A New Judicial Perspective

Just a decade ago, the Delaware courts gave a wide berth to managers and directors caught up in corporate disputes. This was particularly noteworthy in the takeover arena. The theory held that most shareholders were simply unsophisticated investors who needed protection from their own lack of knowledge and business acumen. At the same time, managers were viewed as paternalistic fiduciaries well positioned to protect the corporation and its stockholders.

On the basis of these assumptions, the balance between managerial prerogative and investor control was tilted clearly towards the managers for the better part of two decades. The Delaware courts decided numerous cases in the 1980s and 1990s that consistently upheld board decisions to turn down the sale of a business to an unwanted suitor, even one that offered a significant premium over the market price of the stock. Whether it was upholding poison pills or simply allowing a board to "just say no" to a surprise bidder, the courts seemed to view shareholders as unthinking children who required the intervention of protective corporate parents.

Consequently, in the "go go" merger era of the '80s and '90s, the Delaware courts rarely overturned the decisions of corporate management and their often rather subservient boards, even when confronted with substantial shareholder objections.

All of this has now changed. One key factor has been the visible acknowledgment from the judiciary that in an era of large, financially sophisticated institutional investors, shareholders are perfectly capable of making informed judgments about their holdings. This "shareholder is smart" view initially surfaced in a 2000 decision involving a challenge to an anti-takeover action taken by the board of Shorewood Packaging. The court ruled in favor of the potential acquirer, Chesapeake Corp., finding that if shareholders are viewed as smart enough to know when to invest, they should be viewed in a similar manner when it comes to their decision to exit the investment through the sale of the enterprise.

William Chandler, one of Delaware's most influential judges, set the judicial agenda again this February with a strongly worded opinion on backdating that may open the door to a flood of shareholder derivative lawsuits. Typically, the courts haven't been friendly places for shareholder challenges to executive compensation practices. But in a case involving Maxim Integrated Products, the judge allowed the action to go forward.

His harshly worded decision signaled a new view about judicial faith in board decision-making: "Based on the allegations of the complaint and all reasonable inferences drawn therefrom, I am convinced that the intentional violation of a shareholder-approved stock option plan, coupled with fraudulent disclosures regarding the directors' purported compliance with that plan, constitute conduct that is disloyal to the corporation and is therefore an act in bad faith."

The message here is clear: Boards today must give deference to shareholder views in ways that were unheard of 10 years ago. In this new era, the Delaware courts can no longer be seen as reflexive defenders of managerial privilege. Dossier The Courts June/