Wachtell Lipton’s Errors on Shareholder-Paid Director Bonuses

Amid debate over shareholders offering contingent payments to directors, Wachtell Lipton recommends an option that may be tempting for incumbent boards: unilaterally adopting a bylaw banning the arrangements.  Boards should be wary of this advice.

True, Wachtell’s position concurs with my view that such payments are lawful, contrary to the position urged by my esteemed fellow corporate law Prof., Stephen Bainbridge.  But that’s where Wachtell and I part company, first because Wachtell’s proposal is myopically universal and second because it errs on a basic legal point about board and shareholder power.

In my view, not only are the arrangements lawful, but shareholder bodies ought to have the choice to embrace or reject them.  My guess is that they are desirable for some corporations in some settings and not so for others.  Therefore, the use or rejection of these ought to be determined, as with much else in corporate life and law, in context by business people participating in particular governance situations.

The eight lawyers at Wachtell signing a Firm “Shareholder Activism Alert,” in contrast, urge universal and complete abolition. The lawyers do not appear concerned with context or the range of situations in which the arrangements might come up.  Instead, they see them as “egregious” under all circumstances, branding the devices “Dissident Director Conflict/Entrenchment Schemes.” 

Wachtell condemns the idea as posing numerous threats in all cases.  It does not matter, for instance, whether a bonus is earned based on a stock price that out-performs a peer-group over the 3-year term of service on a staggered board.  (That is the example in the pending Hess case that has stoked academic debate on this topic; curiously, Wachtell’s memo cites 2 profs who have criticized the plan but does not mention the 5 who have okayed it.)   

Instead, Wachtell warns of threats, in several overlapping bullet-pointsundermining board prerogatives on time-frame, creating a multi-tiered board with sub-classes and creating specific economic incentives in which director and shareholder interests are in conflict.  

The more basic error Wachtell makes is when it says that directors of Delaware corporations can simply amend the bylaws to make such arrangements a disqualification for board service.  It says boards “can adopt this bylaw under the authority of Section 141(b) of the Delaware General Corporation Law which provides that ‘the certificate of incorporation or bylaws may prescribe other qualifications for directors.'”  

But 141(b) is not a grant of authority to amend bylaws, only a statement of where such director qualifications may appear (either the certificate or bylaws).  Section 109 of the Delaware General Corporation Law is where the statute grants the authority to amend bylaws, and it gives shareholders, not boards, that power.   DGCL 109(a).  A Delaware corporation’s shareholders can opt to share power to amend bylaws with directors, but only by including such a provision in the certificate of incorporation.  DGCL 109(a).  

So any Delaware corporate board planning to consider Wachtell’s idea must first ask their lawyer to review their certificate to find out if it would be lawful for a board to adopt such a bylaw (and those incorporated elsewhere must checking local statutes, which vary on the point.)  As my Corporations students learn every year, boards that pass ineffective bylaws face embarrassment and even risk losing the outcome of a contest for corporate control. See Datapoint v. Plaza Securities, 496 A.2d 1031 (Del. 1985) (board adopted bylaw was ineffective because it addressed a topic that the Delaware General Corporation Law required to be in the certificate).

Boards and shareholders weighing the merits or demerits of any corporate governance device, including shareholder bonuses for director performance, should be prepared to address legal questions such as who has the authority to speak for the corporation on a given topic.  Boards must make such business judgments as they believe best advance the interests of the corporation and its shareholders given the particular context in which the decision is made.

Directors doing so must, above all, appreciate that they are making a business judgment, not a legal judgment, one for boards, not lawyers. Cf. Ace Limited v. Capital Re, 747 A.2d 95 (Del. Ch. 1999).  We law professors and lawyers sometimes have strong opinions on the attractiveness of given governance devices, but such opinions are irrelevant to the decision whether to embrace or reject a lawful one. That logic of the business judgment rule extends to us.

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5 Responses

  1. AF says:

    I missed it, where does Wachtell say these schemes are legal?

  2. Lawrence Cunningham says:

    AF: Sorry you missed it; I hoped it would be understandable to ordinary readers (e.g., not to lawyers only).

    Wacthell’s 8 lawyers wrote a 2-page memo about the topic. It is linked in the post (and the firm circulated it widely).

    After describing the schemes in abstract terms, with various pejorative labels, the memo said they are “egregious” and posed assorted “threats.” It then said Delaware boards could, by statute alone, unilaterally adopt bylaw amendments addressing them. (That is incorrect, as the post explains.)

    My post says that the Wachtell memo “concurs with my view that the schemes are lawful,” which would be obvious to trained lawyers though perhaps not to lay people; had Wachtell found them illegal, it would have said so, rather than calling them “egregious” or “threatening” and then concocting the (erreonous) bylaw amendment route.

  3. AF says:

    Professor Cunningham: I apologize if I was unclear. I read the memo; I meant that I missed the part where Wachtell concurs with your view that the schemes are lawful.

    I disagree that it would be “obvious to trained lawyers” that Wachtell concurs with your view that the schemes are lawful simply because it does not say that they are unlawful. To be sure, I would agree with a weaker version of your reasoning: I would agree that had Wachtell found these schemes *clearly* unlawful, it probably would have said so. But it strikes me as quite plausible that Wachtell chose not to address the lawfulness of these schemes not because it affirmatively believes they are lawful, but rather because it sees their lawfulness as a difficult question which (in Wachtell’s view) can be avoided by adoping its proposal.

  4. Lawrence Cunningham says:

    Interesting possibility.

  5. Anon says:

    Revealed today that Wachtell was representing Hess in the pending proxy fight where this question came up, though its memo never mentions that important fact!