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The Delaware courts, which in years past usually blessed the decisions of management and compliant corporate directors, are acting more like meddlesome activists these days. In a string of opinions involving eBay Inc., the Walt Disney Co., the Oracle Corp., the HealthSouth Corp., and, most recently, Hollinger International Inc., Delaware judges have been casting a more critical eye on boardrooms. And that, in turn, has some in the corporate bar warning that executives and boards have lost the best legal friends they could have had. “In my opinion you’re seeing decisions you would not have seen two to five years ago,” says David Berger, a partner at Wilson Sonsini Goodrich & Rosati. “We’re seeing an increased willingness of judges to review board decisions with greater scrutiny.” Berger and others link this shift to the string of corporate scandals. “[The Delaware judges] appear to be taking seriously the corporate misdeeds that have come to light,” says Davis Polk & Wardwell’s Paul Kingsley. Charles Elson, director of the University of Delaware’s John L. Weinberg Center for Corporate Governance, puts it bluntly. “There’s a revulsion [among the judges] to what they saw,” says Elson, who agrees that there’s been an “unmistakable trend” toward tougher scrutiny. In February, the court continued on this path when Delaware Chancery Court Vice Chancellor Leo Strine Jr. harshly rebuked former Hollinger Chairman Lord Conrad Black for trampling the rights of minority shareholders in his attempt to sell his controlling stake in the company’s parent. Delaware rulings like the Hollinger opinion matter because the small state is the home of incorporation of so many major companies, and sets the direction for corporate law nationwide. It also sets meters humming: A shifting legal landscape in Delaware means more work for lawyers who advise companies on corporate governance. While the Hollinger decision was not unexpected, earlier this year the court took a more surprising swipe at a common management perk in a derivative suit against eBay and several officers and directors. The suit charged certain directors with breaching their fiduciary duties by taking “bribes” from the Goldman Sachs Group Inc. in the form of coveted shares in other companies’ initial public offerings. Investment banks often doled out these shares during the technology boom to reward valued customers. The lucky holder could usually flip, or “spin,” the IPO shares for a quick profit. EBay CEO Margaret Whitman, for example, made millions from shares in more than 100 IPOs, courtesy of Goldman Sachs. (The Securities and Exchange Commission banned this activity last year.) Addressing the issue for the first time, Delaware Chancellor William Chandler III took aim at this practice. “[One cannot] seriously argue that this conduct did not place the insider defendants in a position of conflict with their duties to the corporation,” Chandler wrote, rejecting the defendants’ motion to dismiss. Perhaps more significantly, the judge held that the outside directors who did not get these shares could not be entrusted to decide whether to bring this action on behalf of the company. Because eBay had given them large blocks of options as compensation for their duties, the judge wrote, they could not be considered independent of management. Goldman Sachs was also kept in the suit as a defendant for allegedly aiding and abetting this improper activity. It’s probably no coincidence that this new attitude bloomed in the wake of Sarbanes-Oxley. “Delaware doesn’t want a reputation of being soft on corporate directors who don’t meet their obligations,” says Wilson Sonsini’s Berger. In pre-Enron days, the court was more likely to accept boardroom behavior that bordered on the outrageous. After Disney agreed to pay Michael Ovitz roughly $140 million in severance pay following his disastrous one-year tenure as president, Chancellor Chandler in 1998 dismissed with prejudice a shareholder suit claiming that directors had breached their fiduciary duty by blindly approving his employment contract. On appeal, the Delaware Supreme Court in 2000 decided to give the suit another chance and allowed the plaintiffs to amend their complaint. On reconsideration last year, Chandler, in a post-Enron mind-set, refused to dismiss. He found that the facts as alleged by the plaintiffs indicated that the directors failed to exercise any business judgment when they approved Ovitz’s contract. “The court is responding to the times. It’s taking a harder look at [director] independence,” says George Newcombe, a litigation partner in the Palo Alto, Calif., office of Simpson Thacher & Bartlett who represented an Oracle special committee in a corporate governance case. “Lots of serious questions are being raised by these opinions,” he says. In the Oracle decision, also issued last year, Vice Chancellor Strine questioned the independence of a committee set up by the Oracle board to investigate allegations of insider trading made in a shareholder suit against CEO Lawrence Ellison and others. Strine concluded that the plaintiffs raised reasonable doubts about the independence of committee members, including Stanford Law School professor Joseph Grundfest, in part because Ellison was such a huge contributor to Stanford. Despite this slate of decisions, companies won’t likely flee Delaware to incorporate in other states. Delaware judges are still the most experienced in this specialized area. “If you have a tough corporate governance issue, there’s no better place to be,” says Simpson Thacher’s Newcombe. One repercussion, says Davis Polk’s Kingsley, is that clients are now “more attentive” to their advice. Earlier this year, at a Wilson Sonsini luncheon for in-house counsel, Berger warned that “all the precedent about the business judgment rule no longer applies.” Scary news for clients, but good news for lawyers. Susan Beck is a senior writer at The American Lawyer, where this article first appeared in the April issue.

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