The Delaware Court’s recognition of changing investor base is creating changes in the way it approaches governance-related decisions
More than 150 corporate secretaries, general counsel, other corporate lawyers, judges and academics met at the first Delaware Law Issues Update conference held at the University of Delaware on November 20 and 21.
Hosted by the Society of Corporate Secretaries and Governance Professionals and the John L. Weinberg Center for Corporate Governance at the University of Delaware, the event featured panel discussions on directors’ fiduciary duties in compensation decisions, M&A trends, corporate responses to multi-jurisdictional litigation and many other areas undergoing change within the Delaware Chancery Court.
Underlying the evolution of how the Delaware Court arrives at governance-related rulings is recognition of changes in the shareholder base over the past few decades. There are also a variety of approaches among new kinds of shareholders, who are generally much more knowledgeable than they were in the 1960s, a Chancery Court justice said in his opening remarks.
During a session about directors’ fiduciary duties in compensation decisions, panelists cited various cases in which shareholders had charged boards with dereliction of their duties of care, loyalty or waste in approving certain kinds of executive pay plans. The lesser known duty of directors not to waste corporate assets by overpaying for employment services was the pretext for Brehm v. Eisner, in which the Delaware Supreme Court ruled that the board’s decision didn’t meet the waste standard.
Unless the presumption is rebutted, the Court won’t second-guess the reasonableness of a board’s compensation decision if the decision can be attributed to any rational business purpose,’ a representative of the Delaware Court said.
When it comes to open-ended stock option plans, ‘corporate decisions are most appropriately decided by boards that can deliberate, as opposed to shareholders,’ which aren’t able to deliberate, said Arthur Kohn, a partner at Cleary Gottlieb Steen & Hamilton.
‘It’s useful for the Delaware courts to be the prime arbiter of whether executive compensation plans are in the company’s best interests, and not up to regulators,’ Kohn elaborated after the session. ‘These are business judgment decisions.’
A panel titled ‘When bad things happen to good companies’ considered the nature of Caremark-type claims under Delaware law after a company experiences a large unexpected liability and how companies should respond to them. Among these claims are books and records demands and demands that boards bring action against alleged wrongdoers, including directors.
The Caremark case in 1996 showed that the board has an ongoing duty to stay abreast of anything occurring at the company involving risk. Much of the discussion revolved around the need for the board to ensure there’s a communication system by which risk-related information can be funneled up from the business units to the top level of management and the board.
Among the three lines of defense companies have against risk (internal controls within business units, the compliance program and internal audit) the weakest link is often the compliance function, said Nicole Sandford, a partner and national practice leader for governance services at Deloitte & Touche.
It’s critical that the compliance department does its own independent assessment of business units’ internal controls to determine whether or not they’re adequate to prevent misconduct, she said.
While there’s currently a hyper focus on regulation, companies need to watch out for other factors to ensure misconduct doesn’t occur, which requires thinking ahead, she said. The pressures on firms in heavily regulated industries to keep up with minimum regulatory requirements means they often don’t have the ability to be on the lookout for other signs of misconduct, she added.
Chancellor Leo Strine headlined a panel on the latest developments in M&A deals which looked at ongoing disclosure issues concerning business projections, financial advisor disclosure and the newest devices being used to protect deals from outsiders. Panelists discussed Strine’s recent ruling in Great Hill Equity Partners v. SIG Growth Equity Fund, which found that all communications involving the seller’s attorney-client privilege are included among the rights, privileges, powers and franchises, and property that is transferred to the buyer upon a merger’s closing under Delaware General Corporation Law Section 259.
The final session on November 20 considered federal and state judicial developments, including a growing trend by companies to adopt exclusive forum provisions in their bylaws or charters that prohibit cases from being litigated in multiple jurisdictions. Large investors don’t want their portfolio companies to litigate in multiple forums, but they understand shareholders’ rights to bring suits in any jurisdiction they choose, a corporate lawyer on the panel said.