Within corporate law there is a tense awareness of the overwhelming power of controlling shareholders. Oftentimes, such shareholders exert prodigious force over the actions of the company’s board of directors, in part because controlling shareholders may handpick the board.1 Using their connections to the board, a controlling shareholder may influence company action in an interested2 transaction in a way that lines the pocket of the large, institutional, controlling shareholder rather than maximizing value for the individual shareholder.3 Corporate boards have attempted to skirt this uneasy relationship by appointing “objective” bodies to oversee the interested transactions.4 However, these objective bodies are often composed of directors who still are tangentially related to the controlling shareholder itself. Disinterested directors are still subject to the whims of the controller, either through the threat of the loss of a seat at the board or through other additional benefits the controller may confer.5 Corporate law has relied on oversight by independent directors—directors who have no ties to the controller or the company besides their service on the board—to safeguard against controller opportunism. However, due to their conflicts, independent directors cannot be expected to effectively guard the interests of public investors.
This brief discussion will center on a new solution to this problem: statutorily defined independent directors. Only through meeting specific requirements, like being approved by a majority of minority shareholders or by serving on the board for a specific amount of time, can a director be considered truly independent and thus approve or veto an interested transaction.
The benefits of adopting a statutory requirement for independent directors are twofold. First, such an adoption would reduce the court’s burden in judicial review.6 No longer would courts agonize over whether to employ an entire fairness or a business judgment rule. Rather it would be the qualifications of the directors themselves that would be challengeable. Having a salient body of statutory framework to evaluate whether a director is compromised would go far in alleviating a cumbersome legal system. Second, clarity and certainty would come to an area of the law that is sorely lacking in both. It would no longer become necessary to define explicitly what a controlling shareholder is with respect to an interested transaction. Delaware has defined control status to mean that a stockholder has “effective control of the board.”7 What this means in practice is hardly clear. A simple percentage of ownership of the company is evidence for control, but not necessary to establish that a stockholder has control status.8 Other factors, such as the perception of control, or the ability to set company policy all factor in to whether a stockholder is deemed to be “controlling” or not and whether a heightened judicial standard is applied to some of their transactions.9 Courts have heretofore been rock solid in their confidence that independent directors could faithfully consider a shareholder’s demand to pursue litigation against a controlling shareholder.10 Rather than courts focusing on the shareholder, statutory requirements put the focus on the directors themselves.
Businesses and shareholders would also be given an immense amount of clarity. They would know precisely what kind of directors of a company would be able to sanitize the interested transaction proposed by any of the controlling shareholders. If Director 1 owes her seat on the board to Apple, she cannot vote on a merger with iTunes, but would be fully qualified to make her voice heard in other transactions.
Once this backbone of the statutory regime is laid, then the criteria can follow. First, any statutory regime that seeks to define independence must require that such a director is one that is approved by a majority of minority shareholders.11 Controlling shareholders would thus lose a critical edge in that a director who owed their appointment to the controller would be disbarred from reviewing an action taken to benefit the controller. Second, independent directors must have served as a director for a period of time. A proposal to Michigan’s Business Corporation Act in 1987 attempted to set a time of three years as being the minimum to forecast independence, but the exact amount of time is not the most salient point, it is more important that the director must have been served for at least some time on the board.12 Third, there should be an expansion of which directors attain “interested” status within a transaction. This should include directors who are not only financially involved with the transaction, but also those directors who have some sort of affiliation to the controller. Such affiliation could include prior employment with the controller, ownership in equity of the controller, or personal ties to officers of the controller. It may seem over-expansive to limit participation of directors in this manner, but it is absolutely crucial to ensure fairness. Without some measure of certainty, the power of controlling shareholders will remain unchecked. The specifics of statutorily created independent directors still needs to be fleshed out, but the need to create independent creators is certainly a pressing one, as public shareholders are desperate for protection against a controller with adverse interests.
Ronald J. Gilson & Jeffrey N. Gordon, Controlling Controlling Shareholders, 152 U. Pa. L. Rev. 785, 787 (2003). ↩
an interested transaction is one in which the shareholder has a personal financial interest ↩
Id. at 788. ↩
Ann M. Lipton, After Corwin: Down the Controlling Shareholder Rabbit Hole, 72 Vand. L. Rev. 1977, 1981 (2019). ↩
Id. at 1987 ↩
Scott J. Gorsline, Statutory “Independent” Directors: A Solution to the Interested Director Problem?, 66 U. Det. L. Rev. 655, 664 (1989). ↩
Lipton, supra note 3, at 1990. ↩
Id. at 1991. ↩
Id. at 1988. ↩
See Gorsline, supra note 5 at 666. ↩
CORPORATION, FINANCE AND BUSINESS LAW SECTION, STATE BAR OF MICHIGAN, PROPOSED REVISED MICHIGAN BUSINESS CORPORATION ACT, REPORTERS’ DRAFT #1, Nov. 9, 1987, § 450.1505(3). ↩