Steve Davidoff's analysis of the recently initiated litigation re Affiliated Computer Services, Inc. before the Delaware Chancery Court was highlighted yesterday by Steve Bainbridge. He said a few things about controlling shareholders and their fiduciary duties under Delaware corporate law, triggered by Davidoff's remark that
Mr. Deason is not a controlling shareholder but rather owns only 43.6 percent of the voting interest and is restricted by agreement from taking majority control of the company.
As Bainbridge rightly emphasized,
In In re Cysive, Inc. Shareholders Litigation, 836 A.2d 531 (Del.Ch. 2003), VC Leo Strine held that:
Although it is true that he does not control a majority of the company's voting power, that was also true of the controlling stockholder in Lynch itself, which only controlled 43.3% of the votes. Moreover, in Lynch the stockholder held to have control was (in simplified terms) limited contractually to naming no more than five of the company's eleven directors. Likewise, in Western National, the 46% stockholder was limited to electing two members of the board for a period beyond the merger at issue and was subject to certain restrictions on the purchase of additional shares.
If nonmajority shareholders contractually barred from electing a majority of the board can nevertheless be deemed "controlling," so should a 40+% shareholder even though he is contractually barred from going over 50%.
For that 2003 decision go here. I believe Weinstein Enterprises, Inc. v. Orloff, 870 A.2d 499 (Del. 2005) is still particularly instructive in this respect:
the term 'control' does not have a fixed legal meaning. Its definition varies according to the context in which it is being considered, e.g., fiduciary responsibility, tort liability, filing consolidated tax returns, sale of control. For that reason, 'control' - or its absence - is frequently used to describe a judicial conclusion that is reached after a fact specific analysis.
As Professor Deborah DeMott has noted, 'control assumes very different forms in the paradigmatic relationship between equity investors and a corporation.'
Shareholders' control is often latent and indirect in form. Corporate law itself allocates to shareholders only the power to elect directors, and under some circumstances, to remove directors once elected, and to adopt or reject fundamental transactions proposed by directors. Holding a majority of voting power does not in itself place a shareholder in a position of active control. If the shareholder assumes no additional role within the corporation, the shareholder is not a direct participant in operational decisions or in the fomulation of strategic policy. Nonetheless, shareholders hold power to control in a latent form because they may be able to remove directors, and in all events may replace the incumbents if they resign or when their terms expire.
In the context of imposing fiduciary responsibilities, it is well established in the corporate jurisprudence of Delaware that control exists when a stockholder owns, directly or indirectly, more than half of a corporation's voting power. In addition to the election of directors, many of the most fundamental corporate changes also require approval by a majority vote of the stockholders, e.g., mergers, consolidations, sales of all or substantially all of the assets of a corporation and dissolutions. Conversely, a stockholder that owns less than half of a corporation's shares will generally not be deemed to be a controlling stockholder, with concomitant fiduciary responsibilities. For a stockholder that own less than a numerical majority of a corporation's voting shares to be deemed a controlling stockholder for purposes of imposing fiduciary obligations, the plaintiff must establish the actual exercise of control over the corporation's conduct by that otherwise minority stockholder.
(footnotes omitted)
As to the second scenario, the devil is in the detail: the difficulty for the pIaintiff will obviously be to overcome his burden of showing that the minority shareholder actually exercised control over the corporation's conduct. Bare allegations of control won't cut it. On the other hand, a plaintiff will generally not have to prove that the minority shareholder "oversaw the day-to-day operations of the [corporation]. Allegations of control over the particular transactions at issue are enough" (In re Primedia, Inc. Derivative Litigation, 910 A.2d 248 (Del. Ch. 2006)). For some of the pittfalls for controlling shareholders see, e.g., Abraham v. Emerson Radio Corp., 901 A.2d 751 (Del. Ch. 2006) (about the situation in which the controlling shareholder may have sold his stake to a known looter and may face liability for doing so). Things are different in wholly owned (100%) relationships, where the corporation has only one shareholder: in those situations, the shareholder generally doesn't owe any fiduciary duties to the subsidiary (see, e.g., Anadarko Petroleum Corp. v. Panhandle E. Corp., 545 A.2d 1171 (Del. 1988) and Trenwick America Litigation Trust v. Ernst & Young, L.L.P., 906 A.2d 168 (Del. Ch. 2006)).
I tackled this issue in more detail in Judicial Review of Director Conduct - Under Dutch and Delaware Corporate Law (diss.), Deventer: Kluwer 2007, no. 7.e. I also noted there that a similar development is taking place in Dutch corporate law, especially in right of inquiry case law, although the doctrinal lines aren't fully developed yet and Dutch law doesn't know the concept of fiduciary duty as such (instead we prefer to coin things in terms of 'reasonabless and fairness' or duties of care). Interestingly, the Dutch corporate governance code as amended in 2008 now suggests (see no. 9 of the Preamble) that
[t]he management board is responsible for weighing up the different interests with respect to the company's strategy, while the supervisory board must oversee this process. Both these organs are accountable to the general meeting for the performance of their roles. Unlike the management board and the supervisory board, the other stakeholders of the company are not in principle guided exclusively by the interests of the company and its affiliated enterprise. For example, shareholders can give priority to their own interests with due regard for the principles of reasonableness and fairness. The greater the interest which the shareholder has in a company, the greater is his responsibility to the company, the minority shareholder and other stakeholders.
(emphasis added)
The emphasized sentence quite clearly suggest that with control comes responsibility. Unfortunately, the code doesn't add anything to this suggestion in the sections about the shareholder meeting and individual shareholders. In my forthcoming publication titled Facets of Responsibility in Contemporary Corporate Governance (About the Triad Duty, Responsible Behavior and Accountability), to be published in the second half of November 2009, I attempt to add some contours, partly inspired by Delaware case law on point. So more on this later.
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