Friday, April 26, 2024

The Delaware contretemps continues

Previously, I posted about the grumbles of discontent from the corporate bar regarding several recent Delaware Court of Chancery rulings, resulting in proposals for statutory amendments that seemed somewhat hasty and poorly thought-out.  Sujeet Indap had a piece in the Financial Times about it; before that, there was coverage in a local Delaware outlet.

Now, Law360 reports on a new memo issued by Wilson Sonsini, reminiscent of Martin Lipton's famous Interco memo, warning that Delaware may no longer be as friendly to business.  From the memo:

In recent months, a conversation has emerged as to whether Delaware should remain the favored state of incorporation for business entities. Indeed, many of our clients have asked us whether they should remain in Delaware or choose Delaware as the state of incorporation for their new ventures. In this discussion, we provide our reflections on that question and various factors that entrepreneurs, investors, and companies should consider when weighing incorporation in Delaware against incorporation in another state. ...

In the conversations that we have had with clients, businesspeople, and others in the corporate bar, we have heard the following reasons given for reconsidering incorporation in Delaware:

  • A growing number of cases that have addressed technical issues, in the M&A context and elsewhere, and reached unexpected results in a manner that has impacted corporate structuring and transaction planning
  • A perception that Delaware judges have in several opinions adopted an increasingly suspicious or negative tone toward corporate boards and management, and toward the corporate bar
  • The challenges that the case law can pose for companies with influential founders or significant stockholders, the process mechanisms that such companies are expected to use, and the remedies that have been reached in those cases
  • A sense that Delaware judges can be skeptical of the governance of venture-backed private companies and many Silicon Valley-based companies
  • The increasingly active, and successful, plaintiffs’ bar in both technical and fiduciary claims, which can leave boards and management with the sense that they are planning around “gotcha” litigation driven by plaintiffs’ lawyers more than those lawyers’ individual clients

Obviously, the third point here regarding influential founders/significant stockholders is a reference to the MFW process, which the Delaware Supreme Court just reaffirmed.  But the Delaware Supreme Court also just granted interlocutory review in TripAdvisor, which raises the possibility that some of the tension will be ratcheted down through a narrowed definition of what counts as a conflicted transaction that triggers the need for entire fairness review/MFW cleansing in the first place.

What's more interesting to me are points 2 and 4.  I assume that some of those objections are about Moelis, which struck down the type of shareholder agreement that seems to have become common in VC-backed firms and was carried over to the public space, and maybe even go as far back as decisions like Trados, which held that in a VC backed firm, the directors' fiduciary obligations run to the common over the preferred (even though Trados itself did not grant any damages to the common shareholders).

But I also suspect that some of the sturm und drang has its antecedents in In re Oracle Corp. Derivative Litig., 824 A.2d 917 (Del. Ch. 2003), when then-Vice Chancellor Strine held that the independence of a special committee was compromised by close professional and networking ties.  The case was a break from prior Delaware jurisprudence, which treated directors as independent in almost all situations that didn't involve either blood or money, and the Delaware Supreme Court rejected his approach in Beam v. Stewart, 845 A.2d 1040 (Del. 2004).  Once Strine ascended to the Delaware Supreme Court, though, the caselaw started inching back his way, starting with Sanchez, continuing on with Sandys v. Pincus, and culminating in Marchand v. BarnhillThe thing about these more nuanced tests for dependence/independence is that they may, in fact, hit Silicon Valley companies particularly hard, because of the chumminess of the tech world, and it's not surprising that once independence is questioned, the tone of the opinions is going to come off as skeptical, in a manner that defendants do not like.  

Anyway, I'll just conclude by echoing the comments in the Law360 article, namely, that whatever the correct direction of Delaware law, this kind of open warfare (and, frankly, attempted deployment of political muscle) challenges the reputation Delaware has built for comity and a technocratic approach to lawmaking. That's the kind of thing that undermines Delaware's legitimacy as, in a sense, a de facto federal agency.  It's the kind of thing that invites more intrusion from federal regulators, and less respect from other jurisdictions - not just other states, but around the world.

Ann Lipton | Permalink