For the past two decades, Delaware court decisions addressing non-majority control have aligned with one of two competing schools of thought. A functional school has examined the ability to exercise control over corporate conduct, considered multiple sources of influence, and recognized that relatively low levels of voting power could support control, particularly in combination with other factors. A formal school has examined the ability to exercise control over the board, discounted sources of influence other than stock ownership, required that the non-majority stockholder wield influence equivalent to a majority owner, and treated one-third voting power as a de facto floor for non-majority control.
Influential commentators recently attacked the functional school as novel and anomalous, and their advocacy contributed to amendments to the Delaware General Corporation Law that defined “controlling stockholder” in formal terms. In two companion articles, both published in the Fordham Journal of Corporate & Financial Law, I examine whether the claim of novelty holds up. The first article (the Historical Article) surveys a century of case law. The second article (the Statutory Article) examines statutory regimes that deploy the concept of control for the same purposes as fiduciary doctrine. Both show that the functional approach has always been dominant.
The Two Schools
The Historical Article traces case law addressing non-majority control from its origins in the early 20th century. It shows that the prevailing approach has always been functional. In 1912, the Supreme Court of the United States held that Union Pacific Corporation exercised non-majority control over the Southern Pacific Railroad. The justices looked for the ability to control corporate conduct, considered not only stock ownership but also the executive positions that Union Pacific personnel held at Southern Pacific, and took into account the transactional history between the companies. In Delaware, Chancellor Wolcott applied functional principles in Guth v. Loft, a landmark case from 1938, to conclude that a CEO and 11 percent stockholder controlled his corporation. Sixty years later, then-Vice Chancellor Strine reached a similar conclusion in Cysive, where he held that a CEO, chairman, and 35 percent stockholder exercised non-majority control.
The formal school, by contrast, is a recent innovation. Its core tenets first emerged in two Delaware decisions issued in 2006, and then coalesced into a recognizable framework in decisions issued around 2014. After that, a subset of Delaware decisions deployed the formal school’s tenets with increasing frequency, typically resulting in pleading-stage dismissals. Other Delaware decisions, by contrast, continued to take a functional approach.
Insights From Statutory Definitions
The Statutory Article examines codified definitions of control. Those definitions offer useful guideposts insofar as they openly assert what control means. That said, many statutory regimes deploy the concept of control in wide-ranging contexts. To avoid comparing apples and oranges, the Statutory Article focuses on regimes that operate in areas where fiduciary doctrines also govern and that deploy the concept of control for the same reasons equity imposes fiduciary duties on controllers: to ensure the law reaches those actually exercising authority and to constrain unfair transactions. That approach prioritizes two groups of statutes: regimes that police relationships between investors and entities, and regimes that police relationships between controllers and their controlled affiliates. It excludes regimes that use control for unrelated purposes, such as federal tax law’s 80 percent threshold for consolidated returns.
Statutes Addressing Investors’ Relationships With Entities
The first category starts with the Securities Act of 1933 and the Exchange Act of 1934. Both statutes use the concept of control extensively, but neither statute defines it. Congress intentionally avoided a fixed definition because it wanted the statutes to apply “wherever the fact of control actually exists.” In other words, Congress wanted a functional approach. In 1948, after developing guiding principles through regulatory rulings and caselaw, the SEC promulgated a uniform definition for both acts: Control is “the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” That definition is the most widely applicable test for control in American law, and it has remained substantively unchanged for nearly eight decades. It is functional in every respect.
State blue sky laws followed suit. Twenty-five states use the securities law definition verbatim or with minor variations. Thirteen states go further by presuming control at specified ownership levels: three at 10 percent, two at 20 percent, and eight at 25 percent. Only California uses a bright-line rule, and it establishes control at 10 percent. No state follows the formal school in using a bright-line test to foreclose control.
Statutes Addressing a Controlled Company’s Relationship With Its Controller
The pattern continues in the second group. The New Deal securities regimes all deploy a functional approach. The Public Utility Holding Company Act of 1935 uses a variant of the securities law definition and adds a presumption of control at 10 percent ownership. The Investment Company Act of 1940 uses a variant of the securities law definition and adds a presumption of control at 25 percent ownership. The Trust Indenture Act of 1939 treats 5 percent ownership as creating a disqualifying conflict of interest, implying control exists at that level.
The same is true in banking and insurance. The Bank Holding Company Act of 1956 deems control to exist at 25 percent ownership and separately authorizes case-by-case findings of non-majority control. Federal Reserve regulations implementing the Bank Holding Company Act create graduated presumptions of control by combining ownership thresholds as low as 5 percent with rights such as board representation, executive positions, contractual vetoes over operational and policy decisions, and other significant relationships. That is a functional approach. The National Association of Insurance Commissioners’ Model Insurance Holding Company System Regulatory Act presumes control at 10 percent ownership, and 41 states have adopted that definition.
The federal statute that governs review of foreign investment (FIRRMA) also defines control in functional terms. Its implementing regulations identify combinations of contract rights and other sources of influence that can establish non-majority control. The regulations also provide examples in which single-digit ownership stakes plus specified veto rights can establish control.
Thirty-seven states, including Delaware, have business combination statutes that take a functional approach to control. Those statutes start with the securities law definition and presume control using ownership thresholds that start between 5 and 25 percent, with most setting the threshold at 10 percent. Twenty-five states have control share statutes that require a vote when an investor crosses 20 percent ownership and one-third ownership, reflecting a legislative judgment that both levels carry significance for purposes of non-majority control.
What the Statutes Reveal
The statutory consensus is striking. The securities law definition or a near variant undergirds every major federal regime in the survey and the securities acts of 25 states. It treats control as a question of fact, recognizes multiple sources of influence, and embraces both contractual control and small-block control. The most sophisticated regimes—the Bank Act and FIRRMA regulations—provide detailed guidance for finding non-majority control based on combinations of stock ownership and other indicia of influence.
None of the regimes deploy the formal school’s signature features, such as requiring board control, voting power equivalent to majority voting control, or the ability to engage in retribution against independent directors or minority stockholders. None treat one-third ownership as a bright-line floor.
Some authorities have argued that control means different things in different areas of the law. That claim is accurate only at a high level of abstraction. In areas analogous to fiduciary doctrine, statutory regimes display remarkable consistency. All are functional.
Conclusion
Delaware’s functional school was neither novel nor anomalous. It applied the dominant historical and statutory approach. The formal school, by contrast, was an outlier. Reasonable minds can debate which approach is better as a matter of policy, and good-faith debate on that question should be welcomed. But the debate should proceed on accurate premises about which approach has historically prevailed in American law.
J. Travis Laster is a vice chancellor of the Delaware Court of Chancery. This post is based on his recent article, “How to Evaluate Non-Majority Control: What History and Statutes Tell Us—Part Two: The Definitional Consensus,” published in the Fordham Journal of Corporate and Financial Law and available here.