Portnoy v. Cryo-Cell: Vote Buying, Manipulation of the Voting Process, and the Race to the Bottom (Part 3)

We are continuing the discussion of Portnoy v. Cryo-Cell, CA No. 3142-VCS, Del. Ch., Jan. 15, 2008, a 73 page tome. Primary materials, including the case, can be found at the DU Corporate Governance web site.

Among the many allegations in the case, Plaintiff also challenged the arrangement where management obtained the agreement from a shareholder to buy shares (and vote them for management) in return for a second position on the board of directors. Once the election was completed, the board would be expanded and the director added to the board.

Defendants denied that the arrangement even existed. The court, however, found "their denial lacking in credibility." Nonetheless, much like his opinion in Desimone, VC Strine wrote what was essentially an apology for the practice. As he noted:

• In voicing this concern, I recognize that there is a rather obvious retort, which is that incumbents should not be adding new candidates only on the condition that those who suggest them agree to vote for the management slate at the next election. But if one is going to address the issue maturely - in the sense of actually realistically considering the human, business, and practical considerations that motivate pragmatic settlements of difficult problems - then that is no answer at all. From the subjective view of the incumbents, one of the benefits they are accomplishing by a settlement of that kind is to protect the company from the distraction of a costly and fractious battle over control. The incumbents may well believe, in good faith, that their continuance in office is best for the stockholders.

In other words, Delaware courts purport to agree that boards cannot act solely with an entrenchment motive. Yet if they agree to dole out board seats to shareholders who buy dissident votes, this is acceptable where they believe that "their continuance in office is best for the stockholders." But of course, incumbent management always believes that to be true. The mere fact that management is running for reelection is evidence that it believes continuation in office is good for shareholders. Thus, management will always be in a position, under VC Strine's standard, to justify this type of behavior. In other words, its not a standard at all. He is, therefore, providing a carte blanche for the right to bargain board seats to those shareholders who purchase dissident shares.

Ultimately, the Vice Chancellor found for plaintiff but only because of inadequate disclosure. Moreover, the violation was not apparently the agreement of the supporting shareholder to buy dissident shares but the fact that the board would be expanded after the meeting to include an additional director. See Id. ("What the Cryo-Cell stockholders did not know was that [the CEO] had promised that the board would use its fiduciary powers to expand the board to seven members and seat another person designated by [the supporting shareholder]. Problematically, the Cryo-Cell stockholders did not know that [the supporting shareholder] clearly intended to designate . . . a person whose recent past would have weighed heavily on the mind of a rational stockholder considering whether to seat him as a fiduciary.").

This case shows the need for access and federal standards that to some degree even the playing field. Shareholders seeking to run a competing slate against management already have an uphill battle, needing to use their own funds while management can rely on the corporate treasury. The Vice Chancellor expands that authority to allow management to interfere in the voting process in those rare cases when dissident shareholders appear likely to win by cutting a deal whereby another shareholder will eliminate dissident votes in return for positions on the board. In a close election, as this one apparently turned out to be, it allows management to use positions on the board to tip the balance.

Certainly this type of behavior ought to be viewed with considerable suspicion. Not, apparently, by the Delaware courts.