Delaware Sides With Shareholders in ‘Plurality Plus’ Case

Companies with a “plurality plus” standard for electing corporate board directors have a new warning to contemplate from the Delaware Supreme Court: Yes, you can ignore shareholder votes calling for a director’s ouster, but it will come at a price.

The case in question, Westland Police & Fire Retirement System v. Axcelis Technology, is the first to challenge a board’s decision not to accept a director’s resignation under a plurality-plus voting standard. That standard does not require directors to win an outright majority of votes to be elected, but it does require them to offer their resignation if they don’t. Boards then have the discretion to accept or decline the resignation.

In this case, Axcelis (a microchip manufacturer based in Massachusetts) declined to accept the resignation of three board members who failed the plurality-plus standard during elections in 2008. That prompted a lawsuit from the Westland, Mich., retirement fund, which had already been unhappy with the Axcelis board for rejected a buyout offer. Westland filed the usual books-and-records request allowed under Delaware corporation law, to review directors’ thinking about keeping those three directors. Axcelis argued that its decision about the directors isn’t subject to that section of the law (Section 220)—and now the Delaware Supreme Court has ruled that, yes, such decisions can subject companies to books-and-records requests.

That opens the door to more such complaints in the future. As a result, boards that keep directors who have tendered their resignation had better be prepared to back up their decisions.

Reder

“The court essentially provided shareholders a new framework for pursuing inspections in the context of a plurality-plus provision,” says Bob Reder, a partner in the law firm Milbank, Tweed, Hadley & McCloy. The increased access to information will give shareholders more leverage to challenge boards that don’t accept the resignations of unpopular directors.

John Grossbauer, a partner in the law firm Potter Anderson & Corroon, says more challenges to boards that decline to accept director resignations under a plurality-plus system are likely on the way. “The fact that the court provided stockholders guidance on how to articulate books-and-records requests in a way that will pass muster suggests that there will be more,” he says.

Section 220 of Delaware General Corporation Law says shareholders can review a company’s books and records if they have proper purpose and the records sought relate to that purpose. Such requests are usually used to obtain a list of stockholders to run a proxy fight; they’re also commonly a precursor to litigation. But shareholders have had a difficult time proving to the courts that they have a “proper purpose” to view the records. The Westland case lowers that threshold in instances where the board declines to accept plurality-plus resignations.

Regan

Bill Regan, a partner at the law firm Katten Muchin Rosenman, says books-and-records requests have grown more important in recent years because courts want plaintiffs to pursue those first, to put “meat on the bones” of a complaint that ultimately winds up in court.

“The court essentially provided shareholders a new framework for pursuing inspections in the context of a plurality plus provision.”

—Bob Reder,

Partner,

Milbank, Tweed, Hadley & McCloy

In Axcelis’ particular case, the board rejected a takeover offer in 2008, and the stock price promptly tanked. Three directors who helped make that decision then failed to win a majority of votes at the next shareholder meeting, but the board refused their resignation offers. Making matters worse, the board had adopted its plurality-plus standard without shareholder approval, at a time when many companies were adopting rules that directors must win an outright majority in uncontested elections.

The bad news for Westland is that it lost its own complaint, first in the Delaware Chancery Court and then on appeal at the Delaware Supreme Court. But Westland only lost because the Delaware Supreme Court ruled that it hadn’t met its evidentiary burden to demonstrate a proper purpose for inspecting Axcelis’ records. The court then went on to give broader guidance about how shareholders could craft other inspection requests that would be permissible, and that is the blueprint other plaintiff lawyers are sure to use in the future.

Held Accountable

The board’s decision to adopt a plurality-plus standard without shareholder input did play a role in the outcome: “Where, as here, the board confers upon itself the power to override an exercised shareholder voting right without prior shareholder approval … the board should be accountable for its exercise of that unilaterally conferred power,” the opinion states. In this case, the court said that to hold the Axcelis board accountable, shareholders had a right to seek inspection of “any documents and other records upon which the board relied in deciding not to accept the tendered resignations.”

SUPREME COURT ANALYSIS

The following excerpt from law firm Milbank, Tweed, Hadley & McCloy provides an explanation of the Supreme Court’s analysis in City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc.:

Proper Purpose—Investigation of Potential Wrongdoing or Mismanagement

In denying Westland’s appeal, the Supreme Court initially discussed the applicable standard of review in a

DGCL §220 books and records case. When asserting a claim under DGCL §220, a shareholder has the burden of

demonstrating a “‘proper purpose’ … that is ‘reasonably related to such person’s interest as a stockholder.’” In this

connection, a “proper purpose” includes the desire on the part of a shareholder to investigate “possible wrongdoing

or mismanagement” on the part of directors. Westland, therefore, had stated a proper purpose.

However, the Supreme Court agreed with the Court of Chancery that a plaintiff must present “some

evidence” to “suggest a credible basis” from which a court could infer the existence of directorial wrongdoing

or mismanagement that would warrant a books and records investigation. A relaxation of the “credible basis”

standard, described by the Supreme Court as the “lowest possible burden of proof,” would “be tantamount to

permitting inspection based on the plaintiff-stockholder’s mere suspicion of wrongdoing.” The Supreme Court

also agreed with the Court of Chancery’s application of the facts, ruling that the Vice Chancellor’s denial of

Westland’s claim “must stand, because the record provides no credible basis to infer that [the board’s actions]

were other than good faith business decisions.”

The Supreme Court next addressed Westland’s contention that the directors’ actions under the plurality plus

policy should be subject to a Blasius review in the context of Westland’s DGCL §220 claim. Westland argued

that, by withholding their votes in the May 2008 director elections and thereby triggering Axcelis’ plurality plus

policy, a majority of Axcelis’ shareholders had expressed their will that the three directors should be removed.

Accordingly, the board’s failure to accept these resignations frustrated that shareholder will and justified a books

and records investigation into the board’s motivations and process. The Supreme Court quickly dismissed this

argument, noting that “it improperly attempts to shift to Axcelis Westland’s burden to establish a ‘proper purpose’

for a Section 220 inspection.”

Source

Milbank Alert on Supreme Court Decision (Sept. 7, 2010)

“The court emphasized that if the plurality-plus policy had been adopted by the stockholders, the decision might have come out differently, so if a board is planning to adopt such a standard, they might want to think about whether to put it up for a shareholder vote,” Grossbauer says.

The opinion also cited Pershing Square v. Ceridian Corp., where the Chancery Court held that investigation of whether a director is suitable for office constitutes a “proper purpose” under Section 220. If enough shareholders withhold their votes from incumbent directors to trigger their resignations under a plurality-plus policy, the court said, that alone can constitute sufficient “credible evidence” of the directors’ unsuitability to warrant a books-and-records inspection.

In other words, according to Reder, “The court essentially said: ‘If you had stated director suitability as your purpose instead, you might’ve gotten this inspection.’”

Regan says the ruling probably won’t discourage companies from adopting plurality-plus provisions, but he says companies that adopt such a policy through a board resolution should be prepared to respond to books-and-records requests if they don’t accept resignations tendered under the policy.

Grossbauer

The decision may also provide shareholder activists with an avenue for gaining access to corporate books and records for use in a future proxy-access fight, Grossbauer warns. Boards need to “build a good record, seek advice, think through their reasons and articulate them in a thoughtful way,” he says. “If a shareholder plaintiff is well-advised, it won’t be as easy for a company to defeat such a request.”

The ruling leaves some questions unanswered. Going forward, Regan says the next fights will be over the scope of inspection requests and which corporate documents relate to the question of director suitability.