In Coster v. UOP Cos., Inc., the Delaware Supreme Court finally addressed the longstanding debate over the validity of the Blasius doctrine. (The following is based in part on the discussion of Blasius and Unocal in my books Mergers and Acquisitions (Concepts and Insights) and Corporate Law (Concepts and Insights).)
In Unocal v. Mesa Petroleum,[1] the Delaware Supreme Court laid out what has been called an “intermediate” or “enhanced business judgment” standard of judicial review, but is perhaps best described as a “conditional business judgment rule,”[2] to govern target board of director actions taken in. response to an unsolicited takeover offer. In Unocal, the Delaware Supreme Court reaffirmed the target’s board general decision-making primacy, which includes an obligation to determine whether the offer is in the best interests of the shareholders. In light of the board’s potential conflict of interest vis-à-vis the shareholders, however, judicial review was to be somewhat more intrusive than under the traditional business judgment rule: “Because of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders, there is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred.”
The initial burden of proof is on the directors, who must first show that they had reasonable grounds for believing that a danger to corporate policy or effectiveness existed. The directors satisfy this burden by showing good faith and reasonable investigation. The good faith element requires a showing that the directors acted in response to a perceived threat to the corporation and not for the purpose of entrenching themselves in office. The reasonable investigation element requires a demonstration that the board was adequately informed, with the relevant standard being one of gross negligence.[3] Assuming the directors carry their initial burden, they next must prove that the defense was reasonable in relationship to the threat posed by the hostile bid.
Because unsolicited takeover bids often end up involving a shareholder vote, such as when the acquirer conducts a proxy contest to elect a new board of directors for the target in hopes that the new board will remove any takeover defenses that may be impeding the offer, there long was a question about how Unocal applied when the target board’s actions allegedly disenfranchised target shareholders.
The problem was that in that context Unocal bumped up into another line of cases arising out of Blasius Industries, Inc. v. Atlas Corp.[4] In Blasius, the Delaware Chancery Court held that where the board of directors takes actions for the “primary purpose” of interfering with the free exercise of the shareholder franchise, the board must demonstrate that it had a “compelling justification” for doing so. Taken by itself, Blasius proved to be “an unworkable standard of review, as once a court triggers Blasius, it would seem impossible for the directors to provide a compelling justification for disenfranchising their shareholders.”[5]
When a board action affecting the shareholder franchise takes place in other contexts, such as a simultaneous tender offer and proxy contest, Unocal provide the basic standard of review for the board’s actions. In applying Unocal’s proportionality prong, however, the courts treated board action that purposefully disenfranchises the shareholders as “strongly suspect.”[6] Attempting to merge the two created an even more untenable standard.
I have never been a fan of Blasius.[7] (See my post Professor Lipton asks "What about Blasius?" Well, what about it?) So I pleased to learn that the Delaware Supreme Court has finally more or less killed off Blasius by essentially merging it into Unocal. See Coster v. UIP Cos. Inc.
I’m going to skip over the facts and the case’s convoluted procedural history, as Ann Lipton has a great post on the Chancery Court opinion and an excellent post on the Supreme Court decision.
The key passage is at 31-32:
First, the court should review whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit.” The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interests of the stockholders.
Second, the court should review whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise. To guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control, a board that is properly motivated and has identified a legitimate threat must tailor its response to only what is necessary to counter the threat. The board’s response to the threat cannot deprive the stockholders of a vote or coerce the stockholders to vote a particular way.
Critics of Unocal have long complained that it is an essentially toothless standard.[8] Assuming arguendo that they are correct, does this mean that judicial review of shareholder disenfranchisement will now be reviewed with a lenient eye?
There are suggestions in the opinion that Unocal is to be applied contextually. See Coster at 31 (stating that “the court’s review is situationally specific and is independent of other standards of review”). There are also suggestions that, as applied to shareholder disenfranchisement, the standard may not be Unocal but rather what might be called Unocal+. See Coster at 31 (“Unocal can also be applied with the sensitivity Blasius review brings to protect the fundamental interests at stake – the free exercise of the stockholder vote as an essential element of corporate democracy.”); id. at 33 (“Applying Unocal review in this case with sensitivity to the stockholder franchise is no stretch for our law.”). In other words, it is at least possible that Unocal will be applied in this context with a more skeptical eye than it is in other situations.[9]
There are also suggestions that the new Unocal/Blasius standard and the sensitivity it supposedly demands will be more limited in scope than early Blasius decisions suggested. Some 15 years ago, a New York court suggested that Blasius is now limited to proxy contests involving director elections:
Blasius has been largely limited to disputes over the election of directors. Accordingly, “courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.” Of particular significance here, “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office.”[10]
There are a few passages in the Supreme Court decision suggesting that the new standard is in fact limited to proxy contests over the election of directors and similar situations:
- Describing the standard as calling for “enhanced judicial scrutiny of board action that interferes with a corporate election or a stockholder’s voting rights in contests for control.” Coster at 30.
- “When a stockholder challenges board action that interferes with the election of directors or a stockholder vote in a contest for corporate control, the board bears the burden of proof.” at 31.
- Noting the need “[t]o guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control . . ..” at 32.
The key question here is whether by “corporate elections” the court meant all proxy contests or only proxy contests involving election of directors. If Unocal/Blasius is in fact now so limited, it will have important implications for cases like the current litigation involving the AMC APES shares, in which the AMC board allegedly interfered with the shareholder vote but not in the context of a proxy contest for electing directors. If so, is the standard of review now applicable to such matters the business judgment rule?
Finally, on a personal note, let me vigorously object to the Supreme Court’s claim that there are “fundamental interests at stake”; i.e., “the free exercise of the stockholder vote as an essential element of corporate democracy.” As regular readers know, much of my scholarly output over the last several decades has been devoted to the proposition that corporations are not democracies.[11] And I am not alone in saying that corporations are not democracies.[12]
[1] Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del.1985).
[2] Michael P. Dooley, Fundamentals of Corporation Law 547 (1995). Like the traditional business judgment rule, the conditional Unocal rule can be applied only to actions that are within the power or authority of the board. As a preliminary inquiry one thus must ask whether the board had the authority under the governing statutes and the corporation’s organic documents to take this specific action. Moran v. Household Int’l, Inc., 500 A.2d 1346, 1350 (Del.1985).
[3] Moran v. Household Int’l, Inc., 500 A.2d 1346, 1356 (Del.1985); Harvey L. Pitt, On the Precipice: A Reexamination of Directors’ Fiduciary Duties in the Context of Hostile Acquisitions, 15 Del. J. Corp. L. 811, 878 n. 264 (1990).
[4] 564 A.2d 651 (Del.Ch.1988).
[5] Mary Siegel, The Problems and Promise of “Enhanced Business Judgment”, 17 U. Pa. J. Bus. L. 47, 81 (2014).
[6] Stroud v. Grace, 606 A.2d 75 (Del. 1992). A New York court has suggested that Blasius is now limited to proxy contests involving director elections:
Blasius has been largely limited to disputes over the election of directors. Accordingly, “courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.” Of particular significance here, “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office.”
In re Bear Stearns Litig., 870 N.Y.S.2d 709, 733 (N.Y. Sup. 2008) (citations and footnote omitted).
[7] I direct the reader's attention to Harry G. Hutchison, Director Primacy and Corporate Governance: Shareholder Voting Rights Captured By the Accountability/Authority Paradigm, 36 Loy. U. Chi. L.J. 1111 (2005), which deploys my director primacy model to very good effect in analyzing shareholder voting rights, and makes a compelling case for scuttling Blasius.
[8] I defended Unocal against those charges in Stephen M. Bainbridge, Unocal at 20: Director Primacy in Corporate Takeovers, 31 Del. J. Corp. L. 769 (2006).
[9] Ann Lipton has noted that “commenters have noted the tension between Unocal/Unitrin - which allow boards to block shareholder sales out of fear shareholders will act out of ignorance - and Blasius, which does not allow boards to block shareholder votes out of that same fear. Now that we know for sure Blasius is an aspect of Unocal, will Delaware confront that tension more directly?”
[10] In re Bear Stearns Litig., 870 N.Y.S.2d 709, 733 (N.Y. Sup. 2008) (citations and footnote omitted).
[11] Stephen M. Bainbridge, The Case for Limited Shareholder Voting Rights, 53 UCLA L. Rev. 601 (2006).
[12] See Christian C. Day et al., Riding the Rapids: Financing the Leveraged Transaction Without Getting Wet, 41 SYRACUSE L. REV. 661, 677 (1990) (“Corporations, after all, are not democracies.”); Jason Iuliano, Do Corporations Have Religious Beliefs?, 90 IND. L.J. 47, 81 (2015) (“As anyone who has interacted with corporations knows, they are not democracies.”).
