Inequitable action does not become permissible simply because legally possible."

Experience has shown that, by merger with another company, or through a competing offer, a "target" can often obtain, for its stockholders, a higher price, or price equivalent, per share than the first offeror is willing to provide. To make the alternative transaction in the face of a raid, management needs capital flexibility and time to act.

03

A potential target must have sufficient securities available to provide for splits in common or issuance of securities in connection with acquisitions. The statute provides for the initial capitalization " and permits amendment of the certificate of incorporation to increase or reclassify authorized common stock. Preferred may be authorized subject to the board's authority to fix the rights and preferences without amendment of the charter." Convertible securities may be created for later use." This is not to say that the manipulation of shares to perpetuate management is encouraged. Only a failure to read the Delaware cases would lead to such a conclusion.

B. ABUSE OF CAPITAL FLEXIBILITY

i. Sale of stock to insiders and increasing authorized shares

Delaware courts have long applied strict fiduciary rules to the purchase and disposition by the corporation of its own securities. More than a half century ago, Chancellor Josiah O. Wolcott wrote:

Directors of a corporation are frequently spoken of as its trustees. Their acts are scanned in the light of those principles which define the relationships existing between trustee and cestui que trust. Tested by these familiar company enough stock to fix themselves in undisputed control of its affairs, is reprehensible."

As recently as March 10, 1976, Vice Chancellor Marvel enjoined a corporation from increasing its authorized shares to eliminate a 50% stockholder from his position." The basis for these rulings are time honored fiduciary principles governing the relationship between directors and stockholders.

Many Delaware cases have declared that efforts to "freeze out" a minority interest are actionable without regard to the fairness of price," and, similarly, an effort to eliminate majority voting control by the issuance of stock without first offering the majority holder the right to buy has been enjoined.""

In Condeo v. Lunkenheimer,' ,100 Vice Chancellor Marvel stated these principles flatly:

... [S]hares may not be issued for an improper purpose such as a takeover of voting control from others....

The converse of the above rule is also established, namely that corporate machinery may not be manipulated so as to injure minority stockholders. In Condec, the target company (Lunkenheimer), in fighting off a takeover, had sought to increase the float of common stock to abort an apparently successful tender offer by "purchasing" an asset from the merger partner whom management wished to "marry". This, the court wrote, "is a case of a stockholder [the offeror] with a contractual right to assert voting control being deprived of such control by what is virtually a corporate legerdemain. Manipulation of this type is not permissible." 101

21 Schnell v. Chris-Craft, 285 A. 2d 437, 439 (Del. Supr. 1971).

92 8 Del. C. § 102(a) (4).

93 8 Del. C. § 242 (a) (3).

48 Del. C. §§ 102(a) (3), 151 (a), and 242 (a).

95 8 Del. C. §§ 151 (e) and 242 (a) (5).

96 Bowen v. Imperial Theatres, Inc., 115 A. 918, 921-22 (Del. Ch. 1922).

97 Chinetti v. Chinetti-Garthwaite Imports, Inc., C. A. 5025, (Del. Ch., filed March 10, 1976).

98 Allaun v. Consolidated Oil, 147 A. 257, 260 (Del. Ch. 1929); Bodell v. General Gas & Elec. Corp., 140 A. 264 (Del. Supr. 1927); Bennett v. Bruil Petroleum Corp., 99 A. 2d 236 (Del. Ch. 1953).

Canada Southern Oils, Ltd. v. Manabi Exploration Co., 96 A. 2d 810, 813-14 (Del. Ch.

1953).

100 230 A. 2d 769, 775 (Del. Ch. 1967).

101 230 A. 2d at 777. At page 775, the Vice Chancellor said: It is a breach of [fiduciary] duty, wholly apart from any consideration of preemptive rights, for directors to make use of the issuance of chares to accomplish an improper purpose, such as to enable a particular person or group to maintain or obtain voting control, against the objection of shareholders from whom control is thereby wrested.

ii. Purchase and redemption of shares

Quite recently on similar principles, Vice Chancellor Brown dealt with the use of corporate funds by management, not to issue more shares, but to redeem on a selective basis certain shares of voting preferred stock held by a member of management in a voting trust.10 The voting trustee and his associates on the board had voting control of the corporation without the use of the trust shares and the trust was to expire in about six months. Upon the expiration of the trust, control would effectively shift away from the trustee and his associates in management and devolve on the beneficial owners of the trusteed shares. To make matters worse, the redemption was selective; that is, the remaining preferred, all of which was held outright by the trustee and another director, was not scheduled for redemption. The Vice Chancellor restrained the redemption: In addition, it is unquestionably Delaware law that the use of corporate funds to purchase corporate shares primarily to maintain management in control is improper. [Citations omitted] Here it appears that redemption of all preferred shares other than those owned by Leslie and Nadeau will assure their continued control of Penntech (even though they may not be under open assault at present) and particularly if it does away with such shares prior to the expiration of the voting trust which present management now controls. Under such circumstances, a selective redemption of a large amount of voting stock which thereby guarantees control in those determining to make the redemption would initially seem no different in result than a purchase of shares with corporate funds to remove a threat to incumbent management policy and control, in which latter case the burden is on the directors to justify the purchase as one primarily in the corporate interest and not their own. [Citation omitted.]

At this juncture, to redeem all other preferred stock, but none of their own, so as to continue their own business incentive and to avoid a possible, but yet unsubstantiated, tax consequence to the other preferred shareholders, does not appear sufficient to carry the day for the present defendants when the various other factors alleged by the plaintiff are considered.108 The Petty court cited Bennett v. Propp as controlling. In Bennett, the target corporation bought its own shares in an effort to thwart a tender offer.105 The Delaware Supreme Court had affirmed a derivative plaintiffs' judgment on behalf of the corporation against two of the directly responsible officers and directors. The Supreme Court stated the proposition in clear terms:

104

Sadacca's purchases were made to preserve the control of the corporation in himself and his fellow directors . . . The use of corporate funds for such a purchase is improper."

108

In the face of the overwhelming authority in the Delaware courts, a management that seeks to abuse the capital flexibility made available by the statute and manipulate its capital, or indeed perform any act in order to stay in office, runs a grave risk not only of having its actions restrained or annulled, but also of paying dearly for the effort.

C. GRANTING TIME TO STOCKHOLDERS AND MANAGEMENT

Many state legislatures have felt that the timing set out in the Williams Act, 100 which permits a tender offer to be made and closed over a ten day period, did not give management time to exercise its fiduciary duty, the stockholders time to consider the worth of the offer, or competitors the time to raise the price. Between 1968 and 1976, eleven states enacted laws to deal with the problem.108 It was widely recognized as a legitimate legislative goal to protect a target's stockholders by giving them sufficient time and information to make a considered

102 Petty v. Pennetch Papers, Inc., 347 A. 2d 140 (Del. Ch. 1975). 103 347 A. 2d at 143.

104 187 A. 2d 405 (Del. Supr. 1962).

105 In the trial court, the Bennett case had been decided by the same Vice Chancellor who had two years before decided Kors v. Carey, 158 A. 2d 135 (Del. Ch. 1960). The Kors case had recognized an exception to the rule, recited also in Cheff v. Mathes, 199 A. 2d 548 (Del. Supr. 1964), in cases where directors reasonably believe that the takeover would be injurious to the company.

108 187 A. 2d at 408.

107 Public Law 90-439; 15 U.S.C. § 78 (d) and (e).

108 Colorado, Hawaii, Idaho, Indiana, Kansas, Minnesota, Nevada, Ohio, South Dakota, Virginia, and Wisconsin.

and knowledgeable decision. However, it has been charged that one of the major purposes of such statutes is to protect entrenched management. The mechanism for such an abuse lies in the hearing on fairness to be held by the state's securities commissioner. Such hearings are frequently protracted and, in most cases, occur before a politically appointed officer who has no love for the out of state officer. In April of 1976, after careful study, Delaware adopted such a law as new Section 203 110 of the General Corporation Law. The official comment accompanying the bill outlines its basic terms and aims:

100

During the past several years a number of public offers to purchase shares of stock in a corporation have been made upon such short notice that the shareholders have not been given ample opportunity to determine if the offer is fair, or to see if some more favorable offer might be made in the auction of an open market. Even management in some instances has not had time to evaluate the fairness of the offer and to determine whether to recommend it to its shareholders, to oppose it, or to take no position. The statute here proposed would require any such offeror to give notice to the corporation of the basic terms of a proposed offer 20 days before it is to open and to keep the offer open for a minimum of 20 days. By providing this minimum period of 40 days, the shareholders will have time to evaluate the offer, and the market place will have an opportunity to react to the offer.

111

Thus, Delaware neither permits the "Saturday Night Special," "2 which favors the underpriced raid, nor does Delaware go to the other extreme and grant management a friendly forum in which to seek to avoid a fair competitive offer for the stockholders' shares.

V. REMEDIES

Delaware offers corporations and stockholders a specialized forum and procedures for the prompt enforcement of their rights. Article IV of the Delaware Constitution of 1897 and Chapter 3 of Title 10, Del.C.Ann., establishes the Delaware Court of Chancery as the separate equity court, with jurisdiction to oversee operations of Delaware corporations and to enforce the General Corporation Law. The court's work gives its judges the experience necessary for informed application of equitable and corporation law principles.

The men who have served as Chancellors and Vice Chancellors have had, almost uniformly, distinguished records of public service." The judges' decisions, cited and quoted above, show their enlightened concern for intra-corporate justice.

Delaware law provides a number of situations where the Court of Chancery is specifically empowered to direct that particular steps be taken to protect stockholder interests. Some of these situations have been discussed previously."

114

100 Such provisions for hearings exist in Hawaii, Idaho, Indiana, Kansas, Minnesota, Ohio. Pennsylvania, South Dakota, Virginia, and Wisconsin; prior to 1976, only Colorado and Nevada did not provide for such a hearing.

110 8 Del. C. 203, effective May 1, 1976.

111 Official Commentary to 203, H.B. 916, 31 March 1976.

112 Among attorneys the shortest offers are drawing the most fire. Despite some recent successes, pressure is building for change. "Called Saturday Night Specials, quickies, or blitzkriegs, these offers run no more than eleven days-including weekends and are designed to take the hostile target by surprise, panic the shareholders into selling, and just barely meet the Williams Act's seven-day minimum time period." Fitzhugh, John, "Cash Tender Offers: Rage and Outrage"; SEC 1976; at page 165, Law Journal Press. 113 Professor Cary attacked Delaware judges generally in an unfortunate ad hominem passage. Cary, Federalism Article, at 690-696. The cases cited in the earlier portion of this review seem to us a better defense to Cary's charges than engaging in the same notoriously dangerous "social jurisprudence"; that is, trying to predict a judge's vote from his personal history. Cary's "history", itself, is superficial, many of the Delaware judges having come from the rural part of the State, e.g., Vice Chancellor Brown and Justice McNeilly; others have risen primarily through extensive service on the courts, not private practice, e.g., Chief Justice Herrman, Justice Duffy and Chancellor Quillen.

1148 Del. C. § 211, "Meetings of Stockholders", supra at pages 1-3; see also Ch. Ct. R. 81 which sets out the procedures for a corporate election held by court order and allows punishment of recalcitrant directors for contempt of court; 8 Del. C. § 220, "Stockholder's Right of Inspection", supra at pages 5-10; 8 Del. C. § 225, "Contested Election of Directors: Proceedings to Determine Validity", supra at page 4; 8 Del. C. $262. "Payment for Stock or Membership of Person Objecting to Merger or Consolidation" [appraisal], supra at pages 27–32.

Other examples of similar significance can be cited.115 Considered together, however, these statutory remedies are only a part of those available to litigant stockholders.

118

117

120

121

119

A stockholder can bring suit in Chancery to enforce individual, class 116 or derivative claim arising under the corporation law. Such suits may seek money damages, or preliminary and permanent injunctive relief, as well as specific performance of statutory or contractual obligations or such other relief as the court finds appropriate. Whatever the relief sought, stockholders' suits receive prompt attention from a judge whose docket is not overly cluttered.12 Sequestration of the defendants' assets provides a unique mechanism to make most defendant directors and officers subject to suit by stockholders in the Court of Chancery. Although they may live and work outside Delaware, if the defendant holds stock in any Delaware corporation, such stock is subject to sequestration at the court's order to compel appearance in answer to a stockholder complaint.123 However, the existence of judicial stockholder litigation machinery does not necessarily assure the protection of minority rights. Rules can be burdensome or expensive. Delaware, unlike some states, does not discourage stockholder litigation by requiring a substantial bond for costs. The rules with respect to pleading and prosecuting class and derivative actions are modeled on the federal rules for maintaining such actions and contain no unusual inhibitions or restrictions. With respect to the requirement that a derivative plaintiff make a prior demand upon the board or fellow shareholders to bring suit, the Delaware rule is so liberal as to make that requirement a virtual nullity."

Compromise or dismissal of stockholder derivative or class litigation is rigidly controlled by the court in order to insure that the non-participating minority is protected. Notice provisions are, if anything, more rigorous than under the federal rules.

The court's role in passing upon proposed compromise of stockholder actions has always been more than cursory. Where an objection is made, the objecting stockholder or class member has a right to reasonable discovery and may conduct an evidentiary hearing with respect to the fairness of the settlement. Proposed settlements in stockholder litigation have been disallowed because of inadequate protection of corporate or minority interests. 125 Even where the objection has been denied, the proceeding or review has resulted in an improvement of the deal for the benefit of minority shareholders. Manacher v. Reynolds 12 for example, an appeal to the Delaware Supreme Court from a Chancery decision that a settlement was fair, was compromised by substantial improvement in the terms of the settlement.

1

Nor has the Court of Chancery been reluctant to award substantial counsel fees, where plaintiffs have been successful in achieving meaningful benefits for

115 8 Del. C. 168, "Judicial Proceedings to Compel Issuance of New Certificate"; 8 Del. C. 223, "Vacancies and Newly Created Directorships"; 8 Del. C. § 226, "Appointment of Custodian or Receiver of Corporation on Deadlock or for Other Cause"; see also Ch. Ct. R. 160; 8 Del. C. § 278, "Continuation of Corporation After Dissolution for Purposes of Suit and Winding up Affairs"; 8 Del. C. § 283, "Revocation or Forfeiture of Charter Proceedings",

116 Ch. Ct. R. 23, "Class Actions".

117 8 Del. C. § 327; Ch. Ct. R. 23.1 "Derivative Actions by Shareholders".

119 E.g., Brophy V. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949), supra note 50 (derivative action to require corporate employee to account to the corporation for profits realized from insider trading).

118 E.g., Gimbel v. Signal Cos. Inc., 316 A.2d 599 (Del. Ch. 1974), supra note 44 (class action by minority stockholder to enjoin sale of stock in wholly owned subsidiary). 120 E.g., Western Airlines, Inc. v. Allegheny Airlines, Inc., 313 A.2d 145 (Del. Ch. 1973) (to compel performance of contractual obligations by successor corporation pursuant to 8 Del. C. § 259).

121 E.g., Baron v. Allied Artists Pictures Corporation, 337 A.2d 653 (Del. Ch. 1975) (to compel payment of dividends on preferred stock and return voting power to common stockholders).

123 Unlike most state and federal courts, the Delaware Court of Chancery remains strictly a court of equity. 10 Del. C. § 341. Delaware's "law" court, the Superior Court. is charged with jurisdiction over such burgeoning areas of litigation as criminal, tort, and domestic relations cases. 10 Del. C. § 541. This makes the Court of Chancery expert in the traditional areas of equity such as trusts, estates and fiduciary relations, as well 123 The Delaware Sequestration Statute. 10 Del. C. § 366, was recently upheld by the Delaware Supreme Court against a constitutional attack raised by defendant directors. The Greyhound Corporation v. Heitner, C.A. No. 132, 1975 (Del. Supr., filed April 15, 1976). 124 Mintz v. Bohen, 210 A.2d 509 (Del. Ch. 1965).

125 See e.g., Steigman v. Beery, 203 A.2d 465 (Ch. 1964).

120 165 A.2d 741 (Del. Ch. 1960).

the minority shareholders or the corporation by judgment or by compromise. Such awards provide real incentive to minority shareholders and their attorneys to challenge questionable corporate transaction.127

Stockholders do, in fact take advantage of such remedies. In 1973 through 1975, 897 actions were filed with the Court in New Castle County. Of those, close to one-third (258) were corporate matters; 63 of which were filed derivatively. Furthermore, 73 sequestration orders were entered by the Court to compel appearances by non-resident defendants. In corporate and other matters, Chancery issued 90 orders granting interlocutory injunctive relief.128

VI. CONCLUSION

We have sought to set out, by illustration from existing cases, statutes and other authorities, the substantial principles underlying Delaware Corporation Law as well as the procedures available for their enforcement.

We will have achieved our purpose if the result is a greater understanding in the reader of these significant features of the law.

Senator HARTKE. Our next witness is Mr. Ralph Nader. Who do you have with you?

STATEMENT OF RALPH NADER, CORPORATE ACCOUNTABILITY RESEARCH GROUP; ACCOMPANIED BY MARK GREEN; AND JOEL SELIGMAN

Mr. NADER. Thank you, Mr. Chairman.

With me is Mark Green and Joel Seligman, who are coauthors with. me of the report constitutionalizing the corporation, a case for Federal chartering of giant corporations.

Thank you for the opportunity to testify this morning on a subject of this hearing and this committee which will, hopefully, initiate the greatest public debate on the role of the giant corporation in American history. This is going to be a lengthy and arduous discussion. There will undoubtedly be numerous days of hearings and deliberations in both Houses of the Congress; and I know no one who has more stamina to conduct such hearings than the present chairman of this hearing today.

I thank you for that interest in this subject.

As you know so well, prior hearings of the Senate Commerce Committee as well as other hearings of other congressional hearings in the last 10 years have documented a wide array of the most serious abuses of corporate power in categories, economic, health, and safety, and in categories political, multinational, and credit.

These abuses need to be viewed in the form of a comprehensive approach to corporate reform. No longer can we expect that each pattern of disclosure can generate its own deterrent power which leads to corrective action. Indeed, that expectation a decade ago was highly speculative to begin with. In the light of a decade's experience, it is quite clear that corporations are invulnerable to what was once considered significant deterrent forces; namely, disclosure, congressional admonition, Government law enforcement, in part because of inade

127 Those who may conclude that, on some statistical basis, the rulings of the Delaware Courts more often favor management than complaining stockholders overlook the fact that defendant management is likely to take to final judgment only those cases in which they believe their position to be strong. Cases in which the exposure to liability is great, or even slightly more than marginal, are frequently resolved by compromise, which results are generally never reflected in reported decisions.

128 These figures and others reflecting the Court's docket are informally maintained pursuant to direction of the Chancellor by the law clerks of the Court of Chancery.