be “Entirely Unfair” to Minority Shareholders in Parent Merger with Partially Owned Subsidiary

Two Delaware cases that were decided in the summer of 2001 strip a target’s minority shareholders of the protections afforded them by an entire fairness review in the context of a parent company’s acquisition of a partially owned subsidiary through a tender offer followed by a back-end short-form merger. In In re Siliconix Inc. Shareholders Litigation, a class action lawsuit, Delaware Vice Chancellor John Noble held that a unilateral tender offer (whether a cash offer or a stock-for-stock exchange offer) by a parent for a subsidiary does not invoke the entire fairness doctrine, principally because the transaction does not involve a merger requiring any action from the target’s board of directors. In Glassman v. Unocal Exploration Corp., handed down a month later, the Delaware Supreme Court held that in a short-form merger pursuant to title 8, section 253 of the Delaware Code, the ‘parent corporation does not have to establish entire fairness, and, absent fraud or illegality, the only recourse for a minority stockholder who is dissatisfied with the merger consideration is appraisal.‘ As a result of these two decisions, it appears that a parent company can freeze out the minority without ever having to satisfy an entire fairness review by first engaging in a tender offer, and subsequently executing a short-form merger.

Augmenting the Duties of Directors to Protect Minority Shareholders in the Context of Going-Private Transactions: The Case for Obligating Directors to Express a Valuation Opinion in Unilateral Tender Offers After Siliconix, Aquila and Pure Resources

This article addresses the threat posed by unilateral tender offers initiated by controlling shareholders. First, the article will examine why it is particularly compelling today for majority shareholders to acquire the remaining stock in the public companies they control. Second, the article will address the process for taking a company private and the various deal structures that can be employed. Third, the article will review the standard of conduct governing directors in various related-party transactions. Fourth, the article will discuss both recent Delaware judicial decisions making it easier for directors to sit on the sidelines while controlling shareholders use the inherently coercive tender offer process to force minority shareholders into accepting below-value offers for their shares, and recent Delaware case law rejecting this trend. Finally, the article concludes by proposing significant changes to the rules governing directorial duties to minority shareholders in the context of controlling-shareholder initiated unilateral tender offers.

Sales and Elections as Methods for Transferring Corporate Control

Delaware case law has rendered the tender offer obsolete as a method for purchasing a company whose directors oppose the acquisition. A potential acquirer facing target opposition today must run an insurgent director slate, in the expectation that its directors are more likely to sell. The Delaware courts have not justified their preference for elections over markets as the preferred vehicle for implementing changes in control. Informal scholarly analyses ask transaction cost questions, such as whether proxy contests are more costly than takeovers. This article attempts to break new ground by asking whether there are systematic differences in the performance of elections and markets in the corporate context. Recent models of voting processes, we argue, strongly suggest that elections are inferior to markets. Proxy contest elections sometimes can be won by incumbent managements when a transfer of control would be efficient, a conclusion consistent with the sparse data; and the proxy election process aggregates information regarding the sale decision less well than markets do, thereby implying that proxy voters are less well-informed. Theory and data thus suggest, at the least, that the intellectual burden of proof should change: the task now is to justify using elections to transfer control despite their apparent deficiencies. The article briefly considers the policy implications of this change in perspective.

A Buy-Side Model of M&A Lockups: Theory and Evidence

Lockups are an increasingly important element of M&A deals in the United States. We present, for the first time, descriptive data on lockup incidence, trends, and their relationship with Delaware case law. Prior commentators have argued that lockups should have little or no impact on allocational efficiency in the market for corporate control. We offer a new theoretical model of lockups that includes several “buy-side” distortions, such as agency costs, informational effects, switching costs, reputational effects, and endowment effects for bidders, and show that lockups can in fact change bid outcomes. We find strong support for this “buy-side” model of lockups from a large sample of M&A deals over the past twelve years. We also find that the type, size and structure of lockups affect deal outcomes. These results suggest that courts and corporate boards should scrutinize lockups more closely than prior commentators have

A Buy-Side Model of Lockups: Theory and Evidence

Lockups are an increasingly important element of M&A deals in the United States. We present, for the first time, descriptive data on lockup incidence, trends, and their relationship with Delaware case law. Prior commentators have argued that lockups should have little or no impact on allocational efficiency in the market for corporate control. We offer a new theoretical model of lockups that includes several buy-side distortions, such as agency costs, informational effects, switching costs, reputational effects, and endowment effects for bidders, and show that lockups can in fact change bid outcomes. We find strong support for this buy-side model of lockups from a large sample of M&A deals over the past twelve years. We also find that the type, size and structure of lockups affect deal outcomes. These results suggest that courts and corporate boards should scrutinize lockups more closely than prior commentators have advocated.

Brown v. Board of Education at 40: A Legal History of Equal Educational Opportunities in American Public Education

INTRODUCTIONOn May 17, 1954, the United States Supreme Court handed down perhaps its most significant ruling of all time. In a unanimous 9-0 opinion in Brown v. Board of Education of Topeka, Kansas (Brown I) (1954), the Court held that the de jure segregation of public education based on race deprived minority children of equal educational opportunities in violation of the Equal Protection Clause of the 14th Amendment. A year later, in Brown II (1955), the Court set about dismantling segregated school systems. While subsequent rulings attacked de facto and de jure segregation in the wider arena of American society, Brown I remains unchallenged as the catalyst for systemic change. Beginning with school desegregation efforts and culminating in the civil rights movement and a generation of heightened consciousness for African Americans and other disenfranchised groups, Brown I spawned an era of equal educational opportunities.In light of the Supreme Court's monumental ruling in Brown I, this article briefly discusses more than three dozen of the cases involving court-ordered public school desegregation decided in the 40 years since 1954. Further, it provides a detailed commentary and analysis of the Court's leading opinions.A LEGAL HISTORY OF PUBLIC SCHOOL DESEGREGATIONThe history of the Supreme Court's involvement in school desegregation can be divided into four periods: the first spanning the decade from 1954 to 1964, the next from 1965 to 1979, the third from 1980 to 1989, and the last covering the early years of the 1990s.A Decade of All Deliberate Speed: 1954-1964Flushed with victories in Sweatt v. Painter (1950) and McLaurin v. Oklahoma State Regents for Higher Education (1950)--companion cases that prohibited interschool and intraschool segregation, respectively, in higher education--the National Association for the Advancement of Colored People (NAACP) was set to launch a frontal attack on racial segregation in the public schools. Accordingly, its chief counsel, Thurgood Marshall, and his team of NAACP attorneys laid the groundwork for Brown I. In light of the central role Brown I occupies in American history, this case will be examined in greater detail here than the other rulings succeeding it.Brown I is cited as Brown v. Board of Education of Topeka, Kansas because the lead case was initiated there. It actually involved four class-action suits filed on behalf of African American students who were denied admission to schools attended by White children due to laws that either mandated or permitted racial segregation. The other actions originated in New Castle County (Delaware), Clarendon County (South Carolina), and Prince Edward County (Virginia). Segregation was allowed under state law in Kansas, and it was required both by the state constitutions and statutes in Delaware, South Carolina, and Virginia. The Delaware suit was an appeal from a state court action; the remaining cases sought further review of federal court rulings.The lower federal courts based their decisions to uphold de jure segregation on the pernicious standard established by the Supreme Court's 1896 ruling in Plessy v. Ferguson but which apparently originated almost half a century earlier in a Massachusetts case, Roberts v. City of Boston (1850). Only in the Delaware case did the Court order the immediate admission of African American students to schools previously attended exclusively by White children. It did so based on its finding that the schools attended by White youngsters were superior with respect to such factors as teacher training, pupil-teacher ratios, and physical plant facilities. Thus, although each action was premised on different facts and a variety of local conditions, they were consolidated on appeal in light of their common legal question. Oral arguments in Brown I were initiated in December 1952, but the Court was unable to reach a decision, seemingly because it was divided on the constitutionality of the separate-but-equal doctrine. …