Corporate Governance

Fiduciary Duties of Officers and Directors: Gantler v. Stephens (The Impact of Shareholder Ratification)(Part 6)

By J. Robert Brown

We are examining the recent decision by the Delaware Supreme Court in Gantler v. Stephens.

The Court clarified one aspect of shareholder ratification that has caused considerable confusion in the Chancery Court.  Ratification of a conflict of interest transaction by disinterested shareholders presumably must have some affect.  The majority of decisions addressing the issue have concluded that the approval mechanism results in the application of the business judgment rule to the transaction.  Thus, the duty of loyalty becomes the duty of care.  This approach, hardly justifiable based upon traditional corporate law principles (its discussed in Speaking With Complete Candor: Shareholder Ratification and the Elimination of the Duty of Loyalty), was not sufficient for some members of the Chancery Court.  There were cases that suggested that in fact disinterested shareholder ratification would render the transaction not subject to challenge under any theory.

The Supreme Court in Gantler clarified this area and came down on the side of shareholders.  Ratification would not extinguish the right to challenge the board's action.  As the Court noted:

• 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).

Moreover, the opinion reaffirmed the traditional view that certain types of transactions (waste in particular) would only be "ratified" if approved by a unanimous vote of shareholders.  Chancery court decisions had suggested that the approach ought to be repealed, reducing the protections afforded for shareholders.  See Harbor Fin. Partners v. Huizenga, 751 A.2d 879, 895 (Del. Ch. 1999)(opinion by VC Strine)("Although I recognize that our law has long afforded plaintiffs the vestigial right to prove that a transaction that a majority of fully informed, uncoerced independent stockholders approved by a non-unanimous vote was wasteful, I question the continued utility of this 'equitable safety valve.'").  The Court in Gantler, however, had this to say:

• Nothing herein should be read as altering the well-established principle that void acts such as fraud, gift, waste and ultra vires acts cannot be ratified by a less than unanimous shareholder vote.

The decision, therefore, clarified the standards for ratification and while it did not tamper with the application of the business judgment rule to appropriately approved transactions, it cut off the movement towards a more extreme standard of review (which would really be no standard at all).

Primary materials from the Chancery Court can be found on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on February 15, 2009 (boomark / email).