Ghada Amer, “Le Champ de Marghuerites” (2011)

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 2 of 17 Chapter 17 Shareholder Litigation Derivative vs. direct actions –Derivative action: 2 suits in 1- enforce fiduciary duties to corporation –Direct action: representative suit - protect Sh rights –Distinction between two: who recovers? Demand requirement –Board decides lawsuit’s merits –Aronson test: (1) director disinterest + independence, (2) decision protected by BJR Module VII – Fiduciary Duties Special litigation committee –Judicial review: BJR or more? –MBCA: universal demand + board dismissal Plaintiff standing –Adequacy –Contemporaneous ownership Policy issues –Who guards the guards? –Challenge of settlements –Nature of attorneys’ fees Citizen of world Law profession Corporate practice Bar exam Bar exam

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 3 of 25 1.Fundamentals –Introduction to firm –Corporate basics 2.Corporations and policy –Corporate federalism –Corporate social responsibility –Corporate political action 3.Corporate form –Organizational choices –Incorporation –Locating corporate authority 4.Corporate finance –Numeracy for corporate lawyers –Capital structure 5.Corporate externalities –Piercing corporate veil –Corporate environmental liability –Corporate criminal liability 6.Corporate governance –Shareholder voting –Shareholder information rights –Public shareholder activism 7.Fiduciary duties –Shareholder litigation –Board decision making –Board oversight –Director conflicts –Executive compensation –Corporate groups 8.Stock trading –Securities markets –Securities fraud class actions –Insider trading 9.Corporate deals –Sale of control –Antitakeover devices –Deal protection 10.Close corporations –Planning –Oppression 1.Fundamentals –Introduction to firm –Corporate basics 2.Corporations and policy –Corporate federalism –Corporate social responsibility –Corporate political action 3.Corporate form –Organizational choices –Incorporation –Locating corporate authority 4.Corporate finance –Numeracy for corporate lawyers –Capital structure 5.Corporate externalities –Piercing corporate veil –Corporate environmental liability –Corporate criminal liability 6.Corporate governance –Shareholder voting –Shareholder information rights –Public shareholder activism 7.Fiduciary duties –Shareholder litigation –Board decision making –Board oversight –Director conflicts –Executive compensation –Corporate groups 10.Close corporations –Planning –Oppression

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 4 of 17 Shareholder self-protection Vote –Approve fundamental transactions –Elect directors (annually, special meetings) –Remove directors / fill vacancies –Initiate action (amend bylaws, adopt resolutions) Sue –Enforce fiduciary duties (derivative suits) –Protect rights (disclosure, voting, appraisal, inspection) Sell –Liquidity (except insider trading) –Takeovers (tender offer) Prof. Robert Thompson

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 5 of 17 Enforcement of fiduciary duties …

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 6 of 17 Derivative suit (enforce duties to corporation) Corporation Shareholder (lawyer) Fiduciaries “on behalf of corporation” violation of corporate duties (recovery to corporation) Delaware Supreme Court: “if an action is derivative, the plaintiffs are then required to comply with the requirements of Court of Chancery Rule 23.1, that the stockholder: (a) retain ownership of the shares throughout the litigation; (b) make pre-suit demand on the board; and (c) obtain court approval of any settlement. Further, the recovery, if any, flows only to the corporation.”

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 7 of 17 Class action (enforce duties to shareholders) Corporation Sh rep (lawyer) Insiders “on behalf of class” violation of direct duties (recovery to shareholders) Shareholder class

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 8 of 17 How distinguish …

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 9 of 17 Tooley v. Donaldson, Lufkin & Jenrette (Del. 2004) CS agrees to buy DLJ - through a $90 tender offer. CS exercises its rights to delay the tender offer by 22 days, which the DLJ board accepts. Tooley (and his law firm) claim the board violated duties to the public DLJ shareholders. Why was lawsuit brought as class action? Why is this not a derivative action? Credit Suisse (new 71% SH) Minority shareholders DLJ Board Plaintiff shareholder

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 10 of 17 Delaware Supreme Court:.. in determining whether a stockholder's claim is derivative or direct … That issue must turn solely on the following questions: (1)who suffered the alleged harm (the corporation [derivative] or the suing stockholders, individually [direct]); and (2)who would receive the benefit of any recovery or other remedy (the corporation [derivative] or the stockholders, individually [direct])? Tooley v. Donaldson, Lufkin & Jenrette (Del. 2004) Chief Justice Norm Veasey

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 11 of 17 ALI Principles A derivative action … (1) Creates recovery goes to the corporation [class action recovery shared by all shareholders in class] (2) Has preclusive effect that spares corporation and defendants multiplicity of actions (3) Entitles successful plaintiff to an award of attorneys' fees from corporation [class action, from the fund] (4) Allows board to take over the action or to seek dismissal

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 12 of 17 Hypos 1.Board issues new stock, but denies preemptive rights to existing shareholders. Sh sues. 2.Parent corporation refuses to allocate business opportunities to partially-owned sub. Sh of sub sues parent. 3.Board grants CEO a lifetime employment contract. Sh sues.

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 13 of 17 Demand requirement …

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 14 of 17 FRCP Derivative Actions (a) Prerequisites. This rule applies when one or more shareholders … bring a derivative action to enforce a right that the corporation may properly assert but has failed to enforce. The derivative action may not be maintained if it appears that the plaintiff does not fairly and adequately represent the interests of shareholders who are similarly situated in enforcing the right of the corporation or association. (b) Pleading Requirements. The complaint must be verified and must: (1)allege that the plaintiff was a shareholder or member at the time of the transaction complained of, or that the plaintiff's share or membership later devolved on it by operation of law; (2)allege that the action is not a collusive one to confer jurisdiction that the court would otherwise lack; and (3)state with particularity: (A) any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the shareholders or members; and (B) the reasons for not obtaining the action or not making the effort. (c) Settlement, Dismissal, and Compromise. A derivative action may be settled, voluntarily dismissed, or compromised only with the court's approval. Notice of a proposed settlement, voluntary dismissal, or compromise must be given to shareholders or members in the manner that the court orders.

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 15 of 17 Aronson v. Lewis (Del. 1984) Meyers Parking gives its CEO (and 47% shareholder) a sweetheart employment and retirement package. Shareholder Lewis (a serial plaintiff) claims this is waste. Why is this a derivative suit? Who controls the corporation’s litigation decisions. Why doesn’t Lewis ask the board to sue? Asking the board to sue all the directors is futile - no? Who dominates the board? Where does the court start its analysis? Why the BJR? Directors Shareholders Corporation Board Plaintiff shareholder

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 16 of 17 Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1)the directors are disinterested and independent and (2)the challenged transaction was otherwise the product of a valid exercise of business judgment. Hence, the Court of Chancery must make two inquiries, one into the independence and disinterestedness of the directors and the other into the substantive nature of the challenged transaction and the board's approval thereof.

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 17 of 17 Quick quiz (Delaware law) 1.True or False. Fink “dominated” the directors since he owned 47% of the company’s stock and chose them to the board. 2.True or False. Shareholders can avoid making a demand on the board by suing all the directors, who become necessarily “interested” in the lawsuit. 3.True or False. Fink’s deal (where it was unlikely the corporation would receive any services) is a “waste of corporate assets” - nobody would say corporation got its money’s worth. 4.True or False. Despite academic claims of board “structural bias,” boards regularly decide to sue their own members. 5.True or False. Whether a lawsuit has merit is something judges know better than directors - no reason for BJR abstention.

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 18 of 17 Board dismissal …. Use of “special litigation committee”

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 19 of 17 Derivative suit (board request for dismissal) Corporation Shareholder (lawyer) Directors “on behalf of corporation” violation of corporate duties (recovery to corporation) Delaware Supreme Court: [When confronted with a request for dismissal from an SLC] first, the court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. …. The second step provides a balance of corporate and shareholder interests … the Court should determine applying own independent business judgment whether to dismiss.” Board (SLC)

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 20 of 17 MBCA (demand in derivative litigation) § 7.42 Demand No shareholder may commence a derivative proceeding until: (1) a written demand has been made upon the corporation to take suitable action; and (2) 90 days have expired from the date the demand was made unless … the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting …. § 7.44 Dismissal (a) A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsection (b) … has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation. (b) … the determination in subsection (a) shall be made by: (1) a majority vote of independent directors present at a meeting of the board of directors if the independent directors constitute a quorum; or (2) a majority vote of a committee consisting of two or more independent directors appointed by majority vote of independent directors present at a meeting of the board of directors, whether or not such independent directors constituted a quorum. (c) None of the following shall by itself cause a director to be considered not independent for purposes of this section: (1) the nomination or election of the director by persons who are defendants in the derivative proceeding or against whom action is demanded; (2) the naming of the director as a defendant in the derivative proceeding or as a person against whom action is demanded; or (3) the approval by the director of the act being challenged in the derivative proceeding or demand if the act resulted in no personal benefit to the director.

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 21 of 17 Derivative suit (board request for dismissal) Corporation Shareholder (lawyer) Directors “on behalf of corporation” violation of corporate duties (recovery to corporation) Wisconsin Supreme Court: Independence depends on: 1.Whether named as defendant 2.Whether approved challenged transaction 3.Whether have financial dealings with corporation 4.Whether have non-financial relationships with insiders 5.Whether acts as consultant, counsel 6.Whether small SLC (less group think) 7.Whether SLC is well advised by banker, lawyer Board (SLC)

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 22 of 17 Delaware Shareholder MBCA Shareholder Board Court Demand excused Universal demand Suit (after 90 days) Move to dismiss SLC

Corporations: A Contemporary Approach Slide 23 of 59 1.Which of the following should be a derivative suit? a.Board enters into merger, without necessary Sh approval b.Board has Corp buy majority Sh’s art collection c.Board gives CEO “complete control” over corporation 2.Delaware requires Shs make demand on board … a.Always b.when time is of essence c.Unless excused as futile 3. Delaware excuses demand … a.When current board majority is financially interested b.When majority of current board not independent c.When BJR does not apply 4.In Aronson v. Lewis … a.Directors dominated because CEO was 47% Sh b.Directors interested because all directors were sued c.Demand was not excused 5. After Aronson v. Lewis a Sh (pre-suit) must have particularized facts that … a.Old board was personally tied to interested director b.Majority of current directors financially interested in transaction c.All directors interested/dominated 6.In Delaware, a Sh who makes demand on board … a.Concedes board is disinterested and independent b.Can still sue and show board interested and non-independent c.Can sue after waiting for 90 days for board to act Answers: Chapter 29 Planning in CHC

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 24 of 17 The end

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 25 of 17 Chapter 17 Shareholder Litigation Derivative vs. direct actions –Derivative action: 2 suits in 1- enforce fiduciary duties to corporation –Direct action: representative suit - protect Sh rights –Distinction between two: who recovers? Demand requirement –Board decides lawsuit’s merits –Aronson test: (1) director disinterest + independence, (2) decision protected by BJR Module VII – Fiduciary Duties Citizen of world Law profession Corporate practice Bar exam Bar exam

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 26 of 25 1.Fundamentals –Introduction to firm –Corporate basics 2.Corporations and policy –Corporate federalism –Corporate social responsibility –Corporate political action 3.Corporate form –Organizational choices –Incorporation –Locating corporate authority 4.Corporate finance –Numeracy for corporate lawyers –Capital structure 5.Corporate externalities –Piercing corporate veil –Corporate environmental liability –Corporate criminal liability 6.Corporate governance –Shareholder voting –Shareholder information rights –Public shareholder activism 7.Fiduciary duties –Shareholder litigation –Board decision making –Board oversight –Director conflicts –Executive compensation –Corporate groups 8.Stock trading –Securities markets –Securities fraud class actions –Insider trading 9.Corporate deals –Sale of control –Antitakeover devices –Deal protection 10.Close corporations –Planning –Oppression 1.Fundamentals –Introduction to firm –Corporate basics 2.Corporations and policy –Corporate federalism –Corporate social responsibility –Corporate political action 3.Corporate form –Organizational choices –Incorporation –Locating corporate authority 4.Corporate finance –Numeracy for corporate lawyers –Capital structure 5.Corporate externalities –Piercing corporate veil –Corporate environmental liability –Corporate criminal liability 6.Corporate governance –Shareholder voting –Shareholder information rights –Public shareholder activism 7.Fiduciary duties –Shareholder litigation –Board decision making –Board oversight –Director conflicts –Executive compensation –Corporate groups 10.Close corporations –Planning –Oppression

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 27 of 17 Enforcement of fiduciary duties …

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 28 of 17 Derivative suit (enforce duties to corporation) Corporation Shareholder (lawyer) Fiduciaries “on behalf of corporation” violation of corporate duties (recovery to corporation) Delaware Supreme Court: “if an action is derivative, the plaintiffs are then required to comply with the requirements of Court of Chancery Rule 23.1, that the stockholder: (a) retain ownership of the shares throughout the litigation; (b) make pre-suit demand on the board; and (c) obtain court approval of any settlement. Further, the recovery, if any, flows only to the corporation.”

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 29 of 17 Class action (enforce duties to shareholders) Corporation Sh rep (lawyer) Insiders “on behalf of class” violation of direct duties (recovery to shareholders) Shareholder class

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 30 of 17 Demand requirement … [in Delaware]

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 31 of 17 Aronson v. Lewis (Del. 1984) Meyers Parking gives its CEO (and 47% shareholder) a sweetheart employment and retirement package. Sh Lewis (a serial plaintiff – really a plaintiff’s law firm) claims this is waste. Why is this a derivative suit? Who controls the corporation’s litigation decisions. Why doesn’t plaintiff ask the board to sue? Asking the board to sue all the directors is futile - no? Who dominates the board? Where does the court start its analysis? Why the BJR? Directors Shareholders Corporation Board Plaintiff shareholder

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 32 of 17 Our view is that in determining demand futility the Court of Chancery in the proper exercise of its discretion must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1)the directors are disinterested and independent and (2)the challenged transaction was otherwise the product of a valid exercise of business judgment. Hence, the Court of Chancery must make two inquiries, one into the independence and disinterestedness of the directors and the other into the substantive nature of the challenged transaction and the board's approval thereof.

Corporations: A Contemporary Approach Slide 33 of 59 1.Which of the following should be a derivative suit? a.Board issues new stock, without preemptive rights b.Board has Corp buy majority Sh’s art collection c.Board gives lifetime employment to CEO 2.Delaware requires Shs make demand on board … a.Always b.when time is of essence c.Unless excused as futile 3. Delaware excuses demand … a.When current board majority $$ interested b.When current board not independent c.When BJR not apply 4.In Aronson v. Lewis … a.Directors dominated because CEO was 47% Sh b.Directors interested because all directors were sued c.Demand was not excused 5. After Aronson v. Lewis a Sh must have particularized facts that … a.Current directors personally tied to interested director b.Current directors financially interested in challenged tx c.All directors interested/dominated 6.In Delaware, a Sh who makes demand on board … a.Concedes board is disinterested and independent b.Can still sue and show board interested and non-independent c.Can sue after waiting for 90 days for board to act Answers: 1-b (c – either deriv, direct) / 2-c / 3-abc / 4-c / 5-b / 6-a Chapter 29 Planning in CHC

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 34 of 17 Universal demand and board dismissal …. [under MBCA]

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 35 of 17 MBCA (demand in derivative litigation) § 7.42 Demand No shareholder may commence a derivative proceeding until: (1) a written demand has been made upon the corporation to take suitable action; and (2) 90 days have expired from the date the demand was made unless … the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting …. § 7.44 Dismissal (a) A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsection (b) … has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation. (b) … the determination in subsection (a) shall be made by: (1) a majority vote of independent directors present at a meeting of the board of directors if the independent directors constitute a quorum; or (2) a majority vote of a committee consisting of two or more independent directors appointed by majority vote of independent directors present at a meeting of the board of directors, whether or not such independent directors constituted a quorum. (c) None of the following shall by itself cause a director to be considered not independent for purposes of this section: (1) the nomination or election of the director by persons who are defendants in the derivative proceeding or against whom action is demanded; (2) the naming of the director as a defendant in the derivative proceeding or as a person against whom action is demanded; or (3) the approval by the director of the act being challenged in the derivative proceeding or demand if the act resulted in no personal benefit to the director.

Corporations: A Contemporary Approach Slide 36 of 59 1.Which of the following should be a derivative suit? a.Board misleads Shs about impending merger b.Board has Corp buy CEO’s wife’s art collection c.Board announces revised dividend policy 2.MBCA requires Shs make demand on board … a.Always (except emergency) b.When time is of essence c.Unless excused as futile 3. MBCA requires dismissal of derivative suit … a.When current board asks b.When majority of independent, disinterested Ds ask c.When Sh makes demand 4.Under MBCA, derivative suit must be dismissed if in good faith and after reasonable inquiry … a.Ds constituting board quorum ask b.Special litigation committee (properly chosen/composed) asks c.Demand was not excused 5. Under MBCA, Ds aren’t independent … a.If they have personal ties to interested director b.If they have financial interest in challenged tx c.If they have been sue 6.In MBCA, Sh making board demand … a.Concedes board is disinterested and independent b.Can still sue to show current Ds interested and non-independent c.Can sue after waiting for 90 days for board to act Answers: Chapter 29 Planning in CHC

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 37 of 17 The end [of short Ch 17]

Corporations: A Contemporary Approach Chapter 17 Shareholder Litigation Slide 38 of 17 Corporations (shareholder checklist) Structure of corporation Financial rights Corporate externalities (limited liability) Corporate governance Fiduciary duties (directors, controlling Shs) –Shareholder litigation –Board decision making –Board oversight –Director self dealing (conflicts) –Executive compensation –Duties within corporate groups Liquidity rights –Stock trading –Corporate deals Close corporation

"Delaware’s Balancing Act" JOHN ARMOUR, University of Oxford - Faculty of Law, Oxford-Man Institute of Quantitative Finance, European Corporate Governance Institute (ECGI) BERNARD S. BLACK, Northwestern University - School of Law, Northwestern University - Kellogg School of Management, European Corporate Governance Institute (ECGI) BRIAN R. CHEFFINS, University of Cambridge - Faculty of Law, European Corporate Governance Institute (ECGI) Delaware’s courts and well-developed case law are widely seen as integral elements of Delaware’s success in the competition among states for incorporations. Today, however, Delaware’s popularity as a venue for corporate litigation is under threat. Increasingly, as the empirical evidence summarized in this paper shows, corporate cases involving Delaware-incorporated companies are being brought and decided elsewhere. This paper examines the implications of this “out-of-Delaware” trend, emphasizing in so doing a difficult balancing act that the Delaware courts face. If Delaware accommodates litigation too readily, plaintiffs’ attorneys will file a plethora of “weak” cases and companies, fearful of lawsuits, may begin to incorporate elsewhere. On the other hand, if plaintiffs’ attorneys believe the Delaware judiciary is unwelcoming, they will tend to file cases in other courts. Delaware could then lose its status as the de facto national corporate law court and may no longer offer the rich body of up-to-date case law precedent upon which “users” of Delaware corporate law depend. Delaware’s overall corporate law “brand” could in turn become less valuable, thus jeopardizing its pre-eminence in the competition for incorporations.

Corporations: A Contemporary Approach Chapter 14 Shareholder Voting Rights Slide 40 of 59 Group Hypo Your group is the Council of the Section of Corporation Law of the State of Delaware. As such, you are responsile for formulating and recommending to the Delaware General Assembly amendments to the Delaware General Corporation Law.Council of the Section of Corporation Law of the State of Delaware the Recently, as shareholder litigation has become a fixture of mergers and acquisitions (M&A) practice, some corporations have experimented with putting fee-shifting provisions in the corporate bylaws. The purpose has been to discourage groundless shareholder claims, particularly in M&A transactions where more than 90 percent of such transactions are challenged, often by multiple shareholders. See § Are such bylaws valid, when unilaterally created by corporate boards without shareholder approval? In 2014, the Delaware Supreme Court addressed the enforceability of a board-passed, fee-shifting bylaw. ATP Tour, Inc. v. Deutscher Tennis Bund (German Tennis Federation), 91 A.3d 554 (Del. 2014) (en banc). The case, brought by a member of the Association of Tennis Professionals Tour, challenged a board-passed bylaw amendment that provided any member that brought an intracorporate claim and failed to obtain “a judgment on the merits that substantially achieves the remedy sought” could be compelled to reimburse the ATP Tour for its defense costs. The court ruled that the ATP bylaw was facially valid, given that it dealt with an intracorporate matter – a proper subject for the bylaws. The court explained, however, that a facially-valid bylaw might be invalid if it had an improper purpose, though the court pointed out that deterring litigation was not an improper purpose. The court said that corporations could create a fee-shifting bylaw “midstream” even against members who had joined the corporation before the bylaw’s adoption. The ATP decision -- though involving a not-for-profit, non-stock corporation -- has potentially far-reaching implications for for-profit corporations. If used by corporate boards to discourage – if not squelch – shareholder litigation in M&A transactions, it could lead to such litigation being brought by shareholders as “packaged settlements” in which management would be asked to enter into a settlement agreement without actual litigation. It could lead to shareholder activists proposing their own bylaw amendments to either rescind or prevent board-passed, fee-shifting bylaws. See § It could lead to retaliatory “just say no” votes against directors who had approved such bylaws. And, as has happened in Delaware, it could lead to state legislative proposals that would preclude boards from unilaterally creating fee-shifting bylaws. Time will tell.