According to the Chief Justice of Delaware’s Supreme Court, Hon E Norman Veasey, over half of the Fortune 500 and over half of the New York Stock Exchange companies are Delaware corporations. In May, there was a celebration in Delaware to mark the 100th anniversary of the enactment of the landmark Delaware Corporation Law. Judges, attorneys and corporate governance scholars all came together to honor the past and speculate about the future impact of what is probably the most influential court ruling on corporate governance issues anywhere in the world.
For decades, judicial decisions in Delaware have profoundly affected US corporate governance. The courts have defined and redefined, through a series of important cases, what boards of directors can and cannot do.
In addition to setting the parameters of fiduciary responsibility for boards, they have arbitrated between shareholders and boards on key issues such as the use of poison pills and other takeover defenses. With the increasing globalization of corporate governance and the absence of any transnational court, it is quite likely that the Delaware courts will continue to influence governance practice, not only domestically but internationally too. This will be true not only for publicly-traded corporations, but for a whole series of private transactions such as joint ventures and private debt and equity placements.
Corporate haven
The combination of legislation and case law decided in the courts of Delaware, although traditionally favoring directors, has been shifting during the past decade a bit more toward shareholders. Historically, directors saw their decisions protected from shareholder lawsuits, as long as they acted as prudent businesspeople would under the so-called ‘business judgment rule.’
But in 1985 four landmark cases were decided which radically changed the corporate governance landscape. In the Smith v. Van Gokom case, directors received a wake-up call that required them to consider all material information reasonably available before making a business decision. This was followed by Unocal, a case which Veasey calls a ‘sea change’ in the judicial review of the conduct of directors of a target corporation. Defensive measures in relation to the threat of a takeover must be deemed ‘reasonable’. While the Household case held that directors do have the power to install a poison pill, future boards of directors have to be mindful of their fiduciary duties in considering the obligation to redeem the pill in the face of certain threatened takeovers.
Finally in 1985, in Revlon, Veasey noted that the court ruled that ‘when the directors move from the mode of defending the firm’s independence to the mode of selling control they must obtain the best value reasonably available for stockholders.’
Since the 1985 blitz of decisions, a number of cases have continued to put directors on notice that they must consider shareholders in certain decisions, especially when sale of the company is at stake. The most recent of these is the dramatic 1999 Quickturn decision which rendered judicial defeat to directors’ ability to adopt a new and popular form of poison pill referred to as a ‘dead hand’ poison pill. The basic issue is whether a current board of directors can institute a variation of the poison pill that cannot be voted upon by certain directors. According to Veasey, such a plan is ‘invalid if newly-elected directors are disabled, even for a limited period of time, from exercising their future business judgment on redemption.’
Another type of wake-up call was issued to directors in the Caremark case. The case involved not just the traditional notion of the business judgment rule, but a broader mandate for the board to exercise oversight responsibility. In the decision of former Chancellor William T Allen who rendered the opinion, the board has an obligation ‘to include a good faith attempt to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may, in theory at least, render a director liable…’
According to the current Chancellor, William B Chandler III, the court now has before it a Caremark-type of case which applies to a company’s auditing accountability processes and procedures. This is likely to put directors of companies on notice to extend their Caremark oversight to re-examine their auditing information systems.
While noting that each case is decided on its merits and specific facts, Chief Justice Veasey has put together suggestions for boards of directors to increase the confidence investors and courts have in the decisions they make.
Global model
The role of Delaware as a global model, is reinforced by recent global financial crises. These crises have demonstrated that weak corporate governance can seriously undermine investor confidence in entire markets as well as in individual corporations, which in turn can intensify high stock market volatility, capital flight and the disruption of international capital flows.
Intergovernmental organizations, specifically the OECD, the World Bank and the IMF, are responding with efforts to define worldwide general corporate governance principles, and to help improve market regulations and controls. Individual companies, within this rapidly changing regulatory and legal framework, have the opportunity to take much more specific and proactive steps to strengthen their competitive position in the global capital markets. An important way to accomplish this is to improve their corporate governance practices to meet rising shareholder expectations and to attract stable and committed international investors.
Delaware provides a ‘nuts and bolts’ reference for global companies to adopt specific good governance practices – not merely sweeping governance principles as the various codes direct. As a preeminent model, case law arising from shareholder and corporate debate in Delaware helps shape international corporate governance. In the 21st century, Delaware will clearly play a role in governance expectations to minimize the risk of future financial crises – not just for US companies and shareholders but for global companies and their increasingly transnational shareholders as well.
Dr Carolyn Kay Brancato is head of the Conference Board’s Global Corporate Governance Center
