Governance Drafting

Practical Provisions for the Boardroom and Beyond

“Secret”(?) Strategies Still Shelved: Elon Musk’s “Plan B” and Twitter’s Possible “Plan ESG”

Would it not have been both legal and legitimate for Twitter’s board of directors to reject Elon Musk’s acquisition offer, despite the premium that it promises current shareholders, on the grounds that a Musk-controlled Twitter could harm such other stakeholders as. . . . everyone on the planet?

     Many people, including some lawyers, mistakenly assume that a board is legally required to maximize the monetary interests of shareholders.

     In the most notable judicial expression of that idea, the Michigan Supreme Court in 1919 ordered the Ford Motor Company to distribute a special dividend from the company’s extraordinarily large (current, and for the foreseeable future) profits.  The Court, rejecting majority shareholder and president Henry Ford’s purportedly patriotic purposes of creating more jobs at Ford and keeping automobiles affordable, insisted that a corporation is to be “organized and carried on primarily for the profit of the stockholders.”  Dodge v. Ford Motor Co., 170 N.W. 668, 684 (Mich. 1919).

     But even that decision, by using the qualification, “primarily,” allowed boards also to take into account shareholders’ non-monetary interests, as well as to consider the concerns of other parties.     

    Moreover, in their co-authored 2005 law review article, a current and a former member of Delaware’s influential Court of Chancery observed that the Ford holding “was atavistic even at its date of publication,” but remains in law school casebooks only because “there are no other cases that really stand for [that] position.” William T. Allen & Leo E. Strine, Jr., When the Existing Economic Order Deserves a Champion: The Enduring Relevance of Martin Lipton’s Vision of the Corporate Law, 60 Bus. Law. 1383, 1385 n.7 (2005).  

     By contrast, today’s casebooks emphasize that many ESG (environmental, social, and governance) initiatives are entirely compatible with shareholders’ financial interests, such as when they improve employee hiring, morale, and retention, and when they enhance a company’s public image and goodwill.

     Some of these casebooks also note the Delaware Supreme Court’s recognition that a board “may have regard for various constituencies in discharging its responsibilities, provided there are rationally related benefits accruing to the shareholders,” Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 183 (Dec. 1986); and the United States Supreme Court’s acknowledgment that “modern corporate law does not require for-profit corporations to pursue profit at the expense of everything else, and many do not do so,” Burwell v. Hobby Lobby Stores, Inc., 134 S.Ct. 2751, 2771 (2014).

    Indeed, in the specific context of takeovers, the Delaware Supreme Court has held that a target’s board may appropriately consider “the impact of. . . the potential acquisition on other constituencies, provided that it bears some reasonable relationship to general shareholder interests.” Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1282 n.29 (Del. 1989).

     Twitter’s Certificate of Incorporation identifies the company’s purpose as “to engage in any lawful act or activity” permitted to a Delaware corporation.  Its corporate governance guidelines indicate that the board is expected to “act in a manner it reasonably believes to be in the best interests of the Company and its stockholders.”

     The company’s directors were certainly mindful of rising public concern and anger over, and demands for federal regulation of, Twitter’s privately-produced policies, which can increase political polarization; enable the dissemination of misinformation; and lead to mental and emotional, and even physical, harm to some users. 

     In this environment, Musk’s public criticisms of Twitter’s operations, especially his announced intention to radically reduce the company’s efforts (beyond complying with existing laws) to moderate content, could well have justified a conclusion by the board that his control would not be “in the best interests of the Company and its stockholders.”

    In fact, in a very recent interview at TED, Musk himself seemed prepared to subordinate the financial interests of Twitter’s shareholders, instead positioning himself as a champion and defender of “freedom in the world.”

    He claimed that his acquisition offer “is not a way to sort of make money. . . It’s just that I think my strong, intuitive sense is that having a public platform that is maximally trusted and broadly inclusive is extremely important to the future of civilization. . . . I don’t care about the economics at all.” 

     Twelve minutes later, Musk, who in March 2020 kept Tesla’s factory in Fremont, California operating for several days in defiance of local authorities’ pandemic-related closure orders, could not resist the opportunity to publicly revisit one of his disputes with the SEC, and to refer to some of its personnel as “those bastards.”

     None of this could have reassured the directors about the potential for Twitter’s complete regulatory compliance, or constructive relationships with regulators, under Musk’s control.

     If Musk could position his offer as protecting “the future of civilization,” why couldn’t Twitter’s board have justified a rejection of it on that same ground?

     Shortly after insulting the SEC, Musk declined to disclose the “Plan B” that he was preparing to deploy if the board rejected his offer. 

    To bolster the “poison pill” arrangement that the company had already put in place, Twitter’s directors could have easily, and possibly successfully, invoked their own “Plan ESG.”

“This Isn’t an Algebra Book”: On Corporate Governance (3d ed. 2022)

Why did you write this book?

      Years ago, I spent part of one summer reading through a huge stack of casebooks to see if I should add any topics to the supplements that I’d created for my Business Associations course. 

      To me, none of those books focused enough on recent and exciting developments in the relative rights and responsibilities of directors, officers, shareholders, and stakeholders (such as a company’s customers, employees, and suppliers). 

     At the same time, I thought that combining a traditional casebook with aspects of a guidebook, workbook, and sourcebook would be useful not only to law and business students, but also to executives and shareholders and their counsel.

   The book, which I believe was the very first casebook on the law of corporate governance, was published in 2010; and the second edition, in 2013.

What approach does the book take?

     From the beginning, and more in each successive edition, the book identifies hundreds of practical issues facing boards, and emphasizes specific processes and careful drafting to resolve, minimize, or even preclude problems and potential personal liability.

     Some of those concerns aren’t complex or esoteric, but still worth addressing in advance. 

     For example: should a board have a blanket rule that (or even a procedure for determining when) directors can’t take notes during board meetings, or must shred their notes before leaving the boardroom?  Creating that policy during a crisis would certainly look suspicious.

     This isn’t an algebra book, with numerical answers in the back.  There probably can’t be a one-size-fits-all answer to most of its questions, but talking through how to answer them should give any board the opportunity to refine and clarify its own processes, and to bring up related issues for discussion. 

     Of particular relevance to shareholders and stakeholders, and their advocates and activists, are the materials concerning mechanisms for introducing and implementing ESG (environmental, social and governance) initiatives, like enhancing board diversity and advancing shareholder proposals.

Why did you change the book’s title for this edition?

     I added the word, “Provisions” to reflect an even greater emphasis on the use and techniques of drafting, particularly for elements of a company’s articles of incorporation, bylaws, committee charters, and governance guidelines.  As in the second edition, there’s a checklist summarizing considerations for drafting those core corporate documents.

    The book and its new online supplement (because there’s now more content than can easily fit between two covers) include, separated graphically from other text, illustrative composite provisions based on those in the governance documents of major corporations. 

What else has been added?

    Citations to hundreds of legal decisions, as well as discussions of: the new outspokenness of CEOs on social justice concerns; the board’s responsibility for cybersecurity and compliance; “executive sessions” of the board; developing rules of conduct for board and shareholder meetings; emergency bylaws; advisory boards; advisory directors, emeritus directors, honorary directors, board observers, and “executive chairs”’; the “financial literacy” requirement for directors; disclosure to, and voting by, shareholders on executive compensation arrangements; “refreshing” the board through age and term limits for directors; and bylaw provisions relating to forum selection, fee-shifting, and mandatory arbitration.

      Discussions of virtual meetings, and of “social enterprises” such as benefit corporations and Certified B Corporations, have been updated.  And, there are more detailed references to the specific governance practices required by the NYSE and Nasdaq exchanges, as well as to those preferred by institutional investors like TIAA and CalPERS, and by proxy advisors like ISS and Glass Lewis.

    I’ve also indicated ten good reasons why (although it sounds intrusive) boards might want to bar their directors from dating each other.

     Law and business students, practitioners, and executives should find of special interest the appendices, which include a detailed discussion of how to present “actionable” advice to decision-makers, a list of recommended reading for new and current directors, and a completely updated list of governance-related Web sites.    

How would you sum up the book’s evolution, over twelve years and three editions?

     I think it’s become steadily clearer to everyone, both inside and outside the boardroom, that the art and science of being a successful director require an ongoing commitment to institutional and personal education.

    Today, the roles and decision-making responsibilities of directors are more complex than ever before. 

     Amid public and private pressures for greater transparency and accountability, directors must harmonize, or at least balance, the interests of different groups of shareholders and of stakeholders. They oversee the company’s compliance with increasingly complex and connected levels of state and federal statutes, regulations, and court decisions, and with the requirements of stock exchanges.

    As a result, boards are devoting even more attention to “on-boarding” presentations for their new directors, and to continuing education programs for all of their members.  (One appendix contains a variety of suggestions for constructing these.)

   In their personal reading, many directors, potential directors, shareholders, and stakeholders and their counsel are seeking accessible and action-oriented materials to help them participate effectively in resolving the latest issues in the systems, structures, and strategies of corporate governance.

   I designed and developed Corporate Governance: Principles, Practices and Provisions not just for the law school classroom but also as a practical resource for all of those readers. I hope that everyone finds it useful.


On September 24, 2021, the Supreme Court of Delaware, in a unanimous en banc decision, connected, consolidated, and clarified crucial components of corporate counseling.

     The power to bring suit in the name of the corporation against directors or officers has traditionally been regarded as a prerogative of the board.  For this reason, and to forestall a flood of possibly-ungrounded litigation, courts are normally reluctant to allow a shareholder to bypass the board entirely and file a “shareholder derivative” suit without first making a “demand” on the board to examine, investigate, and possibly initiate litigation itself.

     Thus, Rule 23.1 of Delaware’s Court of Chancery requires a shareholder filing a derivative lawsuit to “allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.”

     In United Food and Commercial Workers Union v. Zuckerberg, — A.3d –, 2021 WL 4344361 (Del.) (“Zuckerberg”) (download pdf), Delaware’s Justices adopted the three-part test enunciated in the same litigation by the Court of Chancery, 250 A.3d 862, 890 (Del. Ch. 2020), to define situations of “demand futility,” which justify a shareholder’s instituting a derivative lawsuit without alerting or consulting the board. (Accordingly, it affirmed the lower court’s holding that demand on Facebook’s board had not been excused.)

    This “universal test,” like its predecessors, requires the shareholder to show that, had a demand been made, a majority of the board could not have been trusted to evaluate and respond to it appropriately.  As the Chancery Court put it, “To determine whether a board of directors could properly consider a demand, a court counts heads. If the board lacks a majority of directors who could exercise independent and disinterested judgment regarding a demand, then demand is futile.”  250 A.3d at 877.

      In the process, the Delaware Supreme Court adjusted the interactions among (but did not overrule) its own, now-overlapping and -outdated, precedents from 1984, 1993, and 2015, in light of the exculpation-enabling provision that had been added to the Delaware General Corporation Law (DGCL) in 1995. 

      As the Court acknowledged, “[C]hanges in the law have eroded the ground upon which that framework [of caselaw] rested.  Those changes cannot be ignored, and it is both appropriate and necessary that the common law evolve in an orderly fashion to incorporate those developments.” Zuckerberg, at *16.

● Significance of Demand Futility

     Once a shareholder has convinced a Delaware court that demand was “futile” (or, “excused”), both parts of the test governing the board’s (or its special litigation committee’s) motion to dismiss the suit reverse mainstay, and markedly management-friendly, principles of corporate jurisprudence.  Zapata Corp. v. Maldonado, 430 A.2d 779, 789 (Del. 1981).

          ● First, although the usual standard of the “business judgment rule” creates a presumption that directors have fulfilled their duties of care and loyalty (which a plaintiff must overcome by showing particularized facts raising reasonable doubt in this regard), because in a demand futile situation the shareholder has had to incite the court’s suspicions of the directors’ motives and decision-making, it is now the board that bears the burden of demonstrating that its motion to dismiss is in the company’s best interest

      But even if the board carefully documents the independence of the members of the special litigation committee that it created to assess the merits of the lawsuit, and the diligence with which those directors reached the conclusion that the lawsuit should be dismissed, it must overcome Zapata’s second, and generally unpredictable, step:

            ● Under the second step, the court—which in most other contexts defers to the directors’ management expertise, particularly with regard to financial matters—“should determine, applying its own independent business judgment, whether the motion should be granted. This means, of course, that instances could arise where a committee can establish its independence and sound bases for its good faith decisions and still have the corporation’s motion denied. . . . The Court of Chancery should, when appropriate, give special consideration to matters of law and public policy in addition to the corporation’s best interests. ”  Id. (emphasis added).

     As the Chancery Court has recognized, “[I]t is unusual for the Court of Chancery to apply the second prong of the Zapata standard,” In re WeWork Litigation, 250 A.3d 976, 1013 (Del. Ch. 2020), which it elsewhere characterized as a “conceptually difficult step” that “it is difficult to rationalize in principle; but it must have been designed to offer protection for cases in which, while the court could not consciously determine on the first leg of the analysis that there was no want of independence or good faith, it nevertheless ‘felt’ that the result reached was ‘irrational’ or ‘egregious’ or some other such extreme word.”  Carlton Investments v. TLC Beatrice Holdings Int’l Holdings, Inc.,  1997 WL 305829 (Del. Ch.), at *2.

● Digression: Zapata and the “Enhanced Scrutiny” Standard

    The Chancery Court has also noted “practitioner concern about the reasonableness analysis” in Zapata’s second prong, “which marked the Delaware Supreme Court’s first deployment of something akin to the two-step standard of review that later emerged as enhanced scrutiny.”  In re EZCORP, Inc. Consulting Agreement Derivative Litigation, 2016 WL 301245, at *27.   The Chancery Court’s decision in Zuckerberg acknowledged that “The development of enhanced scrutiny can be traced to Zapata. . . .”  250 A.3d at 881 n.9.

     As Delaware’s “’intermediate standard of review’”—between the deferential business judgment rule and the strict “entire fairness” standard (under which directors who had an actual conflict of interest with regard to a transaction, such as in some situations involving a controlling shareholder’s self-dealing, must satisfy the court that both the process and the terms of that transaction were objectively fair)—enhanced scrutiny “governs ‘specific, recurring, and readily identifiable situations [such as mergers or acquisitions of their company] involving potential conflicts of interest where the realities of the decisionmaking context can subtly undermine the decisions of even independent and disinterested directors,’ [and] requires that the [directors] ‘bear the burden of persuasion to show that their motivations were proper and not selfish’ and that ‘their actions were reasonable in relation to their legitimate objective.’”  Firefighters’ Pension System of the City of Kansas City, Missouri Trust v. Presidio, Inc., 251 A.3d 212, 249 (Del. Ch. 2021) (citations omitted).

     The Delaware Supreme Court held in 2015 that no matter which of these three standards of review applied to a particular situation, a shareholder derivative suit seeking monetary damages from directors who are protected by an exculpation provision in the company’s articles of incorporation “must plead non-exculpated claims [i.e., breaches of the duty of loyalty] to survive [the board’s] motion to dismiss.”  In re Cornerstone Therapeutics Inc. Shareholder Litigation, 115 A.3d 1173, 1175-76 (Del. 2015).

● Factual Background

      The decision in Zuckerberg resolved an issue that arose from the Facebook board’s approval in 2016, on the recommendation of a special committee of the board, of a stock reclassification proposed by Chair and CEO Mark Zuckerberg, to enable him to maintain his voting control while selling some of his Facebook stock to fund his philanthropic pursuits. 

     Thirteen separate actions brought by shareholders to challenge this initiative were collected as one class action by the Chancery Court.  Before trial, and at Zuckerberg’s request, the company abandoned the stock plan.

      Then, without making a demand on the board, the United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund (“Tri-State”) filed a shareholder derivative action with the Chancery Court, seeking judgments against the directors personally, both for Facebook’s costs (more than $20 million) of defending the plan, and for the legal fees (more than $68 million) that Facebook had paid, under the corporate benefit doctrine, to counsel for the class action plaintiffs.

● Legal Background

      Facebook and the directors moved to dismiss the derivative suit, on the grounds that Tri-State had not satisfied the demand futility requirements of either Aronson v. Lewis, 473 A.2d 805, 814 (Del. 1984), or Rales v. Blasband, 634 A.2d 927, 934 (Del. 1993).

     Both of those decisions were decided after (and created specific pleading paths for shareholders to invite the Chancery Court to invoke) Zapata; and, both effectively require the shareholder to overcome the business judgment rule’s presumption that, had she actually made a demand, the directors would have, in determing whether to pursue legal action against company executives, fulfilled their fiduciary duties of care and loyalty to the company.

    Central to this inquiry is whether a majority of the directors are independent—that is, whether their judgment is, would be, or would have been compromised by a personal interest in the challenged transaction; by a personal connection to a someone who did have such a personal interest; and/or by the possibility of their significant personal liability for their role in, and/or (including negligence) in approving, the challenged transaction.  Buckley Family Trust v. McCleary, 2020 WL 1522549 (Del. Ch.), at *9.

● The Effect of Exculpation Provisions

     The last of these three elements of independence posed particular concerns in light of the 1986 addition to the Delaware General Corporation Law (DGCL) of Section 102(b)(7), in the Delaware Legislature’s swift response to the state Supreme Court’s groundbreaking imposition of personal liability on respected corporate directors for breaching their duty of care, in Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985). 

     That subsection enabled companies to add to their articles of incorporation exculpation provisions such as the one that Facebook subsequently installed: “To the fullest extent permitted by law, no director of the corporation shall be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director.”  Zuckerberg, at *9 n.120.

     Notably, Section 102(b)(7) appears to allow directors to be exculpated from liability only for breaches of their duty of care to the company.  It specifically negates any attempt to “eliminate or limit” directors’ liability for breaches of their “duty of loyalty”; “for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; or, “for any transaction from which the director derived an improper personal benefit.” 

   (In response, shareholder derivative suits reframed as breaches of the duty of loyalty, or of the obligation of good faith, some claims that might once have been seen as violations of the directors’ duty of care, including directors’ failure to monitor corporate operations and react to “red flags.”  See In re Caremark International. Inc. Derivative Litigation, 698 A.2d 959, 970 (Del. Ch. 1996) (concluding that “a director’s obligation includes a duty to attempt in good faith to assure that a corporate information and [compliance] reporting system, which the board concludes is adequate, exists”); Stone v. Ritter, 911 A.2d 362 (Del. 2006) (holding that the obligation of good faith is not a free-standing ground for liability, but instead an element of the duty of loyalty).

    In Zuckerberg, the Court considered: If directors would not face personal liability for their alleged misconduct because it would be covered by an exculpation provision, could they be seen as independent for purposes of the Aronson test?  If so, it would be more difficult for shareholders to plead that demand on the board would have been futile.

● The Aronson Test for Demand Futility

      Under the two “prongs,” or alternatives, of Aronson, if a majority of the board was not replaced between the alleged misconduct and a shareholder’s filing a derivative suit, the shareholder must, by offering particularized facts, create a reasonable doubt that “(1) [a majority of] the directors are disinterested and independent[,] [or] (2) the challenged transaction was otherwise the product of a valid business judgment.”  Zuckerberg, at *7, quoting 473 A.2d at 814.  

      The second option could involve allegations that directors had breached their duty of loyalty (including its component of good faith).  For instance, the Chancery Court found that this prong would encompass situations in which the plaintiff could produce particularized facts “’. . .  sufficient to raise (1) a reason to doubt that the action was taken honestly and in good faith or (2) a reason to doubt that the board was adequately informed in making the decision,” including directors’ intentional violations of law, intentionally acting for a purpose other than the corporation’s best interests, or intentionally failing to fulfill a known duty to act.  Lenois v. Lawal, 2017 WL 5289611, at *10 (Del. Ch.) (citations omitted).

     The second prong might also (or only) encompass situations of alleged breach of the duty of care, such the board’s approval (as in Aronson) of an alleged waste of corporate assets, the potential personal liability for which would have rendered those directors unable to respond without bias to a demand.  

     Whether loyalty and/or care grounds the complaint, the Aronson Court observed that although “the mere threat of personal liability for approving a questioned transaction, standing alone, is insufficient to challenge either the independence or disinterestedness of directors, . . . in rare cases a transaction may be so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of liability therefore exists [for directors]” that would excuse the plaintiff’s failure to have made a demand on the board.  473 A.2d at 815 (emphasis added).

     Aronson also mentioned in passing that “if this is an ‘interested’ director transaction, such that the business judgment rule is inapplicable to the board majority approving the transaction, then. . . futility of demand has been established by any objective or subjective standard,” although it acknowledged that “drawing the line at [the disinterestedness and independence of] a majority of the board may be an arguably arbitrary dividing point.”  Id. at 815 and 815 n.8.

     The Chancery Court later elaborated that, “A decision approved by at least half of the corporation’s directors who would consider a demand, even when acting by committee, can be imputed to the entire board and thus triggers the Aronson test. . . . ”  Teamsters Union 25 Health Services & Insurance Plan v Baiera, 119 A.3d 44, 56 (Del. Ch. 2015). 

● The Rales Test for Demand Futility

      The non-independence of a majority of the board is even more explicitly stated in the Rales test, of which the Zuckerberg Court considered Aronson a “special application.”  Zuckerberg, at *7. 

     Although the Chancery Court had previously “commented on many occasions that the Aronson and Rales tests look different but they essentially cover the same ground,” Buckley Family Trust v. McCleary, 2020 WL 1522549 (Del. Ch.), at *9, it had also observed that “Delaware law has evolved to recognize Rales as the ‘general’ and ‘overarching test for futility,’” noting that “Aronson has been regarded as Rales’s narrower and circumstance-specific sister test. . . .”  Gottlieb v. Duskin, 2020 WL 6821613 (Del. Ch.), at *4.

     The Rales test applies when “the board that would be considering the demand did not make a business decision which is being challenged in the derivative suit.  This situation would arise in three principal scenarios: (1) where a business decision was made by the board of a company, but a majority of the directors making the decision have been replaced; (2) where the subject of the derivative suit is not a business decision of the board; and (3) where. . . the decision being challenged was made by the board of a different corporation.”  634 A.2d at 933-934.

     It also applies “where a derivative plaintiff challenges a decision approved by a board committee consisting of less than half of the directors who would have considered a demand, had one been made.” Teamsters Union 25 Health Services & Insurance 119 A.3d at 56-57.

      In any of those cases, the particularized facts in the shareholder’s complaint must create a “reasonable doubt that, as of the time the complaint is filed,” a majority of the board “could have properly exercised its independent and disinterested business judgment in responding to a demand.”  634 A.2d at 934.

     Referring to the second of its three numbered situations, the Rales Court specifically noted that, “The Board did not approve the transaction which is being challenged. . .  In fact, the . . .  directors have made no decision relating to the subject of this derivative suit. Where there is no conscious decision by directors to act or refrain from acting, the business judgment rule has no application.”   Thus, the second prong of the Aronson test (concerning whether the transaction was the product of the board’s “valid business judgment”) was also inapplicable.  634 A.2d at 933.

      (In 1934, Ogden Nash’s “Portrait of the Artist as a Prematurely Old Man” concluded,   “[T]he suitable things you didn’t do give you a lot more trouble than the unsuitable things you did./ The moral is that it is probably better not to sin at all, but if some kind of sin you must be pursuing,/ Well, remember to do it by doing rather than by not doing.”)

     Effectively, Rales requires the shareholder to satisfy the first prong of the Aronson test (i.e., to contest the independence and disinterestedness of directors) with regard to a majority of the board at the time the shareholder instituted her derivative lawsuit.

●  Decoupling “Valid Business Judgment” from the Possibility of Personal Liability

     Before the Delaware Supreme Court, Facebook’s directors argued that, even if the shareholder could meet the second prong of the Aronson test (“the transaction was [not] the product of a valid business judgment”), demand should not be excused because the company’s exculpation provision insulated them from personal liability, thereby preserving the impartiality with which they could have considered a demand.

     Yet Tri-State asserted that the “valid business judgment” criterion should be applied without regard to the directors’ potential liability (or exculpation).

     The Court suggested that the second prong of the Aronson test, which it had enunciated eleven years before Section 102(b)(7) had been added to the DGCL, “used the [‘valid business judgment’] standard of review as a proxy for whether the board could impartially consider a litigation demand,” because at the time that decision had been issued, “rebutting the business judgment rule through allegations of [duty of] care violations exposed directors to a substantial likelihood of liability,” and, “It is reasonable to doubt that a director would be willing to take that personal risk.”  Zuckerberg, at *10.

      On the other hand, if the shareholder could not satisfy the second prong of Aronson by showing a breach either of the duty of care or of the duty of loyalty, the business judgment rule’s protective presumption would remain, so that “allowing the derivative litigation to go forward would expose the directors to a minimal threat of liability.”  Because the directors would thus be considered capable of impartially evaluating a demand, the situation would not qualify as “demand futile”: the shareholder would be required to make such a demand, rather than filing her complaint.  Id. 

     Thus, after reviewing Court of Chancery decisions addressing the application of this prong to shareholder derivative suits involving claims for which directors would be exculpated from liability under Section 102(b)(7), the Delaware Supreme Court affirmed the lower court’s decision in Zuckerberg, which had held that demand is not excused in such situations. 

      That is, “[E]xculpated care violations no longer pose a sufficient threat to excuse demand under the second prong of the Aronson test.  Rather, the second prong requires particularized allegations raising a reasonable doubt that a majority of the demand board is subject to a sterilizing influence because directors face a substantial likelihood of liability for engaging in the conduct that the derivative claim challenges.”  Id. at *15.

●  The New, “Universal” Test for Demand Futility

     In place of Aronson and Rales, the Zuckerberg Court adopted as a new “universal test for assessing whether demand should be excused as futile,” the three-factor test, involving the assessment of the board on a “director-by-director basis,” id. at *17, that had been enunciated by the Court of Chancery:

      “If the answer to any of the [following] questions is ‘yes’ for at least half of the members of the demand board [i.e., the board as of the time the shareholder filed her suit, as opposed to the directors in place when the alleged misconduct occurred], then demand is excused as futile.” 

     ● (1) whether the director received a material personal benefit from the alleged misconduct that is the subject of the litigation demand;

     ● (2) whether the director would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand; and

     ● (3) whether the director lacks independence from someone who received a material personal benefit from the alleged misconduct that is the subject of the litigation demand or who would face a substantial likelihood of liability on any of the claims that are the subject of the litigation demand.  Id.

    The Zuckerberg test’s focus on the independence of the “demand board” avoids not only problems of how to treat directors who had abstained from the board’s vote to approve alleged misconduct, but also questions of whether to apply the Aronson test rather than the Rales test to  directors who joined the board after the alleged misconduct had occurred.

     By the time the Delaware Supreme Court issued its decision in Zuckerberg, the Chancery Court had already applied its own test to resolve another situation, in which the parties disagreed over whether the Aronson test or the Rales test applied: there, the Chancery court had noted that its third option “distills key questions necessary to resolve demand futility under both tests.”  Berteau v. Glazek, 2021 WL 2711678 (Del. Ch.), at *25-26.

● Interpretations and Implications

            ● Definitional Concerns.  The crucial terms of the Zuckerberg test—“material personal benefit” (not necessarily limited to financial gain, but possibly including favors, sexual or otherwise) and “substantial likelihood of liability,” are undefined.

      In fact, although Aronson’s illustration of a “substantial likelihood of liability” was a “rare” situation in which a transaction is “so egregious on its face that board approval cannot meet the test of business judgment,” 473 A.2d at 815, Rales had held that, for purposes of impugning a director’s independence, must only “make a threshold showing, through the allegation of particularized facts, that [its] claims have some merit.”  634 A.2d at 984.

      Moreover, courts are still grappling from case to fact-sensitive case to enunciate the elements and degree of interpersonal connections that would compromise a director’s independence generally, and/or her disinterestedness with regard to a particular transaction.

           ● The Extent of Exculpation.  It is unclear whether a director whose conduct, though legal, has involved her assumption of extreme and unnecessary physical or mental risks, or has embarrassed the company (perhaps by generating a controversy that causes, or threatens to cause, boycotts of the company’s products or services), has breached a non-exculpable duty of loyalty.  If so, the director could be subject to personal liability, and would not be regarded as independent for purposes of a demand futility analysis.

Factor 2 Not Redundant.  As the Delaware Supreme Court indicated, its new test de-emphasizes Aronson’s second prong, although a director’s potential personal liability for the challenged transaction remains relevant to his ability to respond appropriately to a demand, under Zuckerberg’s Factor 2.  Zuckerberg, at *16.

     If a company’s articles of incorporation contain exculpation provisions, a director would be effectively immunized from personal liability for everything but a breach of the duty of loyalty.  In that case, Zuckerberg’s Factor 2 could be satisfied only by challenging his conduct, including his approval of a transaction, on the grounds of his alleged breach of loyalty (or, good faith).

     However, if a director had violated his duty of loyalty by approving a particular transaction, would he not also have violated one or both of Factor 1 (receiving a material personal benefit) and Factor 3 (being closely connected to someone who received such a benefit, or who faced a substantial likelihood of liability with regard to the transaction)?

     In other words, is Factor 2 a redundant portion of the Zuckerberg test for demand futility?

     Not necessarily, if the loyalty breach relates to a director’s “duty to monitor” (or, “duty of attention”) under Caremark and Stone, as discussed above.  A director could have neglected to ensure the installation of even a basic monitoring system, and/or failed to heed its warning(s), without receiving an improper personal benefit, or being connected to someone who did.

     Yet such cases are not common: the Court of Chancery recognized in Caremark that its “test of liability—lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight—is quite high,” 698 A.2d at 971, and characterized such a cause of action as “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.”  Id. at 967.

            ● Factor 3, and Eligibility for Exculpation.  When examining whether a director lacks independence from someone who. . . would face a substantial likelihood of liability,” the court would presumably review that director’s personal connections to any officers accused who had been accused of misconduct by the shareholder, because, unlike directors, officers have generally not been seen as eligible for exculpation, and would thus remain potentially liable for their own involvement.  See Gantler v. Stephens, 965 A.2d 695, 709 n.37 (“Although legislatively possible, there currently is no statutory provision authorizing comparable [to Section 102(b)(7)] exculpation of corporate officers.”).

          ●  Factors 2 and 3, and the Possibility of Indemnification (and/or Insurance).  Although not only directors but also officers may be indemnified by the corporation for personal liability, DGCL 145(a) provides that this relief can only be made available to someone who fulfilled the duty of loyalty, by “act[ing] in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person’s conduct was unlawful.”

     However, even if indemnification, like exculpation, could negate the “substantial likelihood of liability,” it might not be available for some breaches of the duty of care, so directors (and officers) might still be potentially liable for their involvement (or negligent non-involvement, as the case might be) in a particular transaction or situation, complicating a shareholder’s effort to establish that the situation was demand-futile.

    A similar analysis would probably apply to the availability of any directors’ and officers’ (D&O) insurance secured by the corporation or the executives themselves, which would probably contain the same exclusions (and perhaps others as well).


     Among fictional law firms, perhaps the ultimate illustration of Robert De Niro’s observation that “Everyone has their own mishegoss” (Yiddish: craziness/ eccentricity/ peculiarity) was Boston’s Cage & Fish, the setting of the 1997-2002 Fox television series, Ally McBeal.    

    Objections that the show undermined the perception of female professionals and professionalism led to a 1998 Time magazine cover, “Is Feminism Dead?”, featuring images of Susan B. Anthony, Betty Friedan, Gloria Steinem, and Calista Flockhart’s McBeal.

    The firm’s most egregious violator of social, cultural, and legal standards, name partner Richard Fish (Greg Germann), habitually and breezily (and, often, successfully) declared, “Bygones,” when attempting to dispel, or forestall, outrage over his remarks.  

    Under what circumstances can a board of directors, charged with monitoring a corporation’s performance and compliance, similarly set aside its (and shareholders’) concerns, misgivings, umbrage, and even fury, and justifiably decide not to pursue current and/or former directors and/or officers for corporate damages attributed to the executives’ alleged—or even well-documented— breaches of fiduciary duty?

●  The Larger Context of Responding to Shareholders’ Demands and Derivative Lawsuits

     Courts have dismissed shareholder derivative lawsuits when, even if the pleadings’ allegations of past misconduct could be substantiated, a board and/or its special litigation committee (SLC) determined, in their “sound business judgment” (which is presumed, under the business judgment rule), that “the best interests of the corporation” would not be served by allowing the litigation to continue.  Gall v. Exxon Corp., 418 F. Supp. 508, 518-519 (S.D.N.Y. 1976) (involving executives’ alleged bribery of Italian politicians).

    Directors, in deliberating whether the corporation should move for the dismissal of an existing derivative lawsuit, are entitled to consider the “unfavorable prospects for success of the litigation, the cost of conducting the litigation, interruption of corporate business affairs and the undermining of personnel morale.”  Id. at 514 n.13.

     See also In re Primedia, Inc. Shareholders Litigation, 67 A.3d 455, 472 (Del. Ch. 2013) (observing that because the court had “evaluated the risk-adjusted recovery as ‘low,’ it fell within a range of reasonableness for the SLC to recommend [dismissal], rather than imposing upon Primedia the time, expense, and distraction of litigation”); London v. Tyrrell, 2010 WL 877528 (Del. Ch.), at *10 (noting, before criticizing the SLC’s report and denying the company’s motion to dismiss, the SLC’s arguments that discovery “will be extremely disruptive to [the Company’s] operations,” and that “negative publicity associated with the suit will immediately damage the Company’s goodwill and reputation in the government contracting community”); and Kaplan v. Wyatt, 484 A.2d 501, 520 (Del. Ch. 1984) (concluding that two claims “do not appear to be matters of sufficient substance to warrant further protracted litigation and disruption of corporate affairs”).

● Application to Officers’ Departures

     Similar concerns (which might suggest analogies to efforts to terminate a personal relationship quietly and neatly) are implicated by shareholder challenges to a board’s severance awards to, and/or separation agreements with, senior officers.

     For instance, in its September 7, 2021 decision rejecting Boeing’s motion to dismiss a shareholder lawsuit against directors for damages suffered by the company as the result of two crashes of its 737 MAX planes, the Delaware Court of Chancery did grant the director defendants one victory. 

     The Court dismissed, for failure to plead particularized facts, claims that the directors had wasted corporate assets, and/or had acted in bad faith, by allowing Dennis A. Muilenburg, the company’s CEO and Chairman, to (in the Court’s summary) “receive unvested equity-based compensation in a quiet retirement, despite knowing that he misled the FAA and the Board, and failed in his response” to the crashes.  In re Boeing Company Derivative Litigation, 2021 WL 4059934 (Del. Ch.), at *35.

     De Niro, as Goodfellas’ mobster Jimmy Conway, identified to teenage protégé Henry Hill “the two greatest things in life: Never rat on your friends, and, Always keep your mouth shut.”  Yet although the shareholders “theorize the Board bought Muilenburg’s silence because he knew the depth of the Board’s ignorance about the 737 MAX,” the Court found that “nothing in the [discovery] production gives rise to the reasonable inference that Muilenburg intended to retaliate against the Board by placing the blame at its feet.” Id. 

     Moreover, “it is reasonable to infer that the Board was validly exercising its business judgment when it decided to allow Muilenburg to retire with compensation.  At that time, Boeing was facing substantial backlash and had spent millions of dollars addressing the 737 MAX corporate trauma.  Even accepting as true that the Board allowed Muilenburg to go quietly and with full pockets to avoid further public criticism, it is reasonable to infer that doing so was in furtherance of the legitimate business objective of avoiding further reputational and financial harm to the Company.”  Id. at 36.

     Such reasoning has protected other boards against challenges to financial arrangements that they had approved for departing executives.  As the Chancery Court (foot)noted, id. at *36 n.341, it had upheld a board’s decision to settle with a CEO instead of firing him for cause, which “could have embroiled the Company in an embarrassing legal battle with its former CEO.”  Shabbouei v. Potdevin, 2020 WL 1609177 (Del. Ch.), at *12. 

      The Court had also indicated, in examining practices for awarding bonuses to executives, the importance of “ensuring a smooth and harmonious transfer of power, securing a good relationship with the retiring employee, preventing future embarrassing disclosure and lawsuits, and so on.”  Seinfeld v. Slager, 2012 WL 2501105 (Del. Ch.), at *6.  (Later in Goodfellas, Conway and mob boss Paul Cicero (Paul Sorvino) even ordered the now-adult Henry Hill (Ray Liotta) to return to his wife, Karen (Lorraine Bracco), because their marital discord endangered the group’s criminal activities.)

     In decisions not cited in the Boeing opinion the Court had, in rejecting a shareholder challenge to executives’ separation agreements, observed that the complaint “fails to address other relevant factors considered by the Special Committee and Subcommittee when rejecting the demand, [including] ‘concern of disruption to or distraction from the business,. . . .’” City of Tamarac Firefighters’ Pension Trust Fund v. Corvi, 2019 WL 549938 (Del. Ch.), at *10; and had emphasized that “[s]everance agreements can be used to ensure cooperation from executives or to secure other benefits.”  Friedman v. Dolan, 2015 WL 4040806 (Del. Ch.), at *8.

     For instance, Hewlett-Packard’s departing CEO Mark Hurd had “agreed: (1) to extend certain confidentiality agreements; (2) not to disparage the Company; (3) to cooperate, among other things, ‘with respect to transition and succession matters’’ and (4) to release all claims he had against the Company.”  Zucker v. Andreessen, 2012 WL 2366448 (Del. Ch.), at *8.

    Although that board might well have been able, if it had terminated Hurd for cause and thereby denied him a severance payment, to defeat his anticipated litigation, “the Company would need to incur considerable costs of time, resources, and negative publicity in the interim.”  Id.  In addition, the severance award itself might have ensured the unanimity of the directors in terminating Hurd, which “may have been valuable to HP from an investor-relations standpoint”; and, denying the payment “could have undermined [the Board’s] efforts to attract outside executive talent” to replace Hurd as CEO.  Id. at *9.

    Most notably, the Court had found that the directors of The Walt Disney Company had not breached their fiduciary duties by awarding departing president Michael Ovitz the large amount of severance called for by his employment agreement, because “terminat[ing] Ovitz for good cause [would have] exposed Disney to the risk and expense of a protracted court battle” (or, some might say, could have “made a scene”).  In re The Walt Disney Company Derivative Litigation, 731 A.2d 342, 264 (Del. Ch. 1998), aff’d sub nom. Brehm v. Eisner, 746 A.2d 244 (Del. 2000).

     In short, directors can legitimately decide not to make, or invite, a (state or) “federal case” out of their efforts to remove an executive.

     In any event, the board might not want a former officer to end up believing that, as De Niro’s Conway judiciously (and with diplomatic restraint) pointed out, after witnessing a volatile confrontation, “You insulted him, a little bit. . . You got a little out of order, yourself.”


     On September 7, 2021, Delaware’s Court of Chancery rejected a motion by The Boeing Company (“Boeing”) to dismiss a shareholder derivative lawsuit against its directors for billions of dollars of damages suffered by the company as the result of the directors’ alleged failure to oversee the design, production, and remediation of the firm’s 737 MAX airplane.

     That airplane model was announced by the company in 2011 and delivered to airlines beginning in 2017.  In October 2018, one of those planes crashed in the Java Sea; in March 2019, another crashed in Ethiopia.  All passengers and crew of both planes—a total of 346 people—were killed.

     The 102-(double-spaced)-page opinion (download), whose especially clear and simple recitation of facts and exposition of law suggest that the Court anticipated a readership well beyond the business bar, connected cornerstones for corporate counsel: Rales v. Blasband, 634 A.2d 927 (Del. 1993), and In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996), as applied in Marchand v. Barnhill, 212 A.3d 805 (Del. 2019).

     Under Rales, a shareholder may institute a suit in the name of the corporation without first alerting the board to possible wrongdoing by directors and/or officers—and thus may deny the company the opportunity to investigate, and possibly to initiate its own lawsuit—if the directors would themselves face a “substantial likelihood of liability” for the alleged misconduct.

     In Caremark, as numerous Delaware decisions subsequently observed, the Chancery Court imposed extremely low requirements for directors’ supervision of a company’s operations.  To face personal liability, they must be shown either to have “utterly failed to implement any reporting or information system or controls”; or, after installing such a system, to have “consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.”

     Yet in Marchand, which concerned an company that had allegedly manufactured and sold listeria-contaminated ice cream, the Delaware Supreme Court found just such a breach of the directors’ responsibility.  The board had not adopted sufficient systems, schedules, and structures to address the products’ purity, which was “the most central safety and legal compliance issue facing the company,” and thus required the board’s oversight to be “more rigorously exercised.”

     While clarifying that the governance failures addressed in Marchand did not constitute “any sort of prescriptive list” for all companies and industries, the Court of Chancery, in ruling on Boeing’s motion to dismiss, found that decision “dispositive in view of [the] remarkably similar factual allegations” of the board’s mismanagement.

     The Court concluded that the shareholders had legimately established a claim alleging, and were therefore entitled to discovery about, violations by the majority of the Boeing directors of the board’s “rigorous oversight obligation where safety is mission critical, as the fallout from the Board’s utter falure to try to satisfy this ‘bottom-line requirement’ can cause ‘material suffering,’ even short of death, ‘among customers, or to the public at large,’ and attendant reputational and financial harm to the company.”

     Although the full opinion’s substance (and style) repay careful study, its damning discussion of Boeing’s apparent mismanagement offers at least ten practical (if not surprising) lessons to other boards, especially those of companies whose products or services could, if defective, physically injure or even kill people:

     ● First, product safety should be among the priorities of the audit committee. 

      The Chancery Court found that although Boeing’s audit committee “was tasked with handling risk generally, it did not take on airplane safety specifically.  Its yearly updates regarding the Company’s compliance risk management process did not address airplane safety.”  In short, according to the pleadings, “the Audit Comttee did not regularly or meaningfully address or discuss airplane safety.”

     ● Second, product safety should be a focus of discussion at every board meeting. 

     At Boeing’s board meetings, “airplane safety was not a regular set agenda item or topic. . . . While the Board sometimes discussed production line safety, the Board often met without mentioning or discussing safety at all.”

     The Court found that, “[t]he Board did not regularly allocate meeting time or devote discussion to airplane safety and quality control until after the second crash.  Nor did the Board establish a schedule under which it would regularly assess airplane safety to determine whether legitimate safety risks existed.”

     ● Third, senior officers should promptly inform directors about product safety issues or concerns.

     “Management’s periodic reports to the Board did not include safety information[, but instead] focused primarily on the business impact of airplace safety crises and risks.” Indeed, “[t]he nature and content of management’s ad hoc reports to the Board indicate that the Board had no regular process or protocols requiring management to apprise the Board of airplane safety.”

     It was only six months after the first crash (and six weeks after the second) that the Board “critically assessed” the plane’s navigational software, “the FAA certification process, and pilot training requirements” for the 737 MAX, and adopted a practice of “Board-level safety reporting.”

     ● Fourth, unlike Boeing’s, a board should establish “a means of receiving internal complaints about product safety” by which concerns come specifically to, or are quickly elevated to, the directors’ attention, rather than remaining at or “below the level of the most senior officers.”

     “While some. . . complaints made their way to senior management, none made it to the Board.  The Board was unware of whistleblower complaints regarding airplane safety, compliance, workforce exhaustion, and production schedule pressure at the 737 MAX facility.”

     Astonishingly, “[m]anagement did not bring the [first crash] to the Board’s attention for over a week.”

     ● Fifth, directors should personally request product safety information and discussions if they are not forthcoming from senior officers.

     “According to three people present at the August [2011] Board meeting, no Board member asked about the safety implications of reconfiguring the 737 NG with larger engines” to create the 737 MAX.

     In fact, the pleadings and their exhibits indicated that “the Board received intermittent, management-initiated communications that mentioned safety in name, but were not safety-centric and instead focused on the Company’s production and revenue strategy.  And when safety was mentioned to the Board, it did not press for further information, but rather passively accepted management’s assurances and opinions.”

     “The Board did not request any information about [the first crash] from management, and did not receive any until. . . over one week after it happened.”  Despite being aware of a Wall Street Journal article suggesting that critical software was seriously defective, the directors “did not question management’s contrary position,” and apparently did not request, or receive, more written material about the software, the company’s interactions with the FAA, the necessary level of pilot training for 737 MAX airplanes, “or about airplane safety generally.”

     Boeing’s then-Lead Director and a fellow director did, five days after the second crash, “recommend[ ] a Board meeting devoted to product safety.”

     Several weeks later, the board heard, for the first time, presentations from the company’s Vice President of Engineering and from its Vice President of Safety, Security & Compliance.

     ● Sixth, directors should assess crically information provided by officers.

     At Boeing, “Management’s ad hoc reports were. . . one-sided at best and false at worse, conveying only favorable and optimistic safety updates and assurances that the quality of Boeing’s aircraft would drive production and revenue.”

     Even worse, “as in Marchand, Boeing management knew that the 737 MAX had numerous safety defects, but did not report those facts to the Board.”

     ● Seventh, directors should not be reluctant to initiate internal investigations, particularly of a situation that might recur, and/or might indicate larger concerns.

     Four months after the first crash, the board, in an addendum to its meeting minutes, indicated that it had “decided to delay any investigation until the conclusion of the regulatory investigations or until such time as the Board determines that an internal investigation would be appropriate.”   

     ● Eighth, board meetings should be held promptly upon reports of product failure, and directors should be advised that (except for situations of personal emergency) their attendance is mandatory.

     More than three weeks after the first crash, the individual serving as both Boeing’s Chair and its CEO “e-mailed the Board to invite them to an ‘optional’ . . . Board call [two days later] for an update” on that situation from himself, the General Counsel, and the Chief Financial Officer. “This was the first time the Board convened after the crash.”

     That e-mail instructed directors to: “Consider this phone call ‘optional’, understanding that many of you have family and friend activities planned for this coming weekend.”

     ● Ninth, minutes should be taken at such meetings, and should at a minimum reflect the general issues considered. 

     It would be particularly helpful for the directors’ defense if not only the minutes but the meetings’ agenda/schedule, and the documents distributed before and during the meeting, demonstrated that a significant amounts of time and discussion were devoted to product safety issues.

     Because no minutes were created for Boeing’s board call, the court referred to a document indicating management’s “talking points,” which of course could not by itself indicate the board’s reception of, or engagement with, the presentation made to it.

     Although minutes were taken at the board’s two regularly-scheduled meetings three weeks later, they “reflect[ed] that the Board’s primary focus relating to the 737 MAX and Lion Air [i.e., the first] Crash was on restoring profitability and efficiency in light of longstanding supply chain issues. . .  The Board allocated . . . five minutes to reviewing a four-page legal memo ‘including matters related to the Lion Air incident.’  And it allocated ten minutes to Compliance Risk Management.  The associated risk management report contained one page on the FAA Settlement, which said nothing about the 737 MAX or airplane safety generally.”

      In addition, “The Board did not consider, deliberate, or decide on grounding the plane or other immediate remedial measures until after the second crash [about four and a half months after the first] and the FAA’s grounding over Boeing’s objection.  No Board minutes or agendas between November 2018 and March 2019 reference a discussion about grounding the 737 MAX.”

     ● Finally, individual directors should not publicly misrepresent the responsiveness of the board—and the other directors should insist on public corrections to, or should themselves publicly correct, such misstatements.

      After reviewing a number of statements made by the Lead Director at the time, including “that the Board met within twenty-four hours of the [second] crash to discuss potential grounding of the 737 MAX and recommended that the 737 MAX be grounded,” the Court observed that, “Each of [his] representations was false.”

     As if that were not damaging enough, the Court also considered those statements “evidence that at least [he] knew what the Board should have been doing all along.”

      The Chancery Court’s instructive opinion in In re The Boeing Company Derivative Litigation will certainly be included in corporate law classes and materials for years to come. 

      It should also be read by all directors.


     Most major corporations include on their Web sites, often in an “About Us”  or “Investor Relations” section, a page with links to such documents as their Corporate Governance Guidelines/Principles, Articles/Certificate of Incorporation, Bylaws, Committee Charters, and Code(s) of Conduct (sometimes with different codes for directors, employees, and/or suppliers). 

     Some companies also post, if their core corporate documents do not address these issues, separate polices concerning such topics as compensation clawbacks, political contributions, “shareholder rights plans,” “related persons transactions,” the role of the lead director, qualifications for candidates for the board (and/or of independent directors), and specific requirements for stock ownership by senior executives.

     Although these documents are often easy to find, companies could, with minimal effort and expense, enable them to be reviewed even more efficiently and effectively by shareholders, potential investors, actual and possible trading partners, and researchers:

     ● Instead of, or at least in addition to, directly posting the full text of these items on their Web pages (sometimes behind multiple links, corresponding to the different individual sections or provisions), companies could make pdf-format versions of a document available to download.

     ● Each original page of the document could be numbered, “Page [current page number] of [total page number].”

     ● The company’s name, and the document’s title of the document, could appear at the beginning of each document.

     ● Each document could clearly state, at the beginning, the date it was approved by the Board.  Some companies don’t include such dates anywhere; others indicate them only in the name of the pdf file (which might itself be ambiguous: for instance, does “Articles010721.pdf” refer to a document dated January 7, 2021 or, possibly, to one dated July 1, 2021)?

     ● Documents could also indicate, at the beginning or the end, the dates(s) of the version(s) tht they supersede.

     ● The current document’s date might, in addition, be indicated on the company’s Web page, next to the link to download the document; the date of the previous version could also appear, along with a clear indication that that version is no longer operative.

     ● The company could briefly indicate, possibly at the end of a governance document, the nature of the changes introduced by the new version.

     ● Alternatively, the changes made by a document could be summarized in text available through a labeled link posted next to the link to that document; or, the company could retain on its governance documents page (or on a separate page, or in a separate folder) the most recent previous versions of each revised document, behind links clearly indicating that they have been updated.  (Such an update warning might also be added to the text at, or image of, the beginning of the prevous documents themselves.)  Best of all, the company might install, next to the link for the current version, a link to a “redlined” version that marks specific additions to and deletions from the previous version.

     ● Dates on which the board has reviewed a document could be indicated at the end of the document, so as not to confuse readers checking for revisions.

     ● The same policy might be followed for dates on which a document has been “restated,” if a company is using that term as a synonym for “review without revision.”  If, on the other hand, “restatement” refers to actual changes (even if minor, including rephrasings), the Web site could identify those revisions, as discussed above.  In either instance, a company could indicate on its Web site its own definition of the term, “restated.”

     Just, as so many legal documents note, “for the avoidance of doubt.”

PROfessor Egon Guttman (1927-2021): AN APPRECIATION, and A VALEDICTION

     From the day I met Egon Guttman, I admired his knowledge, his humor, and his kindness.

     After I told lawyers I’d practiced with, and then other academics, that I’d joined the faculty of the American University Washington College of Law, many of them said, “Oh, so you’re working with Egon Guttman now—please give him my regards.”  I saw very quickly how widely and well he was respected.

     I could always rely on Egon’s insights, advice, and perspective– about teaching, writing, the law and legal practice, religion, history, literature, or something in the day’s news.

     He had plenty of what in Yiddish is called “sechel” (loosely translated, practical wisdom), and even more “rachmonos” (compassion).  Beyond his mastery of business (and particularly of securities) law, Egon was committed to the protection of consumers, investors, and debtors. 

     Like Dr. Donald “Ducky” Mallard (played by David McCallum) on “NCIS,” Egon had been a lot of places and done a lot of things, and always had a personal or historical story to help explain something.

     But I think he was actually even more like another television character— the high-performance high school music teacher Benjamin Shorofsky (Albert Hague) in the 1980s show (and movie) “Fame,” who went beyond teaching technicalities to inspire in students a true passion for his subject, and to help develop their own maturity and humanity.

     Years ago, I heard, Egon made it a practice to walk through our law library during the stress of exam periods: to reassure students, to answer any questions, and, just by being there, to show that he respected and supported them and their efforts.

     Like Dr. Mallard and Mr. Shorofsky, but in real life, Egon was “old school” in the best sense of that term, and both a chochem (wise person) and a mensch (gentleman). 

    During the years I worked with him, I heard many stories from, and some about, Egon.  I thought the very best one came a few years ago, when we were talking about how synagogues traditionally present siddurim (prayer-books) to members of the congregation observing their bar or bat mitzvah.

     Egon mentioned that a rabbi had consulted him about the best siddur to give on such an occasion.  He had recommended, he said, that the rabbi select one that included prayers not only for services with the congregation but also for the newly-responsible young man or woman to say with family, and by himself or herself.

     As usual, Egon was interested in doing, and in teaching and helping other people to do, “the right thing”—not just in public, where everyone can see it, but in the privacy of their own homes and hearts.

     I was always proud to call myself a colleague of Egon Guttman.

     I will always be even prouder to have been able to call Egon Guttman my friend.

     May the memory of the righteous be for a blessing.


     On August 6, 2021, a divided group of five SEC Commissioners approved a proposal submitted in December 2020 by Nasdaq (originally, an abbrevation of National Association of Securities Dealers Automated Quotations) that will require most of the 4,000 companies whose stock is traded on the exchange to publicly disclose information about the diversity of their boards of directors, and, if they have not satisfied Nasdaq’s new standards in this regard, to publicly explain.

     Although full compliance is expected to begin in two to five years (depending on the type of company), this initiative creates exciting opportunities not only for current executives but also for law and business students, educational institutions, governance advisors, board recruitment and placement firms, and independent organizations devoted to increasing board diversity.

● The Basics

     As described in the 82-page SEC Release No. 34-92590 (download), under the new requirement of Nasdaq Listing Rule 5605(f), each listed company will, “subject to some exceptions, . . . publicly disclose in an aggregated form, to the extent permitted by applicable law, information on the voluntary self-identified gender and racial characteristics and LGBTQ+ status. . . of the company’s board of directors.”

     In addition, each company must “have, or explain why it does not have, at least two members of its board of directors who are Diverse, including at least one director who self-identifies as female and at least one director who self-identifies as an Underrepresented Minority or LGBTQ+.”  Companies whose boards have five or fewer members should have, or must explain the absence of, at least one member who is “Diverse.”  (See “Defined Terms,” below.)

● Concurrences and Dissents

    SEC Chair Gary Gensler stated that these new requirements—in conjunction with a second newly-approved proposal, to enhance compliance by providing board recruiting services for free to Nasdaq-listed companies —“will allow investors to gain a better understanding of [the] companies’ approach to board diversity, while ensuring that those companies have the flexibility to make decisions to best serve their shareholders.”     

     SEC Commissioners  Allison Herren Lee and Caroline A. Crenshaw supported the diversity proposal as “a step forward for investors,” and suggested that further regulation in this area could include “disability [as] a relevant characteristic, as well as diversity among senior management and the workforce more broadly.” 

     Commissioner Elad L. Roisman, though concurring that “Public company boards of directors should not be private clubs with membership limited to narrow social circles,” supported the recruiting proposal but dissented from the diversity disclosure proposal, finding it questionable whether the initiative fell within the Securities and Exchange Act of 1934’s Section 6(b)(5).

     Under that provision, an exchange’s rules must be “designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, . . , to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest,” without allowing “unfair discrimination between customers, issuers, brokers, or dealers,” and without attempting to regulate “matters not related to the purposes of this title or the administration of the exchange.”

     Commissioner Roisman also warned vaguely that if Nasdaq were (against the weight of precedent) to be seen as a state actor, or if the SEC (as a state actor) were to involve itself further in diversity disclosure issues, there might be Constitutional concerns and complications.

     Also writing in opposition, Commissioner Hester M. Peirce similarly objected that the proposal was not authorized by Section 6(b)(5), and added that Nasdaq had not definitively correlated boardroom diversity with enhanced corporate performance. 

     The latter subject had been addressed in some detail, including by a survey of a variety of scholarly analyses, on pages 20-29 and 183-200 of Nasdaq’s February 26, 2021 letter to the SEC [412 pages, including attachments (download)], in which the exchange had responded to “over 200 letters” commenting on the original proposal, and indicated the amendments it had made to its original submission..

     Although the SEC, in approving the proposed rule, noted that the researchers’ results “are mixed, . .  are generally inconclusive, and suggest that the effects of even mandated changes remain the subject of reasonable debate,” it found that “at a minimum, the academic and empirical studies support the conclusion that board diversity does not have adverse effects on company performance.”

● Defined Terms

     Among the terms defined in Nasdaq’s Listing Rule 5605(f)(1) are:

     “Diverse” means an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority, or LGBTQ+.

     “Female” means an individual who self-identifies her gender as a woman, without regard to the individual’s sex at birth.

     “LGBTQ+” means an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community.

     “Underrepresented Minority” means an individual who self-identifies as one or more of the following: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or Two or More Races or Ethnicities.

     “Two or More Races or Ethnicities” means a person who identifies with more than one of the following categories: White (not of Hispanic or Latinx origin); Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander.

     These categories are further defined in the amended proposal’s instructions for completing the required matrix for disclosing board diversity.  See “Page 327 of 354” in an attachment to Nasdaq’s February 26 letter.

● Comply or Explain

     Both the SEC and Nasdaq emphasized that the exchange’s revised listing standards do not force boards to meet specific diversity “quotas,” and that companies could satisfy the requirements by disclosing why they had not seated the specified number of “Diverse” directors. 

     The SEC indicated that Nasdaq “would not evaluate the substance or merits of a company’s explanation.” 

     Nasdaq’s letter to the agency clarified that a company “can choose to disclose as much, or as little, insight into the company’s circumstances or diversity philosophy as the company determines, and shareholders may request additional information directly from the company if they need additional information to make an informed voting or investment decision.”

    Nasdaq’s amended proposal suggests that one explanation that a board might offer is that it “believe[s] that defining diversity more broadly than Nasdaq (by considering national origin, veteran status and disabilities) brings a wide range of perspectives and experiences to the board.”

    As the exchange noted in its amended proposal, the “comply or explain” approach also appears in several federal securities regulations, including those governing a company’s inclusion of a financial expert on the board’s audit committee, and a company’s adoption of an ethics code that applies to its CEO and senior financial or accounting officers.

●  Nine Areas Seeing Development About Qualifications

     Among the resulting opportunities, and areas to monitor for further development (and study) are:

     First, the revisions should draw increased attention to, and possibly the creation of new, independent groups devoted to preparing potential directors who would qualify as “Diverse” under the Nasdaq definition.

     (Without endorsing any in particular,) those organizations include: 50/50 Women on Boards; Alliance for Board Diversity; Boardlist; Catalyst; DirectWomen; Ellevate; Executive Leadership Council; Hispanic Association on Corporate Responsibility; International Women’s Forum; Interorganization Network (ION); New America Alliance; 30% Club (U.S. Chapter); 30% Coalition; Women Corporate Directors; and Women in the Boardroom.

     Second, there will certainly be renewed interest in conferences and organizations that prepare professionals (whether lawyers or not) to be directors; and in written information, including blogs and lists of recommended reading, on the basic and advanced functions of directors. 

     Third, students and alumni of law and business schools might decide to enroll in (regular or continuing/executive education) courses to prepare and position them for the boardroom, possibly to help advance not only a specific corporation’s financial performance but also its contributions to social initiatives.  Some educational institutions might create, or enlarge, specialized programs or centers for this purpose.

     Fourth, the Nominating Committees (sometimes known as Nominating and Governance Committees) of corporate boards, which are charged with identifying candidates for directorship, will probably become more active in reviewing and updating not only candidate lists but also their companies’ governance documents. 

     In the absence of an SEC-mandated definition of the term, the (non-binding, easily and quietly-revised) Corporate Governance Principles (sometimes called Corporate Governance Guidelines) posted on major corporations’ Web sites (often under “About Us,” or “Investor Relations”) can be notably broad in their dimensions and denotations of “diversity”: for instance, they might refer to, “diversity (including diversity with respect to race, ethnicity, national origin, gender, sexual orientation, and age),” or, “diversity with respect to gender, ethnicity, race, nationality, skills and experience in the context of the needs of the Board.”

     Committees might well clarify this issue, and also revisit the disclosure that the SEC does require them to make: “how a board implements any policies it follows with regard to the consideration of diversity in identifying director nominees.”

     In that regard, some boards might add to, or refine in, their Corporate Governance Principles such Rooney Rule-related statements as, “When a professional search firm is used, the Corporate Governance and Nominating Committee directs the firm to provide a diverse slate of candidates for the Board’s consideration,” or “the Governance and Nominating Committee will instruct the search firm to include in its initial list of candidates qualified candidates who reflect diverse backgrounds, including diversity of gender and race or ethnicity.”

    Fifth, corporations might amend their governing documents to enlarge the number (or range, if they prefer not to indicate one specific number) of directors on the board, in order to add new and diverse candidates without necessarily forcing out incumbent directors.  Alternatively or in addition, to ensure regular “refreshment” of the board, Nominating and Governance Committees could adopt, and more strictkly enforce (since their application is often left to the board’s ultimate discretion), term and/or age limits for directors.

   Sixth, significant shareholders who through “proxy access” rules can nominate candidates for directorships might be more likely to nominate individuals who would enhance the diversity of the board.  More generally, shareholders could launch proposals, to be submitted to a vote of shareholders, concerning the extent and transparency of the board’s definition(s) and dislosure(s) of, and efforts to increase, diversity among directors.

     Seventh, California might be joined by other states in requiring certain forms and norms of diversity on the boards of publicly-traded companies whose “principal executive offices” are in the state.

     In September 2018, California amended its Corporations Code to mandate that such companies have a minimum number of female directors (three, for boards with six or more directors; two, for those with five directors, and one, for those with four or fewer directors), and a minimum number of directors “from underrepresented communities” (three for boards with nine or more directors; two, for those with five to eight directors; and one, for those with four or fewer directors). 

     (On the other hand, some state legislators might argue that such rules are less necessary in light of Nasdaq’s revised listing standards.)

     Eighth, it remains to be seen whether the New York Stock Exchange (NYSE) will amend its own listing requirements in a comparable way..

     Ninth, leading investment funds, like State Street Global Advisors and BlackRock; proxy advisors, like Glass Lewis and Institutional Shareholder Services (ISS); and investment banks, like Goldman Sachs, might become even more active in encouraging board diversity practices among the companies whose shares they hold in their portfolios.

     For shareholders large and small, as well as existing and prospective directors, the Nasdaq rules may well have added new boardroom-related meanings to the phrase, “the company you keep.”


     Twenty-five years ago, in Williams v. Geier, 671 A.2d 1368 (Del. 1996), the Delaware Supreme Court heard a minority shareholder’s challenge to a certificate of incorporation amendment that Cincinnati Milacron’s board had recommended and that shareholders had voted to approve.

     Similar to the amendment supported by a vote of J.M. Smucker Company shareholders in 1985, Milacron’s, which was allowed by Delaware General Corporation Law Sections 212(a) (authorizing departures from the default of one-share, one-vote) and 242(b) (enabling the amendment of certificates of incorporation), established “a form of ‘tenure voting’ whereby holders of common stock on the record date would receive ten votes per share.  Upon sale or other transfer, however, each share would revert to one-vote-per-share status until that share is held by its owner for three years.”  Id. at 1370. 

     In affirming the Court of Chancery’s judgment for the defendants, the majority of the Justices found that “the independent majority of the Board” was protected by the business judgment rule in recommending the amendment, and characterized as “dispositive” the approval of the amendment by “a fully informed majority of the stockholders.”  Id. at 1371. 

     The Delaware Supreme Court saw no evidence “that a majority of the Board was interested or acted for purposes of entrenching themselves in office,” or that that they were “dominated or controlled by” a group of major shareholders.  Id. at 1378. 

      Moreover, “Stockholders (even a controlling stockholder bloc) may properly vote in their own economic interest, and majority stockholders are not to be disenfranchised because they may reap a benefit from corporate action [here, the approval of the amendment] which is regular on its face.”  Id. at 1380-1381.

      The Court concluded that the shareholder plaintiff had not shown “that the Amendment and Recapitalization involved waste, fraud, or manipulative or other inequitable business conduct.  Likewise, there is no showing that either the Recapitalization lacked a rational business purpose or that its sole or primary purpose was entrenchment.”  Id. at 1384.

     Few other decisions address “tenure voting,” also known as “time-phased voting” or as involving “loyalty shares.”  Nor does the practice appear to have been adopted by many major domestic corporations.

     Such arrangements have been proposed and promoted as a means of countering the influence of “short-term” shareholders who have, and who seek, no relationship with the company beyond making a fast profit. 

     However, as in the Williams decision, tenure voting raises concerns about solidifying the control of major shareholders, particularly if those shareholders also serve as directors and/or officers.  In fact, one study reported that “when corporate management holds a large block of company stock prior to the implementation of tenure voting and retains at least 20-30% of the total number of company shares on a long-term basis,” it can effectively repel even “a highly motivated dissident shareholder who owns the maximum amount permitted by most poison pills.”  Paul H. Edelman et al., Will Tenure Voting Give Managers Lifetime Tenure?, 97 Tex. L. Rev. 991, 995 (2019). 

      Indeed, one analysis found that although “the percentage of long-term shareholdings consistently trends downward following the adoption” of a tenure-voting arrangement, “on average, almost two-thirds of insiders’ shares were long-term shares—a much higher rate of long-term shareholding than outside shareholders exhibited. . . [I]nsiders controlled approximately 22% of outstanding votes while owning only 11% of outstanding shares.” Lynne L. Dallas & Jordan M. Barry, Long-Term Shareholders and Time-Phased Voting, 40 Del. J. Corp. L. 541, 550 (2016).

     Yet the advantages to management of tenure voting might still be more palatable to institutional investors than a “dual-class voting” system in which management could, by holding special stock that carried multiple votes per share, effectively control the company without ever having a significant ownership stake, thereby uncoupling its interests to an even greater degree from those of other shareholders.  Edelman et al., at 995.

     The Dallas/Barry study concluded (at 551-552) that, in terms not only of the differential between insiders’ voting power and their proportion of share ownership, but of the degree to which the institution of new types of shares encouraged a company’s subsequent issuances of stock, tenure voting was about halfway between one-share, one-vote arrangements and dual-class stock arrangements. 

     Although the chronology of shareholdings can be preserved and tracked on blockchain-based systems, other concerns about tenure-voting arrangements might not be so easily resolved. 

     First, it may reduce, but not eliminate, the effect of short-term trading: “[D]istant, smaller shareholders, even if they hold their stock for longer, will still be free riders in corporate governance and, hence, passive. Trading may decline, but the stock will still have a current price that adjusts to new information–and to the extent directors and managers pay attention to changing stock prices, they will continue to see a stock price to pay attention to.”  Mark J. Roe & Federico Cenzi Venezze, Will Loyalty Shares Do Much for Corporate Short-Termism?, 76 Bus. Law. 467, 470 (2021).

     Second, there remain serious doubts about the viability of installing tenure voting, after their intial public offerings, in corporations listed on the New York Stock Exchange (NYSE) or Nasdaq, each of whom has a policy that:

     “Voting rights of existing shareholders of publicly traded common stock registered under Section 12 of the Exchange Act cannot be disparately reduced or restricted through any corporate action or issuance. Examples of such corporate action or issuance include, but are not limited to, the adoption of time-phased voting plans. . . .”

     But see David J. Berger et al., Tenure Voting and the U.S. Public Company, 72 Bus. Law. 295, 319 (2017) (arguing that, rather than disparately reducing the voting rights of particular shareholders, tenure voting “treats all stockholders alike [by] grant[ing] all stockholders equal per-share voting rights and equal opportunity to gain additional voting rights by holding their shares over time”).

     Third, by one analysis, the ultimate beneficiaries of tenure voting, beyond insiders, might be index fund managers BlackRock, Vanguard, and State Street, which collectively “already own about one-quarter of the stock in a wide array of public companies in the United States. . . . Traders, shareholder activists, and newly formed blockholders with long-term intentions would all lose voting power.”  Roe & Venezze, at 471.

     Fourth, many major institutional investors, fund managers, and proxy advisors have already publicly endorsed the “one-share, one-vote” policy, at least in principle.

     Tenure voting might well, though addressing some problems, create, or exacerbate, others.


Many corporations’ bylaws mention arbitration in one or more ways. 

     Most commonly, they include arbitrations in the definition or category of the personal-liability-generating “proceedings” that might entitle directors or officers to indemnification. 

     Second, some bylaws offer directors and officers the option of arbitration to determine their eligibility for indemnification in certain circumstances. 

     Third, directors and officers contesting the board’s denial of indemnification might be allowed to arbitrate their claim.

     Fourth, some bylaws allow, or require, disputes over the value of the stock held a by departing shareholder to be submitted to arbitration.

    But there is little caselaw on whether bylaws can require shareholders to submit to arbitration claims or other complaints against the company (and/or against one or more of its agents), instead of filing an action in a state or federal court.  Nor does this issue appear to have been addressed specifically by the policies published by many leading institutional investors and proxy advisors.

    The Model Business Corporation Act’s 2.08(c), added in 2016, states that “No provision of the articles of incorporation or the bylaws may prohibit bringing an internal corporate claim in the courts of this state or require such claims to be determined by arbitration.”  But no similar prohibition exists in the Delaware General Corporation Law (DGCL).

     Although both CalPERs’ Governance & Sustainability Principles (Sept. 2019) and the Council of Institutional Investors’ Corporate Governance Policies (Sept. 22, 2020) advise companies not to “attempt to bar shareholders from the courts through the introduction of forced arbitration clauses,” such policies, unlike forum selection or fee-shifting provisions, are not mostly installed unilaterally by, or at the recommendation of, or even championed by, directors.  

      In fact, shareholder-initiated proposals for such bylaw provisions have been the subject of SEC No-Action Letters; the few state and federal court decisions appear to address, usually in specialized situations, director-initiated bylaws.

     ● The SEC’s Stance on Exclusion of Shareholder Proposals of Arbitration

     At least as far back as 2013, pro-shareholder commentators suggested that “courts would uphold a by-law amendment that requires individual arbitration in place of securities class actions[, which] provide little meaningful compensation to institutional or individual stockholders, and instead primarily benefit plaintiffs’ attorneys who recover up to 35% of a settlement value in contingency fees; they do little to deter wrongdoing, as the actual wrongdoers are rarely held personally responsible for losses; and finally, . . . have a major negative impact on the competitiveness of the U.S. capital markets.”  Hal S. Scott & Leslie N. Silverman, Stockholder Adoption of Mandatory Individual Arbitration for Stockholder Disputes, 36 Harv. J.L. & Pub. Pol’y 1187, 1226 (2013).

      However, in 2012, the Securities and Exchange Commission’s Division of Corporation Finance permitted the board of Pfizer, under Rule 14a-8(i)(2) (17 C.F.R. § 240.14a-8(i)(2)), to exclude from proxy materials a shareholder proposal for a bylaw provision requiring most direct and derivative claims against the company or its agents to be submitted for arbitration in New York. 

     The SEC agreed with the company that the proposal would violate existing securities laws, namely, Section 29 of the Securities Exchange Act of 1934, which invalidates “[a]ny condition, stipulation, or provision binding any person to waive compliance with any provision of this title or of any rule or regulation thereunder, or of any rule of an exchange required thereby shall be void.” SEC No-Action Letter, Pfizer, Inc., 2012 WL 587597 (Feb. 22, 2012).

     Pfizer had argued that the bylaw’s restriction that “No controversy or claim subject to arbitration under this Article may be brought in a representative capacity on behalf of a class of stockholders or former stockholders” would impermissibly waive shareholders’ right to bring claims under the Act’s Section 10(b) and Rule 10b-5.  

      Seven years later, the SEC declined to opine on whether Rule 14a-8(i)(2) would exclude from New Jersey-incorporated Johnson & Johnson’s proxy materials a shareholder proposal to require arbitration of claims under federal securities laws: the agency noted that “the Attorney General of the State of New Jersey has indicated that taking the actions requested by the Proposal would be illegal as a matter of New Jersey law.”  SEC, No-Action Letter, Johnson & Johnson, 2019 WL 4306292 (Feb. 18, 2019).

     Concurrently, SEC Chairman Jay Clayton issued a “Statement on Shareholder Proposals Seeking to Require Mandatory Arbitration Bylaw Provisions,” characterizing attempts to compel arbitration of securities claims as “a complex matter that requires careful consideration.”  Without naming Johnson & Johnson, but clearly referring to the agency’s disposition of its request, he observed that:    

     “The staff of the Division of Corporation Finance explicitly noted that it was not expressing a view as to whether the proposal, if implemented, would cause the company to violate federal law.  Since 2012, when this issue was last presented to staff in the Division of Corporation Finance in the context of a shareholder proposal, federal case law regarding mandatory arbitration has continued to evolve. 

     “Further, I am not aware of any circumstances where the Commission has weighed in on the legality of mandatory shareholder arbitration in the context of federal securities law. 

     “In light of the unsettled and complex nature of this issue, as well as its importance, I agree with the approach taken by the staff to not address the legality of mandatory shareholder arbitration in the context of federal securities laws in this matter, and would expect our staff to take a similar approach if the issue were to arise again.  I continue to believe that any SEC policy decision on this subject should be made by the Commission in a measured and deliberative manner.”

     ● State Court Decisions    

     In Elf Atochem North America, Inc. v. Jaffari, 727 A.2d 286, 288 (Del. 1999), the Delaware Supreme Court found enforceable an LLC’s operating agreement provision that “any controversy or dispute arising out of this Agreement, the interpretation of any of the provisions hereof, or the action or inaction of any Member or Manager hereunder shall be submitted to arbitration in San Francisco, California….”    

     The Court rejected the argument that the Delaware Limited Liability Company Act “affords the Court of Chancery ‘special’ jurisdiction to adjudicate its claims, notwithstanding a clear contractual agreement to the contrary,” especially “because the policy of the Act is to give the maximum effect to the principle of freedom of contract and to the enforceability of LLC agreements,” and also because of “the fact that Delaware recognizes a strong public policy in favor of arbitration.”  Id. at 295.

     Arbitration bylaws were similarly upheld in In Corvex Management L.P. v. Commonwealth REIT, 2013 WL 1915769 (Md.Cir.Ct.), after the court observed that “both state and federal law cast a favorable light on arbitration” and that “Plaintiffs clearly had constructive knowledge — and, in fact, actual knowledge — that they were party to the arbitration agreement written into [the] Bylaws.” 

      Not only was the provision’s language “straightforward and unambiguous,” but each share certificate bore a legend indicating that it was “subject to all of the provisions of the Declaration of Trust and Bylaws of the Trust and any amendments thereto. The holder of this Certificate and every transferee or assignee hereof by accepting or holding the same agrees to be bound by all of the provisions of the Declaration of Trust and Bylaws of the Trust, as amended from time to time.”

     Finally, the relevant Maryland statute allowed a real estate investment trust “to … [m]ake and alter bylaws not inconsistent with law or with its declaration of trust to regulate the government of the real estate investment trust and the administration of its affairs.”

     ● Federal Court Decisions

     Although the District Court for the Southern District of New York did not directly address corporate bylaws, in In re Salomon Inc. Shareholders’ Derivative Litigation, 1994 WL 533595 (S.D.N.Y.) at *5, it held that derivative lawsuits against Salomon Brothers and individual defendants were properly arbitrable, because the company, as member of the NYSE, and its executives were bound by the NYSE Constitution’s arbitration requirement:

     “Although the Court harbors considerable doubt as to the suitability of arbitration for the claims in shareholders’ derivative actions, . . . it is bound by the decisions of the Supreme Court and must heed its words: “[A]ny doubt concerning the scope of arbitrable issues should be resolved in favor of arbitration.”  Id. at *8, citing Moses H. Cone Memorial Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983).

    The Third Circuit, in Kirleis v. Dickie, McCamey & Chilcote, P.C., 560 F.3d 156, 158 (3rd Cir. 2009),  decided “a question of first impression under Pennsylvania law: whether a shareholder/director may be compelled to arbitrate her civil rights claims pursuant to corporate bylaws to which she has not explicitly assented.”

     The defendant law firm did not dispute that one of its lawyers, Alyson J. Kirleis, had not seen its bylaws before she sued the firm in federal court for alleged sex discrimination, retaliation, and a hostile work environment, or that she had never signed any document that had referred to or incorporated the arbitration provision. 

     However, the firm argued that, by accepting compensation and other benefits governed by its bylaws, and by holding “various management positions” at the firm, she had had “constructive knowledge” of this restriction. Id. at 159-160.

    Acknowledging “the tension between corporate law principles—which generally impute to members of the corporation knowledge and acceptance of corporate bylaws—and the law of contracts, which requires consent to be bound,” id. at 162-163, the court, applying Pennsylvania state precedent, rejected the implicit agreement argument. “Pennsylvania law requires arbitration agreements to be expliclt,” id. at 164; but “Kirleis never received a copy of the only document containing the firm’s arbitration provision. Without this document, Kirleis could not have explicitly agreed to arbitrate her claims.” Id. at 165.

     However, five years later, the District Court for the District of Massachusetts, in Delaware County Employees Retirement Fund v. Portnoy, 2014 WL 1271528 (D. Mass.) at *11, found that “whatever persuasive value Kirleis may have had is certainly curtailed by the Third Circuit’s subsequent recognition in Century Indemnity Co. v. Lloyd’s, 584 F.3d 513, 531-32 (3d Cir. 2009),  that, under the [Federal Arbitration Act, 9 U.S.C. §§1 et seq.] and Supreme Court precedent, it could not require arbitration agreements to be ‘express’ and ‘unequivocal’ to be enforced because to do so would ‘impermissibly … require more of arbitration agreements than of contracts generally to be enforced whenever the standard differed from the applicable state-law principles of contract law.’”

     The Portnoy court held that where “the stock certificates specifically notify shareholders that they would be bound by the provisions of the Declaration and Bylaws, including Bylaw amendments, . . . and the bylaws were publicly available,” id. at *12, even shareholders who had purchased shares before the board had added the arbitration provision to the bylaws were constructively bound by it.