In a noteworthy decision, Delaware Vice Chancellor Leo E. Strine in Harbor Finance Partners v. Huizenga, 1999 Del. Ch. LEXIS 220, 1999 WL 1059757 (Del. Ch. Nov. 17, 1999), questioned the well-settled rule in Delaware requiring a unanimous shareholder vote (rather than a majority shareholder vote) to ratify waste. According to Vice Chancellor Strine, this rule "has no apparent modern day utility . . . except as an opportunity for Delaware courts to second-guess stockholders."
The court rejected the view that "a transaction that satisfies the high standard of waste constitutes a gift of corporate property and no one should be forced against their will to make a gift of their property" as "inadequate" to justify the rule requiring unanimous shareholder approval in order to ratify conduct alleged to constitute waste because "property of the corporation is not typically thought of as personal property of the stockholders" and "it is common for corporations to undertake important value-affecting transactions over the objection of some of the voters or without a vote at all."
The court pointed to several additional bases for questioning the rule requiring a unanimous shareholder vote to ratify waste.
First, the court stated, the origin of this rule is rooted in the distinction between voidable and void acts: "[v]oidable acts are traditionally held to be ratifiable because the corporation can lawfully accomplish them if it does so in the appropriate manner" and "[t]hus if directors who could not lawfully effect a transaction without stockholder approval did so anyway, and the requisite approval of the stockholders was later attained, the transaction is deemed fully ratified because the subsequent approval of the stockholders cured the defect"; "void acts are said to be non-ratifiable because the corporation cannot, if any case, lawfully accomplish them." The court stated that "[s]uch void acts are often described in conclusory terms as 'ultra vires' or 'fraudulent' or as 'gifts or waste of corporate assets'" and "it is unsurprising that it has been held that stockholders cannot validate such action by the directors, even on an informed basis" because "at first blush it seems it would be a shocking, if not theoretically impossible, thing for stockholders to be able to sanction the directors in committing illegal acts or acts beyond the authority of the corporation." "[T]he types of 'void' acts susceptible to being styled as waste claims," the court continued, however, "have little of the flavor of patent illegality about them, nor are they categorically ultra vires" ( a doctrine that rests "on notions about corporations which originated at a time when corporations were created by special act and largely for public purposes for the exercise of special franchises" and that "statutory and case law changes . . . have essentially whittled down to nothing."
"Put another way," the court continued, the "oft-stated proposition that 'waste cannot be ratified' is a tautology that, upon close examination, has little substantive meaning." The court asked "what rational person would ratify 'waste'?," and stated that "the answer is, of course, no one." To the contrary, "real world stockholders are not asked to ratify obviously wasteful transactions"; rather, the transactions that have been attacked as waste in Delaware courts "are ones that are quite ordinary in the modern business world," including "stock option plans; the fee agreement between a mutual fund and its investment advisor; corporate mergers; the purchase of a business in the same industry as the acquiring corporation; and the repurchase of a corporate insider's shares in the company" (footnotes citing cases omitted). The court described these as "all garden variety transactions that may be validly accomplished by a Delaware corporation if supported by sufficient consideration, and what is sufficient consideration is a question that fully informed stockholders seem as well positioned as courts to answer." These transactions the court stated, "are neither per se ultra vires or illegal; they only become 'void' upon a determination that the corporation received no fair consideration for entering upon them."
Second, the court stated, the rule requiring unanimous shareholder approval in order to ratify conduct alleged to constitute waste "is not necessary to protect stockholders and it has no other apparent purpose." The court acknowledged that "I would hesitate to permit stockholders to ratify a blatantly illegal act ( such as a board's decision to indemnify itself against personal liability for intentionally violating applicable environmental laws or bribing government officials to benefit the corporation" but stated that not permitting stockholders to ratify waste "has little to do with corporate integrity in the sense of the corporation's responsibility to society as a whole." Accordingly, the justification for not allowing a majority of shareholders to ratify waste must be to protect stockholders but "where disinterested stockholders are given the information necessary to decide whether a transaction is beneficial to the corporation or wasteful to it, I see little reason to leave the door open for a judicial reconsideration of the matter."
The court pointed to "[t]he fact that a plaintiff can challenge the adequacy of the disclosure" as "in itself a substantial safeguard against stockholder approval of waste" because "[i]f the corporate board failed to provide the voters with material information undermining the integrity or financial fairness of the transaction subject to the vote, no ratification effect will be accorded to the vote." As a result, the court stated, "it is difficult to imagine how elimination of the waste vestige will permit the accomplishment of unconscionable corporate transactions, unless one presumes that stockholders are, as a class, irrational and that they will rubber stamp outrageous transactions contrary to their own economic interests."
The court also pointed to the fact that "[t]he burden to prove that the vote was fair, uncoerced, and fully informed falls squarely on the board" and the fact that "Delaware law imposes no heightened pleading standards on plaintiffs alleging material nondisclosures or voting coercion" and the "the pro-plaintiff bias inherent in Rule 12(b)(6)." Accordingly, "it is difficult for a board to prove ratification at the pleading stage," and, "[i]f the board cannot prevail on a motion to dismiss," then the directors must "submit to discovery and possibly to a trial." For all these reasons, the court stated, "Delaware law does not make it easy for a board of directors to obtain 'ratification effect' from a stockholder vote."
The rule requiring unanimous shareholder approval in order to ratify conduct alleged to constitute waste, the court continued, also is not "necessary to protect minority stockholders from oppression by majority or controlling stockholders." The court reasoned that "a corporation with a controlling or majority stockholder may, under current Delaware law, never escape the exacting entire fairness standard through a stockholder vote, even one expressly conditioned on approval by a 'majority of the minority,'" because "our law limits an otherwise fully informed, uncoerced vote in such circumstances to having the effect of making the plaintiffs prove that the transaction was unfair." "[D]efendants appreciate this shift, but it still subjects them to a proceeding in which the substantive fairness of their actions comes under close scrutiny by the court ( the type of scrutiny that is inappropriate when the business judgment rule's presumption attaches to a decision."
Third, the court stated, "I find it logically difficult to conceptualize how a plaintiff can ultimately prove a waste or gift claim in the face of a decision by fully informed, uncoerced, independent stockholders to ratify the transaction." The court explained that "[t]he test for waste is whether any person of ordinary sound business judgment could view the transaction as fair" and "[i]f fully informed, uncoerced, independent stockholders have approved the transaction, they have, it seems to me, made the decision that the transaction is 'a fair exchange'" (quoting Michelson v. Duncan, 407 A.2d 211, 224, (Del. 1979)).
According to the court, "it is difficult to see the utility of allowing litigation to proceed in which the plaintiffs are permitted discovery and a possible trial, at great expense to the corporate defendants, in order to prove to the court that the transaction was so devoid of merit that each and every one of the voters comprising the majority must be disregarded as too hopelessly misguided to be considered a 'person of ordinary sound business judgment'" (quoting Michelson, 407 A.2d at 224). The court added that "[i]n this day and age in which investors also have access to an abundance of information about corporate transactions from sources other than boards of directors, it seems presumptuous and paternalistic to assume that the court knows better in a particular instance than a fully informed corporate electorate with real money riding on the corporation's performance."
Fourth, the court concluded, "it is unclear why it is in the best interests of disinterested stockholders to subject their corporation to the substantive costs of litigation in a situation where they have approved the transaction under attack." The court stated that "[e]nabling a dissident who failed to get her way at the ballot box in a fair election to divert the corporation's resources to defending her claim on the battlefield of litigation seems, if anything, contrary to the economic well-being of the disinterested stockholders as a class." The court asked "[w]hy should the law give the dissenters the right to command the corporate treasury over the contrary will of a majority of the disinterested stockholders?"
"[F]or all of these reasons," the court concluded, a "reexamination of the waste vestige would seem to be in order." The court acknowledged that "there may be valid reasons for its continuation" but stated that "those reasons should be articulated and weighed against the costs the vestige imposes on stockholders and the judicial system." "Otherwise, inertia alone may perpetuate an outdated rule fashioned in a very different time."
The court rejected the view that "a transaction that satisfies the high standard of waste constitutes a gift of corporate property and no one should be forced against their will to make a gift of their property" as "inadequate" to justify the rule requiring unanimous shareholder approval in order to ratify conduct alleged to constitute waste because "property of the corporation is not typically thought of as personal property of the stockholders" and "it is common for corporations to undertake important value-affecting transactions over the objection of some of the voters or without a vote at all."
The court pointed to several additional bases for questioning the rule requiring a unanimous shareholder vote to ratify waste.
First, the court stated, the origin of this rule is rooted in the distinction between voidable and void acts: "[v]oidable acts are traditionally held to be ratifiable because the corporation can lawfully accomplish them if it does so in the appropriate manner" and "[t]hus if directors who could not lawfully effect a transaction without stockholder approval did so anyway, and the requisite approval of the stockholders was later attained, the transaction is deemed fully ratified because the subsequent approval of the stockholders cured the defect"; "void acts are said to be non-ratifiable because the corporation cannot, if any case, lawfully accomplish them." The court stated that "[s]uch void acts are often described in conclusory terms as 'ultra vires' or 'fraudulent' or as 'gifts or waste of corporate assets'" and "it is unsurprising that it has been held that stockholders cannot validate such action by the directors, even on an informed basis" because "at first blush it seems it would be a shocking, if not theoretically impossible, thing for stockholders to be able to sanction the directors in committing illegal acts or acts beyond the authority of the corporation." "[T]he types of 'void' acts susceptible to being styled as waste claims," the court continued, however, "have little of the flavor of patent illegality about them, nor are they categorically ultra vires" ( a doctrine that rests "on notions about corporations which originated at a time when corporations were created by special act and largely for public purposes for the exercise of special franchises" and that "statutory and case law changes . . . have essentially whittled down to nothing."
"Put another way," the court continued, the "oft-stated proposition that 'waste cannot be ratified' is a tautology that, upon close examination, has little substantive meaning." The court asked "what rational person would ratify 'waste'?," and stated that "the answer is, of course, no one." To the contrary, "real world stockholders are not asked to ratify obviously wasteful transactions"; rather, the transactions that have been attacked as waste in Delaware courts "are ones that are quite ordinary in the modern business world," including "stock option plans; the fee agreement between a mutual fund and its investment advisor; corporate mergers; the purchase of a business in the same industry as the acquiring corporation; and the repurchase of a corporate insider's shares in the company" (footnotes citing cases omitted). The court described these as "all garden variety transactions that may be validly accomplished by a Delaware corporation if supported by sufficient consideration, and what is sufficient consideration is a question that fully informed stockholders seem as well positioned as courts to answer." These transactions the court stated, "are neither per se ultra vires or illegal; they only become 'void' upon a determination that the corporation received no fair consideration for entering upon them."
Second, the court stated, the rule requiring unanimous shareholder approval in order to ratify conduct alleged to constitute waste "is not necessary to protect stockholders and it has no other apparent purpose." The court acknowledged that "I would hesitate to permit stockholders to ratify a blatantly illegal act ( such as a board's decision to indemnify itself against personal liability for intentionally violating applicable environmental laws or bribing government officials to benefit the corporation" but stated that not permitting stockholders to ratify waste "has little to do with corporate integrity in the sense of the corporation's responsibility to society as a whole." Accordingly, the justification for not allowing a majority of shareholders to ratify waste must be to protect stockholders but "where disinterested stockholders are given the information necessary to decide whether a transaction is beneficial to the corporation or wasteful to it, I see little reason to leave the door open for a judicial reconsideration of the matter."
The court pointed to "[t]he fact that a plaintiff can challenge the adequacy of the disclosure" as "in itself a substantial safeguard against stockholder approval of waste" because "[i]f the corporate board failed to provide the voters with material information undermining the integrity or financial fairness of the transaction subject to the vote, no ratification effect will be accorded to the vote." As a result, the court stated, "it is difficult to imagine how elimination of the waste vestige will permit the accomplishment of unconscionable corporate transactions, unless one presumes that stockholders are, as a class, irrational and that they will rubber stamp outrageous transactions contrary to their own economic interests."
The court also pointed to the fact that "[t]he burden to prove that the vote was fair, uncoerced, and fully informed falls squarely on the board" and the fact that "Delaware law imposes no heightened pleading standards on plaintiffs alleging material nondisclosures or voting coercion" and the "the pro-plaintiff bias inherent in Rule 12(b)(6)." Accordingly, "it is difficult for a board to prove ratification at the pleading stage," and, "[i]f the board cannot prevail on a motion to dismiss," then the directors must "submit to discovery and possibly to a trial." For all these reasons, the court stated, "Delaware law does not make it easy for a board of directors to obtain 'ratification effect' from a stockholder vote."
The rule requiring unanimous shareholder approval in order to ratify conduct alleged to constitute waste, the court continued, also is not "necessary to protect minority stockholders from oppression by majority or controlling stockholders." The court reasoned that "a corporation with a controlling or majority stockholder may, under current Delaware law, never escape the exacting entire fairness standard through a stockholder vote, even one expressly conditioned on approval by a 'majority of the minority,'" because "our law limits an otherwise fully informed, uncoerced vote in such circumstances to having the effect of making the plaintiffs prove that the transaction was unfair." "[D]efendants appreciate this shift, but it still subjects them to a proceeding in which the substantive fairness of their actions comes under close scrutiny by the court ( the type of scrutiny that is inappropriate when the business judgment rule's presumption attaches to a decision."
Third, the court stated, "I find it logically difficult to conceptualize how a plaintiff can ultimately prove a waste or gift claim in the face of a decision by fully informed, uncoerced, independent stockholders to ratify the transaction." The court explained that "[t]he test for waste is whether any person of ordinary sound business judgment could view the transaction as fair" and "[i]f fully informed, uncoerced, independent stockholders have approved the transaction, they have, it seems to me, made the decision that the transaction is 'a fair exchange'" (quoting Michelson v. Duncan, 407 A.2d 211, 224, (Del. 1979)).
According to the court, "it is difficult to see the utility of allowing litigation to proceed in which the plaintiffs are permitted discovery and a possible trial, at great expense to the corporate defendants, in order to prove to the court that the transaction was so devoid of merit that each and every one of the voters comprising the majority must be disregarded as too hopelessly misguided to be considered a 'person of ordinary sound business judgment'" (quoting Michelson, 407 A.2d at 224). The court added that "[i]n this day and age in which investors also have access to an abundance of information about corporate transactions from sources other than boards of directors, it seems presumptuous and paternalistic to assume that the court knows better in a particular instance than a fully informed corporate electorate with real money riding on the corporation's performance."
Fourth, the court concluded, "it is unclear why it is in the best interests of disinterested stockholders to subject their corporation to the substantive costs of litigation in a situation where they have approved the transaction under attack." The court stated that "[e]nabling a dissident who failed to get her way at the ballot box in a fair election to divert the corporation's resources to defending her claim on the battlefield of litigation seems, if anything, contrary to the economic well-being of the disinterested stockholders as a class." The court asked "[w]hy should the law give the dissenters the right to command the corporate treasury over the contrary will of a majority of the disinterested stockholders?"
"[F]or all of these reasons," the court concluded, a "reexamination of the waste vestige would seem to be in order." The court acknowledged that "there may be valid reasons for its continuation" but stated that "those reasons should be articulated and weighed against the costs the vestige imposes on stockholders and the judicial system." "Otherwise, inertia alone may perpetuate an outdated rule fashioned in a very different time."