Delaware Supreme Court Research Articles

Sometimes Silence is Golden: 'Dell Compliance' Following Aruba III

Speculation that interpersonal conflicts among Delaware judges influenced the adjudication of Verition Partners v. Aruba Networks has unfortunately chilled a more productive discussion of the three judicial opinions in this case – decisions whose subtext is key to interpreting the Delaware Supreme Court’s final determination on the case rendered last month. That opinion, “Aruba III”, simultaneously elevated the importance of the “Dell Compliance” standard – that threshold of M&A process adequacy above which the Chancery Court should lend weight to deal price in appraisal proceedings – while saying almost nothing about how that standard should be administered. Aruba III concluded a rich colloquy between Vice Chancellor Travis Laster and the Delaware Supreme Court that began with Dell in which both courts utilize reductionist arguments to debate the appropriate implications of modern ECMH theory for the adjudication of appraisal fair value in public company M&A. While often used to normatively criticize reasoning, reductionism – the practice of analyzing complex phenomenon by reference to simplified abstractions held to represent more fundamental principles –is simply used in its descriptive sense here (for want of a better term). While not inherent, reductionist reasoning in judicial opinions yields tricky precedent because the assumptions that underlie its abstractions are often poorly defined and evaluated for materiality, reducing confidence in how well they track reality. In the Dell and three Aruba decisions, reductionism in the translation of ECMH “principles” to economic reality is used so frequently and with such lax tracking of assumptions that analysis of the literal reasoning in these decisions provides little guidance on how the Chancery Court should determine Dell Compliance. Conversely, a review of their styles of argumentation is more illuminating. When evaluated in this light, Aruba III clarifies that, while couched in terms of the deference to “ECMH principles”, the bounds on the Chancery Court’s discretion found in Dell and DFC were motivated by the desire to focus public-company appraisal on atypically poor and transaction-specific process defects to avoid the categorical application of de novo valuation to broad categories of M&A transactions. By casting Dell and DFC as outlier cases in which identified process defects were simply too generically relevant and non-specific to the case record, Aruba III liberates the Chancery Court, should it so choose, to continue to utilize public company appraisal to police fiduciary misfeasance under a flexible “all relevant factors” standard, but only when process defects fall outside structural failings of “run-of-the-mill” processes and are linked to the deal price based on record evidence. By remaining silent on Dell Compliance beyond these requirements of atypicality and specificity, this bounded but consciously undefined standard appears designed to frustrate both the attempts of transaction attorneys to circumvent functional process review via formalism and the attempts of petitioners to indiscriminately pursue claims based on categorical case theories. Rather than an oversight, such silence may strike the perfect balance of preserving a useful role for public-company appraisal to improve the increasingly feckless state of post-Corwin fiduciary law, while discouraging unfettered appraisal “arbitrage”.

Chronicle of Failure Foretold: Controlling Shareholder Enforcement and the Insignificance of NRG Yield

The regulation of controlling shareholder related-party transactions is one of corporate law’s animating concerns. In the seminal MFW case, the Delaware Supreme Court adopted a solution that incentivizes the corporation to seek prior approval from both an independent director committee and a majority of minority shareholders. The “MFW framework” regards the endorsement of two independent corporate organs as an adequate defense against the dangers of self-dealing. While this holding was rendered in the context of a freezeout transaction, a recent Chancery Court decision extends the apparent protections of the MFW framework to apply to non-freezeouts as well. This Article explains why the Chancery Court’s innovation will not achieve the desired result. Subjecting a transaction to the MFW framework is a voluntary decision. Transaction planners will willingly traverse this path if the benefits outweigh the loss in deal certainty and attendant costs. When almost every freezeout is challenged in court, the voluntary application of the MFW framework is the logical outcome. The calculus in the non-freezeout context leads to a different result. Non-freezeouts must be challenged by a derivative lawsuit. The procedural hurdles inherent in the derivative mechanism affect both the demand for the MFW framework and the incentive to comply. Without a tangible threat of a lawsuit to coax voluntary compliance in the non-freezeout setting, transaction planners have nothing to gain by subjecting the deal to the double approval gauntlet. This Article’s analysis reveals an enforcement gap at a large swath of self-dealing transactions. Recent high-profile litigation (Oracle’s acquisition of NetSuite, Tesla’s acquisition of SolarCity, CBS’ continued compensation to an apparently incapacitated controller) exposes questionable adherence to the MFW framework for obviously conflicted non-freezeout transactions. The paucity of derivative lawsuits foretells a troubling fate for similar transactions at less enticing litigation targets. Worse yet, the superficial step towards improved minority shareholder protection stifles the discussion on additional reform. Note - this Article is accepted for publication in the American Business Law Journal.

The Paradox of Delaware's 'Tools at Hand' Doctrine: An Empirical Investigation

Much has been written on the subject of abusive shareholder litigation. The last decade has witnessed at first an increase and then a dramatic spike in such suits, primarily suits filed in connection with mergers and acquisitions. Delaware courts are known for not just their deep experience in corporate law suits but as being doctrinal innovators. One such innovation occurred in Rales v. Blasband, 654 A.2d 927 (Del. 1993), establishing the “tools at hand” doctrine, whereby before considering whether to grant a motion to dismiss the court admonishes the shareholder-plaintiff to resort to shareholder inspection rights accorded by the Delaware General Corporation Law so as to gather facts necessary for the complaint to survive the pretrial motion. On its face, the doctrine reflects a balanced approach to the competing claims that shareholder litigation is necessary to address and discourage managerial misconduct and the belief the suits are vexatious being brought to garner an extortionate settlement. In this paper, we empirically examine how Rales has dramatically changed the composition of suits in which shareholders seek to exercise their inspection rights. We compare the composition, outcomes, and related questions surrounding such suits maintained 1981-1994 with the post-Rales period 2004-2016. We not only find that post-Rales suits entail substantially more suits involving “books and records” requests but in tracing the results of those requests we find that plaintiff suits maintained after using the tools at hand enjoy better outcomes than where no inspection was sought. Our data also supports the belief that such books and records litigation is something of a surrogate for a trial on the underlying claims of wrongdoing. We also find that many instances in which the tools at hand is pursued there is no follow-on shareholder suit. Thus, our data supports the positive social benefits of Delaware’s innovative tools at hand doctrine. Nonetheless, in the concluding section we bring bad news. Increasing qualification of owners – partners, members and stockholders – inspection rights through private ordering described here raises concern that the potential benefits of the tools at hand doctrine will not be fully realized. We also reason that the Delaware Supreme Court’s decision in California State Teachers Ret. Sys. v. Alvarez, 179 A.3d 824 (Del. 2018) likely eviscerates the tools at hand. Alvarez holds that the Delaware litigant’s suits is precluded by an earlier decision by another jurisdiction that a derivative suit initiated by a different shareholder than was prosecuting the Delaware action lacked standing to sue. We reason that Alvarez is a powerful disincentive for Delaware litigants to pursue the tools at hand as the time expended in pursuing that right may enable competing slothful lawyers to take their chances with a less developed complaint in a sister jurisdiction’s courts on the same claim.

Amicus Brief of Law and Finance Professors in Verition Partners v. Aruba Networks (Appraisal Lawsuit)

This amicus brief, filed with the Delaware Supreme Court in Verition Partners v. Aruba Networks, addresses two topics: (i) application of the efficient market hypothesis in appraisal litigation and (ii) empirical scholarship regarding the effect of Delaware appraisal decisions and amendments to 8 Del. C. § 262 on premia in public M&A transactions.

Unintentional Irony in Landmark Decisions of the Delaware Supreme Court Regarding Corporate Law

Three landmark decisions of the Delaware Supreme Court exhibit unintentional irony: Beam v. Stewart, Smith v. Van Gorkom, and Paramount Communications Inc. v. Time Inc. In Beam, the court concluded that, regarding the decision of whether to seek remedy against Martha Stewart, her fellow directors would not have jeopardized their reputations for the minimal gain of continuing their business and personal relationships with her. Ironically, the court failed to acknowledge that Martha Stewart—in trading on material nonpublic information, which gave rise to the corporate claim against her—jeopardized her reputation (ultimately losing hundreds of millions of dollars and her freedom) for minimal gain (less than $50,000). Having failed to acknowledge that internal inconsistency and unintentional irony, the court offered no explanation why some directors would jeopardize their reputations for minimal gain, but others would not do so. Part I attempts to fill the void and suggests that Stewart suffered from cognitive biases, which would not have affected her fellow directors. In Van Gorkom, the court famously concluded that the plaintiff carried his burden of proving that the board was grossly negligent in informing itself when selling the corporation, although, during a multi-month period, no bidder stepped forward with a superior proposal. The irony of the court’s conclusion is virtually self-evident. Part II further discusses subsequent precedent, which suggests that, viewed in retrospect, the board could have carried its burden that it reasonably informed itself, turning the conclusion of Van Gorkom on its head, and furthering the irony. In Time, the court held that Time’s board did not preclude Paramount from hostilely acquiring Time when it affected an acquisition of Warner. According to the consensus, Time’s board in fact precluded Paramount, so the Time court could not have meant what it wrote. As described in Part III, examining for the presence of preclusive action sometimes may enlighten the ultimate inquiry of reasonableness, but other times, an examination into preclusion proves misleading. In dicta, the Delaware Supreme Court has acknowledged that preclusive conduct may be reasonable. As the inquiry into preclusion has yielded misleading, if not ironic, results, and as the Delaware Supreme Court has indicated that preclusive action may be reasonable, the court should re-examine the utility of the preclusion inquiry as an outcome-determinative filtering device regarding the ultimate inquiry of reasonableness. In these foundational decisions of corporate law, the Delaware Supreme Court could not have meant what it wrote. Each section incorporates clarifying concepts for consideration, and Part IV briefly concludes.

Cracking the <i>Corwin</i> Conundrum and Other Mysteries Regarding Shareholder Approval of Mergers and Acquisitions

This article responds to the Delaware Supreme Court’s important decision in Corwin v. KKR Financial Holdings, which declared that an informed and un-coerced shareholder vote in favor of a merger should lead courts to look skeptically at claims that directors breached their fiduciary duty in making the deal. The article will address the unintended consequences, unanswered questions and outright conundrum created by Corwin. The article’s central insight is that courts need to understand what shareholder approval is really telling us in light of the limited choice that shareholders have in front of them when voting on a proposed merger.

Unocal Fifteen Years Later (And What We Can Do About It)

The coincidence of the new millennium and the fifteenth anniversary of the Delaware Supreme Court's announcement of a new approach to takeover law provides an appropriate occasion to step back and evaluate a remarkable experiment in corporate law - the Delaware Supreme Court's development of an intermediate standard for evaluating defensive tactics. I will argue that Unocal has developed into an unexplained and, I think, inexplicable preference that control contests be resolved through elections rather than market transactions. In doing so, I will highlight the remarkable struggle between the Chancery Court and the Supreme Court for Unocal's soul, a contest I will suggest the Supreme Court won only by fiat. I will also maintain that the current debate over shareholder-adopted bylaws that repeal or amend director-adopted poison pills provides a vehicle to reposition Delaware takeover law. Finally, I will end my retrospective on a note of praise. Intertwined with the development of Delaware takeover law is a reassessment and important expansion of the role of independent directors in corporate governance. There is no reason why this important development cannot be preserved if the Delaware Supreme Court chooses otherwise to restore balance to the law of takeovers.

Fee-Shifting Bylaw and Charter Provisions: Can They Apply in Federal Court? -- The Case for Preemption

In the first months after a decision of the Delaware Supreme Court upholding a fee-shifting bylaw under which the unsuccessful plaintiff shareholder was required to reimburse all defendants for their legal and other expenses in the litigation, some 24 public companies adopted a similar provision — either by means of a board-adopted bylaw or by placing such a provision in their certificate of incorporation (in the case of companies undergoing an IPO). In effect, private ordering is introducing a one-sided version of the “loser pays” rules. Indeed, as drafted, these provisions typically require a plaintiff who is not completely successful to reimburse the other side’s legal expenses, and they apply not only to legal actions but to complaints to agencies by whistleblowers and others.In this testimony before the SEC’s Investor Advisory Committee, Professor Coffee evaluates the actions the SEC could take to slow this trend, the potential for interjurisdictional competition, and the case for federal preemption of such provisions in the case of securities class actions.

'Disney' Goes Goofy: Agency, Delegation & Corporate Governance

In the wake of the corporate debacles that have occurred in the last decade, there has been an increasing legislative and judicial focus on the reform of corporate governance standards. Such reforms, including the Sarbanes-Oxley Act, sing the praises of independent directors in effectuating meaningful corporate governance. The Delaware courts as well have emphasized the importance of independent directors in the corporate governance framework. The Delaware Supreme Court’s decision in Disney seems to be a reaffirmance of the business judgment rule as applied to corporate directors; however, the court’s highly-publicized decision ignores a crucial component of the case: the Delaware Supreme Court implicitly holds that Michael Eisner, as CEO of Disney, had the authority to unilaterally terminate the number-two officer in the corporation and to authorize a severance payment of over $130 million without action from the board of directors. By expanding the unilateral power of the chief executive officer to bind the corporation to such extraordinary transactions, the Disney court’s holding thus slights independent director service on corporate boards. Indeed, under the court’s reasoning in Disney, the effect of independent directors on meaningful corporate governance is diminished.

Appraisal in Delaware: Possible Improvement From the Bottom Up?

We trace the origins of shareholders' rights to judicial appraisal to determine the purpose - to avoid expropriation by majority shareholders. We then trace the meandering path of judicial appraisal in Delaware, which has exhibited a deep distrust of market valuations in favor of broad judicial discretion. While recently the Delaware Supreme Court has begun to attach importance to the deal price arrived at in good faith in mergers, it has continued to ignore the statutory injunction to exclude value added through anticipation or realization of gains through the merger. Instead, too often courts have been swayed or confused by dueling experts to reach values well above deal prices, or occasionally below, without serious consideration of pre-announcement market prices. Only recently has the Chancery Court used an efficiently developed market price to determine value in a manner consistent with the law.

Delaware's Retreat: Exploring Developing Fissures and Tectonic Shifts in Delaware Corporate Law

The 1980’s is appropriately considered the Golden Age of Delaware corporate law. Within that era, the Delaware courts won international attention by not just erecting the legal pillars that frame today’s corporate governance discourse but by interjecting a fresh perspective on the rights of owners and the prerogatives of managers. Four decisions stand out within a melodious chorus of great decisions of that era - Revlon , Inc. v. MacAndrews & Forbes Holding, Inc., Weinberger v. UOP, Inc., Unocal Corp. v. Mesa Petroleum Co., and Blasius Industries, Inc. v. Atlas Corporation. We refer collectively to the decisions as the Golden Quartet and show they each had the same life cycle: first, fundamentally changing Delaware’s judicial review of important recurring questions that both delineate the obligations of managers and defining the owner-manager relationship, only to be later eviscerated with the alacrity with which they first appeared. It is of course the nature of the common law for doctrine to be honed through subsequent decisions and such honing did initially occur in the life of each of these decisions. But it is less common for the doctrine to be abandoned or so seriously qualified as occurred with the Golden Quartet. Multiple forces in the world of corporate governance have affected directors’ and officers’ roles in the modern corporation and hence the Golden Quartet’s force. Chief among such forces are the growing prevalence of the independent director, the increased concentration of the shareholder ownership stakes, and the development of hedge fund activism, to name a few. These are easy explanations and are explanations the Delaware Supreme Court has recognized for stepping back from the earlier-established doctrines. While not disagreeing that each of these forces exists and recast the focus of the doctrine, after close analysis of the rise and fall of the Golden Quartet, we set forth some additional reasons for Delaware’s retreat from each component of the Golden Quartet.

The Effect of CFO Personal Litigation Risk on Firms’ Disclosure and Accounting Choices

AbstractIn Gantler v. Stephens (2009), the Delaware Supreme Court makes explicit that corporate officers owe the same fiduciary duty to the firm and shareholders as do board members. The decision increased the risk of non‐board‐serving officers being added as named defendants to investor litigation but did not change the risk of corporate litigation. Analyzing the effect of the Gantler ruling on non‐board‐serving CFOs, we find a significant change in their behavior as well as in their firms’ disclosure and accounting choices. Specifically, speech tone during earnings calls of non‐board‐serving CFOs becomes more negative when compared to board‐serving CFOs and the firm's CEO, and non‐board‐serving CFO firms disclose bad news earlier and report more conservatively. Results are stronger for firms incorporated in Delaware. Our findings suggest that CFOs respond to personal litigation risk over and above corporate litigation risk.

MOM Approval in a World of Active Shareholders

Majority of Minority (MOM) approval is a common mechanism used in many jurisdictions to control conflicts of interest in related party transactions. Recently, in M & F Worldwide, the Delaware Supreme Court held that MOM approval in a controlling shareholder freezeout shifted the standard of review from Entire Fairness to Business Judgement Rule. In this article, I investigate how MOM approval functions in the presence of active shareholders (both hedge funds and actively managed mutual funds). After reviewing the potential benefits and problems with MOM approval, I review the use of MOM provisions in controlling shareholder freezeouts in the U.S. between 2010 and 2017. I combine this with three case studies involving MOM approval: the Dell MBO; the Oracle/NetSuite merger; and the unsuccessful effort by the Dolan family to take Cablevision private in 2007. I then briefly consider a quite different sort of MOM approval: the EU Takeover Directive’s requirement that conditions mandatory freezeouts on achieving a very high level of ownership (90-95%), typically through a tender offer. The principal lessons of this investigation are ambiguous. First, I do not find significant evidence that the use of MOM conditions in Delaware has attracted the sort strategic behavior by hedge funds or actively managed mutual funds that transactional lawyers have worried about. Except for the 2007 Cablevision deal (an unhappy experience for both investors and the controlling shareholder), I have not found any cases in which shareholders have successfully used MOM provisions to block transactions. Second, as far as I can tell, the MOM condition also does not seem to do much good. I have not found any cases in which shareholders have successfully threatened to block a deal as a way of increasing the consideration paid by the controlling shareholder. Contrary to the hopes of optimists, the MOM condition does not seem to have empowered even large active shareholders to negotiate with controlling shareholders over price. Although it is possible that the MOM condition serves as a shareholder referendum on the performance of the special committee, there is little evidence that it has done so. Third, EU directive’s mandatory version of MOM (the 90-95% threshold for freezeouts) does seem to attract strategic investors who block transactions until they are bought out at a higher price. The lack of observable effects of MOM approval raise a question whether an independent special committee combined with MOM approval provides sufficiently robust protections of non-controlling shareholders to relieve Delaware courts of their traditional role in scrutinizing conflicted controlling shareholder transactions for Entire Fairness.

From Corwin to Dell: The Cost of Turning a Blind Eye

This essay considers the ramifications of the Delaware Supreme Court’s December 2017 Dell appraisal decision within the context of Delaware’s more sweeping clampdown on shareholder litigation protections in recent years, beginning with Corwin in 2015. While the Delaware Supreme Court rejected the “judicial gloss” of a formalized deal price rule in Dell, the gloss has, for all intents and purposes, been applied. The appraisal remedy had already been enfeebled in recent years by a slew of at-or-below deal price rulings, but Dell’s promulgation of a de facto procedural safe harbor marks a more systematic curtailment. The efficacy, as well as the public policy coherency, of Dell is tied to the notion that procedural “best practices” lead to, or are reflective of, fair dealing. Unfortunately, this is often not the case because the actors who are most likely to be conflicted are also the ones most likely to be in control the narrative presented in public-facing materials, particularly amid a broader boardroom shift—the “lone-insider” effect—which has undermined the monitoring capabilities of independent directors. In addition to lower deal premia and higher agency costs, the primary effects of Delaware’s post-2015 effort to dull shareholder defenses, culminating in Dell, will likely be: 1) faster CEO pay growth, and 2) more M&A and higher industry-specific measures of concentration, which research has shown to contribute to declining competition, lower levels of labor market mobility, wage stagnation, and increasing inequality in the United States.

An analysis of when the merger price is the best representation of fair value in an appraisal action

Delaware’s statutorily afforded right of appraisal is once again a hot topic. In an appraisal action, the Delaware Court of Chancery is charged with the task of determining the fair value of recently acquired Delaware corporations. However, the appraisal process is not an easy one, in no small part, to the inflexible statute guiding the appraisal procedure. The process is further complicated by the Delaware Supreme Court’s mandate that the Court of Chancery not to employ a bright line test in determining the fair value even for those transactions that were the result of a free and open market process. As a result, the courts are often left second-guessing a merger value that was the product of a fair merger process. I propose that in an arms-length third-party cash-out merger, the entire fairness standard of review is the appropriate standard to determine fair value within an appraisal action. A statutory safe harbor allowing the judiciary the opportunity to examine the process by which the target company and acquiring company arrived at the final merger value versus questioning the substance of the merger would serve the M&A and shareholder community well. In the absence of a legislative fix, the Court of Chancery has, at the least, provided buyers, sellers, and arbitrageurs alike, with scenarios that will likely result in the court determining that the merger rice is, in fact, the best representation of fair value. Essentially, when the inputs typically used by the court for determining fair value are in some way flawed, the court will likely conclude that the merger price is the best representation of fair value.

The Duty to Negotiate in Good Faith: Are BATNA Strategies Legal?

A negotiator's Best Alternative to a Negotiated Agreement (BATNA) is a key source of negotiating power. The BATNA concept was originally developed in the United States and has been exported to other countries through negotiation books and courses. But can negotiators legally rely on BATNA strategies in civil law countries, where there is a duty to negotiate in good faith? And when does a duty to negotiate in good faith arise in a common law country like the United States? In addressing these research questions, this article concludes that the duty to negotiate in good faith under the civil law weakens the ability of negotiators to rely on their BATNA power and subjects them to the possibility of reliance damages when they violate the duty. Under the common law approach used in the United States, negotiators can exercise their BATNA power unless they decide to assume a duty to negotiate in good faith. The risk of assuming this duty increases when negotiators use preliminary agreements — such as term sheets, memoranda of understanding, letters of intent, and agreements in principle. In light of a recent Delaware Supreme Court decision allowing the plaintiff to recover expectation damages, the consequences of breaching this duty can be severe. The article includes several practical lessons for negotiators who are considering the use of preliminary agreements.

Equity and Corporate Law

The article explores the continuing relevance of the 1991 Delaware Supreme Court decision in Schnell v. Chris-Craft Industries, Inc., in particular the extent to which evolving concepts of good faith have, or should, displace the free-wheeling equity doctrine of Schnell.

White Lies and Good Faith Dishonesty: Sometimes, Presumably, Directors Must Employ Subterfuge to Protect the Corporation

The courts have long struggled with a standard for reviewing board of directors' exercise of corporate control against a fellow director through strategic unequal treatment. While validating corporate secrecy between directors raises old-fashioned questions of corporate morality, there are presumably circumstances in which it is lawful and equitable to withhold information from a fellow director in order to protect the corporation. It seems that in certain contexts, disabling corporate boards from using their best business judgment to not prematurely disclose a planned action that would impair the interests of a director who is perceived to be harmful to the enterprise, contradict their fiduciary duties and would jeopardize stockholders' welfare far more than would strategic silence.In the recent case of Optimiscorp v. Waite, the Court of Chancery and Delaware Supreme Court were called to confront head on with this fundamental question: Can a board of directors call a special board meeting without pre-disclosing its plan to encroach upon fellow director's governance rights, acting in subjective good faith and honest belief the action is in the best interests of the corporation? Although the judicial scrutiny applied to unequal treatment of directors has shifted throughout the years, courts have treated such actions with suspicion, applying general reasoning grounded in fairness principles but without articulating why or what equitable standard of conduct has been violated.This Article examines the Delaware courts' most recent response to the limits of corporate boards' authority to treat fellow directors unequally. Particularly, I argue that the Delaware Supreme Court in OptimisCorp v. Waite failed to distinguish adequately those situations in which blindsiding a director constitutes inappropriate directorial behavior that improperly encroaches upon cognizable rights from the set of situations in which merely not disclosing its plan prematurely should not eliminate directors' protection of the business judgment rule. Thus, I argue the court's analysis and standard of review of exercise of such corporate power need significant refinement.

Optimal Fee-Shifting Bylaws

A fee-shifting bylaw provision requires the plaintiff-shareholder to reimburse the litigation expenses of the defendant-corporation when the plaintiff is not successful in litigation. After the Delaware Supreme Court ruled that the provision is enforceable in 2014, a number of corporations adopted fee-shifting provisions, utilizing the directors’ right to amend bylaws without express shareholder approval. In 2015, the Delaware legislature responded by amending the Delaware General Corporation Law to prohibit fee-shifting. This paper argues that the optimal fee-shifting arrangement lies somewhere between the version adopted by the corporations and no fee-shifting mandated by the Delaware legislature. A more balanced fee-shifting provision will do better in achieving the goal of encouraging meritorious lawsuits and discouraging frivolous ones, especially with respect to direct shareholder lawsuits. For derivative lawsuits, a balanced fee-shifting rule will impose a higher threshold on the merits than the traditional, no-fee-shifting rule. The paper also examines the fee-shifting provisions that are used in commercial agreements, notably stock purchase agreements and bond indentures, that employ more balanced fee-shifting arrangements but with variation. The paper finally argues that, given that there is unlikely one fee-shifting provision that is optimal for all corporations and for all types of litigation, the courts should consider applying the “proper or equitable purpose” requirement more vigorously to maintain flexibility while prohibiting undue restriction on shareholders’ legitimate right to sue.

The Hostile Poison Pill

Whether one ascribes to the agency theory of shareholder primacy or the contractarian theory of director primacy, boards of directors have great discretion in determining whether, when, and how to sell the corporation. Defensive tactics, like poison pills, can be tools in wielding that discretion in the service of creating shareholder value. However, a poison pill either to oppress a minority shareholder, as in eBay v. Newmark, or to minimize the impact of activist shareholders, as in Versata Enterprises, Inc. v. Selectica, Inc., seems to exceed the “maximum dosage” of the pill. The NOL poison pill, while facially plausible as a tool to protect tax assets from impairment caused by a Section 382 “ownership change,” may be a stepping stone to a low-trigger anti-shareholder pill. Instead of warding off uninvited potential acquirers, the pill could ward off shareholder voice. Though the original poison pills were blessed by the Delaware courts to ward off hostile bidders, now boards can use a hostile poison pill to ward off noisy shareholders. With the threat of the 1980s-era hostile bidder behind us, a new threat to board authority has emerged: the activist shareholder. These types of investors, often activist hedge funds, agitate not for control of a corporation, but for access to the board to argue for changes in strategy. Defensive tools used against hostile bidders at first seem inapplicable to these types of nuisances; staggered boards and poison pills with typical 15-20% triggers seem irrelevant. However, a pair of cases decided in Delaware may give managers an idea of how to cope with these aggressive blockholders. One case, Air Products and Chemicals, Inc. v. Airgas, Inc., allowed a company’s board to keep a poison pill in place for over a year even though the bidder did not seem to pose much of a cognizable threat to the corporation. By itself, Airgas does not seem to give much relief to a board dealing with a noisy 5% or 10% shareholder. However, the Delaware Supreme Court the year earlier had blessed a poison pill that would be triggered if a shareholder increased its ownership to 4.99% of the corporation, the lowest ownership threshold to be brought before the court. In Versata Enterprises, Inc. v. Selectica, Inc., the Delaware court upheld the poison pill even though the board did not focus its argument on the threat of a takeover. In this case, the “danger to corporate policy and effectiveness” existed because of the activist shareholder’s creeping purchases would constitute an “ownership change” under existing federal tax law and would lead to the loss of certain tax assets, net operating loss carryovers (NOLs). Because the NOLs were a very large, if unusable, asset to Selectica that would be severely limited under Section 382 of the Internal Revenue Code if the ownership change occurred, the court held that the low-trigger rights plan was reasonable and proportionate against a legitimate threat. Together, these cases seem to suggest a new weapon to be used against activist shareholders: a poison pill with a very low trigger.Unfortunately, the Delaware courts took at face value Selectica’s argument that the creeping acquisition could involuntarily cause the target company to lose a large tax asset. The Unocal test is supposed to require the board to articulate its rationale for implementing a defensive tactic, foreclosing the opportunity for pretextual arguments. However, this analytical technique may not work in the NOL context where the presence of NOLs may give a board of directors cover for keeping blockholders away. This Article attempts to shed some light on the operation of Section 382 to disclose some of the faulty assumptions surrounding both the necessity and efficacy of the NOL poison pill. In addition, this Article uses a dataset of 155 companies that adopted NOL poison pills between 1998 and 2014 to examine what types of firms are using this defensive tactic. A board might argue in good faith or not that an NOL poison pill is necessary to defend itself against a strange and diverse cast of characters: the Hostile Acquirer, the Accidental Bungler and the Bad Faith Saboteur. However, an NOL poison pill necessarily has little or no deterrent effect and no physical effect against any of these actors. In fact, the only shareholder that the NOL poison pill effectively deters is the activist shareholder, suggesting that the use of the poison pill in these cases may be “hostile.”