Chads hanging around

Shareholder voting is riddled with inexactitude. Shareholders who sell their stock after the record date for a vote but before the vote itself retain their franchise. Banks that hold shares in "street name" for individuals may lend the shares to short sellers, leading to confusion and even overvoting. Hedge funds may retain voting rights while divesting their economic exposure to a stock. And then there are the challenges inherent in counting thousands of proxy cards in a short time.

Usually, these shortcomings don't become problematic, because most shareholder votes aren't close. The vote on Transkaryotic Therapies Inc.'s 2005 sale to Shire Pharmaceuticals Group plc was an exception. The biotechnology company's shareholders narrowly approved the deal, with only 53% voting for it while 35% sought appraisal, an extraordinarily high percentage. Carl Icahn snapped up a 5% stake after the record date for the vote solely to seek appraisal, a very unusual gambit, given that appraisal proceedings can take years.

That litigation continues. But on June 19, Chancellor William B. Chandler III issued a ruling in a suit brought by Transkaryotic shareholders who challenged the validity of the shareholder vote on the merger; the company's disclosure; and the alleged failure of the company's directors to fulfill their fiduciary duties.

Chandler's dismissal of all but one of the fiduciary duty claims was unremarkable. But his ruling on the disclosure claims and his refusal to dismiss the challenge to the shareholder vote were noteworthy.

The judge didn't even reach the merits of the disclosure claims, instead holding that they were no longer ripe for consideration because the sale had closed. Chandler described the duty of disclosure as "a specific application of the duties of care and loyalty," a characterization that nonetheless "does not render this area of the law clear," as the judge's review of the cases showed.

On one hand, he noted, the Delaware Court of Chancery has held that disclosure violations "lead to irreparable harm." On the other, recent court rulings "have made clear a desire to avoid entirely monetary damages and expressed a preference for having disclosure claims brought as motions for a preliminary injunction before the shareholder vote." Chandler reconciled the two positions by holding that Chancery will grant neither monetary nor injunctive relief for disclosure violations after the consummation of a deal "where there is no evidence of a breach of the duty of loyalty or good faith by the directors who authorized the disclosures."

This is a paradoxical result unless the court considers disclosure "a low-cost, low-benefit remedy," as Edward Rock, a corporate law professor at University of Pennsylvania Law School, puts it. If a company failed to disclose a significant fact, such as management's being on both sides of a transaction, that would probably be a breach of the duty of loyalty rather than a mere disclosure violation. Thus, Rock says, "the category of disclosure violations is, by necessity, going to be situations where you don't have anything worse."

As a result of Chandler's ruling on the point, "the cost of post-deal settlements involving disclosure claims should go down," wrote J. Travis Laster (pictured) of Wilmington, Del.-based Abrams & Laster LLP in a memorandum to clients. In response, the plaintiffs' bar will likely seek more pre-closing disclosure-based injunctions in an effort to get "a meaningful disclosure remedy and a commensurate fee award," wrote Laster, who helped advise Transkaryotic along with Robert Baron of Cravath, Swaine & Moore LLP in New York.

Chandler's ruling on the validity of the merger vote shows the practical problems that poor voting mechanics can cause. Transkaryotic shareholders approved the merger by 929,831 votes. But the plaintiffs alleged that there were two proxy cards associated with a single State Street Bank & Trust Co. account that held 1.55 million shares. Chandler found it "unclear" whether the proxy card was duplicated twice during discovery in the case or the tabulation of votes and would not dismiss the claim, a ruling, he held, that "should not in any way imply that I am optimistic that plaintiffs will succeed in carrying their ultimate burden of proof at trial."

Nevertheless, the mere prospect that a Delaware court could invalidate a merger years after its closing should lead companies to monitor their elections more carefully, says Rock, who along with New York University School of Law professor Marcel Kahan has explored the matter in "The Hanging Chads of Corporate Voting."

Rock believes the issue will become more pressing. "What counts as a close election is changing," he says. "In a world in which everyone holds shares in a normal, long way, a close election is 2%. But in a world where you have short interest of 7% or 8%, it seems to me that a 4% to 6% difference becomes close."