One of the few downsides to board service is the exposure to liability that directors of all corporations potentially face, day in and day out, as they perform their fiduciary duties. The chance of being sued for a major merger decision is now 90 percent; but that well known statistic is just the tip of an even larger iceberg. The Court of Chancery for the state of Delaware, where some one million corporations are incorporated (among them most major public companies), hears more than 200 cases per year, most of them involving director and officer liability. And given the high esteem in which Delaware courts are held, these influential D&O liability decisions impact the entire nation.
Why did we get involved? Since its founding in 1977, NACD has striven to serve members in many ways. Through research reports, webinars, and live events, we provide directors with the information, insights, and networks they need to become effective board leaders. Yet there is another important way in which NACD has been helping directors over the years. From time to time, when directors express concerns about pending policy matters, we amplify those concerns to the powers that be—including all three branches of the federal government as well as state courts, particularly Delaware’s. In this way, we can be the “voice of the director.”
In our Rural/Metro brief, we spoke on behalf of the directors in this case (who, because they had settled out of court, could not directly represent themselves); far more importantly, however, we spoke on behalf of all directors in every state, addressing the legal principle at issue. We urged the Delaware Supreme Court to reverse Chancery’s finding that Rural/Metro’s directors had breached their fiduciary duties when they approved the company’s sale. NACD believes the Court of Chancery’s decision may expose directors of Delaware corporations to an unreasonable risk of litigation and personal liability for good-faith decisions made on the basis of their reasonable business judgments and in consultation with expert advisors.
Will our line of reasoning in the Rural/Metro amicus brief prevail? Whatever the outcome, NACD’s messages is likely to keep Delaware’s courts focused on standards of good faith rather than an ideal but unreachable goal.
In this regard, we can take heart from precedent. The Rural/Metro friend-of-the-court brief was the second one NACD has filed in recent years. The previous amicus brief, written in 2008 and presented by the law firm of Sidley Austin LLP, addressed the issue of indemnification in the matter of Bohnen v. Troy Corp. 962 A.2d 916 (Del. 2008). NACD asserted that the indemnification protection of former directors should continue past their years of service in legal matters that involved those same years.
Initially, the court could not consider our brief for technical reasons. However, NACD’s position was ratified in 2009 when, in response to concerns expressed by various parties including NACD, the Delaware legislature amended Section 145(f) of the Delaware General Corporate Law. As revised, Section 145(f) provides that a director’s right to receive indemnification or advancement pursuant to a company’s charter or bylaws generally “shall not be eliminated or impaired … after the occurrence of the act or omission that is the subject of the … indemnification or advancement.”
Even now the issue of indemnification remains current. Late last month, in the case of Blankenship v. Alpha Appalachia Holdings Inc., C.A. No. 10610-CB (Del. Ch. May 28, 2015), the Delaware Court of Chancery upheld and clarified the rights of former directors and officers to receive advance defense costs when they are named in litigation connected to their past board service. As stated in a recent article from Gibson Dunn, “This decision reaffirms the strong protection of director and officer indemnification and advancement rights under Delaware law.” The decision in this case cites Section 145 of the Delaware Code more than a dozen times, which demonstrates that NACD is truly making a difference for directors and the companies they serve.
“There is nothing new under the sun,” complained the author of Ecclesiastes. This old lament comes to mind when I hear about “new” solutions in governance. I can usually find a precedent near at hand—whether it is something we have done here at NACD within the director community, or else a solution we’ve seen coming from other governance groups such as managers, shareholders, and professionals.
But I have to say that Bridging Board Gaps:Report of the Study Group on Corporate Boards, released in late April, contains some new perspectives and some new thinking.
A New Gathering
The Study Group on Corporate Boards is new in the breadth of its representation across U.S. public company governance and, frankly, the celebrity status of its members. At NACD we take pride in our Blue Ribbon Commission reports, which bring together a diverse group of participants in governance. The Study Group assembled an equally strong group with a wide range of backgrounds and affiliations.
Study Group Co-Chair Charles Elson
Co-Chairs Charles Elson, University of Delaware; Glenn Hubbard, Columbia Business School; and Vice-Chair Frank Zarb, Hellman and Friedman, currently serve on a total of seven major corporate boards. The Study Group also includes other prominent corporate directors, plus an array of retired chief executives, senior managers, shareholders and professional advisors of note, and also two retired jurists—Chief Justice E. Norman Veasey, retired from the Delaware Supreme Court, and Chancellor William T. Allen, retired from the Delaware Court of Chancery.
Also serving in the Study Group is Arthur Levitt, former chairman of the Securities and Exchange Commission; former Treasury Department Secretary Paul O’Neill; former general counsel of the Securities and Exchange Commission, David Becker; and a representative of organized labor, Damon Silvers, policy director and special counsel of the AFL-CIO. The group even includes Jon Hanson, chairman emeritus of the National Football Foundation and a director of the
Study Group Co-Chair Glenn Hubbard
company that owns the New York Yankees.
So exactly what did the Study Group say that was new? The main message of their report is twofold:
1. There are natural limits to what boards (as part-time nonmanagers), by definition, can do, and we all need to face those limits and adapt to them. Previous reports leave this difficult truth unaddressed.
2. Even given these limits, some boards are falling short of their potential.
The Study Group identified seven gaps: gaps in purpose, culture, leadership, information, advice, debate, and self-renewal. Every member made a significant contribution to the discussion. My own area of focus was the issue of information asymmetry, which I have addressed in a number of NACD publications. Management will always know more than the board about the company; that gap is inevitable, but it can be narrowed.
In my view, however, the truly new message in the report lies in the last three areas: advice, debate, and self-renewal. Boards are not investing enough in advisors; their fear of treading on management’s toes leads to serious gaps in knowledge. Also, boards are too deferential in their discussions. Rigorous debate is required and there is also a place for outright dissent (votes need not always be, as they usually are, unanimous). And finally, the third message that to me seems quite new is the suggestion that although obviously evaluation is the best way to refresh board membership, boards should consider term limits—a backstop that fewer than one in ten corporate boards have implemented, according to NACD research.
A New Start
Although as a lifelong auditor, I am constitutionally incapable of being star struck, I must say it was an honor to serve with this distinguished group. Indeed, I can’t imagine any American man or woman of business being uninterested in what this unique and high-caliber team has to say. I commend this report to the attention of every corporate director, and to all who care about free enterprise in America and in our global economy.
Get the Report and Discuss Its Recommendations with Jon Hanson, Charles Elson, and Ken Daly
Ken Daly and Charles Elson will be joined by fellow Study Group member Jon Hanson to discuss the recommendations in their report at the Master Class NACD will conduct in Wilmington, DE, June 7- 8, 2011. The Master Class is open to experienced directors only, and is best suited to lead directors and committee chairs. Check out the full agenda here. To register for the Master Class, where you will receive a complimentary copy of the Study Group report, click here.
Formally known as a shareholder-rights plan, business news has been flush with reports of companies adopting the provision. Well-known companies—such as Barnes & Noble, Airgas and most recently Family Dollar Stores, Inc.—have recently implemented shareholder-rights plans in the face of takeover bids. While poison pills are often controversial and their use is strictly limited in Canada, Australia and the U.K., the Delaware Chancery Court recently upheld their use in the U.S., a decision reinforced by the Delaware Supreme Court. In the new environment of increased investor participation, directors may choose to revisit the implications of the poison pill.
The poison pill was created by Martin Lipton, a noted mergers and acquisitions lawyer with the business law firm of Wachtell, Lipton, Rosen, and Katz in the early 1980s. A response to activist investors gaining control of companies through either the proxy statement or share purchases, the poison pill earned its name from its impact—impairing both the company and the bidder. Following specific trigger events, such as a large equity acquisition by an entity, the shareholder-rights plan gives shareholders the right to buy additional stock at a discounted price. In the commonly used “flip-in” style, all shareholders, except the acquirer, can purchase additional discounted stock. The flood of equity purchases thus dilutes the purchasing power of the acquirer, but also devalues the current value of company stock.
Popular through the 1990s, many shareholder-rights plans were dismantled in the 2000s, likely the result of decreased M&A activity and shareholder pressure. When used in combination with a staggered board, these provisions can form an effective method of board entrenchment, a point of contention with shareholders. NACD’s Key Agreed Principle VIII: Protection Against Board Entrenchment, recommends that “governance structures and practices should encourage the board to refresh itself.” Many also view the decline of poison pills as the result of proxy advisory services’ recommendations. For instance, Institutional Shareholder Services recommended a “no” vote for companies that renewed an expiring pill that was not put to a shareholder vote within one year.
Why, then, the resurgence in use of poison pills? Many companies saw their market value decline as a result of the recent economic crisis, creating more opportunities for hostile takeovers. Now in the midst of a recovery, M&A activity has picked up as well. Directors have a fiduciary duty to provide the greatest possible shareholder value in a transaction. In the case that directors feel they are receiving an inadequate bid, a poison pill can provide the board with time to deliberate and negotiate a better offer for shareholders. In the case of Airgas, the Delaware Supreme Court upheld the use of a shareholder-rights plan as “a reasonable response to a threat posed by an inadequate offer.”