As discussed earlier this month, there has been a lot of chatter and speculation recently about companies changing their states of incorporation from Delaware to other states. In an interview with Business Insider, the new Governor of Delaware acknowledged that the state remained a “‘competitive environment’” and that “his state needed to take challenge seriously,” including addressing “issues such as the balance of shareholder and management rights….I think within the coming weeks, you’re going to see some things rolled out that will help move our state forward and bring us into 2025 and beyond to make sure we’re protecting and growing the corporate franchise.” A new bill designed to take up that challenge in a significant way—Senate Bill 21—was introduced in Delaware on Monday and is awaiting consideration by the Judiciary Committee. In essence, the bill would offer a process for boards to invoke safe harbor protection from litigation over potentially conflicted transactions for directors and controlling stockholders. The bill would also address Delaware’s provisions related to books and records. The impact could be fundamental.
According to the Delaware Business Times, the bill, which is co-sponsored by a bipartisan group of legislators, includes “sweeping changes” to Delaware’s corporate law. The DBT reports that the group of legislators issued a statement indicating that “this bill would ‘restore’ Delaware law, ensuring it is balanced[, would] maintain stockholder rights and [be] workable for corporate leaders and directors.” As reported, the statement also observes that “[u]ncertain standards or barriers to responsible options that cause widespread frustration among Delaware companies are not helpful to anyone, especially to the stockholders who would not enjoy the value of Delaware’s legal protections at all if companies feel forced to relocate to less balanced jurisdictions….For the last century, Delaware law and all relevant stakeholders have benefited from our law having balanced protections and being shepherded by expert corporate law practitioners and thoughtful elected officials….That is what this legislation reflects.” It’s worth noting, as Reuters points out, as opposed to the usual practice, this “bill was not drafted by the state’s bar association, which typically oversees changes to the state’s corporate law.” Nevertheless, Bloomberg Law reports that the legislators were advised by a panel that included retired University of Pennsylvania law professor Larry Hamermesh, former Chancellor William B. Chandler III and former Delaware Supreme Court Chief Justice Leo Strine.
Below is a very quick summary (from the synopsis and the bill). Generally, the bill would, among other things:
- Amend § 144 (Interested directors; quorum) to provide “safe harbor procedures for acts or transactions in which one or more directors or officers as well as controlling stockholders and members of control groups have interests or relationships that might render them interested or not independent with respect to the act or transaction.”
- Amend § 144 (a) to provide that certain potentially conflicted acts or transactions involving directors or officers, will be protected—that is, “may not be the subject of equitable relief, or give rise to an award of damages or other sanction”—if approved or ratified by a “majority of the disinterested directors or by a majority of the votes cast by the disinterested stockholders entitled to vote thereon, in each case upon disclosure or in full knowledge of the material facts giving rise to the conflict or potential conflict.” (Remember that the current law provides only that, if properly approved or ratified, the potentially conflicted transaction is not “void or voidable.”) The transaction may also be fair to the corporation, which is defined to mean that the “act or transaction at issue, as a whole, is beneficial to the corporation or its stockholders,” taking into account the consideration or other benefit conferred and whether transaction is the product of fair dealing and fair price, that is, “comparable to what might have been obtained in an arm’s length transaction available to the corporation.”
- Define “what parties constitute a controlling stockholder or control group and provide safe harbor procedures that can be followed to insulate from challenge specified acts or transactions from which a controlling stockholder or control group receives a unique benefit.” A controlling stockholder is defined with a relatively bright line to mean a holder of a majority of the voting power or the functional equivalent of majority control, including ownership or control of at least 1/3 of the voting power—a threshold that some suggest might allow certain significant holders to avoid review as controllers altogether. The amendments would also define a “controlling stockholder transaction” as an act or transaction between the corporation or one of its subsidiaries and a controlling stockholder or a control group, or “an act or transaction from which a controlling stockholder or a control group receives a financial or other benefit not shared with the corporation’s stockholders generally.”
- Add new § 144(b), which would provide that a controlling stockholder transaction that is not a “going private transaction” may rely on the statutory safe harbor—“may not be the subject of equitable relief, or give rise to an award of damages or other sanction against a director or officer of the corporation or any controlling stockholder or member of a control group, by reason of a breach of fiduciary duty by a director, officer, controlling stockholder”—“if it is approved or recommended, as applicable, by a committee consisting of a majority of disinterested directors or approved or ratified by a majority of the votes cast by the disinterested stockholders.” The transaction may also be fair to the corporation.
- Add new § 144(c), under which a controlling stockholder transaction that is a “going private transaction” may be entitled to the protection of the statutory safe harbor “if it is negotiated and approved or recommended, as applicable, by a committee consisting of a majority of disinterested directors and approved or ratified by a vote of a majority of the votes cast by the disinterested stockholders entitled to vote thereon. The transaction may also be fair to the corporation.
- Set forth “criteria for determining the independence and disinterestedness of directors and stockholders.” In the CLS Blue Sky article cited above, the authors highlight that, under the proposed legislation, a “director deemed independent under NYSE/Nasdaq rules is now presumed disinterested unless strong, particularized evidence proves otherwise. Additionally, a director’s nomination by an interested party does not, by itself, suggest the director is interested.” That, they suggest, runs counter to caselaw “where a director’s controller-backed nomination played a key role in determining that the director wasn’t independent. This change makes it harder to challenge director independence.”
- Provide in new § 144(d) that no controlling stockholder or control group, in its capacity as such, may be liable for monetary damages for breach of fiduciary duty other than for a breach of the duty of loyalty, acts or omissions not in good faith or involving intentional misconduct or a knowing violation of law or any transaction from which the person derived an improper personal benefit.
- Not “displace any safe harbor procedures or other protections available at common law.”
- Amend § 220 (inspection of books and records) to “define the materials that a stockholder may demand to inspect pursuant to a request for books and records of the corporation,” and “set forth certain conditions that a stockholder must satisfy in order to make an inspection of books and records.” The bill would require that that stockholder have a “proper purpose,” defined as “a purpose reasonably related to a stockholder’s interest as a stockholder.” The article referenced above points out that this provision “restricts what stockholders can request in a 220 demand, potentially excluding emails, text messages, or informal board communications, which have become central to derivative litigation.” It would also cap stockholder access to records at three years, which “limits the window for stockholder investigations, particularly in long-running governance disputes or cases where corporate misconduct surfaces years after the fact.”
- Clarify that “information from books and records obtained by a stockholder from a production under § 220 will be deemed to be incorporated by reference into any complaint filed by or at the direction of a stockholder on the basis of information obtained through a demand for books and records.” The bill would allow the corporation to “impose reasonable restrictions on the confidentiality, use, or distribution of books and records” and to redact portions not related to the stockholder’s purpose.
- Add new § 220(b)(4), which would preserve “whatever independent rights of inspection exist under the referenced sources” and “not create any rights, either expressly or by implication.”
- Add new § 220(f), which would provide that, in the event that “the corporation does not have specified books and records, including minutes of board and committee meetings, actions of board or any committee, financial statements and director and officer independence questionnaires, the Court of Chancery may order the production of additional corporate records necessary and essential for the stockholder’s proper purpose.”
Note that, under § 1 of Article IX of the Delaware Constitution, because this Act would amend the general corporation law, it would require the affirmative vote of two-thirds of the members elected to each house of the General Assembly.
In terms of reactions to the proposed legislation, Reuters quotes Tulane Professor Ann Lipton, who expressed the view that the bill “would make shareholder litigation in Delaware ‘dramatically less successful.’” Reuters continued that opinions of the potential impact differ: “[s]ome experts argue shareholder lawsuits prevent the worst board room abuses and self-dealing. But others say litigation acts as kind of tax on companies that rarely results in much benefit for shareholders and that the real policing of corporate boards comes from institutional investors such as large pension funds.”
DBT solicited commentary from recognized Delaware law experts and predicted that SB 21 would be “highly controversial and will likely face pushback from attorneys who represent defendants and shareholders.” Lawrence Cunningham, the director of the University of Delaware’s Weinberg Center for Corporate Governance, told DBT that “much of the debate will focus on independence of directors and fairness in how a corporation is governed. ‘The goal is clear: increase certainty for dealmakers while maintaining Delaware’s balance between shareholder protections and director discretion. But legislative line-drawing in corporate law is always contested. Critics will debate who should set the rules [and] how much procedural protection is enough.’” Commentary from Charles Elson, the founder of the UD Weinberg center, was more critical. He told DBT that SB 21 “would ‘destroy the typical traditional balance’ between shareholder prerogative and managers and controlling shareholders—and it would invite complete federalization of regulating corporations. ‘[This bill] doesn’t just tip the balance; it completely tilts it. It’s a terrible signal to send to the business world….That’s not the way business has been done here…If the goal is to attract a controlling shareholder like that, you absolutely destroy the whole point of the law….The whole reason institutions came to Delaware is that it was an exclusive forum for resolving disputes, and with that, it gained a great gift in the neutrality of the system. This would shift the balance to majority shareholders and it would end our reputation.’”
In their CLS article, the four academics also expressed some strong views:
“Few moments in Delaware’s storied corporate history have arrived quite like this one. All at once, we’re seeing a broad legislative package that cuts across foundational doctrines—controller conflicts of interest, derivative litigation, access to corporate records—and does so with a speed and scope that contrasts starkly with the state’s long tradition of incremental, consensus-based reform. For better or worse, the tide has turned, and these amendments are poised to reshape the very equilibrium that has made Delaware the unrivaled home for U.S. incorporations….
“Let’s be clear: These amendments amount to a direct rebuke of the Delaware judiciary. They impose a legislative clampdown on the very judicial discretion that, for decades, has defined Delaware’s distinctive brand of corporate governance. Critics of Chancery may celebrate the move, but in doing so they risk undermining Delaware’s greatest asset: the feedback loop between sophisticated litigation and careful case-by-case refinement of fiduciary law….
“The broader lesson, if history is any guide, is that a legislative revision of this magnitude rarely solves tensions so much as it reconfigures them. Whether that reconfiguration cements Delaware’s future or inadvertently erodes it is the existential question. We can only hope the legislature’s sense of urgency and the bar’s abiding respect for Delaware’s tradition will combine to produce results that protect the state’s precarious leadership. Otherwise, the unstoppable network effect that once brought everyone to Delaware might just discover a new, equally powerful reason to leave.”
(Updated 2/20 to provide information about the drafting panel that advised the legislators.)
