In my article, Dead Hand and No Hand Pills: Precommitment Strategies in Corporate Law, I argued that:
Corporations frequently make use of precommitment strategies. Examples include such widely used devices as negative pledge covenants and change of control clauses in bond indentures, fair price shark repellents, no shop and other exclusivity provisions in merger agreements, mandatory indemnification bylaws, and so on. This paper argues that poison pills also can be understood as a form of precommitment, by which the board of directors commits to a policy intended either to negotiate a high acquisition price or to maintain the corporation's independence.
In Quickturn Design Sys., Inc. v. Mentor Graphics Corp., the Delaware supreme court invalidated a no hand poison pill on grounds that a board of directors lacks authority to adopt such devices. In doing so, the court misinterpreted relevant Delaware law. It unjustifiably called into question the validity of a host of corporate precommitment strategies. Finally, and perhaps most troublingly, it called into question the central tenet of Delaware corporate law; namely, the plenary authority of the board of directors.
This article argues that the Delaware supreme court's decision was wrong both as a doctrinal and a policy matter. There simply is no firebreak between the sorts of board self-disablement deemed invalid by Quickturn and the host of other precommitment strategies routinely used by corporate boards of directors. The Delaware supreme court's conclusion that the former are invalid for lack of statutory authority thus threatens to invalidate all of the latter. The article concludes by arguing that the Delaware supreme court should have analyzed the no hand pill under standard fiduciary duty principles rather than creating a new prophylactic ban on precommitment strategies.
In my book Mergers and Acquisitions (University Textbook Series)
A fiduciary out may be simply a proviso stating that nothing contained in the merger agreement shall relieve the board of directors of its fiduciary duty to the shareholders. Alternatively, the fiduciary out may expressly retain a right for the target's board to solicit other offers or to negotiate with other bidders if its fiduciary duties so require. The most potent version relieves the target board of its obligation to recommend the initial offer to the shareholders if a better offer is made or permits the target to terminate the merger agreement if a higher offer is received.
An effective fiduciary out thus negates the effectiveness of a precommitment device, by allowing the board to opt out of its commitment.
I further discuss Omnicare, Inc. v. NCS Healthcare, Inc., in which the Delaware supreme court by a 3-2 vote held that an exclusive merger must include a fiduciary out, at least where the agreement presents target shareholders with a “fait accompli.”
The majority acknowledged that “[a]ny board has authority to give [a bidder] reasonable structural and economic defenses, incentives, and fair compensation if the transaction is not completed.” In addition, the majority acknowledged that the controlling shareholders “had an absolute right to sell or exchange their shares with a third party at any price.” Yet, the majority nevertheless concluded that NCS’ board “was required to contract for an effective fiduciary out to exercise its continuing fiduciary responsibilities to the minority stockholders.” The majority explained neither what it meant by “an effective fiduciary out,” what the NCS board should have done if Genesis refused to agree to a fiduciary out, nor what it expected the NCS board to do if the controlling shareholders wanted to go forward with the Genesis deal. ... In sum, Omnicare is a most unsatisfying opinion that poses as many questions—if not more—than it answers.
I then shifted gears into a normative analysis:
I find the Delaware courts’ hostility to no shops and other forms of exclusive merger agreements very puzzling. Precommitment strategies are commonplace. Think of Odysseus lashing himself to the mast so that he can hear the Sirens’ song without running his ship aground. Hostility to precommitment strategies certainly does not follow a fortiori from the mere fact that directors are fiduciaries. Why should informed directors acting in good faith not be allowed to lash themselves to the mast of a particular deal? Case law in other jurisdictions allows them to do precisely that. No Delaware court has yet offered a persuasive reason for their hostility to no shop clauses and the like. Instead, the invalidity of such strategies has been asserted by mere fiat.
All of which is prefatory to discussion of a new Delaware decision in WaveDivision Holdings, LLC v. Millennium Digital Media Systems, L.L.C., C.A. No. 2993-VCS (Del. Ch. Sept. 17, 2010), which is available here. Francis Pileggi's blog has a typically excellent discussion by Kevin Brady of the facts and issues here.
The Court of Chancery awarded $15 million in damages against defendants Millennium Digital Media Systems, LLC, et al. (“Millennium”) for breaching agreements with WaveDivision Holdings LLC and Michigan Broadband LLC (“Wave”) that contained “no solicitation” and “reasonable best efforts” clauses ...
No shops and best efforts clauses are classic precommitment devices. Yet, the court held that:
Delaware entities are free to enter into binding contracts without a fiduciary out so long as there was no breach of fiduciary duty involved when entering into the contract in the first place.
Which is precisely what I have been saying all along! But what about Omnicare?
Well, the first bit of good news is that VC Strine cited my article Precommitment Strategies In Corporate Law: The Case of Dead Hand And No Hand Pills, 29 J. CORP. L. 569, 612-623, for the proposition that "To generate wealth for investors, fiduciaries must be able to bind the entity to contracts."
But then we get to something very curious. Nowhere in the opinion does Strine discuss Omnicare. Indeed, the very word Omnicare appears in only one page, where he cites the dissenting opinion and a law review article with the name in its title. Instead, there is only this odd statement: "despite the existence of some admittedly odd authority on the subject, it remains the case that Delaware entities are free to enter into binding contracts without a fiduciary out so long as there was no breach of fiduciary duty involved when entering into the contract in the first place."
Presumably, Omincare is (one of?) the odd authority in question.
I have no doubt that Strine reached the right result. It does strike me as an interesting way for a trial court judge to evade what looks like binding higher court precedent, however.
