I suppose it’s gratifying that the proposed changes to Delaware law support the thesis of my new paper, The Legitimation of Shareholder Primacy.  There, I argue, among other things, that Delaware imposes procedural limitations on managerial behavior that function more as a performance to the general public, to grant corporations a social license to operate, than as real constraints.  So, of course, as soon as those limitations started to have even the tiniest bit of actual bite – and in an environment where the prospect of federal preemption is largely nil, and corporate power has reached the point where a social license to operate may no longer be necessary – managers threaten to depart the state, and Delaware proposes of package of statutory changes that undo certainly the last 10 years of Delaware jurisprudence, if not the last 50, in favor of a model of corporate self-policing.

The story actually begins last year, when, in response to the Moelis decision, Delaware rushed to amend its corporate code to add Section 122(18), permitting corporate-governance-by-contract.  At the time, I asked – quite seriously – what is the value of the corporate form? 

This is very much a debate that’s been raging in academic circles for decades: is there value to the state-imposed rigidity of the corporate form, or should business forms be endlessly malleable according to the desires of corporate participants, so that really everything is reducible to an LLC?

Whatever the correct answer to that debate as a theoretical matter, with Section 122(18), Delaware came down firmly in favor of the argument that the corporate form has no inherent value; private ordering is everything, and we are, in fact, all LLCs now.

That said, one of the key distinctions between LLCs and corporations is fiduciary obligation: in LLCs they are waivable, in corporations they are not.  Fiduciary obligations are, like the rigidity of the corporate form itself, a type of state regulation: They are a judicially-imposed limit on exploitative conduct by managers.

But Delaware’s been eroding that form of regulation for quite some time, first with the adoption of 102(b)(7), then with 122(17), then with Corwin and MFW, and then with the expansion of 102(b)(7).

Still, fiduciary obligations seemed to make something of a comeback, when then-Vice Chancellor Strine set upon a multi-year project, culminating in Marchand v. Barnhill, to seriously examine the social and professional ties among directors as part of the independence inquiry. 

So I suppose it was inevitable that the Delaware legislature would seek to undo that last vestige of regulation, as well as all other remainders.

In sum, the proposed amendments to Delaware law would:

1) Impose single trigger (disinterested director approval, or disinterested shareholder approval) cleansing for conflicted controller transactions except for going private ones, which would continue to require both sets (overrule Match)

2) Eliminate the “ab initio” requirement for cleansing (meaning, a controller could negotiate substantively before the protections are put into place)

As I have said in various spaces, given the demand requirement for derivative claims, I believe controlling shareholder transactions already have a single trigger cleansing requirement in most scenarios (as VC Fioravanti just demonstrated in Trade Desk); the only transactions where double trigger requirements do much work are for the very largest kinds of deals. So, these first two changes, would, as far as I can tell, have the effect of insulating transactions like the Paramount merger with Skydance.

3) Overrule Match’s requirement that special committees be completely independent; majority independence suffices

4) Redefine independence/disinterest to incorporate federal stock exchange standards, so that if the board certifies a particular director as independent under exchange listing standards, that determination presumptively controls, unless a plaintiff shareholder offers “substantial and particularized facts that such director has a material interest in such act or transaction or has a material relationship with a person with a material interest in such act or transaction.”

5) Redefine the “entire fairness” inquiry to mean “the act or transaction at issue, as a whole, is beneficial to the corporation, or its stockholders in their capacity, as such given the consideration paid to or received by the corporation or its stockholders or other benefit conferred on the corporation or its stockholders and taking into appropriate account whether the act or transaction meets both of the following:

a. It is fair in terms of the fiduciary’s dealings with the corporation.

b. It is comparable to what might have been obtained in an arm’s length transaction available to the corporation”

6) Define controlling shareholder to mean someone with a majority of the voting power entitled to vote in director elections, or someone who has one-third of the voting power in a general director election, or power to elect directors who have a majority of board voting power, and has “power to exercise managerial authority over the business and affairs of the corporation.”

Which translated means, you must at least have 1/3 of the voting power in a general election of directors before you can even be considered a controller, so, presumably, someone with a 122(18) contract to control almost all corporate functioning other than director selection would not be a controlling shareholder, so that’s a roadmap for future 122(18) agreements;

7) Overrule Sears Hometown by providing that controlling shareholders can only be liable for loyalty violations

8) Limit Section 220 to cover only formal board materials, rather than emails and other documents where business may be conducted

9) Separately ask the Delaware Council of the Corporation Law Section to propose a bill to cap plaintiffs’ attorneys fees.

Collectively, the changes represent a wholesale repudiation of Delaware’s common law approach to lawmaking; instead, they most closely resemble the MBCA’s rule-bound approach. Moreover, the changes, if adopted, mean it will be laughably easy, with a few incantations of magic words, to create the appearance of procedural regularity, while shareholder plaintiffs will be denied access to the information necessary to establish any procedural irregularity.  At the same time, because fees will be capped for successful claims, plaintiffs’ attorneys will be deterred from taking on the enormous risks associated with stockholder litigation. 

What stands out for me is that Delaware could have proposed to eliminate shareholder litigation altogether.  It would have been simpler, and more honest: a straightforward declaration that litigation does little to substantively protect shareholder value.  That’s not even a crazy position; it’s certainly a vibrant debate among academics.

But rather than be so forthright, the proposal retains the veneer of governance, to create the appearance that conflicts are being policed – but, with no actual substance to back it up.  That is, of course, the thesis of my article. The law itself isn’t doing any work except to launder managerial power.

One final point, for now:  The proposed legislation says nothing about whether it applies to pending cases.  If it does apply to pending cases, it could conceivably upend the Tornetta appeal, regarding Musk’s compensation package.

Update: Reuters reports that Delaware state Senator Bryan Townsend says the bill is not retroactive, and so would not apply to Tornetta. I don’t see that in the text, but we may get clarification along those lines. The analysis below was written before I saw the Reuters report.

Under the new legislation, Musk could not be considered a controlling shareholder, because he never had 1/3 of the vote.  That alone wouldn’t be enough to overturn McCormick’s findings, though; she also concluded that the board was not independent, and shareholders were not fully informed, which meant a judicial determination of “fairness” was necessary.

The statute redefines independence, but again, I’m not sure that would matter to the Tornetta appeal: Under the new statute, listing standards presumptively control, but plaintiffs can rebut with specific facts demonstrating a lack of independence – and they may have those in Tornetta (I would say they surely do, but I can’t be sure whether a “material relationship” under the statute means something different than it does at common law).

The proposed statute also explicitly contemplates that transactions may be ratified by a fully informed shareholder vote, which would seem to validate the Tornetta revote.  But then again, the statute doesn’t say anything about the procedural stage at which such a vote must be taken; what sunk Musk’s “ratification” was, among other things, the fact that it occurred post trial.  (A point I discussed at length in a Shareholder Primacy podcast).

But what I think has the most bite for Tornetta is the redefinition of “fairness.”  If that applies to the appeal – coupled with the unmistakable rebuke the statute is offering to the entire Delaware judiciary (and no, not just “two judges,” but all of them, including Strine and his reinvigoration of the independence inquiry, and the Delaware Supreme Court’s Match opinion) – that could change the Tornetta outcome.

That said, as I warned in my article, “The more freedom Delaware accords corporate managers, and the less scrutiny it applies to their transactions, the less there is for Delaware to, well, actually do.” Delaware could wind up deregulating itself out of relevance entirely.