Truth on the Market

Last fall Guhan Subramanian, Steve Herscovici and Brian Barbetta (“SHB”) posted a paper claiming that Delaware’s antitakeover statute (Delaware GCL Section 203) was preempted by the Williams Act because it did not leave hostile bidders the “meaningful opportunity for success” required by three 1988 federal district courts which had upheld the Delaware law back in 1988. Specifically, SHB concluded:

Using a new sample of all hostile takeover bids against Delaware targets that were announced between 1988 and 2008 that were subject to Section 203 (n=60), we find that no hostile bidder in the past nineteen years has been able to avoid the restrictions imposed by Section 203 by going from less than 15% to more than 85% in its tender offer. At the very least, this finding indicates that the empirical proposition that the federal courts relied upon to uphold Section 203’s constitutionality is no longer valid. While it remains possible that courts would nevertheless uphold Section 203’s constitutionality on different grounds, the evidence would seem to suggest that the constitutionality of Section 203 is up for grabs. This Article offers specific changes to the Delaware statute that would preempt the constitutional challenge. If instead Section 203 were to fall on constitutional grounds, as Delaware’s prior antitakeover statute did in 1986, it would also have implications for similar antitakeover statutes in thirty-two other U.S. states, which along with Delaware collectively cover 92% of all U.S. corporations.

SHB has now been published in The Business Lawyer with several responses, including mine, Preemption as Micromanagement. Here’s the abstract of my paper:

Guhan Subramanian, Steven Herscovici & Brian Barbetta, Is Delaware’s Antitakeover Statute Unconstitutional? Evidence from 1988–2008 , 65 BUS. LAW. 685 (2010) (“SHB”), argues that the constitutionality of the Delaware takeover statute is “up for grabs” because it denies bidders the “meaningful opportunity for success” three Delaware district court opinions require to avoid preemption by the Williams Act. However, this comment on SHB argues that, even assuming the applicable federal cases might be construed to support SHB’s conclusion, courts almost certainly would not follow this approach once they saw, with the aid of SHB’s analysis, the extent to which it requires courts to micromanage state corporate law. Moreover, from a policy standpoint, this micromanagement could have a significant negative effect on the development of state law. In short, rather than providing an argument for preempting the Delaware statute, SHB’s analysis demonstrates why it is important to avoid this result.

SHB respond to the comments, including mine (most footnotes omitted):

Professor Ribstein argues that “[i]t would be inconsistent with [the Delaware trilogy’s] reliance on the legislature’s judgment to invalidate the statute based on circumstances arising after the legislature had applied its judgment.” We know of no principle in constitutional law, nor does Ribstein offer one, suggesting that when the legislature makes a constitutional assessment, and a court later acknowledges that assessment, the constitutional question becomes untouchable. Ribstein states that courts “did not necessarily contemplate that plaintiffs could return to court more than a generation after the [Delaware trilogy],” but this is precisely what the Delaware trilogy envisioned.22 It should be remembered that Delaware passed its first antitakeover statute in 1976 and took it off the books in 1987 because it was likely unconstitutional. It is not obvious why Ribstein’s hypothesized statute of limitations on constitutional claims should run longer than eleven years but shorter than twenty-two.

 22 See SHB, supra note 1, at ___ (citing relevant cases). Professor Ribstein also states that “SHB suggest that the poison pill itself avoids preemption.” Ribstein, supra note 16, at ___. We do not suggest this in our Article; therefore the “attempted distinction” between Section 203 and the pill that Ribstein criticizes, id. at ___, is not a distinction that we try to make. Ribstein then criticizes our Section 203 analysis because (he argues) if it were correct it would call into question defenses of unquestioned constitutional validity, such as the staggered board. See id. at ___. In fact, there is a natural distinction between transactional defenses, such as Section 203 and the pill, and other corporate governance provisions, such as the staggered board. See, e.g., CTS Corp. v Dynamics Corp. of Am., 481 U.S. 69, 99 (1987) (White, J., dissenting) (describing the “fundamental distinction” between transactional defenses such as the Indiana antitakeover statute and other corporate governance provisions, such as cumulative voting and staggered boards).

I do not, in fact, argue for “a statute of limitations.” Rather, my point is that any approach to the Supremacy Clause that would imply a continuing and detailed federal judicial power to review the entire body of state corporate law from a single federal statute would amount to a quite significant federal intrusion into a traditionally state-dominated area. Indeed, SHB call attention to this effect by their attempts to distinguish the poison pill, staggered board provisions and Delaware Section 203.

The SHB analysis is particularly uncalled for given a far less intrusive alternative which the Supreme Court suggested more than 25 years ago – that is, a presumption against preemption of state regulation of internal corporate governance. This was the point I made in discussing SHB’s article when it first appeared last year:

I’m skeptical of the authors’ unconstitutionality claim. Notably, Section 203 is part of the Delaware’s corporate statute, and therefore an integral part of its regulation of internal corporate governance, like its jurisprudence on the poison pill. This is important because, as Erin O’Hara and I explain in The Law Market (p. 126, footnote omitted): “Although the U.S. Constitution probably does not forbid a state from regulating the internal governance of a firm that is incorporated elsewhere, it may confer some extra regulatory power on the incorporating state. In CTS Corp. v. Dynamics Corp. of America, the Court reasoned that “no principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations, including the authority to define the voting rights of shareholders.”  This “authority” in CTS allowed the incorporating state to regulate the governance of firms based in other states, consistent with the Commerce Clause, and to preserve a state corporate law provision notwithstanding a potentially preemptive federal law, under the Supremacy Clause.  

The dangers of superbroad implied preemption of state corporate law are particularly salient in light of the imminent adoption of federal financial reform, as I discussed a few weeks ago:

Although none of the [corporate governance provisions in the Dodd bill] is individually earth-shaking, they cumulatively touch many major aspects of corporate governance formerly left to contract and state law.  This bill thus clearly adds to the framework for federal takeover of internal governance that SOX established. The overall effect is that it will be increasingly difficult to demark an area left exclusively for state law. This leaves little “firebreak” to protect against judicial incursions in the spaces not yet covered by explicit federal provisions.  This could ultimately profoundly affect the relationship between federal and state law regarding business associations. 

A generation ago the Supreme Court could say that “no principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations, including the authority to define the voting rights of shareholders.” CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69, 89 (1987). 

Erin O’Hara and I have argued that this separation between federal and state spheres does and should affect the scope of implied preemption of state law by federal statutes.  Thus, when the Court held that state securities actions were preempted by the Securities Litigation Uniform Standards Act, it emphasized “[t]he magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities.” Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 78 (2006). See also my article on Dabit.

However, we noted that “[m]any federal ‘securities’ laws reach deep into the kind of internal governance issues covered by the [internal affairs doctrine].” Thus, corporate internal affairs are only “relatively safe from federal preemption” and internal affairs is not “a constitutional boundary, as shown by the continuing forward march of federal corporation law.”

Under the Dodd bill, the forward march picks up the pace.  

The combination of increasing federal regulation of corporate governance, the cumulative preemption effects inherent in this regulation, and the extremely broad view of preemption that SHB endorse would effectively annihilate state corporate law. We can only hope that Congress eventually comes to its senses. We shouldn’t add to the political mess by inviting the courts to join in the destruction.