Corporate Law Changes in Delaware

John Quinn is joined by Michael Barlow, Managing Partner and Founding Member of Quinn Emanuel’s Wilmington, Delaware office.  They discuss the evolving state of Delaware corporate law and the legislative response to growing dissatisfaction among corporations over the recent legal treatment of conflicted transactions.  Traditionally, Delaware law has deferred in general to corporate decision-making under the business judgment rule, but rigorously reviewed transactions involving conflicts of interest—particularly those involving controlling shareholders—under an “entire fairness review.”  Entire fairness reviews are fact-intensive and include scrutinizing both the process and terms of the transaction, making early dismissal of claims rare.  In response, Delaware courts developed a safe harbor called the “MFW” framework.  The “MFW” framework involved approval by a special committee of disinterested directors and the minority shareholders.  Still, even under the MFW framework, motions to dismiss were granted in fewer than 40% of cases, leading to frustration among deal planners.

Despite these odds, a Quinn Emanuel team led by Michael recently won a rare complete dismissal of an entire fairness case on behalf of Fidelity National Financial, Inc.  In that case, the court ruled that there were no alleged facts that could support the conclusion that the preferred stock transaction at issue was unfair. 

Frustration among corporate deal planners with what was perceived as activist judicial decisions creating uncertainty (e.g., as to what was a “controlling stockholder,” among other things) has recently led to Tesla, Dropbox and other corporations to express their intent to leave Delaware as their state of incorporation.  “DExit,” is the term coined to describe this trend.  To address these concerns, Delaware enacted Senate Bill 21, a bipartisan effort to clarify and narrow the standards for conflicted transactions.  The legislation provides clearer definitions of controlling stockholders and establishes safe harbors for dismissing cases early if certain procedural protections are followed.  It also reforms the state’s books-and-records statute (Section 220) by limiting the scope of pre-suit corporate document demands.  The next few years will test how effectively the new legislation meets the corporate world’s demand for greater legal certainty.  Finally, Michael believes that Delaware will continue to lead the nation in corporate law due to its unparalleled legal infrastructure and judicial expertise.

Podcast Link: Law-disrupted.fm
Host: John B. Quinn
Producer: Alexis Hyde
Music and Editing by: Alexander Rossi

Transcript

JOHN QUINN: [00:00:00] John Quinn here, and this is Law Disrupted. And today we're gonna be talking about Delaware Corporate law. And who better to talk to about Delaware corporate law than my partner and the head of our Wilmington, Delaware office? Michael Barlow. There's a lot been going on in Delaware and Delaware Corporate law.

Uh, there's some new legislation in the, in the wake of something called Dex Exit where. There was some discontent in some quarters in the corporate world in America with the direction of Delaware law. Uh, there's been some new legislation, uh, we're gonna talk about that. And we're also gonna talk about an important decision that, Mike, that our firm.

Mike and the team, Mike Kalinsky was also involved in others in a case in which we got dismissal of a case that was subject to review under the entire fairness standard. This like rarely, almost never happens, but we'll be able to [00:01:00] talk about that and it, it kind of fits in nicely with the discussion of the changes in Delaware law.

But let's begin with what led up to these decisions and this whole phenomenon of corporations. Reincorporating elsewhere that got the shorthand term. Dex it. So Mike, tell us about Dex exit. What was that? I mean, who was leaving and why? What was the complaint about Delaware corporate law? 

MICHAEL BARLOW: John, happy to be here.

Excited to join you today. Um, so I've been litigating in Delaware here for 25 years and you know, the. People, uh, take a pause and asks themselves at various sort of inflection points in the economy or inflection points in, in, in the law. Sort of why is it that Delaware has established this sort of preeminent place where companies across America decide to incorporate?

Right now, something like 2 million entities are [00:02:00] incorporated in Delaware, two thirds of the Fortune 500. Um, and it's an important part of what we do. I think a lot of times when people ask sort of why Delaware, they're looking at a couple different elements. They're looking at our responsive courts, they're looking at the corporate law, uh, which is well developed, has a whole bunch of different opinions.

Um, they're looking at a state that has a almost, you know. History of, of, of, of more than a hundred years now, of, of actually actively changing the law to affect circumstances, to make sure that they're being responsive to the universe of constituencies that care about Delaware law. And I think that's really what you've heard about in the last year.

What you've heard is companies who've had said, look. We think Delaware law is too uncertain on this issue or on that issue. We want more certainty so that not every deal that we engage in results in litigation. [00:03:00] We wanna make sure we understand what the rules are. And that's what really led to a few recent companies, uh, explaining and expressing a desire to sort of second guess whether or not Delaware is the right place for them.

Uh, obviously Tesla is probably the most preeminent, has very publicly pursued a. Stockholder approval to move their company to Texas. But others have talked about it, including, uh, Dropbox. There were rumors about Facebook. Um, at the same time, the incorporation in Delaware sort of remains pretty robust and it remains a favorite place for pursuing.

When you talk about 

JOHN QUINN: corporations saying Delaware corporate law is uncertain. You know, that kind of. Jars in the, uh, the thought, because when you think of Delaware, you think of a very rich, uh, and historical, uh, body of corporate law, which, uh, the judiciary and the legislature have been very conscious about [00:04:00] promoting.

It's, it's an enormous asset for the state. Uh, it's a lot of business, franchise tax and other things for the state become kind of an industry sort of like. There's people who argue that English law is now the number one export of the uk. And you could argue that Delaware law is the number one export of Delaware.

But certainty is something that you really expect to have that you, that I would associate historically with Delaware law did. Did the courts lose their way or, or what happened? That people start thinking about Delaware laws being uncertain and unpredictable. 

MICHAEL BARLOW: I think what you've had are a, a universe of cases where the law was always set up.

Um, as a result of those kind of situations to, uh, allow essentially, um, a lot of flexibility for the court. And I'm talking specifically about cases involving potential conflict transactions, something that we in Delaware would [00:05:00] call, uh, an entire fairness case. When, when 

JOHN QUINN: you talk about a conflict, uh, transaction, tell us just in general terms what you mean.

MICHAEL BARLOW: Yeah, so, so the ordinary course for Delaware is the business judgment rule, which is to say that, you know, Delaware law assumes that directors are making decisions on an informed basis in the best interest of stockholders, and Delaware law is gonna respect it. We're not here, Delaware Court are not here.

To second guess the opinions of management and directors and what are the risks that they should be taking to best deploy the capital that's been entrusted to them by investors. Where the Delaware courts have always employed a more circumspect view is where a situation where the board of directors, a majority of them are, have some interest in the transaction.

Or in situations involving potentially a conflicted stockholder, um, like a controlling stockholder who potentially owns, uh, more than 50% of the shares. Was that the case with Tesla and Elon Musk? [00:06:00] It was not. It was not. And in, in fact, that's, I think part of what, as you've seen in some of this most recent legislation, it used to be that a controlling stockholder.

I had sort of, it was, it was thought of in most simple terms as somebody with 50% of the shares, because then they can go to a stockholder vote and get whatever changes they want made at the, at the ballot box. In recent years of what you've seen, um, is, is a more nuanced view of what's called transactions specific control, which is looking at situations where the combination of a significant voting authority.

But then also significant management authority or some other means of control over the authority of the company has caused people to be considered to be controllers. And we've had cases where somebody with as little as 20% of stock or, or even less than that for other reasons related to that, has been considered a controller.

And what I think transaction planners were looking for and what they were concerned about in Delaware is, look, I don't know, at the outset of a [00:07:00] transaction. If, if, if, if my major investor is a controlling stockholder or not, I don't know necessarily know how to structure this transaction to, uh, basically best protected against litigation.

Yeah. 

JOHN QUINN: This is 

MICHAEL BARLOW: an instance 

JOHN QUINN: of where that uncertainty started to, to leak in. Like who is a controller? 

MICHAEL BARLOW: Like, who is a controller? And, and, and the risk that you would find out after somebody sued that somebody who was a minority investor was also a controller, was part of the, part of the impetus for some recent legislation to provide clarity about that.

JOHN QUINN: I think you were telling us that, uh, if the, the business judgment rule, it's pretty straightforward. You're going to absent, uh, special circumstances. The court isn't going to second, second guess the business judgment of the board of directors. But if it's a conflicted transaction, if it's a controller transaction, the business judgment rule is is not going to apply some other, there'll be another standard that applies and that's the entire fairness test.

MICHAEL BARLOW: And that's the entire fairness [00:08:00] test, which usually has two components, um, both fair process and fair price. Um, is the price fair and is the process that the parties engaged in? Fair? Now what, what, and usually if, if, if the entire fairness test applied. That meant you were gonna have a trial. Fundamentally, that was sort of the reflex approach to everybody because it's a potential conflict transaction.

And we'll put that, put it in the hands of the judge to make a decision about whether or not the process and the price were fair. But what the Delaware courts did over, over the last 15 to 20 years was develop a a essentially so safe harbor. And what that safe harbor did was say to directors, if you set up a structure.

That looks like arms length negotiation that actually sort of creates real arms length negotiations. We're gonna protect that against later second guessing by a court. And that became what's known as the MFW standard, and it had two components. First, you set up a fully empowered committee of independent and [00:09:00] disinterested directors, and they're fully empowered to decide whether or not the company's gonna do that.

And then secondarily, you're going to let the minority stockholders vote on it. So take away the potential authority and control of a large stockholder controlling stockholder to sort of influence the outcome and then, then let them negotiate. 

JOHN QUINN: That would seem pretty straightforward that, I mean, if you just go through those two hoops, uh, your transaction's gonna be bulletproof and you can get dismissal of a lawsuit.

MICHAEL BARLOW: You would think, uh, I, I think the court intended it to be bulletproof, because if you're gonna go through all of this process, then you want to be able to tell the people who are involved, we're doing this because we wanna make sure that the people who are best situated to decide this, which are the directors of the company and the stockholders of the company.

Are fully empowered to make these decisions. We're not gonna leave it to litigation later. And, and so you wanna have an understanding of how that process is going to, uh, [00:10:00] result. The problem was in practice, uh, I saw some analysis, you know, the motions to dismiss based on companies that followed the MFW standard were granted less than 40% of the time over the last 10 years.

And as a result, uh, I think transaction planners became somewhat frustrated that the courts were often second guessing. First, are the directors really independent? Second, uh, was the vote taken by stockholders fully informed? Did they have all the information they needed? And one of the results of all that is you've seen this more recent legislation, which we'll talk, I'll, I'll talk about, it's called Senate Bill 21.

That's really intended to create more clarity around those rules. 

JOHN QUINN: What does that mean then? Uh, you know, because you can challenge, I guess, the disclosures to the shareholders in the proxy statement. You can still challenge independents of directors. Do they go to the same country club? Do their kids go to the same schools and all those different [00:11:00] things.

And I say that, uh, you know, with a, a joking tone in my voice, but I've seen those, you know, I've seen shareholder cases where they cite those kinds of. Informal relationships among, among directors. So you say less than 40% of the cases actually get dismissed even when you comply with the MFW test. Does that mean then that all those other cases must necessarily go to trial under the, uh, entire fairness standard?

MICHAEL BARLOW: Many, many, most of them do. Um, I will say that we did have a recent case that you mentioned earlier, just decided last week where the court on a motion to dismiss standard rejected an entire fairness case. It was called Fidelity National, uh, what's technically Roofer's Pension Fund versus Fidelity National.

And in that case, the court looked very critically at the allegations that were made by the plaintiff. Uh, and said that those allegations did not [00:12:00] evidence that a particular transaction, a $250 million preferred stock investment by the controlling stockholder into its publicly held minority parent. It, it, it decided that there were no good allegations.

That that transaction was not, uh, entirely fair to stockholders. That there was no allegation that the price at which that transaction was engaged in. Was unfair and dismissed it. That's an extremely, uh, rare outcome because ordinarily the entire fairness standard means you're going to trial. But there are cases, and we had one just last week where the court said, notwithstanding entire fairness, you are going, uh, this case can be dismissed because the allegations are such that, um, that, that, that they're just too weak.

And I think that's a real evidence of the issue that you've seen out there with Delaware, this sense that. Anytime there's a controller transaction, even if it's wildly beneficial to the company, uh, even if it doesn't make sense to follow the MFW standard [00:13:00] because, for example, you don't wanna take the time or there isn't the time available to, to send the question to stockholders, many of those transactions can be potentially beneficial to the company.

And so the concern that you've heard from a lot of people is every transaction gets sued upon just because it's gonna implicate the entire fairness standard. So that's problematic for Delaware. Um, we got one of them dismissed last week, but it is the case that most of them end up going to trial. I think what's important about the case that we got dismissed last week though, is again, the.

Um, company involved, which was, uh, f and g Life and annuities set up a special committee to negotiate the terms of the investment. And that special committee had independent lawyers, they had independent financial advisors to negotiate against the controlling stockholder. And they followed a very, um, deliberate and thoughtful process that was laid out in the opinion.

And what I think is really interesting [00:14:00] is the court says in a footnote. Interestingly enough, this case might have been dismissed under the new statute, uh, because they set up a special committee that went through a process. Um, so we could talk a little bit about the new statute, but the court was definitely foreshadowing what's likely to come under Delaware law, which is increased certainty for fully empowered special committees and stockholder votes.

That's 

a 

JOHN QUINN: good segue to talk about, uh, the new legislation. I mean, how would it have been different? How would the decision have been? Any different or how would've been addressed differently under the, the mechanism set up in the new statute? Sure. 

MICHAEL BARLOW: So what the, what the new statute does is it says, uh, it's called, it's Senate Bill 21.

Technically Senate substitute one for Senate Bill 21, and it's the result of, um, a group of former judges, academics, and others who sat down. Uh, and then with the support of Delaware's governor and with the support of both [00:15:00] Republicans and Democrats and Delaware's legislature pulled together a piece, legislation.

Based on existing case law, but is intended to provide additional certainty for transaction planners engaging in transactions. And, um, it, uh, after a a few months of legislative process, it became law. Just a few weeks ago. Uh, and it applies both retroactively and prospectively to any case for which there's not a sort of pending litigation as of the date the bill was filed.

Um, and, and what it really does is it sets up three safe harbors. It says for, for three different kinds of conflict transactions. If you go through these hoops and if you follow them with fidelity, follow these procedures with fidelity. Uh, the case should be dismissed. And so for example, if it's a, um, if it's a tri, a transaction between a a, a company and its directors, the legislation provides [00:16:00] a safe, safe harbor if you either go out there and have it approved by a majority of disinterested directors or if it's approved or major, uh, by a, by a majority of disinterested stockholders.

So you don't have to have both. You don't. Right. So that's a, that's a comparison to the MFW standard right now. You own, under the statute, you only need to have both, uh, both the approval by a majority of the minority and approval by a special committee in a situation where it's a controlling stockholder.

Going private transaction. Um, and again, those are, um, sort of specific transactions, for example, where a controlling stockholder has a, a significant part of the equity of the company already. Uh, he, she or it wants to own the rest of the equity and engages in a transaction. In that situation, you need to have both a fully empowered special committee that considers the issue and [00:17:00] votes to approve it.

And a, uh, approval and ratification by a majority of the minority. But if it's a transaction that's not a going private. If it's a transaction with a controlling stockholder or it's a transaction just, just generally involving a potentially interested directors, the, the new law empowers the court to dismiss those claims if it was approved by either.

A, uh, majority of disinterested directors or a special committee, or by a majority of disinterested stockholders. So it's putting the tools back in the hands of the sort of stockholders and the independent directors. 

JOHN QUINN: You mentioned that it also addressed the definition of who is a controlling stockholder, which I, I've been a subject of some uncertainty.

MICHAEL BARLOW: Yeah. And, and so what I think there was some concern, uh, that we wanted to get away from a sort of, I know it when I see it standard of who is a controlling stockholder, um, because. [00:18:00] That was never the, the standard. It was never that, uh, it was never sort of put that way, but often procedurally you didn't know until later in a matter whether or not the person was going to be designated a controlling stockholder or not.

And that matters a lot because controlling stockholders have fiduciary duties. And so what they did in, in creating these safe harbors is they set up a situation where they said, for, for controlling stockholders to be a controlling stockholder. You have to own a majority of the voting power. Have the right to elect or have the right to elect a board majority, or have the functional equivalent of majority voting power through ownership of at least one third of the voting power and the power to exercise managerial authority.

So what doing is of creating. More clear lines to, to say, okay, you might be a controlling stockholder [00:19:00] because you own more than a third and you have managerial authority, but if you have less than a third and you don't have managerial authority, you, you're not gonna be a controlling stockholder. So we're creating that, uh, for purposes of the statute that, that clarity in the law that didn't exist previously, 

JOHN QUINN: that that concept of managerial.

Managerial authority may still be a, a, a source of dispute or litigation, I suppose. 

MICHAEL BARLOW: Yeah, and I think what you're gonna see over the course of the, um. Gosh, I don't know, six months, one year, two years, three years is what you're gonna find is a, a lot of these issues are going to be litigated at Senate Bill 21.

Now, nobody's writing on a totally blank slate because Delaware law is pretty robust and it's gotten more case law borrowed by many other states. So many of these concepts that are actually in the legislation have foundation in what courts have said in the past. But you [00:20:00] definitely put your finger on something that courts are gonna care about going forward, which is what is the kind of managerial authority over the corporation's business and affairs, which when combined with one third of the voting power can be sufficient to render somebody a controlling stockholder.

We're gonna see some 

JOHN QUINN: cases, um, I mean a lot of these plaintiff's cases are preceded by a corporate books and records demand where. The plaintiff's counsel, uh, gets their hands on corporate records. There's section, uh, two 20 of the Delaware Corporation law that facilitates that, that had been a cottage industry in itself, litigating these, uh, books and records demands, and I understand the statute also addressed, uh, the availability of books and records and shareholders' ability to get those.

MICHAEL BARLOW: You know, the ebbs and flows of Delaware corporate law over [00:21:00] the years, going back at least to, I think the 1990s. The courts have said when they're, particularly, when they're dismissing claims, boy, we wish the stockholder had used the quote tools at hand to investigate as much as they could before they brought this lawsuit.

Section two 20, which is the statute in Delaware law, that allows the stockholders to request more information from the company is the sort of major tool that has they, that the courts have said repeatedly. We want you to use the tools at hand to go investigate these claims before you bring them and, you know, after years and years of imploring stockholders to do that.

Um, many stockholders got quite good at it, and what happened was pretty much every time there was some bad corporate event in a company's life, they would get numerous demands from stockholders for investigatory demands. In addition to the number, the depth of those document requests got deeper and deeper.

And [00:22:00] you saw cases after, after case where companies would produce. Large volumes of documents and plaintiffs would say, it's not sufficient for me to get the financials for the last three years. I want financials for the last 10 years. It's not sufficient for me to get board minutes of the directors. I want to get the CFO's emails.

So you had a series of, uh, basically fights over the course of the last 20 years about what is the appropriate scope. Of documents that a company is required to give its stockholders. And what the new legislation does is it sets up a list of, okay, these are the documents that you can get. And then it says, if you need more than this, you've gotta really show a compelling need to get it.

So you can get, for example, board minutes, uh, committee minutes, financial statements, stockholder agreements, your basic corporate governance documents, documents about the independence of the [00:23:00] directors. That's all sort of the core documents. That Section two 20 as modified by the statute allows you to get, but then at the same time, the statute says.

You can get more. You really have to show a compelling need, or you have to show that one of those categories of documents is just missing and we have to give you the functional equivalent of it. Well, this is a very significant change. It is, and it's gonna change, you know, functionally how companies, uh, you know, minute things, right?

Like usually what you want to do when you're, when you're representing a board of directors, is make sure the minutes sort of fully reflect the discussions that. The board engages in so that you have a memorialization of the collaborative and, and, and the discussion process that the director's engaged in making a decision.

Um, I think we're sort of past the days when it's questions were asked and answered and then you sort of. Stop the board minutes. [00:24:00] So the now basically those board minutes are going to be documents that have to be given over to stockholders. Um, but we're drawing a line and saying, look, if you've got board minutes, if you've got the last three years of financials, we're not gonna allow this to become a fishing expedition for a whole bunch of other sorts of documents.

Uh, unless you can really show a compelling need that the documents that you've been given don't satisfy your purpose. 

JOHN QUINN: It's interesting what you, what you say, because usually board minutes don't go into a whole lot of detail. Usually they're written with an eye to actually making sure that if plaintiff's lawyers get their hands on them, they're not gonna, there's not nothing there.

They're gonna be able to mine for a lawsuit. 

MICHAEL BARLOW: Right. And I think you wanna just make sure that for people who are advising boards, um, that, that minutes sort of reflect the discussion and the engagement that people, uh, as directors engage in, right? So it shouldn't [00:25:00] be a perfunctory box checking process. We came in, we discussed the audit for 20.

Questions were asked and answered and we walked out. I mean, if there's real discussion there, that's the kind of thing that if you write that up in the minutes and you discuss it in the minutes and then someone sues about the 2025 audits, those documents will be in the record. And you can say, as directors, look, you can see from the minutes that we actually fully considered all of these issues that you're now complaining about.

So it can sometimes behoove directors to make sure that the minutes have a record of the. Full scope of their deliberations without obviously the, um, you know, going into unnecessary and picking you in detail. 

JOHN QUINN: You know, there, there's a, uh, a saying. I, uh, I can't remember what it originated about the United States Supreme Court.

About the US Supreme Court reads the news follows the headlines that you can, uh, sort of track in decisions, sometimes a reflection of, uh, the public's reaction to public events. I don't [00:26:00] know whether that's a fair generalization or not, but it seems like here, even if the Delaware chance rate court wasn't reading the news.

The no Delaware legislature certainly was. You had this phenomenon of, uh, Elon Musk being very vocal after his compensation p package was struck down. Uh, you know, the, the MOAs decision, uh, about agreements with stockholders that got a lot of criticism. You had Tesla reincorporating, uh, in Texas, Texas setting up a business court, trying to attract this kind of.

Business. You have Nevada that supposedly has a looser fiduciary duty standard. You know, in chancery court you don't get a jury trial and you're not gonna get, uh, punitive damages maybe. Uh, those are things that you can get elsewhere. Uh, I don't know about Texas, but you presumably can in Nevada, how do you think this all shakes out?

Do you think that this new legislation puts an end to the Dex exit phenomenon, or does it remain to be [00:27:00] seen? 

MICHAEL BARLOW: Um. The book has not yet been written on this. Look, if there are a lot of factors that go into deciding what is the best place to incorporate your company, um, and so for example, Tesla expressed the importance and significance of its corporate home in Texas and wanting be to be close to its corporate home in Texas, while at the same time noting.

Texas corporate law in many respects isn't all that different from Delaware corporate law. So, um, the benefit of being in Delaware is you have the established law that's existed for a long period of time. And in those other states, they're frequently saying to themselves, okay, we're just going to adopt Delaware law on this point.

And so the, the, the question for companies is, you know, what is the right place for us? Delaware continues to offer some, I think, significant advantages with respect to the certainty that its [00:28:00] courts provide. Um, the court process in Delaware and the accessibility to courts, um, has always been desired by transaction planners, right.

Your contract is only as good as whether or not you can enforce it and enforce it quickly. And I think Delaware boards are somewhat unparalleled in their, uh, ability to move mountains to make sure that, for example, specific performance on contracts gets awarded and deals close, and there's deal certainty, the kind of deal certainty that powers our economy.

So from that perspective, Delaware has. Has lots to offer. And I don't think, uh, I don't think the story is written. I think you're both going to see companies sort of evaluating what's the best jurisdiction for them. But I also think Delaware's gonna remain a leading jurisdiction for a long time, simply because its, courts have something that's unique and it's got a body of law that's, that's sort of unmatched.

Um, and, and, and sort of can be copied but never [00:29:00] replicated. 

JOHN QUINN: I agree completely. It's very hard for me to see, uh. The, uh, importance of Delaware corporate law, uh, incorporation in Delaware being materially changed, but fascinating, a whole episode, uh, over the last 18 months or so. How long? It's been very, very interesting.

It was very interesting the way, uh, the politicians in the legislature immediately caught onto this phenomenon, uh, and address the issues that we're being mooted about in the, in the business world. I. We've been talking with Mike Barlow, Delaware corporate lawyer, litigator governance expert extraordinaire, who I'm very glad to call my partner.

Thanks for being with us, Mike. This is John Quinn. This has been Law Disrupted.

Thank you for listening to Law Disruptive with me, John Quinn. If you enjoyed the show, please subscribe and leave a rating and review on [00:30:00] your chosen podcast app. To stay up to date with the latest episodes. You can sign up for email alerts at our website, law Hype Disrupted fm, or follow me on X at JB Q Law or at Quin Emanuel.

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