The Controlling Shareholder Enforcement Gap

Abstract

The regulation of controlling shareholder related-party transactions is one of corporate law's animating concerns. A recent Chancery Court decision extends the double approval framework endorsed by the Delaware Supreme Court—independent director committees and a majority of the minority shareholders—to non-freezeout transactions. This article explains why the Chancery Court's innovation does not decrease the risk faced by minority shareholders. Subjecting a transaction to the double approval framework is a voluntary decision. Transaction planners will willingly traverse this path if the benefits outweigh the loss in deal certainty and attendant costs. When almost every freezeout is challenged in court, the voluntary application of this framework is the logical outcome. The calculus in the non-freezeout context leads to a different result. Non-freezeouts must be challenged by a derivative lawsuit. The procedural hurdles inherent in the derivative mechanism affect both the demand for the ratification framework and the incentive to comply. Without a tangible threat of a lawsuit to coax voluntary compliance in the non-freezeout setting, transaction planners have nothing to gain by subjecting the deal to the double approval gauntlet. This article's analysis reveals a large gap in the enforcement of self-dealing transactions. Recent high-profile litigation exposes questionable adherence to the double approval framework for obviously conflicted non-freezeout transactions. The paucity of derivative lawsuits foretells a troubling fate for similar transactions at less enticing litigation targets. Worse yet, the superficial step toward improved minority shareholder protection stifles the discussion on additional reform.