More companies will prompt shareholders next spring to vote on a measure to protect top executives from damages liability for making ill-informed decisions, following a change in Delaware law.
Delaware changed its General Corporation Law, effective Aug. 1, to allow companies to limit the monetary liability of certain executives, including the CEO and CFO, for duty of care breaches. Previously, the protections were allowed only for board members.
A Nov. 4 lawsuit against Fox Corp. over its adoption of the protection highlights the question of how some shareholders might respond.
Besides Fox, more than 98% of Avid Bioservices Inc. shareholders voted in favor of the language in October. Advisory firm Institutional Shareholder Services says it plans to generally recommend voting “for” proposals to add officer exculpation provisions in a company’s charter.
“Assuming there are no huge stockholders’ challenges in the spring, we would expect this to be fairly commonplace five years from now, maybe even two or three years from now, with the vast majority of companies having adopted this provision,” Alston & Bird LLP attorney Andrew Sumner said. Many votes are expected to take place at shareholder votes in the spring.
But in voting for the protections, shareholders might be shooting themselves in the foot by eliminating a legal tool they can use to weed out unfair mergers and acquistions, including those tainted by self-interest or that are overpriced, legal scholars say.
Delaware courts already have made it tougher to test mergers in litigation, having closed various avenues for such challenges. Duty-of-care breach claims against officers can be a path for plaintiffs to survive the early stages of a case and get to discovery, where they can probe the merger more deeply.
“From a shareholder perspective, having that option is really beneficial,” Tulane law professor Ann Lipton said.
Since the mid-1980s, Delaware has allowed companies to include a provision in their charter limiting the personal liability of directors for monetary damages for breaches of the duty of care, which requires informed decision-making.
Those protections, which allow directors to perform their roles without fear of being liable for money damages for a mistake, didn’t extend to corporate officers, like CEOs and CFOs.
It was a “bizarre technicality,” said Travis Wofford, chair of Baker Botts LLP’s Corporate Department in Houston. Individual shareholders started to find the technicality useful as they sued for money damages for misstatements made in company sales.
In a 2019 decision related to the acquisition of the Fresh Market Inc., the Delaware Chancery Court allowed a shareholder to press forward with claims of care violations against the grocery stores chain’s CEO and chief legal officer, even though its board directors were protected from liability.
Some legals scholars and defendants companies have criticized lawsuits over merger disclosures as often being frivolous attempts to extract settlement fees for the plaintiff’s attorneys, while providing little value to investors.
“Due care claims targeting officers are the latest result of the shareholder plaintiffs’ bar’s efforts to develop litigation tactics that offer potentially lucrative fee awards” in mergers and acquisitions lawsuits, according to a research paper, written last year by two former Delaware Supreme Court justices and a University of Pennsylvania law professor.
Delaware’s GCL amendment moves to reduce the imbalance between directors and officers. One important carve-out is that officers aren’t shielded against claims brought by shareholders on behalf of the corporation.
Still, some attorneys worry the change needlessly shields certain reckless conduct.
“Now that the duty of care is eliminated for officers too, it’s yet to be seen if officers of Delaware corporations will begin to operate in an even more careless or risky manner,” Nicholas Perricone, special counsel at Mintz Levin Cohn Ferris Glovsky and Popeo PC, said.
The protections may become standard in companies’ charters, as their attorneys continue to recommend them.
The lawsuit against Fox could provide guidance on process for some companies whose shareholders will be voting.
Fox was sued by the Electrical Workers Pension Fund, Local 103, I.B.E.W. in what may be the first lawsuit related to the new liability shield. The pension fund’s legal challenge stems from Fox’s dual-class voting structure, which generally gives no voting rights to holders of Class A common stock.
The pension fund argues that, as a Class A shareholder, it has the right under Delaware law to vote on the change.There’s early momentum behind adoption of the provision.
Dozens of companies in the Russell 3000, which tracks the largest U.S.-traded stocks, have a dual-class voting structure in which one or more classes had no vote as of March 2021, according to non-profit Council of Institutional Investors.
“I think this case is applicable to any public company with non-voting stock in their capitalization structure,” Taylor Bartholomew of Troutman Pepper Hamilton Sanders LLP said.
More broadly, some attorneys warn that companies that don’t exculpate top officers will face a greater risk of litigation. There is a “likelihood of the plaintiff’s bar to be looking for new theories of liability based on the differential between how directors and officers are exculpated,” Wofford said.
But Lipton said the protections against frivolous litigation in Delaware have swung too far. She questioned the benefits to shareholders that the officer shield provides, while cautioning that it could allow unfair mergers to get through.
“I think a lot of institutions think ‘frivolous litigation’ and just shrug,” Lipton said. “I don’t think they’re recognizing the value of shareholder claims for disciplining the system.”
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