Lotta news lately about companies seeking to leave Delaware, so it’s amusing to see a company fighting to get in. 

Daktronics is incorporated in South Dakota of all places (is it lonely there?).  South Dakota mandates cumulative voting, which makes it much, much easier for a minority blockholder to gain board representation, as Matt Levine explains here.

And such a blockholder has emerged, in the form of Alta Fox.  Alta Fox is both a shareholder and a holder of Daktronics notes, but the notes are convertible into shares, so on a fully diluted basis, Alta Fox owns over 11% of Daktronics’ voting power.  Given that, at least some of Alta Fox’s director nominees would likely have been seated in a proxy contest but – plot twist! – Daktronics called a special meeting of its shareholders to vote on reincorporation to Delaware, where cumulative voting is not the default.

And, as I understand it, Daktronics is calling for that vote before Alta Fox’s shares convert, so that Alta Fox will be heading into the meeting with less than its full voting power. In response, Alta Fox filed a lawsuit (in federal court, presumably because it just likes the judges and/or procedures better), alleging that Daktronics’s proposal represents a breach of fiduciary duty and shareholder oppression.

So, quick point: Shareholder oppression is a remedy unavailable in Delaware, but available in most other states in one form or another, and typically protects shareholders in close corporations from the unreasonable frustration of expectations by a majority shareholder or controlling group.  Usually, the issue is that the majority group is refusing to pay dividends or otherwise cutting the minority shareholder off from the economic benefits of the investment, leaving the minority shareholder trapped with illiquid holdings that are not generating any income.  So, employing the doctrine in the context of a public company would be unusual, but I’m not an expert in South Dakota corporate law (is anyone?) and we’ll have to see how that unfolds.

That said, the more interesting question is how to think about the legal issue of using reincorporation as a defensive tactic.

As Ben Edwards posted, earlier this week, the Delaware Supreme Court decided Maffei v. Palkon, where it held that reincorporation out of Delaware into Nevada – even if forced through by a controlling shareholder – will not be treated as a conflicted transaction subject to entire fairness review.  But there’s an important caveat: the Delaware Supreme Court made clear that if there is an actual transaction under consideration, such that the plaintiffs can show reincorporation would rob them of specific rights, then entire fairness might be the appropriate standard of review.  As the court held:

[T]he hypothetical and contingent impact of Nevada law on unspecified corporate actions that may or may not occur in the future is too speculative to constitute a material, non-ratable benefit triggering entire fairness review…. Given the absence of any allegations that the Conversion decisions were made to avoid any existing or threatened litigation or that they were made in contemplation of any particular transaction, we hold that Plaintiffs have failed to adequately allege facts showing Defendants’ receipt of a material, non-ratable benefit….

We note that Plaintiffs have not alleged that Defendants have taken any articulable, material steps in connection with any post-conversion transactions.  If directors or controllers were to take such steps in furtherance of breaching their fiduciary duties prior to redomesticating, even though such transactions or conduct would not be consummated or take place until after the change of corporate domicile, then our standard of review could be different.  Although we do not reach that issue today, under such a scenario the conduct of those alleged to have engaged in it could still be subject to Delaware law.  But, as we have stated above, the record here suggests the existence of a “clear day” and the absence of any material, non-ratable benefits flowing to the controller or directors as a result of the Conversions.

So, back to Daktronics.  Here, the reincorporation is not intended to effectuate a specific transaction, but it is intended to thwart shareholder voting rights in the context of a particular, threatened proxy contest.  And – I have no idea what South Dakota law is, I doubt anyone knows – but under Delaware law, such actions would usually be evaluated under the heightened scrutiny of Unocal/Coster.  Specifically, as the Delaware Supreme Court put it in Kellner v. AIM:

the court should review whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit.” The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interests of the stockholders.

In other words, as Kellner put it, takeover defenses are prohibited when they interfere with voting rights and are adopted by a board “for the primary purpose of precluding a challenge to its control.”

Now, relocating to Delaware does not preclude Alta Fox’s challenge, but it does seem like reincorporation is intended to change the rules of the game to Alta Fox’s detriment mid-stream, so I venture to guess that a Delaware court, confronted with the problem, would in fact employ the heightened test rather than business judgment review.

Anyhoo.  I don’t know how the case comes out, I don’t even know if a South Dakota court will look to Delaware precedent.  But it’s interesting that even after Maffei, we immediately see an example of reincorporation as potentially subject to a heightened standard of review.

And another thing.  New Shareholder Primacy podcast is up!  This week, Mike Levin talks to Lauren Thomas of the Wall Street Journal.  Available here at Spotify, here at Apple, and here at YouTube.