Elite Delaware Court Stands Up to ‘Big Money-Powered People’

Delaware’s elite corporate law court is shaping what it means to be a controlling shareholder.

The details vary in the recent decisions involving Tesla Inc., TripAdvisor Inc., and Sears Hometown and Outlet Stores Inc., but the overall message to controllers is clear: Acting in bad faith or not fully informing minority shareholders and keeping them from getting a fair shot will get you into trouble with the Court of Chancery.

The court is exploring shareholder control in different contexts where there isn’t a lot of precedent, said Jill Fisch, a professor of business law at the University of Pennsylvania’s law school.

Taken together, these opinions consider how broadly to define control, whether some transactions need heightened scrutiny, and what counts for someone to be a controlling shareholder, she said.

“You can read all three decisions as applying really heavy scrutiny to actions taken by companies with controlling shareholders that arguably favor the interests of those controlling shareholders,” she said.

‘Fearless’

The court’s chief judge, Kathaleen St. Jude McCormick, and it’s longest-serving judge, J. Travis Laster, have been “fearless” in holding iconic corporate founders and executives accountable to their shareholders, said University of Iowa law professor Robert Miller, who has written about the development of Delaware corporate law.

“In a certain sense the Delaware franchise is on the line in cases like these, where, ‘We prove that we stand up to big money-powered people and that everybody gets a fair deal in Delaware. And you don’t get a better deal just because you’re the richest guy in the world,’” he said.

In invalidating Musk’s $55 billion pay package at Tesla, McCormick found that Musk’s influence at Tesla made him a controlling stockholder and therefore subject to Delaware’s most stringent standard of judicial scrutiny.

In the unique Sears Hometown case, Laster set a new standard for controlling stockholders. He said they must show good faith and can’t intentionally harm the company or minority shareholders when they push through changes the way corporate boards typically do. Blocking a board decision also draws an enhanced level of court review.

Laster also set standards for moving a company’s incorporation out of Delaware in a separate case. He determined that Greg Maffei, who controls TripAdvisor through super-voting shares could move the company’ to Nevada, even if their investors believe that will make it harder to hold directors and officers accountable.

‘It’s the Control’

What Musk or other “superstars” seeking to emulate Maffei should take away from the court’s recent rulings is that it’s not necessarily the number of shares they hold.

“It’s the control,” said Carliss Chatman, who teaches corporate law at Southern Methodist University.

Say a billionaire activist investor has enough shares to do “what he thinks is righting the ship,” but actually makes the company’s performance worse, she said.

“Then he could be subject to this new standard” from Laster’s Sears Hometown opinion, she said. “If his judgment is not correct, then he could be liable.”

‘Expect to Get Sued’

Corporate America may have been shocked by the decision rescinding Musk’s pay package at Tesla, but it’s more likely to be impacted by the ruling that found another billionaire, Eddie Lampert, short-changed shareholders.

Laster ordered Lampert to pay $18.3 million to former shareholders of Sears Hometown. As a controlling stockholder, Lampert intervened in its board’s liquidation plan in such a way that he could buy out the company for a price “below the range of fairness,” according to the Jan. 24 opinion.

It’s the first time the court addressed fiduciary duties owed when a controlling stockholder uses their voting power to change a company’s status quo. When doing so, the controller owes a duty of good faith requiring them to refrain from intentionally harming the company or minority shareholders, along with a duty of care demanding they avoid gross negligence, Laster said.

In most cases involving controlling shareholders, they clearly assume the power of a director. “In that situation, everybody agrees controlling shareholders have the same fiduciary duties as directors,” Miller said.

Directors always must act in the company’s best interest, even over shareholders’ objections, to provide financial oversight and manage the business operations, Miller added.

In Lampert’s case, “here we have a really pure case where the shareholder is acting obviously, clearly, entirely in his capacity as a shareholder,” using his voting powers to change the company’s bylaws and replace two directors, he said.

Laster’s decision puts that type of behavior at risk for a person or an entity holding a majority of the stock. “The obvious set of cases where it would matter would be where the shareholder, acting as a shareholder, does something the board doesn’t like—putting somebody onto the board, or voting someone off the board, or voting in a way that doesn’t follow the votes of the public shareholders,” Miller said.

Such a shareholder “could now expect to get sued,” though the enhanced level of review mandated under Laster’s opinion wouldn’t be hard to clear in most cases, he said. “He’d probably win, but he could expect to get sued.”