We’ve covered the TripAdvisor litigation here for some time.  With the case before the Delaware Supreme Court, Nevada has weighed in with an amicus brief.  Nevada, on behalf of Francisco Aguilar, Nevada’s Secretary of State, was represented by its Office of the Attorney General,  friend of the BLPB, Anthony Rickey, and DLA Piper’s John Reed.  Ann’s Tweet even makes an appearance.

Nevada argues that Delaware’s Chancery Court should not accept allegations in a complaint about Nevada law instead of analyzing Nevada law itself.  It also argues that the decision risks creating an exit tax on any corporation that seeks to leave Delaware for Nevada–or some other state.  To the extent that any other state arguably offers benefits that wouldn’t be available to a controlling shareholder in Delaware, the same standards would apply.  Thus, a reincorporation to Texas, Florida, or California might even be covered.  Depending on how far you take it, any corporation seeking to redomesticate to any of the many states with constituency statutes might face the same kind of challenge.

The amicus also points out that claims that Nevada has “raced to the bottom” should sound familiar to Delaware because Delaware itself has faced this accusation for many years. And while the TripAdvisor complaint included some comments made in Nevada’s internal legislative debate, the same could happen with Delaware with Delaware Representative Madinah Wilson-Anton‘s statement that any “lover of democracy, transparency, and the rule of law should be grossed out” over process leading to recent proposed amendments in Delaware.

It’s in Nevada’s interest to push back on the notion that Nevada law creates a “liability free” jurisdiction.  One common criticism of Nevada law is that its business judgment statute appears to exculpate for violations of the duty of loyalty.  What often gets missed though is the nuance.  Nevada does not separate loyalty and care for exculpation.  It does not exculpate for fiduciary breaches that include “intentional misconduct, fraud or a knowing violation of law.”  Any knowing betrayal or intentional violation of a duty of loyalty would not be exculpated.  While Delaware may allow liability for unintentional and unknowing violations of law, Nevada does not impose liability for those mistakes.

One thing that often gets glossed over, is that Nevada, like Delaware, has a strong economic incentive to balance investor and management rights in ways that maximize shareholder value.  If investors did not think that Nevada law’s benefits were worth the bargain, they could sell or discount what they pay for Nevada shares.  Indeed, the TripAdvisor decision considered looking at market reactions for potential damages.  If the market ever gave a negative judgment about a state’s corporate law, you could expect firms to flee the jurisdiction or the state to quickly move to correct the problem.

Which is why you get an extra blog post this week.

So I’m reading this entire fairness conflicted controller opinion and right there at the end, VC Laster preemptively wanders into a Caremark discussion – and the reason this is important is it hits on some of the issues I’ve blogged about previously with respect to the (over) extension of Caremark.

The case is Firefighters’ Pension System v. Foundation Building Materials, and I’ve got threads up at other social media spaces of the horror show of fiduciary breaches (help yourself), but here I’ll talk about the Caremark piece, which is tangential to the actual claims but important for theory. 

The traditional rule is that “Delaware law does not charter law breakers,” articulated in In re Massey Energy Co., 2011 WL 2176479 (Del. Ch. May 31, 2011), and part of a general family of cases that fall under the Caremark rubric that requires Delaware managers to take reasonable steps to ensure legal compliance.

Here’s what VC Laster writes in Foundation Building Materials:

timing principles govern Massey and Caremark claims. Before a plaintiff can invoke those theories, the plaintiff must point to some sufficiently concrete corporate injury. Typically, that will require a prior adjudication that the statute or regulation was violated, the payment of a fine or penalty, or a settlement.

The existence of a predicate injury serves an important policy function by limiting the ability of plaintiffs to use Massey and Caremark claims as vehicles to litigate alleged violations of far-flung statutory and regulatory regimes. Without that type of gating requirement, a stockholder plaintiff could assert that directors had knowingly violated a statutory or regulatory scheme in another state or country, plead facts supporting a statutory violation, and then litigate that claim in the Court of Chancery

In prior blog posts, I’ve expressed concern about how Caremark claims have been used as political weapons to attack corporate conduct even before a prior adjudication of wrongdoing or obvious injury to the corporation.

VC Laster’s new opinion therefore takes some first steps toward cabining that kind of use. 

The problem that remains theoretically, of course, is that to the extent the claim involves intentional lawbreaking, it isn’t intended to protect shareholders at all.  A claim for intentional lawbreaking can proceed even if, ex ante, the corporation calculates – correctly! – that the net present value of the wrongdoing, taking into account the risks involved, financially benefits shareholders.  In that sense, Massey claims are for society, not shareholders; they represent the outer limits of shareholder primacy.

For that reason, one could argue that the requirement of a prior corporate trauma raises questions about “fit.”  If the claim isn’t really about shareholders at all, why must there be a corporate trauma first before the claim can be brought? 

The argument would be, I suppose, something like, for the purposes of practicality of enforcement, it’s a risk shifting framework.  Directors can take that risk of lawbreaking to benefit shareholders, but they’re the ones who will financially suffer (or their insurance) if the risk doesn’t pan out and ultimately the corporation is injured as a result, because they’ll functionally indemnify the corporation for any damages suffered as a result of the lawbreaking.

The problem is, that kind of calculus fits poorly with Massey-like rhetoric about Delaware not chartering lawbreakers; it ends up right back with a permission structure for lawbreaking.  

Maybe this is a time when other news has overtaken corporate governance disputes, but governance disputes are we do here, so.

Also, what obviously has my attention right now are two issues: the upcoming Tesla vote on Musk’s pay and redomestication to Texas, and the proposed amendments to the DGCL.  This blog post is a couple of quick notes about both.

On the Tesla vote.

I previously blogged that a good argument could be made that restoring Musk’s pay package now offers no economic benefit to Tesla, and therefore would fall into the legal category of waste – which, under current doctrine (even if subject to challenge in the modern era) would require unanimous shareholder approval.  At the time, I offered the reservation that, from a practical perspective, waste would be difficult to litigate (and yes, if shareholders vote in favor, the effect of the vote will absolutely be litigated, by Tornetta, the current plaintiff, if no one else).  That’s because a court might be hesitant to hold that major institutional shareholders – with a fiduciary duty to maximize value for their beneficiaries – would cast an economically irrational vote.  From there, the court might reason backward and conclude that it couldn’t possibly be economic waste.

I also offered a rejoinder – namely, institutions might vote to approve the package because they were “coerced,” perhaps due to Musk’s threats to develop AI in his private businesses rather than Tesla (which he is using Tesla data to do).  But in my post, I treated that as a difficult argument to make, given that there was no suggestion of a threat in the proxy; the plaintiff would have to reach back to those earlier comments by Musk and ask a court to draw the inference that they were still influencing shareholders in June.

And then, of course, Musk couldn’t quite stay off ex-Twitter and he reaffirmed the threat, which Tesla was then forced to file as proxy solicitation material.  He also hinted at it during an earnings call before stopping himself, which was also filed as solicitation material, and Musk boosters are making the point pretty explicitly on social media:

And all the reporting mentions the threat to develop AI outside of Tesla, so, now, it’s much easier for the plaintiff to argue that any shareholder vote in favor of Musk’s pay is coerced, and therefore without ratifying effect.  It works in tandem with the waste argument, even though they’re also alternatives – why did shareholders vote for waste? Coercion.  How do we know it was coercive?  Because of the lack of (legitimate) economic value for Tesla.  Etc.

And then there’s Texas. I think it would be difficult, legally, for shareholders to challenge reincorporation to Texas as somehow damaging to their rights; leaving aside the uncertain status of TripAdvisor, Texas’s law is similar to Delaware’s, and so formally, reincorporation doesn’t present the same specter of self-dealing.  (I’m not saying no one’s gonna try, who knows what those wacky shareholders might do).  And Tornetta’s legal team probably is going to stay focused on the pay package rather than the Texas issue (except to the extent they’re worried a reincorporation in Texas means a new lawsuit will be filed there that’s res judicata in Delaware).

Nonetheless, the attempt at reincorporation now adds color to the pay dispute.  Because yes, of course, Tesla’s proxy statement makes clear, the states have a lot of formal similarities in their laws.  And academics debate whether there’s any real benefit to incorporating in Delaware, and it might be reasonable for a startup entrepreneur setting up a new company headquartered in Texas to choose Texas as its chartering state.  But Tesla is not a new company – it’s an established public company that has already been operating according to (well, not according to) Delaware law for a while, now contemplating an expensive switch – involving special committee payments, advisors, hours, and expert analysis, not to mention vote whipping – for benefits that even the company itself claims largely are about branding. 

Even then, if Tesla were doing this on a clear day, then, you know, shrug. 

But it’s not a clear day, it’s in the wake of two high profile losses for Tesla – the Tornetta decision, and the earlier settlement over director pay – and one personal one for Musk, namely the Twitter case (which he dropped, because he knew he would lose), and comes only after Musk tweeted his declaration that Tesla would reincorporate in Texas, reincorporated his other companies out of Delaware, and tweeted that he would not acquire Delaware companies.  In the midst of several tweets about Delaware’s perfidy, he even urged other companies to leave.  Given that context – not to mention Chancellor McCormick’s previous findings regarding the Board’s deference to Musk – there is certainly cause to doubt that the Board, or the special committee, was entirely forthcoming about its reasons, and acting entirely in good faith, when insisting that Tesla should move to Texas right now because Tesla is “all-in on Texas,” and not at all acting on Musk’s personal ire.  Which is apparently what ISS said in its proxy recommendation – I don’t have access to the report itself, but it noted that, while the move itself was unobjectionable, “the process undertaken by the board to reach a decision . . . does leave something to be desired.”  And certainly outside observers read the move as an attempt to free the board to give Musk as much compensation as he wants.

And if that’s right – that no matter how thorough the proxy statement is about describing the Board’s reasoning and the special committee’s diligence, it’s impossible to escape the doubts raised by the context in which this is occurring – then even if the Texas proposal is not directly challenged by Tornetta, the fact of its existence supports the argument that all of the Board – including the special committee – is beholden to Musk.  Therefore, none of the Board’s actions – including the recommendation that the pay package be restored – can be trusted.

Point being, it adds heft to any legal challenges to the pay vote.

BUT!!  Given that it is, frankly, politically awkward for one state – Delaware – to claim there’s anything wrong with incorporating in another state, I wouldn’t be surprised if Chancellor McCormick didn’t want to engage with the Texas issue directly.  But it could still affect her thinking (and the thinking of the Delaware Supreme Court on appeal).

On Proposed Amendments to Delaware Law

Prior posts in reverse chronological order here, here, here, and here.

VC Laster has been active on LinkedIn, highlighting various ambiguities in the proposed DGCL 122(18).  But he’s doing more than poasting; in Columbia Pipeline Merger Group Litigation and in Wagner v. BRP Group, Inc., his legal reasoning reads as a direct challenge to the synopsis to those amendments, by demonstrating the fiduciary “outs” they propose are ephemeral.

For example, the DGCL 122(18) synopsis says:

even the enforceability of a claim for money damages for breach of the covenant may be subject to equitable review, and related equitable limitations, if the making or performance of the contract constitutes a breach of fiduciary duty…

New § 122(18) does not relieve any directors, officers or stockholders of any fiduciary duties they owe to the corporation or its stockholders, including … with respect to deciding whether to perform, or cause the corporation to perform, or to breach, the contract, whether in connection with their management of the corporation’s business and affairs in the ordinary course or their approval of extraordinary transactions, such as a sale of the corporation

However, in both Columbia Pipeline and BRP, Laster extensively discusses how fiduciary obligations cannot require corporations to break contracts, or free them of consequences (including damages or equitable remedies) when they do so.  The synopsis suggests contracts might be set aside when directors’ actions are reviewed under “enhanced scrutiny”; Laster takes that one on as well in both cases, concluding that it’s a misreading of Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34 (Del. 1994).

Additionally, the synopsis says:

New § 122(18) does not relieve any directors, officers or stockholders of any fiduciary duties they owe to the corporation or its stockholders, including with respect to deciding to cause the corporation to enter into a contract with a stockholder or beneficial owner of stock….

In BRP, Laster highlights that fiduciary duties are only owed to current – not future – shareholders.  Which means, if fiduciary obligations are the only thing that protects shareholders when boards adopt these contracts, anyone who was not a shareholder at the time of contracting will have no claim.  In practical effect, a contract adopted pre-IPO could not be challenged by public stockholders.

Additionally, in Moelis, Laster held that the improper provisions of a stockholder agreement might be replicated via a preferred share issuance, though reserving the question just how far preferred shares might go.  In BRP, he elaborated on that point, arguing that some restrictions on board authority must be contained in the charter “proper,” and cannot even be included in preferred shares.  As he put it:

A counterparty also would not be able to secure covenants that bind the board through a preferred stock issuance. A certificate of designations can set forth “the designations and the powers, preferences and rights, and the qualifications, limitations or restrictions” of the class or series of stock that the board authorizes using blank check authority. 8 Del. C. § 102(a)(4). That list of features does not include imposing covenants on the board. To constrain or mandate action by the board under Section 141(a) requires a charter provision directed to the board, not a charter provision limited to the “the designations and the powers, preferences and rights, and the qualifications, limitations or restrictions” of a class or series of shares.  That type of provision could appear in the original charter. It also could be implemented through charter amendment duly approved under Section 242, or through a merger or comparable transaction where the DGCL authorizes amendments to the charter of the surviving corporation. A covenant binding the board could not be imposed through a certificate of designations. Under current law, it also cannot be imposed through a governance agreement.

Proposed DGCL 122(18) would authorize contracts that:

covenant that the corporation or one or more persons or bodies will take, or refrain from taking, actions specified in the contract

The implication being, DGCL 122(18) would authorize contracts that go further than what could be accomplished in a preferred share issuance.  Assuming that’s right, it just further demonstrates how DGCL 122(18) would more than authorize governance contracts, but actually encourage a shift of governance from the corporate form and into personal contracts. 

I previously posted about the proposed changes to Delaware law, the latest version of which would allow shareholder agreements insofar as they don’t go further than what a charter – including a preferred share issuance – could allow (except for the exemption from DGCL 115). 

One thing I should have mentioned, though, highlighted by Marcel Kahan and Edward Rock here, is that the difference between a share issuance/charter provision, and a contract, is highly salient for purposes of an exchange listing.  Exchanges define control in terms of voting power, not contractual power; moreover, they prohibit corporate actions that would limit shareholder voting power after listing; dual class shares are fine, they just need to be established prior to listing rather than taking away shareholder voting power mid-stream.  What they don’t address, though, is power through shareholder agreements.  Which means, if the DGCL is amended as proposed, a public company could hand over additional governance powers to particular shareholders through contract, without affecting the formal voting power of existing shareholders, and very possibly remain compliant with Exchange rules.

To put it concretely: Elon Musk has vocally demanded 25% voting power of Tesla so that he can control the development of AI. He’s also admitted he can’t get that through a switch to dual-class shares, because of the listing rules.  If the DGCL changes go through, though, there is no reason the board couldn’t “contract” with him to give him outsized influence over Tesla’s governance, regardless of how existing shareholders vote. 

And that leads to the elephant in the room.  Delaware law is all about shareholder wealth – full stop.  My paper on Twitter v. Musk (which is now published and the final version is on SSRN, by the way /plug) is all about the fallacy of relying on Delaware law to advance any value other than shareholder wealth maximization.  But corporate governance does, in fact, matter to the rest of us; it matters whether single individuals wield nearly unchecked power over how corporations behave. 

Back in the 1930s, Congress actually legislated to discourage the use of holding companies, precisely in order to limit the power that individuals could wield over large corporate structures with only a small slice of equity interest.

More recently, as I talk about in my paper Beyond Internal and External, the FTC settled with Mark Zuckerberg to prevent him from exercising his rights as a shareholder to interfere with Facebook’s compliance with a privacy settlement.  Zuckerberg’s unchecked power in his shareholder capacity threatened Facebook’s ability to comply with the law.

So these proposed DGCL changes have very far reaching social consequences that simply have not been explored by Delaware lawmakers, let alone The Rest of Society.

Anyhoo, links to a recent news article here and a collection of Chancery Daily links here.

Earlier this month, VC Glasscock issued an opinion in Kormos v. Playtika Holding UK II, where he dismissed breach of fiduciary duty claims against the Chair/CEO and CFO of a controlled company.  The opinion made reference to an earlier bench ruling where he sustained claims against the company’s controlling shareholder, Giant/Alpha, which is what alerted me to the bench ruling – which issued in January – in the first place.  And that bench ruling is actually what has my attention.

Playtika Holding Corp is a publicly traded company with a controlling shareholder, Playtika Holding UK II Limited (“Holding”).  Holding is a wholly-owned subsidiary of Giant/Alpha.  In 2021, Giant/Alpha faced a liquidity crisis and desperately needed to raise cash, which it sought to do by selling Holding’s Playtika stock, potentially in connection with a sale of the entire company.  But the process was rushed and messy, with Playtika itself and Giant/Alpha running separate inquiries; eventually, Giant/Alpha instructed Playtika’s board to stop talking to potential buyers, but to instead cause Playtika to institute a self-tender for its own stock.  SEC rules require that tender offers treat all shares of a class equally, which meant that the public shareholders – as well as Giant/Alpha – were able to tender in to the offer.  But, with Giant/Alpha tendering, it could receive cash back from Playtika which would then solve its liquidity problems.

Plaintiffs, the public holders of Playtika, alleged that this was a conflicted transaction that was not in Playtika’s best interests, and was therefore subject to entire fairness review (though they did not claim the price paid for the shares was unfair).

There’s just one problem with that argument, doctrinally: ever since Sinclair Oil Corp. v. Levien, 280 A.2d 717 (Del. 1971), we know that in order to be a conflicted transaction, implicating the duty of loyalty, the controller must receive a nonratable benefit, i.e., some benefit not available to the other stockholders – and arguably, it has to be a benefit that specifically comes at the minority’s expense.  In Sinclair itself, for example, the controlling shareholder caused the company to pay out massive dividends that allegedly robbed the company of the ability to take advantage of alternative opportunities, and it did so for its own private reasons.  Still, the dividend payments weren’t a conflict transaction – and were therefore subject only to business judgment review – because all shareholders got the same dividends, controller and noncontrollers alike.  The controlling shareholder did not receive a special benefit at the expense of the minority (As the Delaware Supreme Court put it, “a proportionate share of this money was received by the minority shareholders of Sinven. Sinclair received nothing from Sinven to the exclusion of its minority stockholders. As such, these dividends were not self-dealing”).

Similarly, in Playtika, the self-tender may have been motivated by Giant/Alpha’s need for cash, but all shareholders could participate in the tender on equal terms, meaning, it wasn’t a conflict transaction, and was therefore subject only to business judgment review.

Except! 

There was a twist.

Giant/Alpha did not want to risk tendering so many shares that it actually lost control of Playtika.  So, it negotiated a provision whereby Playtika would have to announce the number of shares tendered publicly, which would allow Giant/Alpha to keep close tabs on the status of the offer.  Giant/Alpha could also withdraw shares that it previously tendered – which I gather was a negotiated term of the agreement, but also, by the way, required under SEC rules for all tendering shareholders.  So, because Giant/Alpha was able to monitor the shares tendered, and withdraw its own shares, it could adjust its tender and maintain control of the company.

Those provisions, according to VC Glasscock – as he explained in his bench ruling in January, and again in his recent opinion earlier this month, were a nonratable benefit to Giant/Alpha, because they uniquely allowed Giant/Alpha to maintain control, which was not something the minority could share.  And that was enough to transform the Playtika self-tender into a conflict transaction, subject to entire fairness review.

So here’s the thing.

Treating the right to monitor the number of public shares tendered as a nonratable benefit to Giant/Alpha – let alone one that comes at the expense of minority shareholders – strikes me as a bit of a reach.  SEC rules require that tendering shareholders be able to withdraw before the tender offer closes; that wasn’t a benefit unique to Giant/Alpha.  And if Playtika publicly announced how many shares had been tendered, that meant everyone could see what the status was.   

That said, the whole scenario was obviously hinky from the get-go.  There was an awful initial search for alternative transactions; the self-tender itself was designed to benefit Giant/Alpha, and you can see why a judge might be looking for a reason to at least scrutinize the arrangement more closely.  Hence, a nonratable benefit was identified – Giant/Alpha’s ability to modulate the number of shares it tendered. 

And it matters because, as I’ve written two papers about, and also blogged repeatedly (here, here, here, here, here, here, here, here, here, here, here, here, here, and here), the more that Delaware makes it very easy to insulate deals from review unless they involve a controlling shareholder conflict, the more that courts are motivated to identify a controlling shareholder conflict in order to give themselves the opportunity to review problematic transactions.  As my papers discuss, that’s often exhibited in the definition of what it means to be a controlling shareholder in the first place – but, as we can also see here, it exhibits itself in the definition of conflict, as well.

Anyway, that kind of morass is exactly why the Delaware Supreme Court granted interlocutory review of TripAdvisor, i.e., to address the definition of a conflict transaction.  But TripAdvisor involves a reincorporation from Delaware to Nevada; I have no idea whether the court will address just that scenario – which obviously involves questions of comity not present for other kinds of potential conflicts – or whether it will take a broader view of the problem.