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Academic papers about appropriate methods of judicial analysis are rarely subjects for columns in The New York Times. Then again, most such papers aren’t written by two sitting and one retired judge as was “Function over Form: A Reassessment of Standards of Review in Delaware Corporation Law.” Delaware Vice Chancellors Jack Jacobs and Leo Strine Jr. and former Chancellor William Allen wrote it. And it attracted the attention of Times business columnist Floyd Norris. In a June 15 column, he declared that the judges’ paper threatens the progress Delaware law has made in the past 15 years in protecting shareholders’ rights. The column, in fact, suggested that the paper presaged that a fundamental, and worrisome, change was taking place in Delaware. However, interviews with attorneys who know the Delaware courts raised doubts about whether the paper was as incendiary as the Times suggested. “The paper is largely an effort to simplify and improve the predictability of Delaware law, not to set it on a new course, as Norris seemed to assume,” said Paul Rowe, a partner at Wachtell, Lipton, Rosen & Katz in New York, where Allen is of counsel. Allen himself described the paper as a technical examination of whether Delaware law is well served by the various standards of review for mergers and sales of companies the state’s courts have created since 1985. “Our point was not to recommend changes in substantive Delaware corporate law, but to suggest ways in which the law could be made more transparent and more coherent and thus be applied more easily in the future,” said Allen, now a professor of law and finance at New York University. Mark Morton, a partner in Wilmington, Del., law firm Potter Anderson & Corroon, said of the judges’ paper, “These guys said that the law needs intellectual pruning. And they’re right; it does.” Norris saw the judges’ proposals as deforestation rather than pruning. Two of the authors’ suggestions may have animated his concern. Currently, when a corporation engages in a transaction with a related party — as when a company sells its 75 percent-owned subsidiary to a third party — Delaware law requires that the deal be entirely fair to the subsidiary’s public shareholders. The judges proposed that if a majority of those shareholders approve the deal, or if a special committee of the parent company’s independent directors blesses it, Delaware courts should defer to those judgments. This is an application of the business-judgment rule, under which courts defer to the decisions of a company’s directors unless there is a showing of fraud or self-interest. Morton said this would be a noteworthy change in the law and might lead companies to opt for special committees rather than putting conflicted transactions to a shareholder vote. Shareholder activists would probably prefer the latter method. The Times columnist wrote that though Delaware law currently encourages boards to be careful about protecting minority shareholders, the proposal by Allen, Jacobs and Strine “amounts to an invitation to test the law again.” That argument overlooks Delaware courts’ protection of minority shareholders in two recent decisions. In December, Chancellor William Chandler issued a ruling that strongly supports the role of special committees. The directors of Intermedia Inc. had decided to sell both their company and its subsidiary, Digex, to WorldCom Inc. despite the opposition of Digex directors. Chandler’s decision suggested Intermedia directors behaved illegally and spurred the companies to renegotiate the deal. Digex shareholders walked away with $180 million in WorldCom stock; under the old deal, they would have gotten nothing. The other decision came in November in McMullin v. Atlantic Richfield Co. Delaware Supreme Court Justices Randy Holland and Joseph Walsh and Chief Justice Norman Veasey held that even when a majority shareholder wants to sell a company it controls, the target’s board must maximize the value of the company for all shareholders. Even if the Delaware courts were to adopt the rule Allen proposed, they would not be allowing companies to trample on minority shareholders’ rights, said Lawrence Hamermesh, a professor at Widener University School of Law in Wilmington. He put together the May 23 conference at which the three presented their paper. Hamermesh said such a rule would not allow companies to set up a mere “facade of a special committee” to cure conflicts. The issue, he said, is “that in a conflict transaction, once the company establishes that the decision was made by a disinterested, active, fully functioning special committee, then that decision ought to be granted business-judgment rule deference.” Then there’s the other proposal that apparently caught Norris’ eye. Under current Delaware law, if a court finds that a target company’s directors aren’t careful enough in approving a deal, the target must show the sale “was entirely fair as to both process and price.” This policy is attractive to shareholder plaintiffs, who can force a trial once they’ve proven a lack of care regardless of actual damages in the case. In their paper, the judges proposed that the shareholder should bear the burden of proof in such cases. This may be aimed at reducing the incentive for shareholders to bring such cases if the deal really was fair. “It brings a bit more of a calculated approach to the plaintiff’s side in looking at the issue,” Morton said. Allen denied that his proposals have a pro-management bias. Instead, he said, “It has been our intention to help clarify and make more coherent the existing body of doctrine that has been produced on a one-by-one basis over the last 15 years, and it’s appropriate to go back and make some mid-course procedural changes.” Indeed, Strine’s musings in several of his legal opinions have led many lawyers to fear that he is more apt to tilt the law toward shareholders rather than management. Such concerns aren’t new. The story of corporate law over the past 15 years has in many ways been the history of the rise of shareholders at the expense of company management and directors. It’s highly unlikely Delaware courts could halt that trend even if they wanted to — and their recent decisions give no indication that they do. Copyright (c)2001 TDD, LLC. All rights reserved.

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