Kurz v. Holbrook: Shareholder Voting, Omnibus Proxies, and the Role of DTC: Third Party Vote Buying

We are discussing Kurz v. Holbrook, 2010 Del. Ch. LEXIS 24 (Del. Ch. Feb. 9, 2010).

Another issue addressed by the court were allegations of vote buying.  These concerns arose because Kurz, a director and member of the TBE Group, acquired shares that could not yet be transferred (due to transfer restrictions) and in the process obtained an irrevocable proxy for the undelivered shares.  The votes were, apparently, outcome determinative. 

The court acknowledged that vote buying “is an incendiary phrase” that “carries connotations of bribery and corruption.”  Nonetheless, as VC Laster rightfully notes, the Delaware courts have, since Schreiber v. Carney, 447 A.2d 17 (Del. Ch. 1982), recognized that vote buying was a permissible practice.

The transaction raised three distinct issues.  First was whether the practice even involved vote buying since there were no corporate assets used in the transaction.  Assuming it did, the second was whether the purchases violated the standards for vote buying set out in Schreiber and its progeny.  The last was whether the acquisition of the votes without actually obtaining the shares was somehow improper. 

The prohibition on vote buying traditionally arose in the context of companies acquiring votes to facilitate shareholder approval.  In Schreiber, the court approved a transaction in which the company made a loan to a shareholder in return for support for a merger.  Moreover, in the HP case, the Chancery Court indicated that the use of corporate assets was a necessary condition in order to separate vote buying from identical behavior that could occur in a shareholder voting agreement.  As that court noted:

• The appropriate standard for evaluating vote-buying claims is articulated in Schreiber v. Carney. Schreiber indicates that vote-buying is illegal per se if "the object or purpose is to defraud or in some way disenfranchise the other stockholders." Schreiber also notes, absent these deleterious purposes, that "because vote-buying is so easily susceptible of abuse it must be viewed as a voidable transaction subject to a test for intrinsic fairness." At first blush this proposition seems difficult to reconcile with the General Assembly's explicit validation of shareholder voting agreements in Sec. 218(c).  Significantly, however, it was the management of the defendant corporation that was buying votes in favor of a corporate reorganization in Schreiber. Shareholders are free to do whatever they want with their votes, including selling them to the highest bidder. Management, on the other hand, may not use corporate assets to buy votes in a hotly contested proxy contest about an extraordinary transaction that would significantly transform the corporation, unless it can be demonstrated, as it was in Schreiber, that management's vote-buying activity does not have a deleterious effect on the corporate franchise.

Hewlett v. Hewlett-Packard Co., 2002 Del. Ch. LEXIS 44  (Del. Ch. April 8, 2002).  The distinction makes sense because directors have fiduciary obligations and, in general, shareholders do not.  In other words, vote buying if improper is a fiduciary duty violation and therefore ought not to be extended to shareholders, other than perhaps controlling shareholders. 

VC Laster saw things differently.  This case did not involve the use of corporate assts but did involve a fiduciary.  Nonetheless, VC Laster disregarded the distinction set out in Hewlett and instead likened the transaction to “third party” vote buying.   

• Vote-buying that does not involve use of corporate resources--which I will call "third party vote buying"--is an undeveloped area of our law. Although dictum in Hewlett-Packard could be read to suggest that there are no restrictions on the buying or selling of votes when corporate resources are not involved, I do not believe that was what Chancellor Chandler intended. Elsewhere in the Hewlett-Packard decision, Chancellor Chandler noted that "the principle that vote-buying is illegal per se if entered into for deleterious purposes survives." Recent scholarship has cast light on shadowy aspects of the voting process and techniques by which voting rights can be manipulated. I regard the concept of vote buying as broad enough to encompass these practices. When they prove deleterious to stockholder voting, this Court can and should provide a remedy.

The result is correct but the analysis suspect.  It’s true that no corporate assets were used in the transaction.  But the analysis ignores the fact that the purchaser was a director who had a fiduciary duty to shareholders.  Reliance on the purchaser’s fiduciary status would have allowed VC Laster to render a decision consistent with Hewlett, rather than try to explain away the inconsistency, and prevented the case from reaching true third party vote buying schemes. 

By characterizing the issue as third party vote buying (and ignoring the purchaser’s fiduciary status), the analysis unequivocally extends vote buying analysis to shareholder voting agreements by all shareholders, even shareholders without any fiduciary obligations.  In other words, ordinary shareholders seeking to organize through the use of shareholder voting agreements will now have to analyze their behavior for possible illegal vote buying. Indeed, as he notes later in the opinion:

• Nothing in Section 218 states or implies that every voting trust or voting agreement is valid, and nothing in Section 218 speaks to arrangements producing voting incentives directly contrary to ownership interests.  Section 218 does not limit this Court's equitable powers to address deleterious practices.

In short, shareholder voting agreements are in play.  It was an unnecessary step to take and arguably in conflict, as the court in Hewlett noted, with “the General Assembly's explicit validation of shareholder voting agreements in Sec. 218(c)." 

For more on the entire system of beneficial ownership and the role of the depositories, see The Shareholder Communication Rules and the Securities and Exchange Commission: An Exercise in Regulatory Utility or Futility?  The opinion and a number of primary materials are posted at the DU Corporate Governance web site.