Wednesday, February 27, 2008

Management Conduct Taints Board Election, VC Strine Orders New One

A contested corporate election of directors was so tainted by management’s inequitable conduct that the Delaware Chancery Court set the results aside and ordered a new election. The court ruled that management failed to disclose an agreement to obtain the votes of one insurgent shareholder by promising to expand the board and let the insurgent name the new director. Similarly, in an effort to secure another key bloc of votes, management used a combination of threats of ending a key project and the inducement of removing a restrictive legend on the shares of the shareholder it sought to enlist. Management also delayed the annual meeting in order to win the election, was dishonest about the reasons for the delay, and failed to use the time to release an adverse 10-Q. (Portnoy v. Cryo-Cell International, Inc., Del. Chan Ct, CA No. 3142).

Vice Chancellor Strine ordered a new prompt election to be presided over by a special master, with the management slate to bear the costs of their own proxy solicitations, the costs of the meeting, and the cost of the special master. The court rejected management’s plea that the annual report is not ready and the SEC will not let them solicit proxies. Management should seek relief from the SEC, said the court.

While the SEC’s requirements are well-intended ones designed to protect stockholders; noted the court, they are no basis to insulate corporate insiders from their obligations under the corporation law governing their company’s relations to its stockholders. Nothing in the Exchange Act proxy provisions suggests any purpose to interfere with the power of state courts to require that stockholder meetings be held in accordance with the requirements of state corporation law in situations where the company is delinquent in its SEC filings.

The contest began with two separate insurgent shareholder groups. Management made a deal with one insurgent by giving him a seat on the board, which was disclosed to shareholders, and allowing him to also name a new director, which was not.. Vice Chancellor Strine said that the arrangement under which the insurgent was promised a seat on the board for his support of the management slate was not illegal vote buying.

This type of arrangement was not per se improper, noted the court, and would not be judged under an entire fairness standard. Since it had been disclosed, reasoned the court, the arrangement was subject to policing by the shareholders at the ballot box. It would run counter to the business judgment rule, said the court, for judges to ``chew over the complicated calculus’’ made by incumbent boards in adding votes to the management slate. Citing Caremark, the court said that to objectively evaluate the decision would expose directors to substantive second-guessing by ill-equipped judges.

But the undisclosed arrangement to allow the insurgent to name a new member of the board was quite different because, for one thing, it did not go before the shareholder electorate. The failure to disclose this material event was improper and tainted the election.

Directors are under a fiduciary duty to disclose fully and fairly all material information within the board’s control when they seek shareholder action. That disclosure obligation attaches to proxy statements and any other disclosures in contemplation of stockholder action.

The court concluded that stockholders would have found it material to know that
corporate management’s cooperation with the insurgent had now extended to a bargain whereby he would buy up more shares and votes in exchange for having two seats on the board. Reasonable stockholders could have come to the conclusion that they did not want the insurgent to have so much influence

With regard to the threats and inducements used to secure another shareholder’s votes, the court found that management breached its fiduciary duties by intentionally using corporate assets to coerce the shareholder into voting for the management slate. It was inequitable to use powerful tools for entrenchment purposes.