Sometimes I post for a naive audience, sometimes I want to get something out quickly and assume a more sophisticated audience, and with so much movement on SB 21 right now I’m opting for the latter.

So, first – the CLC offered some proposed changes to the law, which you can see here. (Mike Levin and I had just recorded a Shareholder Primacy podcast about the original flavor SB 21; that will still drop tomorrow morning; you can be the judge whether the overall assessment remains good in light of the proposed amendments). Brian Quinn says all that needs to be said about the CLC’s concept of retroactivity; I’ll just highlight what I think is significant.

Under the original version of the law, if the transaction did not involve a controlling shareholder, board level cleansing was achievable even if the board was majority-conflicted. As long as the disinterested directors voted in favor of the deal, it was cleansed – meaning, a board 4-1 conflicted could still cleanse the deal, so long as that single director voted in favor. If the transaction did involve a controlling shareholder, board-level cleansing required the creation of a majority-independent committee, but there was no specification as to how many committee members were necessary – one, in other words, would do.

The new statute says that board level cleansing, either for controller transactions or simply transactions where the board is majority-conflicted, requires the creation of a committee. The committee must have at least two people. All committee members must be disinterested. That’s an improvement, and even tightens the standards of existing law. But. As I understand it, disinterest in committee creation is measured by the board’s determination. In other words, the board – potentially a conflicted board – gets to decide who is disinterested, and put those people on the committee.

Once that occurs, if the deal is subsequently challenged, then – as I read the rule – the court cannot revisit whether the committee was in fact completely disinterested (maybe subject to a good faith challenge? I do not know). What the court can do is determine whether a majority of the actually disinterested people voted in favor of the transaction.

In other words, there’s a conflicted board. The board creates a 3 person committee that it determines is completely disinterested. Later, a shareholder brings a lawsuit, and establishes 2 of the 3 people were not, in fact, disinterested. The transaction still passes muster if that 1 disinterested person favored the deal, because that one person constitutes a majority of the disinterested directors on the committee. That’s how I understand the revisions, anyway.

Here is the relevant language, providing the deal is cleansed if:

The material facts as to the director’s or officer’s relationship or interest and as to the act or transaction, … are disclosed or are known to all members of the board of directors or a committee thereof, and the board or committee in good faith and without gross negligence authorizes the act or transaction by the affirmative votes of a majority of the disinterested directors then serving on the board or such committee (as applicable), even though the disinterested directors be less than a quorum; provided that if a majority of the directors are not disinterested directors with respect to the act or transaction, such act or transaction shall be approved (or recommended for approval) by a committee of the board of directors that consists of 2 or more directors, each of whom the board of directors has determined to be a disinterested director with respect to the act or transaction…

Whether all this is necessary to make incorporators feel comfortable, I do not know, but I really do need to emphasize again: Despite the fact that, under current law, controlling shareholder transactions require approval of both an independent board committee and disinterested shareholder approval – and conflicted director transactions need just one – if the claim concerns an ordinary course type of transaction, the vast majority of the time, the claim will be derivative, and it will be dismissed on the pleadings if there is an independent board. In other words, for many, if not most, transactions under current law, you can get the claim dismissed if there is a majority independent board with no further hullaballoo. I do think that layer of protection for boards/controllers should be a greater part of the conversation.

Beyond that, I keep thinking about the broader problem, namely, how did Delaware get to this place? One answer, that I offer in my The Legitimation of Shareholder Primacy paper, is that the normalization of certain governance practices in private/Silicon Valley companies ultimately clashed with standards that had been established for public companies.

But I think we can actually go further and trace the problems to something else: the Delaware Supreme Court’s decision in C&J Energy, which prohibited preliminary injunctions in most cases.

When I wrote Legitimation of Shareholder Primacy, I was very influenced by Ed Rock’s Saints and Sinners paper. He argued that Delaware decisions are like morality plays, where “bad managers” are called out in storytelling. But, critically, bad managers were rarely actually sanctioned – the jawboning was sufficient to induce discipline – because even when preliminary injunctions were denied, the court was able to weigh in early on problematic processes, which could induce a course correction and/or settlement. The cases never had to proceed to trial or – god forbid – judgment on the merits, because the process of seeking preliminary injunctions was sufficient to invoke court supervision, which could then be supplied without a definitive (and potentially offensive-to-corporate-insiders) ruling.

So I wonder if C&J, by cutting off the option of a preliminary injunction, also cut off an avenue of influence, which meant that court decisions on now-final deals became more high stakes, raising the temperature overall.