? BALANCE(?) OF POWER

The Balance of Power between the management-board and shareholders, especially activist investors, has been a critical subject of corporate governance.

This corporate-analysis report addresses the evolving relationship within the framework of Delaware Corporate Law, particularly in light of Senate Bill 313 (SB 313), which has significantly altered the traditional balance of authority.

The recent amendments to Delaware's General Corporation Law, effective August 1, 2024, have significantly altered the Balance of Power.

The implications of SB 313 and similar legislative changes raise concerns about the shifting power dynamics between the “corporate boards” and “shareholders”.?

Historical Context: Delaware Corporate Law

Delaware has long been the legal home of a substantial majority of U.S. public companies. Its legal framework, notably Section 141(a) of the Delaware Code, grants boards the authority to manage the business and affairs of corporations. Historically, Delaware courts sided with management, ensuring boards held significant control over corporate governance, while shareholders, especially small ones, were often seen as passive participants in corporate decisions.

• What is The General Corporation Law of Delaware?

Delaware statutes governing corporations found in Chapter One of Title 8 Opens in a new window of the Delaware Code. It provides, among other things, laws relating to the formation, management, governance, mergers, and dissolution of Delaware corporations.

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• What is special about Delaware Corporate Law?

One unique aspect of the Delaware legal system is the Court of Chancery. The Delaware Court of Chancery is a special circuit of state courts that specifically handles business disputes. Since the court only handles business disputes, the judges on the court are extremely knowledgeable and experienced in corporate matters.

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• Why is the Delaware Chancery Court so important?

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The Delaware Court of Chancery is widely recognized as the nation's preeminent forum for the determination of disputes involving the internal affairs of the thousands upon thousands of Delaware corporations and other business entities through which a vast amount of the world's commercial affairs is conducted. https://www.delawareinc.com/blog/what-is-the-delaware-court-of-chancery/

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Delaware's judiciary is renowned for its expertise in corporate law, with judges widely recognized for their brilliance, fairness, and impartiality. The state's lack of significant local industries helps ensure the judges' objectivity, as there are fewer potential conflicts of interest or external pressures. This reputation for neutrality has made Delaware's courts a trusted forum for resolving complex business disputes.

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The influence of Delaware's corporate law jurisprudence extends far beyond the state's borders. Judges and policymakers across the globe often turn to Delaware's courts for guidance and precedent in corporate legal matters. This international recognition further cements Delaware's status as a leader in corporate law and governance.

However, over time, Delaware law shifted toward a more balanced model, recognizing the growing importance of shareholder power. Shareholders, particularly activist investors, gained influence, sometimes swaying major corporate decisions.

“Delaware courts began favoring shareholders in certain cases, reflecting an evolving judicial philosophy that acknowledged the increasing role of investors in corporate direction.”

? Senate Bill 313 (SB 313) and Its Impact

SB 313, enacted on August 1, 2024, represents a significant shift in Delaware's corporate governance framework. The bill allows corporations to enter into enforceable contracts with shareholders or beneficial owners of stock outside the “certificate of incorporation”, enabling individual shareholders to strike side-agreements with the company that can bind future boards. This provision introduces new dynamics by allowing minority shareholders, including activist investors, to influence corporate policies in perpetuity through side agreements.

The bill effectively amends Section 141(a), which traditionally vested the board with control over corporate affairs, by allowing shareholders to enter into contracts with the corporation that restrict future corporate actions. These contracts, although not part of the certificate of incorporation, can impose binding obligations on the corporation, making the board subject to shareholder agreements in ways that challenge the traditional balance of power.

?? Repercussions and Risks

The introduction of SB 313 alters the historic equilibrium between boards and shareholders, potentially tilting power in favor of activist investors. While the board retains managerial authority, the ability of shareholders to enforce contractual agreements outside the certificate of incorporation introduces uncertainty and limits the board's flexibility.

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1. Board Vulnerability: The new law opens the possibility for boards to be constrained by secret agreements with influential shareholders, limiting the board's ability to govern effectively. Future boards may find themselves bound by decisions made by previous boards under shareholder agreements, creating a significant risk of corporate rigidity.

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2. Activist Investor Influence: Activist investors, who typically hold minority stakes but wield significant influence, can leverage these agreements to drive corporate decisions in ways that might not align with the interests of all shareholders. The risk of short-termism, where activists push for quick financial returns at the expense of long-term growth, becomes more pronounced under this framework.

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3. Judicial Oversight: Delaware courts, known for their expertise in corporate law, may find themselves challenged to navigate the complexities introduced by these new contractual relationships. The courts' ability to balance fiduciary duties and contractual obligations will be critical in maintaining corporate stability.

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4. Corporate Relocation: The uncertainty introduced by SB 313 may prompt corporations to reconsider their incorporation in Delaware. States with more predictable corporate governance frameworks may become more attractive, potentially diminishing(?) Delaware’s dominance as the home of corporate law. [unless the Federal Government takes over!]

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? Future Vision of Corporate Governance

The evolving corporate governance landscape necessitates a forward-looking approach to balancing power between boards, management, and shareholders. The future of corporate governance will likely be shaped by increased regulatory scrutiny, a greater emphasis on shareholder engagement, and the need for enhanced transparency and accountability.

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1. Strengthened Fiduciary Duties: Boards will need to uphold and strengthen their fiduciary duties in response to the growing power of activist investors. This includes ensuring that decisions made under shareholder agreements align with the corporation’s long-term goals and benefit all shareholders, not just those with the power to influence contracts.

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2. Engagement with Activist Investors: Boards must proactively engage with activist investors to align corporate strategies with shareholder interests while maintaining governance integrity. Open dialogue and transparent decision-making can help mitigate the risks posed by activist-driven agendas.

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3. Federal Intervention: The potential for federal intervention in corporate governance could increase if the uncertainties created by SB 313 lead to widespread dissatisfaction. Federal Regulation may provide more uniform governance standards, reducing the influence of state-specific laws like those in Delaware.

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4. Corporate Flexibility: To counterbalance the restrictions imposed by shareholder agreements, corporations may seek to amend their certificates of incorporation to limit the scope of contracts allowed under SB 313. This would enable boards to retain greater control over corporate governance while still respecting shareholder rights.

? Executive Framework of Best Practices for Corporate Boards and Shareholders

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For Corporate Boards:

• Transparency and Communication: Boards should regularly communicate with shareholders about corporate strategy, particularly when entering into significant agreements that could impact future governance.
• Limit Contractual Constraints: Where possible, limit the scope of shareholder agreements to ensure future boards retain the flexibility to adapt to changing market conditions and corporate needs.
• Focus on Long-Term Growth: Resist pressure from activist investors to prioritize short-term gains at the expense of long-term corporate health. Align decision-making with the corporation’s long-term goals.
• Review Governance Policies: Regularly review governance structures and policies to ensure they reflect the current legal environment and maintain an appropriate balance between shareholder influence and board control.

?For Shareholders (Including Activist Investors):

• Engage Constructively: Activist investors should focus on constructive engagement with the board, aiming for strategies that benefit all shareholders, not just a select few.
• Respect Board Authority: While shareholder power has grown, it is important to respect the board’s managerial role and fiduciary responsibilities.
• Consider the Long-Term: Advocate for policies that support sustainable, long-term corporate growth, rather than focusing solely on short-term returns.

For Regulators and Policymakers:

• Clarify Legal Frameworks: Provide clear guidelines on the enforceability of shareholder agreements and the balance of power between boards and shareholders.
• Monitor Corporate Relocation Trends: As corporations consider relocating from Delaware, regulators should assess the implications for corporate governance standards nationwide.

? The balance of power between corporate boards and shareholders, particularly activist investors, is at a critical juncture.

1. SB 313 introduces significant changes that could disrupt the traditional corporate governance framework.
2. As the dynamics between boards and shareholders continue to evolve, corporations must adopt best practices that safeguard both managerial authority and shareholder rights.
3. The future of corporate governance will depend on the “ability of boards, shareholders, and regulators to navigate this complex landscape while maintaining a focus on long-term corporate health and sustainability”.

References:

“Delaware General Assembly (.gov)” – Legislation Document https://legis.delaware.gov/json/BillDetail/GenerateHtmlDocument?legislationId=141480&legislationTypeId=1&docTypeId=2&legislationName=SB313

THE DELAWARE CODE: https://delcode.delaware.gov/title8/c001/

Relevant Business Cases:

1.?????? A first of its kind decision that controlling stockholders, such as private equity funds, must heed before exercising voting rights to change the company’s status quo, such as seeking to block board-level action.

• https://courts.delaware.gov/Opinions/Download.aspx?id=358990
• https://www.troutman.com/insights/delaware-court-of-chancery-clarifies-fiduciary-limitations-on-controlling-stockholders-exercise-of-voting-power.html

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2.?????? The Activist Investor has acquired enough Southwest stock to call a special meeting of shareholders. Activist shareholder Elliott Investment Management has bought a $1.9 billion stake in Southwest Airlines and is seeking a board shakeup and major changes to the airline.

• https://strongersouthwest.com/wp-content/uploads/2024/09/Press-Release_Elliott-Statement-on-Southwest-Airlines-Board-Resignations.pdf
• https://strongersouthwest.com/southwest-slate/?gad_source=1&gclid=CjwKCAjw3P-2BhAEEiwA3yPhwFkW7zyFZJ42lhSVKm65l8_VUmcROXDaxL-BiQ6Ft41elul_YVcGVhoCHt0QAvD_BwE
• https://apnews.com/article/southwest-airlines-elliott-management-proxy-fight-64902083ada73763dd51a3131d26a207

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"Bo" Subodh Dalvi , Board Director | Executive Advisor | Harvard Business Review ADVISORY COUNCIL | Impact●Investor |

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