ABA Section of Business Law

ABA Section of Business Law
Business Law Today
November/December 1999

---

Beyond the millennium, II

It’s been 100 years since Delaware took the forefront in corporate law: What’s next?

By LAWRENCE A. HAMERMESH

Hamermesh is an associate professor at Widener University School of Law, Wilmington, Del. The proceedings of the symposium described in this article will be published in a forthcoming issue of The Delaware Journal of Corporate Law, published by the law school

Delaware and corporate law almost seem synonymous. Will this special relationship continue? How might it change?

In 1899, the Delaware General Assembly adopted what would become the dominant legal framework for the largest business enterprises in the world — the Delaware General Corporation Law. A hundred years later, a distinguished group of business executives, institutional investors, academics, lawyers and judges assembled in Wilmington to commemorate that auspicious legal development by examining broad trends in Delaware corporate law and practice and how those trends might affect the evolution of Delaware corporate law in its next century.

Craig B. Smith, the current chair of the Delaware Corporation Law Council, set the tone for the gathering: He observed that new technology and the needs of business may require re-examination of long-standing principles of corporate law. As he explained, "We must decide whether those principles have continued vitality. If so, are they sufficiently important to the integrity of our corporation law that we will resist the pressure for change?"

For example, Smith referred to statutes requiring that directors attend board meetings either in person or by means of communication permitting all members to hear each other. He then asked: "Are we ready now to substitute an online chat room format for board meetings? If not, why not? Is our resistance well-founded or based on outmoded traditions and values of marginal importance?"

In the program sponsored by the Widener University School of Law and the Delaware State Bar Association, six panels, each with a distinct perspective, addressed Smith’s invitation to re-examine traditional corporate law principles. The first of those panels focused on the needs and expectations of business managers. Michael Goldman of Potter, Anderson & Corroon, Wilmington, Del., predicted that business will increasingly be dominated by business entities, like LLCs, that best exploit statutory freedom to tailor business arrangements to suit the needs and negotiated desires of the participants.

Goldman particularly stressed statutes permitting business participants to limit or eliminate altogether the operation of traditional fiduciary duties as developed and enforced by the courts. As Richard Agnich, senior vice president of Texas Instruments, Forth Worth, Texas, explained, "if the laws don’t provide or permit a flexible framework for business, creative businessmen will."

Other commentators, however, focused more on predictability than on flexibility as the goal of corporate law. According to Steven Goldstone, CEO of RJR/Nabisco, New York City, corporate law will best serve business by affording reasonably bright lines to guide transactional planning. He was particularly critical of case law indicating the possibility of a fiduciary duty on the part of corporate directors to corporate creditors in insolvency or in a "zone of insolvency."

There was wide agreement that technological advances will increasingly break down global barriers to communication and trade, and business law must develop and adapt to meet these changes. It is only a matter of time before capital flows and corporate governance are initiated, effected and monitored by electronic means, through offerings of securities on the Internet and real-time virtual meetings of stockholders. As Agnich pointed out, the technology is near at hand that would permit direct corporate democracy, in which stockholders make business decisions directly rather than through representative directors. But he also warned against this trend: "Without the capability of a board of directors to govern the corporation and allow management to pursue long-term strategies, you would not see anything but focus on the next quarter’s results."

Similar changes are surely forthcoming in the system for adjudicating corporate law disputes. No one disagreed with Vice Chancellor Jack B. Jacobs of the Delaware Court of Chancery, Wilmington, that some adjudicative mechanism must exist. Given the emphasis on speed and flexibility, however, the panelists felt that trends will favor adjudicatory specialization — business courts, for example, modeled on the Court of Chancery — and technological improvements in adjudicative efficiency, such as video conferencing for hearings or even Internet hearings in which lawyers and others participate without the need to travel to the courthouse.

The next panel focused on one of the most striking recent developments in corporate law: the astronomical growth of equity ownership by institutional investors, particularly mutual funds and pension funds (public and private). Dr. Carolyn Brancato of the Conference Board, New York City, identified some likely — and somewhat opposite — trends both here and abroad. Globally, American institutional investors have been increasingly dominant, and equity holdings for foreign enterprises have become increasingly diverse. At the same time, the increasingly dominant American investors have taken their relatively aggressive ownership style overseas, with demands for greater informational transparency and access to management.

For example, Michael Price of Franklin Mutual Advisers, Short Hills, N.J., described the case of a U.S. fund manager, feeling disenfranchised by managers of a firm in a developing country, who approached the International Monetary Fund to question the prudence of international support for a nation that permits enterprises to disregard basic corporate governance standards.

As reflected in such integrated activism, the traditional system of concentrated ownership by a few banks and closed-door corporate governance outside the United States is giving way to more dispersed ownership and greater transparency and accessibility to outside investors.

In contrast, holdings in U.S. firms have become more concentrated, and those companies increasingly see the development of what has been called "relational investing," in which large holders play an active role in consulting with management about corporate strategy and governance issues, including board composition. Price lauded these trends, although he saw room for improvement in two areas. First, citing the fate of Pennzoil (see the sidebar on page 18), he suggested that the balance of power unduly favors directors over stockholders in hostile takeovers; second, noting recent auditing breakdowns, he joined the call for an improved audit process, including audit committees comprised solely of independent directors, and selection of outside auditors by that committee rather than by management.

The panelists felt that investor/management communication and influence would continue to develop without the need for change in the Delaware corporate law, and that — despite the current interest in stockholder-adopted bylaws as a mechanism for governance control by investors — informal consultation with institutional investors, backed up by the ultimate prospect of replacing the board, is the likely vehicle of choice for institutional investor involvement in corporate governance. It was predicted, then, that governance by directors, rather than direct governance by owners, would continue to be the norm for publicly held corporations.

In the third panel, leading academic commentators on corporate law focused on share-ownership trends and trends in chartering competition and global regulatory competition as likely sources of change. Professor Richard Booth of the University of Maryland School of Law, College Park, noted a potential conflict in trends toward increasing shareholder diversification and management-equity ownership.

Although recent studies support such management ownership as a way to align management and stockholder interests, Booth suggested that shareholders with diversified portfolios may prefer greater risk appetite than the risk levels that managers, dependent on the value of a single issuer — their own corporation — might find acceptable. He also suggested that increasing subdivision of an enterprise’s equity securities — adding preferred stock and tracking stock, for example, to common stock — will likely result in increasing litigation over intracorporate conflicts in which directors must make decisions in the interests of multiple shareholder constituencies.

Professor John C. Coffee Jr., of Columbia University School of Law, New York City, criticized the academically popular concept that Delaware corporate law is the winning product of an efficient competition to produce the optimal corporate law. He sides with those who believe that corporate statutes have essentially converged, driven less by regulatory competition than by leadership from, among other places, the Business Law Section’s Committee on Corporate Laws and its Model Business Corporation Act.

Coffee has observed much more regulatory competition between state and federal laws, on issues such as insider trading, going private and hostile takeovers, where the relative roles of state and federal law have waxed and waned. Globally, Coffee suggested, inter-nation chartering competition is also weak. What seems far more potent as a regulatory competitive force is international competition among stock exchanges for listings, illustrated by Daimler’s decision to list its shares on the New York Stock Exchange in anticipation of the merger with Chrysler.

The ramifications of globalization were the focus of a panel led by Joseph Frumkin of Sullivan & Cromwell, New York City, and David Jackson, general counsel of PowerGen PLC, London, England. They identified the culture clash, even between the United Kingdom and the United States, in coordinating the corporate legal structure of merging multinational businesses. The potential for litigation — including class actions — over alleged fiduciary misconduct in takeovers, for example, is still largely foreign and unacceptable to U.K. firms. Those companies find greater predictability and less cost in a takeover system in which the critical rules of the road are developed and enforced by the Takeovers Board, without resort to litigation.

Frumkin and Jackson suggested that business growth cries out for a legal mechanism — the "Holy Grail" of global M&A — to permit a U.S./U.K combination of equals, but without a formal merger, retaining the separate identities of each company’s shares.

Although Delaware corporate law permits "dual incorporation" by domestication of a foreign corporation into a Delaware incorporation, use of such a structure raises serious cross-national conflicts about rules of director conduct. Hence, Frumkin asks: Will the courts uphold "a charter provision that says in the event of a conflict between Delaware law [notably Revlon duties] and English law, the directors won’t be in a breach of their fiduciary duties if they comply with the requirements of English law in this regard?"

The panelists noted that if global business alliances are to go forward — and the pressure for such alliances grows all the time — Delaware law might best serve the needs of business by accommodating the legal demands and expectations of other legal cultures.

That observation, in turn, prompted Carolyn Berger, justice of the Delaware Supreme Court, Wilmington, and A. Gilchrist Sparks III of Morris, Nichols, Arsht & Tunnell, Wilmington, Del., to question what aspects of Delaware law should be considered "core" values and indispensable features. Must all corporations really afford 10 days’ advance notice of stockholder meetings, for example, if another country’s rules do not? And, more important, are the fiduciary duties developed and administered by the Delaware courts an indispensable feature of the Delaware corporation law framework?

Berger and Sparks in turn questioned whether Delaware corporate litigation should continue to be framed so pervasively in terms of fiduciary wrongdoing, or whether some other system — potentially involving the issuance of advisory opinions — should replace the present litigation framework. In particular, Berger questioned the efficacy of marginal technological improvements in court processes. Instead, she suggested reconsideration of the fundamental character of corporate litigation:

I think that we ought to be willing to take on the sacred cow of the court system and perhaps rethink the way some of these matters are resolved in litigation. ... It seems to me that there might be room for advisory opinions, for example, to help deal with some of the questions of uncertainty and, perhaps, address specific needs in a timely fashion and allow businesses to go about their business without the fear of litigation.

In a panel that also peered into the future of corporate litigation, Chief Justice E. Norman Veasey of the Delaware Supreme Court predicted greater use of court-appointed experts, alternative dispute resolution in corporate cases, reliance on private ordering as well as blending of legal and other professional practices.

Professor Michael Dooley of the University of Virginia School of Law, Charlottesville, addressed claims that the stockholder-derivative suit has ceased to be a viable means of enforcing fiduciary duties. According to Dooley, "We cannot dispense with the derivative suit without doing absolutely irreparable damage to our corporate governance system."

Nonetheless, Dooley suggested a number of ways in which derivative actions might be made more cost-effective: He first proposed statutory authorization of charter provisions requiring arbitration of derivative claims, but he recognized the drafting problems of separating arbitrable from nonarbitrable derivative claims. Alternatively, Dooley proposed statutory limits on recovery of attorneys’ fees in derivative suits, limiting fees to a portion of monetary benefits obtained for the corporation, or, where no monetary benefit is obtained, limiting fees to a specified dollar amount.

William Prickett of Prickett, Jones & Elliott, Wilmington, Del., countered that Delaware courts should not follow the fee-award approach that Dooley suggested but should continue to focus on the actual benefit conferred. Prickett pointed out that rules limiting and expediting discovery could effectively minimize the threat that derivative litigation will be brought to achieve nuisance value settlements.

Peter Atkins of Skadden, Arps, Slate, Meagher & Flom, New York City, led off the last panel, which examined the role of the corporate practitioner, by emphasizing globalization and the need to appreciate, if not master, national differences in corporate law. Pointing to the effort of the Organization of Economic Cooperation and Development (OECD) to develop consensus corporate-governance principles, he suggested that cross-border conflicts of corporate law — which significantly complicate cross-border mergers — could be moderated by developing a global model of corporation law.

Atkins also pointed out issues for the practicing lawyer raised by vastly expanded and accelerated electronic access to information. For all its benefits, this improved access makes it important to define the scope of the directors’ responsibility to gather information through electronic media in connection with corporate decision making. The duty to gather all information that is reasonably available may become overwhelming, if not sensibly limited, given the ease of gathering increasingly broad sources of data. Second, the pressure for rapid decision making, which electronic communication facilitates, intensifies the lawyer’s duty to urge caution and reflection when the lawyer believes that director/clients have not adequately assessed important decisions.

In a somewhat retrospective interlude, the keynote address by former Chancellor William T. Allen, now professor at New York University School of Law, explored the reasons for Delaware’s dominance in corporate law. Many, he said, question whether case law in Delaware is as insightful or predictive as is conventionally believed. Particularly in matters of fiduciary responsibility, Delaware law appears to eschew the bright lines that many might consider economically more efficient.

Allen instead emphasized a sociological aspect of Delaware corporate law in explaining its success. He described "the evolution of a local professional culture" in which judicial diligence and knowledge are rewarded, and in which judges and lawyers in the small community can more readily and comfortably interact and share knowledge and insights about the operation of corporate law.

In concluding remarks, Justice Randy Holland of the Delaware Supreme Court echoed these thoughts, attributing Delaware’s corporate law dominance to its tradition of having a governor, a legislature and a bench and bar "that can respond in a timely way and make appropriate incremental changes in the law." In a way, the gathering of judges, practitioners and academics in Delaware to celebrate the centennial of the General Corporation Law, and contemplate its future, was itself a living demonstration of the processes that Allen and Holland identified.