Stockholder Ratification Doctrine | Brian JM Quinn | May 22, 2017

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Stockholder Ratification Doctrine

by Brian JM Quinn Show/Hide

For anyone with more than a passing familiarity with the law of agency, stockholder ratification doctrine will sound very familiar. As you remember in the Restatement (3rd) of Agency, §8.06 conduct by an agent that would otherwise constitute a breach of a fiduciary duty does not constitute a breach of duty if the principal consents to the conduct, provided that the agent acts in good faith, discloses all material facts that the agent knows, has reason to know, or should know would reasonably affect the principal's judgment, and the agent otherwise deals fairly with the principal. Full and adequate disclosure of an agent's actions followed by knowing and uncoerced assent by the principal in effect cleanses the otherwise disloyal acts of an agent.

In the context of the corporate law, common law courts have adopted a very similar approach to the unauthorized acts of boards, or agents of the corporation. For example, self-dealing by a board will, upon a stockholder challenge, be subject to the stringent entire fairness standard with the board bearing the burden of proving that it dealt fairly with the corporation. However, where the material facts about those acts are fully disclosed to the stockholders and stockholders have an uncoerced opportunity to vote ‘yay or nay' on those actions, board actions so approved by the stockholders will be granted the deference of business judgment rather than be subject to entire fairness review. 

Although in a successful ratification case, the board is not required prove entire fairness, in order to establish that the ratification is effective, the board is required to bear the burden of proving that it disclosed to stockholders all the material facts related to the challenged transaction available to it at the time.  

Once a board has successfully established that stockholder ratification the effect of such ratification is to shift the substantive test on judicial review of the act from one of fairness to one of “corporate waste”.

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  1. 1 Show/Hide More Corwin v. KKR Financial Holdings LLC
    Original Creator: Brian JM Quinn
    In Corwin, the court takes up the question of what is the appropriate standard of review for a challenged merger transaction during a post-closing damages trial, where the directors are disinterested and the transaction has been approved by an informed vote of the stockholders. In such situations, where the stockholders are fully-informed and their vote has not been coerced, courts will be loathe to substitute their own business judgment for that of the stockholders. This result – essentially raitifcation by the stockholders – is consistent with the court’s previous rulings with which you are already familiar (e.g. Williams v. Geier).
  2. 3 Show/Hide More Calma v. Templeton
    Original Creator: Brian JM Quinn

    Because directors have a statutory right to set their own compensation (See DGCL §122(15)), director compensation plans are neither void nor voidable. However, the ability of boards to set their own compensation is not without limits. Director compensation is a quintissential “interested director” transaction. In these cases, directors are deciding the amounts and nature of their own compensation and naturally have at least implicit biases in favor of larger amounts. It is no surprise then that director decisions to set their own compensation are subject to entire fairness review upon a stockholder challenge.    

    In the case that follows, the Chancery Court addresses whether disinterested stockholder approval of a compensation plan for non-employee directors subjects affords the plan the protection of the business judgment presumption rather than the more exacting entire fairness standard.

    This discussion in the case relates to director compensation, not compensation of corporate executives.  Decisions by the board of directors to compensate corporate executives, like the CEO and other C-level executives who are not simultaneously directors of the corporation, are typically treated like arms-length transactions and granted the protection of the business judgment presumption. Absent a successful attack under the waste standard, claims that the board violated their duty of loyalty to the corporation by approving executive compensation plans typically fail.

     

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July 27, 2017

ratification corporate

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