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The common law doctrine of stockholder ratification is a close cousin of Section 144. It is important to remember that the two, though conceptually similar in some respects, are different in effect.
First, consider why 144(a)(1)'s approval by disinterested directors only provides for protection against an attack for voidness and is not a complete defense against a duty of loyalty attack. In the event, a single director (or something less than a majority of directors) is interested, then it is possible for a board to cleanse an interested transaction for purposes of Section 144. At the same time, the fact that a majority of the directors are disinterested (and presumably independent) means that in a derivative suit alleging a violation of the duty of loyalty by the interested director, the plaintiff would likely be unable to plead sufficient facts under Aronson to survive a Rule 23.1 motion to dismiss. On the other hand, where a majority of the board is interested, it would be possible for interested directors to comply with the requirements of Section 144 and have the interested director transaction approved by the disinterested minority. Such an approval, though it would protect a transaction from a voidability challenge, would not be sufficient to prevent a plaintiff from successfully pleading demand futility under Aronson in challenge alleging that the interested director transaction constituted a violation of the directors' duty of loyalty to the corporation.
Second, consider how the common law doctrine of stockholder ratification interacts with the requirements of Section 144(a)(2). Section 144(a)(2) provides a statutory safe harbor from voidness challenges for interested director transactions when the transaction in question was approved by stockholders of the corporation. The relevant question for our purposes is what is the effect of an informed stockholder vote on the standard of review.
We already know that a 144(a)(2) vote will provide protection against a voidness challenge, but will it - or should it - make an interested director transaction immune from any fiduciary duty challenge by stockholders? The language of the statute presents an obstacle to relying on stockholder votes for more than protection against voidness challenges. In the obvious example, as in Fliegler, the majority stockholder is also the interested party. A statutory provision that permitted an ostensibly bad actor to cleanse their own bad acts seems patently unreasonable. Consequently, Section 144(a)(2), like Section 144(a)(1) cannot be relied on to do more than the statute permits.
In Lewis v Vogelstein, 699 A.2d 327 (Del. Ch. 1997), then Chancellor Allen outlined the contours of stockholder ratification in the context of director compensation, a transaction where directors are obviously interested parties, as follows:
What is the effect under Delaware corporation law of shareholder ratification of an interested transaction? ...
In order to state my own understanding I first note that by shareholder ratification I do not refer to every instance in which shareholders vote affirmatively with respect to a question placed before them. I exclude from the question those instances in which shareholder votes are a necessary step in authorizing a transaction. Thus the law of ratification as here discussed has no direct bearing on shareholder action to amend a certificate of incorporation or bylaws. Cf. Williams v. Geier, Del.Supr., 671 A.2d 1368 (1996); nor does that law bear on shareholder votes necessary to authorize a merger, a sale of substantially all the corporation's assets, or to dissolve the enterprise. For analytical purposes one can set such cases aside.
1. Ratification generally: I start with principles broader than those of corporation law. Ratification is a concept deriving from the law of agency which contemplates the ex post conferring upon or confirming of the legal authority of an agent in circumstances in which the agent had no authority or arguably had no authority. RESTATEMENT (SECOND) OF AGENCY § 82 (1958). To be effective, of course, the agent must fully disclose all relevant circumstances with respect to the transaction to the principal prior to the ratification. See, e.g., Breen Air Freight Ltd. v. Air Cargo, Inc., et al., 470 F.2d 767, 773 (2d Cir.1972); RESTATEMENT (SECOND) OF AGENCY § 91 (1958). Beyond that, since the relationship between a principal and agent is fiduciary in character, the agent in seeking ratification must act not only with candor, but with loyalty. Thus an attempt to coerce the principal's consent improperly will invalidate the effectiveness of the ratification. RESTATEMENT (SECOND) OF AGENCY § 100 (1958).
Assuming that a ratification by an agent is validly obtained, what is its effect? One way of conceptualizing that effect is that it provides, after the fact, the grant of authority that may have been wanting at the time of the agent's act. Another might be to view the ratification as consent or as an estoppel by the principal to deny a lack of authority. See RESTATEMENT (SECOND) OF AGENCY § 103 (1958). In either event the effect of informed ratification is to validate or affirm the act of the agent as the act of the principal. Id. § 82.
Application of these general ratification principles to shareholder ratification is complicated by three other factors. First, most generally, in the case of shareholder ratification there is of course no single individual acting as principal, but rather a class or group of divergent individuals — the class of shareholders. This aggregate quality of the principal means that decisions to affirm or ratify an act will be subject to collective action disabilities; that some portion of the body doing the ratifying may in fact have conflicting interests in the transaction; and some dissenting members of the class may be able to assert more or less convincingly that the "will" of the principal is wrong, or even corrupt and ought not to be binding on the class. In the case of individual ratification these issues won't arise, assuming that the principal does not suffer from multiple personality disorder. Thus the collective nature of shareholder ratification makes it more likely that following a claimed shareholder ratification, nevertheless, there is a litigated claim on behalf of the principal that the agent lacked authority or breached its duty. The second, mildly complicating factor present in shareholder ratification is the fact that in corporation law the "ratification" that shareholders provide will often not be directed to lack of legal authority of an agent but will relate to the consistency of some authorized director action with the equitable duty of loyalty. Thus shareholder ratification sometimes acts not to confer legal authority — but as in this case — to affirm that action taken is consistent with shareholder interests. Third, when what is "ratified" is a director conflict transaction, the statutory law — in Delaware Section 144 of the Delaware General Corporation Law — may bear on the effect.
2. Shareholder ratification: These differences between shareholder ratification of director action and classic ratification by a single principal, do lead to a difference in the effect of a valid ratification in the shareholder context. The principal novelty added to ratification law generally by the shareholder context, is the idea — no doubt analogously present in other contexts in which common interests are held — that, in addition to a claim that ratification was defective because of incomplete information or coercion, shareholder ratification is subject to a claim by a member of the class that the ratification is ineffectual (1) because a majority of those affirming the transaction had a conflicting interest with respect to it or (2) because the transaction that is ratified constituted a corporate waste. As to the second of these, it has long been held that shareholders may not ratify a waste except by a unanimous vote. Saxe v. Brady,Del.Ch., 184 A.2d 602, 605 (1962). The idea behind this rule is apparently 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. In all events, informed, uncoerced, disinterested shareholder ratification of a transaction in which corporate directors have a material conflict of interest has the effect of protecting the transaction from judicial review except on the basis of waste. (emphasis added)
In Gantler v. Stephens (965 A.2d 695)(2009), the Delaware Supreme provided some clarity on the question of shareholder ratification:
Under current Delaware case law, the scope and effect of the common law doctrine of shareholder ratification is unclear, making it difficult to apply that doctrine in a coherent manner. As the Court of Chancery has noted in In re Wheelabrator Technologies, Inc., Shareholders Litigation:
[The doctrine of ratification] might be thought to lack coherence because the decisions addressing the effect of shareholder "ratification" have fragmented that subject into three distinct compartments,... In its "classic" ... form, shareholder ratification describes the situation where shareholders approve board action that, legally speaking, could be accomplished without any shareholder approval.... "[C]lassic" ratification involves the voluntary addition of an independent layer of shareholder approval in circumstances where shareholder approval is not legally required. But "shareholder ratification" has also been used to describe the effect of an informed shareholder vote that was statutorily required for the transaction to have legal existence.... That [the Delaware courts] have used the same term is such highly diverse sets of factual circumstances, without regard to their possible functional differences, suggests that "shareholder ratification" has now acquired an expanded meaning intended to describe any approval of challenged board action by a fully informed vote of shareholders, irrespective of whether that shareholder vote is legally required for the transaction to attain legal existence.
To restore coherence and clarity to this area of our law, we hold that the scope of the shareholder ratification doctrine must be limited to its so-called "classic" form; that is, to circumstances where a fully informed shareholder vote approves director action that does not legally require shareholder approval in order to become legally effective. Moreover, the only director action or conduct that can be ratified is that which the shareholders are specifically asked to approve. With one exception, the "cleansing" effect of such a ratifying shareholder vote is to subject the challenged director action to business judgment review, as opposed to "extinguishing" the claim altogether (i.e., obviating all judicial review of the challenged action).
Following Gantler and Vogelstein, it is clear that an informed, uncoerced, vote of disinterested stockholders ratifying a transaction in which corporate directors have a material conflict of interest has the effect of providing the interested director transaction to protection of the business judgment presumption. While such a transaction is still subject to possible attack, the directors' interest may not be the basis of a subsequent challenge.
The court in Corwin reaffirmed this basic teaching in the context of a post-merger trial for damages. Some commentators and defandants have attempted to extend Corwin further. However, the courts have pushed back. In Massey Energy Company Derivative and Class Action Litigation (2017), Chancellor Bouchard provided the following comment on the limits of the reach of Corwin and stockholder ratification:
The policy underlying Corwin, to my mind, was never intended to serve as a massive eraser, exonerating corporate fiduciaries for any and all of their actions or inactions preceding (ed. emphasis added) their decision to undertake a transaction for which stockholder approval is obtained. Here, in voting on the Merger, the Massey stockholders were asked simply whether or not they wished to accept a specified amount of Alpha shares and cash in exchange for their Massey shares or, alternatively, to stay the course as stockholders of Massey as a standalone enterprise, which would have allowed plaintiffs to press derivative claims. Massey's stockholders were not asked in any direct or straightforward way to approve releasing defendants from any liability they may have to the Company for the years of alleged mismanagement that preceded the sale process. Indeed, the proxy statement for the Merger implied just the opposite in stating that control over the derivative claims likely would pass to Alpha as a result of the Merger. To top it off, if defendants' view of Corwin were correct, it would have the disconcerting and perverse effect of negating the value of the derivative claims that Alpha paid to acquire along with Massey's other assets.
In short, in order to invoke the cleansing effect of a stockholder vote under Corwin, there logically must be a far more proximate relationship than exists here between the transaction or issue for which stockholder approval is sought and the nature of the claims to be "cleansed" as a result of a fully-informed vote.
Stockholder ratification will be limited strictly to the claims presented to stockholders. Absent a truly fully-informed vote, stockholders will not be deemed to have ratified director action and directors will not be absolved from wrongdoing.
July 17, 2017
Brian JM Quinn
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