Texas Business Reforms Show Shareholder Democracy Is Thriving

This spring, we at the Alliance for Corporate Excellence worked with the Texas Legislature to enact Senate Bill 29, a set of Texas corporate law reforms designed to help corporate decision-makers to deploy billions of dollars of capital in productive enterprises.

The effect has been clear: In Texas, corporate democracy—not judicial intervention—is the law of the land. We wanted to clarify a few misconceptions about what these reforms mean, especially following the high profile proposal by Coinbase to reincorporate to Texas.

In SB 29, Texas reaffirmed the business judgment rule as the cornerstone of US corporate law. The business judgment rule is a basic principle, adopted in some form by all 50 states, that courts should defer to the business decisions of a company’s disinterested and reasonably informed directors. Even in Delaware, which has been criticized for judicial decisions that have effectively overturned shareholders’ decisions, the business judgment rule is the default.

The idea that boards and shareholders should control business decisions wasn’t always controversial. Delaware Supreme Court Chief Justice Leo Strine noted a decade ago that the law was “reluctant to second-guess the judgment of a disinterested stockholder majority.”

It’s hard to understand how deference to business decisions broadly supported by shareholders “converts ownership into observation.” Rather, Texas understands the best way to empower shareholders is to give effect to their votes, especially when those votes represent—as did the shareholder vote at Tesla Inc.’s recent annual meeting—the views of millions of retail shareholders and not one or two institutions.

This principle was eroded by the Delaware courts, which expanded judicial review to an increasing list of transactions while increasing the fees awarded to plaintiffs’ attorneys. The result was unsurprising. Increased uncertainty and the possibility of life-changing attorney fee awards encouraged a cottage industry of entrepreneurial lawyers seeking claims without plaintiffs, often enlisting shareholders with only a handful of shares and no material interest in a case. This is why more companies began exploring the possibility of a “DExit.”

Texas’ codification of the business judgment rule aims to prevent a similar creeping expansion of judicial intervention and aligns with a view that courts best protect shareholders by preventing fraud and misconduct—not by second-guessing the operational decisions made by a corporation’s directors.

Texas courts still have a mandate to prevent intentional misconduct and fraud. And Texas law still requires transactions between a corporation and its insiders to be approved by disinterested directors or shareholders, or be fair to the corporation. What the law doesn’t support is replacing the business judgment of a corporation’s shareholders and directors with a judge’s opinions.

Beyond the codification of the business judgment rule, SB 29 permits public corporations to adopt an ownership threshold that must be met to bring a claim that the board of directors breached its duties to the corporation. While some opponents have framed this as an attack on shareholder rights, a derivative ownership threshold protects shareholders from those who lack a meaningful economic stake in a corporation.

SB 29 says a threshold selected by a company can’t exceed 3% and can be met by small shareholders working together. An ownership threshold, rather than limiting the rights of shareholders, acts as a filter between claims that reflect the interests of the shareholders and attorney-driven litigation.

If a shareholder doesn’t meet the threshold to bring a claim on their own, that shareholder has ample time to gather others to join in the claim. Claims of wrongdoing that reflect concerns of shareholders—the true owners of a corporation—are likely to survive this filter. Claims driven by plaintiffs’ lawyers racing to the courthouse likely won’t. Shareholders are empowered; lawyers serving as conflict entrepreneurs aren’t.

This Texas reform reflects shareholders’ interests, something confirmed at the recent Tesla annual shareholder meeting. Roughly 75% of the votes cast supported the company’s selected threshold.

When shareholders speak, they speak clearly: Texas corporations should be controlled by shareholders and duly elected boards rather than by activists or courts. Activists have “interests [that] are not aligned with the interests of the corporation and the corporation’s shareholders collectively.” They range from corporate gadflies who routinely propose using the corporation to further their own private agendas, to lawyers who seek to generate fees from lawsuits not broadly supported by the shareholders, to the courts who enable all of these.

All share the common goal of undoing the business judgment of the only corporate decision-makers chosen by the shareholders.

Texas is restoring this traditional understanding of corporate governance by carving out a new path for corporations burdened by a legal system that has become too permissive of judicial second-guessing of core business decisions. Companies and investors seeking shareholder democracy and freedom from costly attorney-driven litigation now have a choice: move west. US enterprise is back, and Texas is leading the way.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Christopher Babcock is president of the Alliance for Corporate Excellence and a partner in the Dallas office of Foley & Lardner, where he serves as co-chair of the Texas Corporate Governance Team.

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