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July|August 2005
What Would Allah Do? By Nadya Labi
The Dread Pirate Bin Laden By Douglas R. Burgess Jr.
On Notice By Sasha Issenberg
Boss of the Bosses By Len Costa
Changing of the Guards By Mary Beth Pfeiffer

Boss of the Bosses

Delaware's most important judge takes on greedy executives, Congress, and the history of corporate law.

By Len Costa

IN THE POST-ENRON WORLD, many fallen moguls have had their transgressions laid bare in court. But in February 2004, newspaper baron Lord Conrad Black of Crossharbour received an unusually explicit judicial whipping. That was the day Black's bad behavior ignited the pen of a sharp-tongued young Delaware Chancery Court judge named Leo Strine. Strine, who was confirmed to the court in November 1998 at the age of 33, has emerged as the hardest-working, wittiest, and most outspoken judge on the world's most important court dealing with corporate law. More than 60 percent of Fortune 500 companies are incorporated in his tiny home state, drawn by a lax corporation law and the court's propensity not to second-guess decisions made by businessmen.

Strine and his colleagues apply the ancient English legal concept of equity, or fair dealing, to resolve disputes between managers, shareholders, and boards of directors. Equity requires a judge to rule on fuzzy determinations of fairness and loyalty, and the court's tone on those counts has shifted since the corporate scandals of the late '90s erupted. Delaware used to be known as the friendliest place for company directors. But, thanks in part to Strine, directors are now treated with more skepticism.

The case of Hollinger, Inc. v. Black centered on whether Lord Black, the company's chairman, could proceed with the sale of a holding company through which he controlled Hollinger International, whose flagship newspapers at the time included the Chicago Sun-Times and Britain's The Daily Telegraph. The deal was negotiated secretly, and the company's board argued that the deal should be kept from going forward because consummating the sale of the holding company was an abuse of Black's loyalty to the company. Absent the lawsuit, Black could have effectively sold control of Hollinger International and its publications without the board or other shareholders having any say.

Strine's ruling began with a bang. "The most interesting corporate law cases involve the color gray," he wrote, "with contending parties dueling over close questions of law, in circumstances when it is possible for each of the contestants to claim she was acting in good faith. Regrettably, this case is not one of that variety." With devastating specificity, Strine laid out the facts, catalogued Black's repeated connivances, and sliced through each of his defenses. Black had "misrepresented facts to the International board," Strine wrote. Black's efforts to sell his holding company were "cunning and calculated." As a witness, he was "evasive and unreliable." And his key claim—that he was railroaded into signing a formal contract with his board that effectively forbade him from pursuing his covert transaction—was "unpersuasive" and "frivolous."

While the adjectives were explosive, Strine's legal reasoning was restrained. He halted the covert sale and struck down amendments to Hollinger's bylaws that would have cemented Black's control over the company. But he did so without rewriting legal standards that protect the rights of shareholders who haven't committed the sort of transgression that Black did.

The Hollinger ruling is but one example of what happens on Strine's legal watch. In the past few years, Strine has halted acquisitions and ordered a billion-dollar merger completed. He has blessed the conduct of independent directors while declaring the decisions of others improperly and uncomfortably conflicted. He has approved a company's right to split up its subsidiary while forbidding others from swallowing up theirs. And in a widely watched performance last year, he used his courtroom to push software maker PeopleSoft and its hostile acquirer, Oracle, to negotiate a $10.3 billion deal. "He got both sides into a kind of group therapy in which the offer went up and the resistance went down," said Columbia Law School professor John Coffee.

Strine's record is enviable. Since his confirmation to the bench in 1998, he has written more than 100 business law decisions. Only a handful have been reversed. "They are extremely well crafted legally," says Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.

But more important, with Congress and the stock exchanges embracing ever-more layers of bright-line regulations to curb abuses, most notably the 2002 Sarbanes-Oxley Act, Strine is proving that Delaware can be tough but flexible and fair. Strine is shifting Delaware's biases away from directors and toward shareholders. In the process, he's increasing the already outsized power of his tiny state in high-profile corporate transactions. He doesn't want corporate America governed by a set of specific rules drawn up in Washington, D.C., that can be violated in specific ways. He wants a system where cases come to Delaware's Chancery Court and judges like Leo Strine decide what they think is equitable.

"IS ANYBODY IN THERE?" ASKED VICE CHANCELLOR STRINE, as he is officially known. The judge was on all fours, peering under the door of a Chancery courtroom on the 12th floor of the New Castle County Courthouse in Wilmington, Del. He was leading me on a tour of his domain, which includes four modern courtrooms and the judges' chambers on the floor below.

Chancery courtrooms are small. Apart from the raised bench, they consist primarily of neatly aligned tables that accommodate the lawyers who sit in opposition during legal proceedings. Journalists, visitors, and arbitrage specialists hoping to profit from trial news must compete for chairs in the back. During high-profile cases, Judge Strine projects the proceedings on a video screen in an overflow room.

Corporate law cases rely on reams of documents and testimony. In Chancery Court, this evidence can be scanned, bar-coded, and projected on a large screen inside the courtroom, a capability that Strine finds particularly useful for impeaching testimony.

"Do you recall saying X?" he asked, in mock dialogue with a witness.

"Well, no, I don't."

"Do you recall giving a deposition?"

"Well, yes, I do."

"Excellent," he said, pointing to the screen. "Let's review your testimony."

Court observers say that Strine often displays a better grasp of legal arguments than the lawyers who present them. By his own admission he's vocal and direct. "I've been turned around 180 degrees by people," he said. "But it's not by me sitting back and not telling them what's on my mind. It's by me saying, 'Mr. X, I've read your brief, and here's what's bothering me. Tell me how to get past it.' It's one of the advantages of not having a jury."

Strine first attracted headlines in 2001 when the shareholders of IBP, a pork and beef processor, asked the Chancery Court to compel Tyson, a poultry producer, to complete a previously agreed merger. Tyson argued that losses and questionable accounting at an IBP subsidiary were grounds to walk away from the deal. But in a 146-page opinion, Strine labeled the company's hesitation "buyer's regret." Rather than issuing an injunction or a damages award, a more traditional Chancery Court remedy, he ordered Tyson to proceed with the deal. "It takes some guts to tell billion-dollar companies they have to merge," said Widener University law professor Lawrence Hamermesh.

But Strine isn't all business all the time. He knows how to use humor to focus attention or to disarm a tense situation. In one exchange, Anthony Clark, a partner at Skadden, Arps, Slate, Meagher & Flom and a lawyer for Tyson, attempted to align himself with Strine by pointing out that they both had to deal with a witness's imperfect recollections.

"My problem and the vice chancellor's problem is. . . ," he began.

"Male-pattern baldness?" interjected Strine, who sports a shiny pate.

CHANCERY COURT JUDGES ARE TYPICALLY FORMER SENIOR PARTNERS from the Wilmington legal establishment. Strine's background is different. After clerking for two judges, including his mentor Walter Stapleton, who is now on the United States Court of Appeals for the Third Circuit, Strine worked as an associate at the Wilmington office of Skadden. But he soon started moonlighting as a policy adviser to then-Democratic Governor Thomas Carper, now one of Delaware's U.S. Senators. In 1993, when he was 28, Strine began to work full time at the governor's office, where he threw himself into the administration's education and antipoverty agenda, including welfare reform, workers compensation, and charter-school reform—the latter taking shape in a bill that Strine wrote.

Not surprisingly, he knocked a lot of heads in Dover, the state capital. His aggressive approach, combined with his age, made his confirmation process in 1998 unusually rocky. Still, Strine says that working for the governor was the best job he ever had, and it continues to exert a strong influence on his working style. Rather than relying on his clerks to draft opinions, Strine tends to write them himself. And for a court that prides itself on speed—all Chancery opinions must be issued within 90 days to reduce uncertainty for businesses—Strine is dazzlingly fast. He issued his Hollinger opinion less than a week after oral arguments concluded.

Strine's time in the governor's office also colors his legal philosophy. He says he has a healthy respect for the State Legislature's intentions when he interprets statutes. And in the realm of equity jurisprudence, he is attuned to making the common law make sense. "When you are talking about people's substantive rights," he said, "contradictions ought to be few and far between."

In Delaware, that can be a challenge. As the judge-made standards of fiduciary review have multiplied over the years, so has the number of gray areas where they overlap. Chancery Court and Delaware Supreme Court opinions sometimes gloss over these inconsistencies or cut in new directions without acknowledging a shift. But Strine grapples openly and honestly in his decisions with bringing clarity to the law. For this reason, he opposes a recent line of cases that is defining a duty of "good faith" for boards that is separate from the existing duties of care and loyalty they must apply in their business decisions. This "balkanization," Strine wrote in a recent opinion, "does no service to our law."

THE DELAWARE CHANCERY COURT IS HOUSED in the New Castle County Courthouse, a modern glass-and-steel structure in Wilmington that also houses the state's Court of Common Pleas, its Superior Court, and its family courts. In the stark lobby, flat-panel video monitors display the day's proceedings, from bail and child support hearings to custody petitions and any corporate law matters before Chancery.

The courthouse's amenities are outward signs of the tremendous tax revenue that Delaware derives from being the country's leading venue for incorporations. More than 50 percent of all U.S. publicly traded corporations, and many international ones too, are Delaware-chartered. For the fiscal year ending June 30, 2006, Delaware will take in nearly half a billion dollars, or nearly a fifth of total state revenue, from franchise taxes on corporations, second only to personal income tax as a revenue generator for the state. Thanks to a legal settlement that Strine helped negotiate for the former governor, Delaware also derives substantial revenue from unclaimed dividends and abandoned accounts held by New York-based brokers, most of which are incorporated in Delaware—$250 million in fiscal year 2006. "Delaware is not just a dominant player," said Harvard law professor Lucian Bebchuk, who studies incorporation trends. "It's a virtual monopoly."

Delaware's pre-eminence in corporate law has deep historical roots. For most of the 19th century, corporations were chartered by acts of state legislatures. But in 1896, New Jersey passed a law that made it easy to charter a company—and it quickly became a leading venue for incorporations. Eyeing the tax revenue, Delaware copied the statute in 1899 and expanded upon it. When Governor Woodrow Wilson of New Jersey enacted tough legislation in 1913 to boost his trust-busting credentials, he chilled the state's incorporation business. Delaware gained the edge and never looked back.

This lead is self-reinforcing: More companies mean more corporate law disputes, and more disputes deepen the expertise of the Chancery Court and develop the state's common law. Today, an entire legal ecosystem supports the process, including homegrown specialist law firms and many out-of-state firms with a strong Delaware practice.

The highly regarded Chancery Court is a major draw. Founded in 1792, it was modeled on Britain's now defunct High Court of Chancery. In the mid-19th century, a powerful legal reform movement in the United States merged state law and equity courts because the latter were viewed as instruments of the British Crown. But in Delaware, unlike every other state, the Court's equity powers were rooted in a statute, not administered by a royal governor, so the climate was more agreeable to the status quo. Only a few other states have separate courts of chancery, and none specialize in corporation law the way that Delaware does.

From the start, Delaware's Chancery Court provided relief to state residents tailored to the facts of a case when no remedy was available under law—for example, if the ownership of land was in dispute between two neighbors. True to its roots, the court today hears many noncorporate law equity cases concerning zoning, labor disputes, and trusts. Strine, who takes these cases very seriously but jokingly calls them his "Judge Judy cases," recently wrote an opinion deciding whether somebody's fence violated a deed restriction.

The Chancery Court remains as big an attraction for corporations as Delaware's lax incorporation laws. Strine and his colleagues are nominated by the governor and confirmed by the State Senate for 12-year terms. The institution is supposed to be apolitical. With limited jurisdiction, focused expertise, and zero risk of juries behaving badly, no court in the country is more skilled in teasing apart the finer points of a preferred stock offering.

AS THE NUMBER OF DELAWARE CORPORATIONS GREW in the early and mid-20th century, the Chancery Court began applying equitable principles to disputes between investors and their fiduciaries, corporate directors, thus creating the common law of corporations. Gradually, mandatory statutory requirements receded and judicial review of the actions of corporate officers and directors became the main force of the law. Writing in 1962, Bayless Manning, soon to be the dean of Stanford Law School, despairingly described corporation statutes as "towering skyscrapers of rusted girders, internally welded together and containing nothing but wind."

More than most judicial institutions, the Delaware Chancery Court doesn't second-guess decisions made by informed, disinterested boards, for fear of chilling commerce and innovation. This philosophy is encapsulated in the state's formal "business judgment rule," which holds that directors aren't liable for mistakes if their choices are made with due care and good faith. Directors get the benefit of the doubt; stockholders challenging a business decision have the burden of proving a violation of fiduciary duty. This deference to the board has imbued Delaware with a reputation for favoring managers over stockholders.

At no time was this bias more evident than in the 1980s, during an era of rampant hostile takeovers. With Congress and the Delaware Legislature unwilling to act to protect threatened boards, the Chancery Court stepped into the policy vacuum. In a series of cases upheld by the state's Supreme Court, Chancery affirmed the legality of what has become the ultimate symbol of a board's privileged power: the "poison pill" takeover defense, which uses the threat of massive stock price dilution to ward off hostile raiders. Unless the court voids a poison pill that doesn't pass a "reasonableness" test—something it has rarely done—shareholders must wage long proxy fights to install new directors who will redeem the pill and consummate the takeover.

Strine openly questions this balance of power and appears to be playing a role in shifting Delaware more to the side of shareholders. Although he has never ruled directly on the limits of poison pills, he invalidated part of a company's takeover defenses in 2000 and criticized the board's claim that its stockholders needed protection from the hostile offer because they couldn't understand the true value of their shares. "If stockholders are presumed competent to buy stock in the first place, why are they not presumed competent to decide when to sell in a tender offer?" he wrote.

The parade of recent corporate scandals has further strained the notion that directors always know best. The Chancery Court has taken notice: Questionable behavior that might once have been dismissed under the business judgment rule is attracting a critical eye. In 2004, Chancellor William Chandler rebuked officers and directors of the online auctioneer eBay for participating in "IPO spinning," the now-banned practice of flipping new shares doled out by investment banks for a quick profit. Later that year, Strine held that two Oracle directors with strong social ties to their fellow board members couldn't be "independent" for the purpose of investigating allegations of director misbehavior.

SOME SCHOLARS, INCLUDING HARVARD'S BEBCHUK, have argued that Delaware's judge-made law is overly vague and indeterminate and thus inefficient. In this line of reasoning, Delaware acts as a fat monopoly, extracting economic profit for the state by triggering endless corporate litigation.

But there is another way to look at it. Strine argued in a 2002 law review article that inconsistencies in the state's corporate common law can be a source of dynamism. They enable judges to update the law slowly and methodically as new facts present themselves, taking account of innovations in business and new understandings about how incentives affect behavior.

In Leo Strine's courtroom, a wariness of absolutes doesn't detract from the forcefulness of a legal ruling. In Strine's Hollinger opinion, for instance, he was careful not to create a broad new rule or standard to govern the rights of shareholders with a controlling interest in a company to amend its bylaws. Instead, he tailored his ruling to the facts of the case, adding to the common law in a gentle rather than jarring manner.

This judicial mindset explains why many observers view the spasm of post-Enron regulations from Congress, the Securities and Exchange Commission, and other standard-setters as a shot across the bow of the Chancery Court. The Sarbanes-Oxley Act and tough new requirements for New York Stock Exchange- and Nasdaq-listed companies were aimed at improving corporate integrity, especially the quality of financial reporting. But these reforms also contained corporate governance mandates that represent a clear encroachment on Delaware's turf.

Strine, in particular, is exercised. In a series of speeches and papers, he has warned against the ill effects of "bright line rules," which can lead to policies that are "too rigid and punitive, and that cannot respond flexibly to future developments." For instance, Strine is troubled by rules suggesting that investors with large but noncontrolling blocks of stock are incapable of acting independently. Under Sarbanes-Oxley, a director who owns 10 percent or more of a company's shares can't serve as a voting member of the audit committee. What the reforms seem to view as a conflict, Delaware law views as an incentive to protect shareholders.

There's also a broader concern with the spirit of the new regulation. One-size-fits-all federal and stock exchange mandates, such as new rules that prescribe the composition of board committees or the number of independent directors, can encourage a focus on rote process rather than attention to the governance challenges of a particular corporation. "By mandating everything, you force boards to check boxes," said Strine. "But if those legal requirements aren't the most important thing directors could be doing to protect the corporation and the stockholders, then it's misguided."

Of course, judge-made corporate law isn't risk-free. Broad principles can create uncertainty for executives. In the hands of a wayward judge, poorly articulated equitable principles or dramatic shifts in doctrine could also create confusing and ever-changing legal guardrails. And since it's the managers who choose where to incorporate, Delaware, the leading venue, has an incentive to play to their interests at the expense of shareholders.

But law could vary even more under a federal regime. When it comes to corporation law, a significant common law component is inescapable: A statute can't capture the innovation and variety that defines business activity. In practice, that means a federal corporation law would empower hundreds of district judges with little corporate expertise but inevitable ties to the local corporate community. "It would lead to politicized and inconsistent results," said the University of Delaware's Charles Elson. "Hence the genius of the Delaware system, as long as it remains above the fray." And fortunately, since Delaware is home to only three Fortune 500 companies, it's far easier for its judges to do just that.

STRINE'S RECENT HANDLING OF THE ORACLE-PEOPLESOFT TAKEOVER BATTLE illustrates this advantage. In an emotionally fraught suit brought by Oracle, Strine was set to rule on the legality of PeopleSoft's takeover defenses, including its poison pill. Unencumbered by a strict law he had to follow or by political influence—imagine if the suit had been brought in California, where lives and jobs were at stake—Strine's inquiry was long, probative, and geared to coaxing the parties towards a deal. "Not so much by browbeating people," said Wilmington attorney Michael Hanrahan whose firm, Prickett, Jones & Elliott, represented PeopleSoft's stockholders. "But by being fairly candid about what he thought of people's positions."

This effort came to a boil in a 39-minute teleconference that Strine conducted with lawyers from both sides in December 2004. Over the preceding 18 months, PeopleSoft had rejected five separate Oracle bids and—thanks to its poison pill—could hold steadfast even after 61 percent of its own shareholders voted in favor of a $24-a-share deal. In the teleconference, Strine and the lawyers discussed a request from PeopleSoft to seal the courtroom so they could present confidential deposition testimony that they hoped would demonstrate PeopleSoft was negotiating in good faith. For Strine, it was an opportunity.

In the deposition in question, George Battle, a key player from the PeopleSoft board, had separated himself from the party line and launched what was effectively the first official counteroffer, saying he could "get behind" an offer of $26.50 a share "and thought the board could." But PeopleSoft had designated the testimony "attorneys' eyes only," so Oracle's lawyers were forbidden from sharing it with their client. Both sides said they were willing to negotiate, but personalities and legal impediments were keeping them from actually doing so face to face.

Strine sensed an opening. On the call, he said the attorneys'-eyes-only designation was "absurd and needed to be changed." And in a touchy exchange with PeopleSoft lawyer Donald Wolfe, he didn't mince words in explaining why. Strine started by saying that he didn't "get the maturity level of what is going on here. . . ."

When Wolfe tried to parry, the judge dug in. "This is not some game of phony Monopoly or some fun-loving little tricky stuff that people do," he said. "I mean, I have got other cases to decide, too, you know, and there is [sic] going to be real costs of a proxy fight, if one goes forward, to both sides, reputationally, financially." Strine then chided Wolfe by wondering aloud how to write an opinion saying that the board member had a price in mind but that Strine didn't know if it had been communicated.

The dispute quickly shook loose. The attorneys'-eyes-only designation was lifted, and PeopleSoft shared the deposition with Oracle the following day. The new information set off a flurry of weekend telephone calls that culminated in a deal announced Sunday night. The magic number was $26.50 a share, the price Battle had cited in his testimony.

History is on the side of the Delaware Chancery Court in maintaining its flexibility: When the English High Court of Chancery began formalizing its equitable doctrines, it became so rigid and repressive that the British Parliament dismantled it in the 1870s.

Strine and his colleagues appreciate the lesson, even when the U.S. government doesn't. Intervention from Washington will ebb and flow in response to national scandals, but the basic rules of corporate governance and the case-by-case approach to moving the law governing most of corporate America are likely to remain a function of Delaware. "We're one of the few places where people complain in both directions," said Strine. For the man who might be the nation's most influential corporate law judge, there's no higher compliment.

Len Costa wrote about the poison pill in the March|April issue of Legal Affairs.

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