Saturday, July 4, 2020

Judicial Primacy

It seems we’re all talking about VC Laster’s recent opinion in In re Dell Technologies Class V Stockholder Litigation.  Stefan posted about Laster’s taxonomy of coercion earlier this week; for me, I want to focus on another aspect of the case, the one that Stephen Bainbridge latched onto as indicative of his “director primacy” view.

The basic set up in Dell was that controlling shareholders – Michael Dell and Silver Lake – engineered a transaction whereby Dell would redeem Class V stock from its holders, and they wanted to cleanse the deal using Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) procedures to ensure it would receive business judgment review.  To that end, they conditioned the transaction on special committee approval and unaffiliated shareholder approval.  Dissatisfied stockholders sued, claiming that despite those efforts, the MFW conditions were not satisfied, and, for the purposes of a 12(b)(6) motion, Laster agreed. 

Laster actually found that, as alleged, the departures from MFW were many and varied, but there’s one aspect in particular I want to focus on, namely, the curious role of the “stockholder volunteers.”  After months of negotiation, the special committee reached a deal with the company that met with immediate objection from Class V stockholders.  Rather than go back to the committee, Dell instead started negotiating directly with a selection of six large investors until a new deal was struck.  At least according to the plaintiffs, the committee perfunctorily approved the revised deal, and it was that deal that was finally presented to the stockholders generally for their vote.  When Class V shareholders sued, Dell argued that the committee-plus-stockholder negotiations were sufficient to satisfy MFW.  In their view, this set up presented the best of all worlds: independent committee protection with direct input from sophisticated shareholders bargaining in their own interests.

Laster disagreed.  He observed that corporate directors are the ones charged with protecting shareholder interests, and that task cannot be delegated to individual shareholders who have no fiduciary obligations to the company and do not have the information available to insiders.  In so doing, he cited several academic articles (including, umm, one of mine, Shareholder Divorce Court) discussing how individual shareholders have private interests that may not match those of the shareholders collectively. 

It was this portion of the opinion that Stephen Bainbridge highlighted as endorsing his “director primacy” theory, which posits that shareholders have a very subordinate role in corporate managerial decisionmaking, even in the context of large transactions.

The part that I’m interested in, however, is Laster’s attention to the varying incentives of even the “disinterested” stockholders.  That’s what I was discussing in Shareholder Divorce Court, namely, how large institutional shareholders are likely to have cross-holdings that affect their preferences, and lead them to favor nonwealth maximizing actions at a particular company if they benefit the rest of the portfolio (after the article was published, I posted about additional empirical work in this area here).  Laster has historically been especially sensitive to these kinds of conflicts.  He authored In re CNX Gas Corp. S’holders Litig., 4 A.3d 397 (Del. Ch. 2010) (which I highlight in Shareholder Divorce Court), where T. Rowe Price was found to be “interested” for cleansing purposes because, across its mutual funds, it held stock in both a target and the acquiring company.  Laster also wrote the opinion in In re PLX Tech. Stockholders Litigation, 2018 WL 5018535 (Del. Ch. Oct. 16, 2018), which I discussed here, where he concluded that a hedge fund’s “short-term” outlook caused its interests to differ from the other shareholders (even though those other shareholders had voted to put the hedge fund’s representatives on the company’s board).  In his Dell opinion, Laster mentions another relevant type of cross-holding, namely, the distinction between investors who own both debt and equity, and investors who own equity alone.  

The problem, though – as I discuss in Shareholder Divorce Court and What We Talk About When We Talk About Shareholder Primacy– is that if you’re going to recognize the heterogeneity of shareholder interest due to these different types of portfolio-wide investments, it’s unclear why a majority vote should be permitted to drag along the minority in a particular deal.  Which conflicts will we recognize as generating bias, and which will we ignore?  That’s the problem that cases like Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) and MFW are forcing Delaware to confront.  Laster’s far more willing to engage here; so far, other judges have, umm, avoided the issue.  For example, Laster cites In re AmTrust Financial Services, Inc. Shareholder Litigation, 2020 WL 914563 (Del. Ch. Feb. 26, 2020), where a controller negotiated directly with Carl Icahn when it seemed shareholders were unlikely to approve a deal endorsed by the special committee, but, as Laster notes, Chancellor Bouchard refused to decide whether such actions forfeited MFW protection.  Similarly – as I wrote about in Shareholder Divorce Court – VC Slights, entertaining a stockholder challenge to Tesla’s acquisition of SolarCity, failed to reach the question whether institutions like BlackRock who owned shares in both entities counted as “disinterested” votes for Corwin purposes. 

In practical effect, it seems, Laster is less about director primacy than judicial primacy, in a way that often puts him at odds with other members of the Delaware judiciary.  (See, e.g., my discussion of Salzberg v. Sciabacucchi, and the differing views of the nature of the corporation expressed by Laster and the Delaware Supreme Court).  Because once you hold that shareholders are too biased to make decisions, that doesn’t necessarily lead to director primacy; instead, it creates more space for the judiciary to step in to protect the interests of the abstract notion of shareholder, distinct from the ones who actually cast ballots.  Or perhaps, we should call it state primacy.  Which was the point of my post last week (as well as the thesis of my post about the PLX case and my What We Talk About When We Talk About Shareholder Primacy essay.  I do have a theme).

And that segues nicely into - happy July 4th, and the birth of the American government!

Ann Lipton | Permalink


Ann, thanks for (as always) shedding new light on an already fascinating case. Dell joins other opportunities we now have to re-engage with corporate law theory - among them, the corporate purpose debate and the (recently reinvigorated) mandatory arbitration debate.

I have only one comment: the "state primacy" model, which is quite common in scholarship, isn't an accurate depiction of corporate law. Instead, we should think in terms of legal primacy: corporate law, as law, governs both directors, shareholders, and the state. Of course, this diverges from most prevalent conceptions: it's not contractarianism (where "anything goes" - but corporate law has many unwaivable rules); it's not director primacy (where directors are subject to very little oversight - but both shareholder activism and successful lawsuits are real); and it's not shareholder primacy (where shareholders call, or should call, the shots - but this doesn't explain the role played by managers, nor features such as capital lock-in and asset partitioning).

Legal primacy is also different from state primacy. By mentioning the "state", corporate scholars aim to say that there are mandatory rules, set by the sovereign (the Delaware legislature and courts), and not subject to alteration by any private actor. That's entirely correct, and it is what happened in Dell. However, this is not unique to corporate law: every area of law - even contract - has certain mandatory rules (say, offer and acceptance, or the requirement of definiteness) that predate "private ordering".

This doesn't mean that the state is party to every contract. It just means that the state - along with common law and equity - makes rules that govern various aspects of private law, of which corporate law is part. Due to inherent power and information asymmetries that characterize the corporate framework, we just happen to have more mandatory rules, grounded in concepts of equity, fiduciary duty, etc. These concepts are not creatures of "the state", but creatures of law. "Judicial primacy" indeed gets very close, since judges ultimately enforce the law.

I've talked about this in my latest article (see particularly footnote 277), but it's always good to have a high-profile case - and even better to have a couple, like Salzberg and Dell just three months apart - give us the opportunity to discuss these points.

Posted by: Asaf Raz | Jul 5, 2020 2:12:25 PM

Hi, Asaf - so glad you enjoyed the post, and that it resonated with your thinking! I'm not sure i can distinguish "state" from "law" though; to me they're kind of the same, though they don't necessarily mean mandatory rules. Judicial review ex post for fairness/equity is not a mandatory-rule thing at all, but it represents the power of the state. But yeah, I think Dell and Salzberg - in the latter case, Laster's view versus the Del SCt's view - really highlight these different theories of the corporation that get at the core of what we've all been debating for, well, a century now.

In any event, thanks for reading - and commenting!

Posted by: Ann Lipton | Jul 5, 2020 2:30:36 PM

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