Corporate Governance

City of Westland Police v. Axcelis: The Erosion of the Credible Evidence Standard (The Suitability Standard)

By J Robert Brown Jr.

In reviewing the lower court decison, the Supreme Court did two things of note.  First, the Court expanded the concept of proper purpose.  Wrongdoing by the board was not necessary.  Plaintiffs did not have to allege an entrenchment purpose.  Instead, shareholders had the right to seek documents that went to an "individual's suitability to serve as a director." 

In reaching the decision, the Court relied mostly on a lower court case, Pershing Square, L.P. v. Ceridian Corp, 923 A.2d 810 (Del. Ch. 2007).  As Chancellor Chandler noted in that case:

• It is difficult for me to understand how determining an individual's suitability to serve as a corporate director is not reasonably related to a person's interest as a stockholder. After all, stockholders elect directors to represent their interests in the corporation and have few other avenues by which they may influence the governance of their companies. Once elected, stockholders may express dissatisfaction only through the electoral check.

The shift was significant.  Plaintiffs would still need to present a credible basis supporting the proper purpose but the evidence would be very different.  Rather than demonstrate that directors had a subjective intent to self perpetuate, an almost impossible standard, plaintiff only needed to show evidence that the directors were unsuitable. 

The second shift by the Court was to essentially eliminate the credible basis standard in the case of boards refusing to accept letters of resignation from defeated directors.  The non-acceptance was sufficient to meet the credible basis test.   

• The less-than-majority shareholder vote may be viewed as a judgment by the holders of a voting majority that those director-candidates were no longer suitable to serve (or continue to serve) as directors. Correspondingly, the Board's decision not to accept those resignations may be viewed as a contrary, overriding judgment by the Board. At stake, therefore, is the integrity of the Board decision overriding the determination by a shareholder majority.

Although using credible basis terminology, the Court dispensed with the need to present affirmative evidence of wrongdoing.  In effect, the Court held that shareholders had an inherent right to inspect the records anytime the board refused to accept letters of resignation under a board adopted policy. 

Shareholders made the same argument in Seinfeld, when they sought to inspect the documents that examined the compensation decisions made by the board.  In that case, the Court rejected the argument, concluding that board action short of evidence of misbehavior did not meet the credible basis standard. 

So this case, while couched in credible basis language, is for the first time acknowledging that shareholders have an inherent right to certain types of information, even absent evidence of wrongdoing. 

Primary materials on this case are posted on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on August 25, 2010 (boomark / email).