Corporate Power in Civil Society

5. Major Delaware Decisions of the 1980s and 1990s

Major Delaware Decisions of the 1980s and 1990s We focus on Delaware courts in this chapter for a straightforward reason: Over 40 percent of the corporations listed on the New York Stock Exchange are incorporated in Delaware, over 60 percent of the Fortune 500, and over 50 percent of the Dow Jones Industrial Average.1 In addition , most corporations that reincorporate choose in overwhelming numbers to move into Delaware. For the purposes of this chapter we simply assert that Delaware’s Chancery Court and Supreme Court wield greater influence in the American corporate judiciary and bar than any other state’s courts. They have done so since the 1920s, and no one suggests that any other state’s courts,or any set of state courts,is likely to challenge Delaware’s dominant position. This begs the question for now of how and why Delaware achieved its dominance, but we will get to this in time (see Chapter 10) as we explain why these courts act at times in norm-based ways rather than market-mimicking ways. I. Delaware Courts and the 1980s 1. Traditional Standards of Review Before the market for corporate control emerged in late 1983, Delaware’s Chancery Court and Supreme Court classified actions taken by corporate officers in only two ways, as either disinterested or interested. Disinterested actions spanned all exercises of management discretion protected from judicial review by the business judgment rule. In order to retain this judicial “presumption” in their favor, corporate officers simply had to act in ways that did not cause shareholders to allege in derivative suits that they had breached their fiduciary duties of care and loyalty. In the course of normal business activities, this is hardly an issue. But it can be an issue in unusual 5 97 transactions, in major corporate decisions involving changes of control or changes in governance structure. In unusual situations, Chancery considered three factors in reviewing business decisions taken or approved by corporate boards of directors. Were the decisions made (a) by independent directors (that is, those having no personal material stake in the transaction), (b) acting in good faith, (c) with due care?2 An often-cited description of this traditional standard of analysis dates from a 1939 decision by Delaware’s Supreme Court (in Guth v. Loft Inc.):3 Corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests. . . . [This rule] demands of a corporate officer or director, peremptorily and inexorably, the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation, or to deprive it of profit or advantage which his skill and ability might properly bring to it, or to enable it to make in the reasonable and lawful exercise of its powers. Actions taken by corporate officers that courts classified as interested were those that failed to meet one or more of the three tests above.With any credible allegation of breach (by a shareholder with standing), Chancery no longer presumed the business judgment rule protected corporate officers from judicial review (when their companies were incorporated in Delaware ). Instead, Chancery applied an “intrinsic fairness” or “entire fairness” standard of analysis to the disputed transaction. In applying this standard, Chancery examined the process leading to the transaction and then its outcome or terms. Thus, intrinsic fairness contained two component parts: fair dealing (process) and fair price (outcome).4 This two-part review includes qualitative considerations of how corporations are governed and how corporate officers conduct themselves within governance structures, not economic calculations of optimality alone. Consistent with Delaware courts’ intrinsic fairness standard, Delaware’s General Assembly allowed one exception or “safe harbor” even for formally interested business transactions. It instructed Chancery (and then Delaware’s Supreme Court, when hearing appeals) to support these transactions (a) when they were approved by an informed majority of directors or shareholders, or else (b) when Chancery was satisfied they were “intrinsically fair” to the corporation. This either/or way of categorizing management actions, as disinterested 98 | Major Delaware Decisions of the 1980s and 1990s or interested, worked well until the hostile takeovers, leveraged buyouts, and management buyouts of the 1980s brought a tidal wave of new cases before Chancery and then Delaware’s Supreme Court on appeal. Hostile tender offers...