Delaware has enacted new rules that overhaul the state’s General Corporation Law (DGCL).
The new rules relate to controlling stockholder transactions, director independence, and books and records requests.
The measure, Senate Bill 21, is aimed at keeping Delaware corporations from reincorporating to other states.
The rules are expected to have a significant impact on how corporate transactions are negotiated and litigated.
This article provides an overview of the new rules. It also provides some steps corporations can take in response to the new measures.
- What are the key takeaways for in-house counsel?
The amendments do:
- Alter the risk-benefit calculus of reincorporating to another state in favor of remaining in Delaware, particularly for controlled or potentially controlled companies.
- Clarify the standards for determining whether a director is considered disinterested and independent. Place stronger weight on independence determinations by the Board.
- Specify the circumstances under which a stockholder or a group of stockholders can be deemed to “control” the company.
- Impose new limits on the types of transactions that require protections of an independent special committee and/or majority of the minority vote to remove the threat of entire fairness challenges.
- Provide limitations on what “books and records” a stockholder can demand under DGCL Section 220, subject to limited and difficult to meet exceptions. Places greater protections for companies responding to such demands.
What the amendments do NOT do:
- This bill does not affect the key benefits of incorporating in Delaware. The Court of Chancery will continue to decide corporate cases quickly and efficiently.
- Delaware’s Secretary of State office will continue to earn its reputation for outstanding and responsive service. And this bill is evidence that the Delaware legislature will dynamically respond to the changing needs of businesses.
- The bill does not alter the analysis performed by the Court of Chancery when a transaction remains subject to “entire fairness” review.
The bill leaves intact other significant aspects of Delaware law, including, stockholder appraisal rights and the need to fully inform stockholders when seeking their approval of a corporate act.
- What are some areas the new rules seek to clarify?
Who Is "Independent"
Under the old law, a director's independence under stock exchange standards does not automatically mean they are independent for fiduciary duty analysis under Delaware corporate law.
- Plaintiffs could survive a motion to dismiss by alleging facts that make it "reasonably conceivable" that a majority of directors are interested in a transaction or lack independence due to personal, financial, or other interests.
- Plaintiffs could potentially make this showing at the pleading stage, using a liberal standard, by citing factors like overlapping club memberships, charitable activities, or past business relationships.
The new rules aim to raise the pleading bar by establishing a presumption of independence and disinterestedness for a director if the board determines the director meets independence criteria under national securities exchange rules.
- The national securities exchange rules assess whether a director is independent from the company, as opposed to the old law, which evaluated a director’s independence based on the specific facts of each case.
- This presumption of independence can only be rebutted by substantial and particularized facts showing the director has a material interest in the transaction or a material relationship with someone who does.
Who Is a "Controller"
Under the old law, a stockholder is deemed a "controlling stockholder" and subject to fiduciary duties under Delaware law if they either (1) hold over 50% of the voting power, or (2) possess a combination of voting power and managerial control that grants them de facto control over the corporation or a specific transaction.
- The second criterion has caused confusion regarding the necessary stake or control level for a stockholder to be considered a "controller," with commentary suggesting that even a 20% stake could suffice depending on the circumstances.
The new rules define a controlling stockholder as one who either (1) controls a majority of the corporation’s voting power for director elections, or (2) has "functionally equivalent" power through ownership or control of at least one-third of the voting power for director elections and managerial authority over the corporation's business and affairs.
- As with the old law, a combination of voting and managerial power is required for a stockholder with less than 50% voting power to be considered a "controller," but the amendment establishes a clear lower limit of one-third of the voting power for such a determination.
What are the Company’s “Books and Records”
Under the old law, stockholders could review a corporation's books and records with a showing of a credible basis to suspect wrongdoing, the lowest pleading burden under Delaware law.
- Case law has expanded "books and records" to include emails and texts from directors and officers in some circumstances, which plaintiffs use to build complaints.
- The Courts also cracked down on redactions, the use of documents incorporated by reference, and, in the most severe cases, imposed sanctions on companies for failing to produce records.
The new rules limit the "books and records" a stockholder can receive to specific categories of documents like board minutes, bylaws, and financial statements.
- Stockholders must describe their demand's purpose and the records sought with "reasonable particularity." The demand must also be made in good faith.
- The records must also be "specifically related" to the stated purpose.
- The Court of Chancery is prohibited from ordering additional documents unless (a) the company has no books and records or (b) the stockholder can show a “compelling need” by clear and convincing evidence that the requested documents are necessary and essential.
- Corporations are allowed to require stockholders to agree that any information in the books and records is incorporated by reference in any subsequent complaint, reducing plaintiffs' ability to selectively use documents.
- Corporations are permitted to redact information not "specifically related" to the stockholder's purpose, a shift from current practice where broad relevance redactions were discouraged.
- How will the rules impact corporate governance practices and corporate strategy?
SB-21 does not change what constitutes sound and sanitary corporate governance practices.
- Companies should continue to rely on Delaware court rulings for guidance on good corporate governance, as well as other authorities such as listed company guidelines, proxy advisory opinions, and investor feedback.
- Certain corporate governance practices like recording minutes of meetings and assessing director independence will take on greater importance after the passage of the amendments.
- Additionally, SB-21 may lead corporate governance practices to face heightened scrutiny and increased litigation as stockholders and their counsel explore alternative causes of action unaffected by the amendments.
- Potential plaintiffs may gravitate toward other types of fiduciary duty claims, such as oversight claims under Caremark and insider trading claims under Brophy. Both of those claims can be effectively mitigated by strong corporate governance practices.
SB-21 will have a positive effect on corporate strategy by enhancing flexibility and reducing litigation risks.
- Under the old law, corporate strategy was prioritized and companies often viewed litigation as a cost of doing business.
- With SB-21, corporate planners now have greater flexibility and options for executing corporate strategy with less litigation risk.
- This type of business environment encourages more innovative and aggressive strategic initiatives and enables companies to pursue opportunities that were previously considered too risky.
- Ultimately, the amendments should foster a more competitive and dynamic business landscape.
- Is there anything companies should do in the short term?
Yes, there are a few immediate steps companies should take to extract the maximum benefits and protections from SB-21:
- Apply limitations of amended Section 220 to any demand issued after midnight on Feb. 17.
- Coordinate with outside counsel to confirm that national exchange and statutory requirements for director independence and transaction cleansing are satisfied.
- Enhance the company’s practices for recording minutes and maintaining other corporate records so as not to run afoul of the new Section 220 standards imposed by SB-21, including maintaining a standard suite of “books and records.”
- Update company’s certificate of incorporation and bylaws to take advantage of recent developments like officer exculpation and developments surrounding forum selection clauses.
- Schedule updated trainings for directors on fiduciary duties and corporate governance.
- Reassess risk management strategies, particularly in the M&A space, to align with reduced litigation risks associated with new legal framework.
- Contact D&O insurers to understand how SB-21 will impact company needs and premiums.
