Let’s say Sally has a dream of starting a social enterprise, the purpose of which is to provide clean water in rural African villages. She has invented a low-cost filter that will revolutionize people’s ability to access clean water. She starts the business with the help of some friendly investors who believe in its mission and don’t care so much about whether they will ever get any returns on their investment. She incorporates in Delaware because that’s what her corporate lawyer friend advises.
The business grows little by little. Selling the filters to local governments, non-governmental organizations (NGOs), and others is generating more profits than Sally ever expected. She wants to expand to more villages and she needs more capital to do it. She finds more investors to fund the expansion.
Sally looks at her books and realizes that her profit margins are quite large. She’s paying herself and her employees good salaries and the business expenses are pretty low. She decides that the right thing to do is to lower the price of the filters and the board agrees with her decision. A few months later she’s happy to see that her profits are much lower and more people are benefiting from her invention.
But then she releases her annual report to her shareholders. She gets some angry calls demanding to know what happened to the profits? She calmly explains that the purpose of the company is not to make profits but to provide clean water. The shareholders call their lawyers. The lawyers threaten to sue Sally and her board.
In this situation, Sally is likely to prevail. The decision to lower the price would likely receive great deference from the court in Delaware because of the business judgment rule. However, Sally now has to contend with the time, energy, and legal fees necessary to respond to even the mere threat of a shareholder lawsuit.
Imagine that a few years later, all this is behind her and everything is still going well with the business. Imagine she has reincorporated in Vermont, a state that has a constituency statute, so that she has a better chance of avoiding shareholder lawsuits in the future. Sally, happy with what she has created, is ready to move on to new adventures. She starts to talk to potential buyers for the company. She will only talk to socially responsible companies and investor groups that she feels confident will continue to make profits secondary to providing affordable clean water.
Word gets out that Sally is looking for a buyer. SuperMega Monolith Corporation (SMM), one of the world’s largest multinational conglomerates, is interested. This filter could make them billions! SMM makes an offer to the board, which the board quickly rejects, fearing that, under SMM’s control, the company’s mission will be lost. SMM then makes an offer directly to Sally’s shareholders—we’ll buy your stock for $50 per share. Sally calls those other potential buyers she’s been talking to but none of them can afford to pay that much. The company’s lawyers advise the board that it has no choice but to let SMM buy the company.
“But, wait,” Sally protests. “We are incorporated in Vermont, and Vermont has a constituency statute that protects us if we block SMM’s offer.” The lawyers shake their heads glumly—“Do you really want to take the chance that the courts will see it your way? Every member of the board could be held personally liable for not meeting their duties to the shareholders to maximize their return.” 1
Sound familiar? This is what happened to Ben and Jerry’s. In 2000, a similar scenario led to the sale of Ben and Jerry’s to Unilever.
- Delaware, by case law, authorizes managers to reject a takeover bid based on “the impact on ‘constituencies’ other than shareholders (i.e., creditors, customers, employees, and perhaps even the community generally).” Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985). See also Paramount Commc’ns v. Time, 571 A.2d 1140, 1153 (Del. 1990) (“Directors may consider, when evaluating the threat posed by a takeover bid, . . . ‘the impact on ‘constituencies’ other than shareholders . . . .’”) (citations omitted). ↩