A. Introduction
In the past twenty years, Delaware's corporate law jurisprudence, particularly in the area of directors' fiduciary duties, has been transformed by the significant increase in hostile corporate takeovers, anti-takeover defensive measures, and merger and acquisition activity in general. Among other things, the last two decades witnessed refinements to the standards of judicial review traditionally used in evaluating claims that directors had breached their fiduciary duties, the advent of new standards of judicial review, and a proliferation of burden shifting doctrines, multi-part tests, and other rules governing judicial review of fiduciary duty claims. While these developments were necessitated by the rapidly changing capital markets and business environment and generally were successful in balancing the interests of stockholders, directors, and other corporate constituencies, they resulted in what many practitioners and commentators now see as a complex and sometimes confusing web of legal rules. Not surprisingly, both courts and commentators recently have begun to reassess the relationship between the various standards of judicial review, the underlying fiduciary duties of due care, good faith, and loyalty, and the array of legal rules that govern their applicability.
One important article in particular, written by the former Chancellor of the Delaware Court of Chancery, William T. Allen, and current Vice Chancellors Jack B. Jacobs and Leo E. Strine, Jr. (hereinafter the "Chancellors"), has proposed simplification of the existing standards of judicial review and related rules to reduce their number, increase their functionality, and better serve underlying corporate law policies.[1] The Chancellors proposed that this would be accomplished, among other ways, by abandoning the effort "to link the 'intermediate' and 'entire fairness' standards of review to a theoretically all-encompassing 'business judgment rule' standard," which the Chancellors view as creating "dysfunctions that confuse, rather than aid, the resolution of fiduciary duty cases."[2]
One of the areas of Delaware fiduciary duty law the Chancellors' article suggests is in need of some fine tuning is that relating to going private mergers by controlling stockholders, particularly case law requiring entire fairness review of such transactions notwithstanding approval by a special committee of independent directors or ratification by a majority of the minority stockholders.[3] This article examines three recent cases – In re Siliconix, Inc. Shareholders Litigation,[4] Glassman v. Unocal Exploration Corporation[5] and In re Pure Resources Shareholders Litigation[6] – that together suggest a simpler and more functional approach to going private transactions and may provide the impetus for a continued refinement of the judicial approach for evaluating such transactions.
B. Delaware Jurisprudence Before Siliconix, et al.
After the Delaware Supreme Court's 1993 decision in Weinberger v. UOP, Inc.,[7] corporate practitioners generally assumed that any transaction whereby a majority stockholder sought to acquire the minority interest through a merger would be governed by the entire fairness standard of review. Unlike the business judgment rule, pursuant to which a Delaware court will refrain from second-guessing the directors' business decision so long as it can be attributed to a rational business purpose,[8] the entire fairness standard ordinarily requires fiduciaries to convince the court that their decision was the product of both a qualitatively fair process and a quantitatively fair price.[9] The Weinberger court also suggested that this heavy burden could be satisfied if the board utilized a mechanism to replicate the type of arm's length negotiation that would occur if an entirely disinterested board were negotiating a buyout.[10] The most common method by which this has been accomplished has been the formation of a committee of independent directors to negotiate the proposed transaction with the majority stockholder.
In Kahn v. Lynch Communication Systems, Inc.,[11] the Supreme Court settled a split in authority in the Court of Chancery,[12] finding that approval of a going private transaction by a well functioning independent committee will not result in the application of the business judgment rule to the challenged transaction, but will relieve the majority stockholder and the controlled board of the burden of proving the fairness of the transaction by shifting the burden of proof to the plaintiff challenging the transaction to show that the transaction was unfair to minority stockholders.[13]
While the Kahn decision resolved the split of authority, the committee process that it endorsed remained expensive and time-consuming. In addition, even if a controlling stockholder was prepared to negotiate the transaction with a special committee, it generally still faced further delay dictated by the need either to hold a stockholders' meeting or to seek to act by written consent,[14] one of which ordinarily was required to consummate the back-end merger that is the typical last step in such transactions.[15] As a result, at the turn of the millennium, the market still had not identified an efficient (from a timing standpoint) or effective (from a judicial review standpoint) method of consummating a going private merger by a controlling stockholder.
C. A New Model Emerges: Siliconix, Unocal Exploration and Pure Resources
The recent decisions in Siliconix, Unocal Exploration, and Pure Resources have suggested a manner of structuring a going private transaction that eliminates the need to use a special committee but still does not saddle the majority stockholder or target board with the burden of proving the entire fairness of the transaction if it is challenged by a minority stockholder. Siliconix confirmed that a controlling stockholder making a tender offer for minority-held shares in the controlled corporation is generally under no obligation to offer any particular price for the minority-held stock and further held that neither the controlling stockholder nor the directors of the controlled company would be required to demonstrate the entire fairness of the tender offer. In Unocal Exploration, the Delaware Supreme Court held that the entire fairness standard of review is not applicable to challenges to short-form mergers effected pursuant to Section 253 of the DGCL. Finally, Pure Resources imposed a three-part test for determining whether a majority stockholder's tender offer for the minority-held shares either will be deemed "coercive". Together, these decisions offer majority stockholders a roadmap – a tender offer that is fully disclosed and non-coercive, followed by a short-form merger – for cashing out the minority without using a special committee or assuming the heavy burden of proving entire fairness.
1. In re Siliconix, Inc. Shareholders Litigation.
Vishay Intertechnology, Inc. ("Vishay"), which indirectly held 80.4% of the common stock of Siliconix Incorporated ("Siliconix"), announced (i) a proposed all-cash tender offer for the remaining publicly held shares of Siliconix common stock, (ii) that it would consider a short-form merger of Siliconix into a Vishay subsidiary for the same price if it obtained over 90% of the Siliconix common stock in the tender offer, and (iii) that it would like the opportunity to discuss the tender offer with a special committee of independent Siliconix directors.[16] Although Siliconix formed a special committee to negotiate the terms of the tender offer with Vishay, the negotiations failed to produce an agreement on an acceptable tender offer price[17] and Vishay determined to proceed with a stock-for-stock exchange offer without obtaining the special committee's approval.[18]
In its motion to enjoin preliminarily the exchange offer, plaintiff alleged that Vishay and the Siliconix board of directors had the burden to demonstrate the entire fairness of the offer price and, as a result of alleged breaches of fiduciary duties and the "oppressive" structure of the offer, the exchange offer. Rejecting plaintiff's arguments, the Court noted that "a controlling shareholder extending an offer for minority-held shares in the controlled corporation is under no obligation, absent evidence that material information about the offer has been withheld or misrepresented or that the offer is coercive in some significant way, to offer any particular price for the minority-held stock."[19] Finding no disclosure violations and that the offer was not coercive, the Court held that the exchange offer was not subject to review under the entire fairness test. In reaching that conclusion, the Court distinguished a "long-form" merger under Section 251 or Section 252 of the DGCL,[20] which would have required board action (and therefore would have justified review under the entire fairness test), from an exchange or tender offer that may (or may not) have been followed by a short-form merger pursuant to Section 253, which would not have required board action (and therefore would not have justified review under the entire fairness test). For those reasons, the Court held that Vishay "was under no duty to offer any particular price, or a 'fair' price, to the minority shareholders of Siliconix" in its exchange offer.[21] Siliconix, therefore, affirms that a bidder – whether or not it is the target's controlling stockholder – has no duty to offer any particular price in its tender or exchange offer.[22]
2. Glassman v. Unocal Exploration Corp.
Section 253 of the DGCL authorizes the board of directors of a Delaware corporation that owns 90% or more of each of the outstanding classes of stock of a subsidiary that are entitled to vote on a merger to merge the subsidiary into itself without any requirement for action to be taken by the board of directors of the subsidiary. Unocal Exploration involved a challenge to such a "short-form" merger of Unocal Exploration Corporation ("UXC") with and into its 96% stockholder, a wholly owned subsidiary of Unocal Corporation ("Unocal"). Plaintiff-appellants contended that Unocal, an earth resources corporation primarily engaged in the exploration and production of crude oil and natural gas, timed the merger of UXC into Unocal to take advantage of a decrease in natural gas prices. On appeal, plaintiff-appellants challenged the fairness of the merger, arguing that mergers effected under Section 253 should be reviewed under the entire fairness test – the same standard that is typically applied to cashout mergers effected by controlling stockholders under the long-form merger statutes, Sections 251 and 252 of the DGCL. Plaintiff-appellants based their argument on, among other things, the Supreme Court decisions in Weinberger, Bershad v. Curtiss-Wright Corp.,[23] and Kahn, each of which were mergers under the Delaware long-form statute but each of which seemingly supported, at least in some respect, the notion that the entire fairness standard of review should be applicable to short-form mergers.
The Delaware Supreme Court rejected plaintiff-appellants' reading of these cases, relying instead on the approach enunciated long ago in Stauffer v. Standard Brands, Inc.[24] The fundamental principle underlying Stauffer (and, therefore, underlying Unocal Exploration) is that Section 253 creates an affirmative right in a 90% stockholder to eliminate minority stockholders' participation in the controlled corporation, rather than merely representing a truncated procedure for effecting a merger in such circumstances. This statutorily-created right "authorizes the elimination of minority stockholders by a summary process that does not involve the 'fair dealing' component of entire fairness."[25] Accordingly, Section 253 "effectively circumscribe[s] the parent corporation's obligations to the minority in a short-form merger."[26]
As the Supreme Court explained:
Under settled principles, a parent corporation and its directors undertaking a short-form merger are self-dealing fiduciaries who should be required to establish entire fairness, including fair dealing and fair price. The problem is that §253 authorizes a summary procedure that is inconsistent with any reasonable notion of fair dealing.... The equitable claim plainly conflicts with the statute. If a corporate fiduciary follows the truncated process authorized by §253, it will not be able to establish the fair dealing prong of entire fairness.... In order to preserve its purpose, §253 must be construed to obviate the requirement to establish entire fairness.[27]
The Supreme Court was careful, however, to note specifically that Section 253 does not eliminate the parent corporation's fiduciary duty to disclose to the minority stockholders all information that is reasonably necessary in order to enable them to decide, on a fully informed basis, whether to exercise their appraisal rights. The Court also reaffirmed the statements in Weinberger with respect to the scope of the matters that can be considered in an appraisal, stating, "fair value must be based on all relevant factors, including damages and elements of future value, where appropriate."[28] Thus, the Court made clear that certain factors that are often raised in an entire fairness claim, such as timing a merger to take advantage of a temporary depression in the stock price or other market fluctuations that affect the underlying value of the stock, may be considered in an appraisal proceeding.
3. In re Pure Resources, Inc. Shareholders Litigation
The Delaware Chancery Court's decision in Pure Resources[29]addressed an offer by Unocal Corporation ("Unocal") for all of the issued and outstanding shares of Pure Resources, Inc. ("Pure") held by the minority stockholders. Pure was the product of a business combination between Titan Exploration, Inc. and a spin off of Unocal's operations. Unocal owned 65.4% of the issued and outstanding stock of Pure. Management of Pure and the former stockholders of Titan held the remaining 34.6% of Pure.
In the summer of 2001, Unocal explored the feasibility of acquiring the rest of Pure, but "the tragic events of that year and other mundane factors" derailed the process.[30] In the spring of 2002, Pure began considering the creation of a "Royalty Trust," which would sell portions of certain mineral rights owned by Pure to third parties in order to reduce Pure's debt and give the company capital to expand.
In August 2002, as a result of pressures generated by the Royalty Trust discussions, Unocal made an exchange offer directly to the stockholders of Pure pursuant to which the stockholders (other than Unocal) would receive 0.6527 shares of Unocal common stock for each outstanding share of Pure common stock tendered. The offer also contained the following key features: (1) a non-waivable majority of the minority tender provision, which included management of Pure as part of the minority, (2) a waivable condition that enough shares be tendered to enable Unocal to own 90% of the outstanding stock of Pure, thus allowing a short-form merger under Section 253 of the DGCL, and (3) a statement that Unocal intends to consummate the short-form merger as soon as practicable at the same exchange ratio.[31]
The Pure Board established a Special Committee to respond to the Unocal offer, which had the authority to retain independent advisors, formulate a recommendation on the offer's advisability, and negotiate with Unocal to increase its bid. The Committee met with Unocal and asked it to increase its offer but was unsuccessful. Based on the analysis and advice of its financial advisors, the Special Committee voted not to recommend the Unocal offer. Management also announced their personal intentions not to tender.
Plaintiffs argued that the offer should be preliminarily enjoined because (i) the offer was not entirely fair, (ii) the offer was coercive, and (iii) the disclosures provided to the Pure stockholders in connection with the offer were inadequate and misleading.[32] Specifically, plaintiffs argued "the structural power of Unocal over Pure and its Board, as well as Unocal's involvement in determining the scope of the Special Committee's authority, made the offer coercive."[33] Plaintiffs further asserted that Unocal used its unique access to inside information from Pure to impose an inadequate bid at a time that was advantageous to Unocal, and then acted in its self-interest by preventing the Special Committee from obtaining the necessary authority to respond to the Offer.[34] For these reasons, plaintiffs asserted that Unocal breached its fiduciary duties as a controlling stockholder and the Pure Board breached its duties by failing to take more proactive measures against Unocal.[35]
Unocal, in its defense, asserted that the entire fairness standard did not apply to the offer, and instead the offer was valid under the standard set forth in Solomon v. Pathe Communications, which permits a controlling stockholder to make a tender offer at any price so long as the offer is not structurally coercive nor contains any misleading disclosures.[36] Moreover, Unocal highlighted the negative recommendation from the Pure special committee, the fact that the tender was conditioned on a majority of the minority provision, and that it intended to complete a short-form merger at the same price as conclusive evidence that Pure's shareholders were not being coerced into tendering their shares to Unocal.[37]
This opinion is, perhaps, most important to practitioners for its thorough and thoughtful analysis of the apparent discrepancy in the policies espoused in the Lynch and Solomon lines of cases. The court began with the general observation that the Lynch line of cases, where a controlling stockholder negotiates a merger agreement with the target board to buy out the minority, "emphasizes the protection of minority stockholders against unfairness" while the Solomon line (tender offer, followed by a short-form merger) "facilitates the free flow of capital . . . so long as the consent of the sellers is not procured by inadequate or misleading information or by wrongful compulsion."[38] The court's general observation on this distinction is worth quoting in its entirety.
These strands appear to treat economically similar transactions as categorically different simply because the method by which the controlling stockholder proceeds varies. This disparity in treatment persists even though the two basic methods (negotiated merger versus tender offer/short-form merger) pose similar threats to minority stockholders. Indeed, it can be argued that the distinction in approach subjects the transaction that is more protective of minority stockholders when implemented with appropriate protective devices—a merger negotiated by an independent committee with the power to say no and conditioned on a majority of the minority vote—to more stringent review than the more dangerous form of a going private deal—an unnegotiated tender offer made by a majority stockholder. The latter transaction is arguably less protective than a merger of the kind described, because the majority stockholder-offeror has access to inside information, and the offer requires disaggregated stockholders to decide whether to tender quickly, pressured by the risk of being squeezed out in a short-form merger at a different price later or being left as part of a much smaller public minority. This disparity creates a possible incoherence in our law.[39]
The court then launched into a detailed discussion of both lines of authority. The Vice Chancellor began with Lynch and its holding that when a controlling stockholder attempts to acquire the remaining shares by way of a negotiated merger pursuant to 8 Del. C. § 251, the entire fairness standard of review applies regardless of whether: (1) the target board was comprised of a majority of independent directors; (2) the target appointed a special committee of independent directors with the authority to negotiate and veto the merger, or (3) the merger was made subject to approval by a majority of the disinterested stockholders of the target.[40]
It was the policy driving the Supreme Court's decision in Lynch that had an impact on the litigation before the Court of Chancery. In colorful, but effective terms, the Vice Chancellor described that policy.
The Supreme Court concluded that even a gauntlet of protective barriers like those would be insufficient protection because of (what I will term) the "inherent coercion" that exists when a controlling stockholder announces its desire to buy the minority's shares. In colloquial terms, the Supreme Court saw the controlling stockholder as the 800-pound gorilla whose urgent hunger for the rest of the bananas is likely to frighten less powerful primates like putatively independent directors who might well have been hand-picked by the gorilla (and who at the very least owed their seats on the board to his support).
The Court also expressed concern that minority stockholders would fear retribution from the gorilla if they defeated the merger and he did not get his way. This inherent coercion was felt to exist even when the controlling stockholder had not threatened to take any action adverse to the minority in the event that the merger was voted down and thus was viewed as undermining genuinely free choice by the minority stockholders.[41]
The Court then examined the Solomon line of cases and the policy behind them. The Vice Chancellor described the "prototypical" transaction at issue in this line of cases as a tender offer by the controlling stockholder to the minority stockholders (often with a minimum tender condition that would allow it to reach the 90% ownership threshold for a short-form merger under § 253).[42] This way of completing a transaction differs markedly from the negotiated merger approach because with the tender offer/short-form merger approach, neither stage requires the target board to take any action.[43]
Another key difference identified by the court was in the type of coercion that might be exerted against the minority stockholders. The court observed:
In the tender offer context addressed by Solomon and its progeny, coercion is defined in the more traditional sense as a wrongful threat that has the effect of forcing stockholders to tender at the wrong price to avoid an even worse fate later on, a type of coercion I will call structural coercion. The inherent coercion that Lynch found to exist when controlling stockholders seek to acquire the minority's stake is not even a cognizable concern for the common law of corporations if the tender offer method is employed.[44]
The court then turned its attention to the question of "whether the mere fact that one type of transaction is a tender offer and the other is a negotiated merger is a sustainable basis for the divergent policy choices made in Lynch and Solomon?"[45] In solving this puzzle, the court noted that "Delaware law has not regarded tender offers as involving a special transactional space, from which directors are altogether excluded from exercising substantial authority," and for this reason it was "important to ask why the tender offer method should be consequential in formulating the equitable standards of fiduciary conduct by which the courts review acquisition proposals made by controlling stockholders."[46] The court queried whether the answer to the question above was that the tender offer method is inherently more protective of minority shareholders, and thus, less scrutiny was required as compared to negotiated mergers?[47] The court ultimately found, however, that the coercive forces weighed equally and that formalistic distinction between the two types of transactions could not bear the weight of scrutiny.[48]
The problem is that nothing about the tender offer method of corporate acquisition makes the 800-pound gorilla's retributive capabilities less daunting to minority stockholders. Indeed, many commentators would argue that the tender offer form is more coercive than a merger vote. In a merger vote, stockholders can vote no and still receive the transactional consideration if the merger prevails. In a tender offer, however, a non-tendering shareholder individually faces an uncertain fate.[49]
The plaintiffs urged the court to find that the absence of a meaningful distinction between the effects the two types of transactions have on the minority shareholders indicated that the court should apply the entire fairness standard of Lynch to tender offers by controlling shareholders. The court rejected the plaintiffs' invitation and found that:
Instead, the preferable policy choice is to continue to adhere to the more flexible and less constraining Solomon approach, while giving some greater recognition to the inherent coercion and structural bias concerns that motivate the Lynch line of cases.
. . .
To the extent that my decision to adhere to Solomon causes some discordance between the treatment of similar transactions to persist, that lack of harmony is better addressed in the Lynch line, by affording greater liability-immunizing effect to protective devices such as majority of minority approval conditions and special committee negotiation and approval.[50]
In applying the Solomon standard to the case at bar, the court noted that "[i]n order to address the prisoner's dilemma problem [of inherent coercion], our law should consider an acquisition tender offer by a controlling stockholder non-coercive only when" (1) it is subject to a non-waivable majority of the minority tender condition; (2) the controlling stockholder promises to consummate a prompt short-form merger at the same price if it obtains 90% of the shares; and (3) the controlling stockholder has made no retributive threats.[51] In addition, the court stated that the informational and timing advantages possessed by the controlling stockholder required some countervailing protection in order to afford the minority the opportunity to make an informed and voluntary tender decision.[52] As such, the controlling stockholder "owes a duty to permit the independent directors on the target board both free rein and adequate time to react to the tender offer, by (at the very least) hiring their own advisors, providing the minority with a recommendation as to the advisability of the offer, and disclosing adequate information for the minority to make an informed decision."[53]
When applying these principles to Unocal's offer, the court held that the offer was coercive because it included within the definition of the "minority" stockholders whose incentives to consummate the transaction were different from the general Pure stockholder, namely those stockholders who were Unocal directors and officers and those who were the management of Pure.[54] The court noted, however, that the Offer would be non-coercive if it were amended to condition approval on a majority of Pure's unaffiliated stockholders.[55]
The court also was faced with several significant issues related to the disclosures that were, or should have been, made to the Pure shareholders. The plaintiffs argued that neither Unocal's S-4 issued in support of its tender offer nor the 14D-9 issued by Pure in reaction to the offer was materially complete or accurate. Before addressing the plaintiffs' specific disclosure claims, the court made some general observations about the disclosure duties that surround transactions such as the one at issue. The court began by noting that "[i]n circumstances such as these, the Pure stockholders are entitled to disclosure of all material facts pertinent to the decisions they are being asked to make."[56] In this case, Pure's shareholders had two initial choices: tender or not tender. If they did not tender then they had a subsequent choice to make in the near future: accept the § 253 merger consideration or seek appraisal.[57] With these considerations in mind, the court found that:
The S-4 and the 14D-9 must contain the information that "a reasonable investor would consider important in tendering his stock," including the information necessary to make a reasoned decision whether to seek appraisal in the event Unocal effects a prompt short-form merger.[58]
The plaintiffs had advanced a panoply of attacks on the disclosures by both Unocal and Pure, but it was the plaintiffs' argument that the 14D-9 should have included the substantive work of the bankers with which the court examined most closely. The plaintiffs asserted that because the Pure stockholders were (1) left to their own devices to accept or reject the merger, and (2) faced with a decision on whether to pursue appraisal upon the consummation of the short-form merger, that they were entitled to "estimates and underlying analyses of value developed by the Special Committee's bankers."[59] In response, the defendants argued that: (1) the 14D-9 already contained a great deal of financial data regarding Pure's past and expected performance, (2) the bankers' opinions were included, (3) forcing the special committee to disclose the bankers' ranges of values could undermine its negotiation posture, and finally, (4) that Delaware law "indicates that a summary of the results of the actual valuation analyses conducted by an investment banker ordinarily need not be disclosed."[60]
The court noted that:
This is a continuation of an ongoing debate in Delaware corporate law, and one I confess to believing has often been answered in an intellectually unsatisfying manner. Fearing stepping on the SEC's toes and worried about encouraging prolix disclosures, the Delaware courts have been reluctant to require informative, succinct disclosure of investment banker analyses in circumstances in which the banker's views about value have been cited as justifying the recommendation of the board. But this reluctance has been accompanied by more than occasional acknowledgment of the utility of such information, an acknowledgment that is understandable given the substantial encouragement Delaware case law has given to the deployment of investment bankers by boards of directors addressing mergers and tender offers.[61]
The court then identified two Supreme Court opinions that it believed evinced the conflicting message regarding disclosures of this type. It identified Skeen v. Jo-Ann Stores, Inc.[62] as espousing the view that "a summary of the bankers' analyses and conclusions was not material to a stockholder's decision whether to seek appraisal," and McMullin v Beran[63] as indicating that such information might well be material in these circumstances.[64]
In resolving this issue, the court found that:
it is time that this ambivalence be resolved in favor of a firm statement that stockholders are entitled to a fair summary of the substantive work performed by the investment bankers upon whose advice the recommendations of their board as to how to vote on a merger or tender rely.
. . .
Moreover, courts must be candid in acknowledging that the disclosure of the banker's "fairness opinion" alone and without more, provides stockholders with nothing other than a conclusion, qualified by a gauze of protective language designed to insulate the banker from liability.[65]
The court ultimately held that the disclosures were inadequate in that they (i) failed to disclose any substantive portions of the work of the financial advisors that the Special Committee relied upon as a basis for their recommendation not to tender,[66] (ii) materially misstated the Pure Board's rejection of the Special Committee's request for broader authority,[67] and (iii) omitted any discussion of two of the motivating factors for the Offer--to eliminate the potential liability exposure certain Unocal designees on the Pure Board would face if Unocal began to compete with Pure in its core areas of operation and the importance of considerations of the Royalty Trust.[68] In light of the inadequate disclosure and the lack of a majority of the unaffiliated minority condition, the court issued a preliminary injunction.[69]
D. A "Road Map" for Going Private Transactions.
The three recent Delaware decisions discussed above together offer majority stockholders a roadmap for accomplishing a cashout of the minority without assuming the heavy burden of proving entire fairness.[70] Of course, the success of such a plan is wholly dependent on the majority stockholder's ability to convince a sufficient number of minority stockholders to tender their shares in order to achieve the 90% ownership level required by Section 253.
Just as Weinberger spawned a significant body of case law relating to use of long form mergers to effect going private transactions, Siliconix, Unocal Exploration and Pure Resources are unlikely to be the last word with respect to going private transactions structured by use of a tender offer followed by a back end, short form merger. To the contrary, the decisions leave unanswered a number of important questions, which portends further litigation and judicial analysis of the issues presented by going private transactions structured to comply with this trilogy of decisions. For example, will Pure Resources be applied to countenance non-review where a target board chooses not to remain neutral but instead recommends to its stockholders that they tender their shares? Will non-review under Siliconix pertain where the target board has independent directors but does not employ either a special committee or an independent investment banker to evaluate the controlling stockholder's offer? After Pure Resources, what amount of tender offer negotiations by the target board or committee may occur before the Delaware courts will decide to subject the transaction to the entire fairness standard of review? While the Supreme Court's decision in Unocal Exploration makes clear that the entire fairness standard of review does not apply to short-form mergers in which the parent holds the requisite amount of subsidiary stock at the time that it determines to merge, has the court left open the possibility that a different result may obtain in circumstances in which a parent corporation requires the assistance of the subsidiary's board of directors in order to reach the 90% threshold prior to consummating a short-form merger?[71] At this point, the manner in which the Delaware courts ultimately will deal with these difficult questions, as well as a host of others, remains uncertain.
E. Implications for the Standard of Review Debate.
Although not directly responsive to the issues raised by the Chancellors in their Standard of Review article, the rationales of Siliconix, Unocal Exploration and Pure Resources implicate the themes raised in the article. Consistent with one of the goals for a "standard of review" articulated by the Chancellors, the rules enunciated in Siliconix, Unocal Exploration and Pure Resources are functional and straightforward. Moreover, they evidence the type of "de-linking" of the business judgment rule from the standard of review applied in cases not involving duty of care violations advocated by the Chancellors.[72] Indeed, they constitute the rare instance in which the Court's have condoned the elimination of any review under business judgment principles as developed over the past two decades.[73] Over time, as the Court continues to consider the host of ancillary questions raised by these decisions, corporate planners should expect to be able to develop increasing confidence in the utility of the new roadmap.
Messrs. Grossbauer, Morton and Pittenger are partners in the law firm of Potter Anderson & Corroon LLP, Wilmington, Delaware. The views reflected herein are those of the authors and may not reflect those of Potter Anderson & Corroon LLP or its clients.
[1] William T. Allen, et al., Function over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. Law. 1287 (2001) (hereinafter Standards of Review).
[2] Id. at 1298.
[3] Id. at 1306-09.
[4] C.A. No. 18700, 2001 WL 716787, Noble, V. C. (Del. Ch. June 21, 2001).
[5] 777 A.2d 242 (Del. 2001).
[6] 808 A. 2d 421 (Del. Ch. 2002).
[7] 457 A.2d 701, 711 (Del. 1983).
[8] See Paramount Communications Inc. v. QVC Network, Inc., 637 A.2d 34, 45 n.17 (Del. 1994).
[9] See, e.g., Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1162-63 (Del. 1995) ("Technicolor III") (quoting Weinberger, 457 A.2d at 711). Fair process, or "fair dealing," involves the actual conduct of the directors in connection with the challenged transaction, including the timing, initiation, structure, and negotiation of the transaction, as well as the manner in which disclosure was made to the directors and stockholders and the manner in which approvals of the directors and stockholders were obtained. See, e.g., Technicolor III, 663 A.2d at 1162-63 (quoting Weinberger, 457 A.2d at 711); id. at 1172-76. "Fair price" means a price that a reasonable seller, under all of the circumstances and in an arm's length transaction, would regard as within a range of fair value, and includes all relevant factors – asset value, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of the company's stock. See Technicolor III, 663 A.2d at 1162-63 (quoting Weinberger, 457 A.2d at 711); Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1143 (Del. Ch. 1994), aff'd, Technicolor III, 663 A.2d 1156.
[10] Weinberger, 457 A.2d at 709 n.7. ("[T]he result here could have been completely different if UOP had appointed an independent negotiating committee of its outside directors to deal with Signal at arm's length").
[11] 638 A.2d 1110 (Del. 1994).
[12] Compare In re Trans World Airlines, Inc. Shareholders Litig., C. A. No. 9844, 1988 WL 111271, at *7, Allen, C. (Del. Ch. Oct. 21, 1988) (business judgment rule becomes applicable where independent committee functioned effectively) with Citron v. E.I. Du Pont de Nemours & Co., 584 A.2d 490 (Del. Ch. 1990) (disagreeing with TransWorld Airlines and giving burden-shifting effect to committee action).
[13] Lynch Communication, 638 A.2d at 1117.
[14] Although the controlling stockholder can approve a back-end merger by written consent (assuming the certificate of incorporation does not restrict action by consent), the action may not be effective until the minority stockholders are provided with an information statement and 20 business days have passed, as required by federal securities law.
[15] A method by which acquirors (both controlling and non-controlling) have addressed the time lag caused by the need for a "back-end" long-form merger is through the use of a tender offer coupled with a "top-up" option granted by the target corporation's board. A top-up option is designed to ensure that the acquiror will achieve 90% ownership of the target so as to enable the acquiror to utilize the "short-form" merger process prescribed by Section 253 of the Delaware General Corporation Law (the "DGCL"), which is discussed below in more detail.
[16] In re Siliconix, Inc. Shareholders Litig, C.A. No. 18700, 2001 WL 716787, at *2, Noble, V.C. (Del. Ch. June 21, 2001).
[17] Id. at *2-*4.
[18] Id. at *4.
[19] Id. at *6.
[20] 8 Del. C. §§ 251, 252.
[21] Siliconix, 2001 WL 716787, at *6.
[22] The principle underlying the Siliconix decision is not new. Rather, it reaffirmed existing Delaware law precedent, including the Supreme Court's decision in Solomon v. Pathe Communications Corp., 672 A.2d 35, 39-40 (Del. 1996).
[23] 535 A.2d 840 (Del. 1987).
[24] 187 A.2d 78 (Del. 1962). As the Supreme Court noted in its opinion, the vitality of Stauffer ebbed and flowed over the years. It was nearly completely overruled in the 1970s, see Singer v. Magnovox Co., 380 A.2d 969 (Del. 1977); Roland Inter. Corp. v. Najjar, 407 A.2d 1032 (Del. 1979), but was revitalized in Weinberger, in which the Court announced it was returning to the "well-established principles" of Stauffer and its progeny "mandating a stockholder's recourse to the basic remedy of appraisal." Weinberger, 457 A.2d at 715. After Weinberger, in cases such as Rabkin v. Philip A. Hunt Chemical Corp., 498 A.2d 1099 (Del. 1985), as well as Bershad and Kahn, the Supreme Court appeared once again to retreat from the principles enunciated in Stauffer, focusing in those cases on the fiduciary duties possessed by a controlling stockholder and the concomitant requirement that self-dealing transactions involving fiduciaries be reviewed under an entire fairness analysis. However, neither Weinberger nor the Delaware Supreme Court cases following it involved a short-form merger effected under Section 253.
[25] Unocal Exploration, 777 A.2d at 242.
[26] Id.
[27] Id. at 247-248. It should be noted that Unocal did cause UXC to employ a special committee of the UXC board of directors to negotiate on behalf of the minority stockholders of UXC. According to both the Court of Chancery and the Supreme Court, Unocal did so in large part because of its awareness of the divergence that had arisen in the law and "engage[d] in a process that it believed would pass muster under traditional entire fairness review." Unocal Exploration, 777 A.2d at 243. Vice Chancellor Lamb found that the use of a special committee did not affect his analysis of the appropriate standard of review, because the committee was established and operated in good faith and was not a "sham designed to lull the public stockholders into believing that their interests have been protected." In Re Unocal Exploration Corp. Shareholders Litigation, C.A. No. 12453, 2000 WL 823376, at *13, Lamb, V.C. (Del. Ch. June 13, 2000) (quoting Iseman v. Liquid Air Corp., C.A. Nos. 9694, 9833, 1989 WL 125234, at *3 Berger, V.C. (Del. Ch. Oct. 23, 1989) (emphasis in original). The Supreme Court, however, did not address this issue with specificity. In the authors' view, this silence should be taken as an acknowledgement by the Court of the uncertain nature of the law of short-form mergers prior to Unocal Exploration. It is not necessarily an endorsement of a broader approach under which the Court will decline to apply standard fiduciary duty analysis where a board (or committee) voluntarily assumes a role in a transaction with respect to which no board action otherwise would be required. See, e.g., Freedman v. Restaurant Assocs. Indus., Inc., C.A. No. 9212, 1990 WL 135923, at *8, Allen, C. (Del. Ch. Sept. 21, 1990) ("Although management may have no general obligation to disclose its purpose or motivation, once it undertook to disclose its purpose in revising the offer, it had an obligation to do so truthfully and candidly."). Indeed, the focus of the Supreme Court in Unocal Exploration upon the lack of a requirement for subsidiary board involvement in a Section 253 "short form" merger reconciles Unocal Exploration with the Supreme Court's earlier opinion in McMullin v. Beran, 765 A.2d 910 (Del. 2000). In McMullin, the Supreme Court found that a controlling stockholder's decision to effect a sale of the subsidiary through a long-form merger requiring subsidiary board approval implicated the fiduciary duties of the subsidiary corporation's directors and the majority stockholder. However, in the course of so holding, the Court specifically noted that the majority stockholder was free to sell its own subsidiary shares for whatever consideration may have been acceptable to it. McMullin, 765 A.2d at 920.
[28] Unocal Exploration, 777 A.2d at 248.
[29] In re Pure Resources, Inc. Shareholder Litig., 808 A.2d 421, 433-34 (Del. Ch. 2002).
[30] Id. at 427.
[31] Id. at 430.
[32] Id. at 432.
[33] Id. at 433.
[34] Id.
[35] Id.
[36] Id.
[37] Id.
[38] Id. at 435.
[39] Id.
[40] Id.
[41] Id. at 436.
[42] Id. at 437.
[43] Id.
[44] Id. at 438 (citations omitted).
[45] Id. at 439.
[46] Id. at 441.
[47] Id.
[48] Id.
[49] Id. at 441-42 (citations omitted).
[50] Id. at 444.
[51] Id. at 445.
[52] Id.
[53] Id. at 445. This case is the third in a recent trilogy of cases where the courts have addressed the issue of the nature of the recommendation (if any) by a target's board in a tender offer to minority shareholders and the nature of the information that must be provided to the minority shareholders in deciding whether to tender. In Siliconix, the Court of Chancery found that given the nature of tender offers as direct transactions between the offeror and the target shareholders, it was not a breach of fiduciary duty for a special committee of the target's board to take a neutral stance and neither recommend for nor against the offer. 2001 WL 716787 (Del. Ch. June 21, 2001). Less than a year later, in Aquila, the Court of Chancery was faced with a slightly different response by the target's board. Here the target board also maintained a neutral stance with regard to the tender offer by the majority shareholder, and provided the minority shareholders with a summary of a banker's analysis of the transaction (but stopped short of providing an official fairness opinion). This approach by a target board responding to a tender offer by the majority shareholder also passed judicial master. 805 A.2d at 191 n. 10.
[54] 808 A.2d at 446.
[55] Id.
[56] Id. at 447.
[57] Id.
[58] Id. at 448 (citations omitted).
[59] Id.
[60] Id. at 448-49.
[61] Id.
[62] 750 A.2d 1170 (Del. 2000).
[63] 765 A.2d 910 (Del. 2000).
[64] 808 A.2d at 449.
[65] Id. In doing so, the Vice Chancellor departed from Delaware practice in requiring disclosure not required under applicable Federal law. Traditionally, Delaware has utilized the same materiality standard as Federal law and Delaware courts have resisted requiring disclosure not required in Federal law. See, e.g., Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985); Malone v. Brincat, 722 A.2d 5, 12-13 (Del. 1998).
[66] 808 A.2d at 449-50.
[67] Id. at 450-51.
[68] Id. at 452.
[69] The plaintiffs, despite their victory in the Court of Chancery, sought an interlocutory appeal of the court's decision. That application was denied by both the trial court and the Supreme Court. See In re Pure Resources, Inc. Shareholders Litig., 812 A.2d 224 (Del. 2002) (Table).
[70] Indeed, this "roadmap" was followed successfully (at least at the preliminary injunction stage) by UtiliCorp United Inc. in its acquisition of the minority interest in Aquila Corp. See In re Aquila Inc. Shareholders Litig., C.A. No. 19237, 2002 WL 27815, Lamb, V.C. (Del. Ch. Jan. 3, 2002).
[71] Unocal Exploration does not resolve whether such "back-end" mergers, which are typically negotiated with the target board of directors as part of an overall transaction, avoid for the parent corporation altogether the need to accept the burden of proving entire fairness. Indeed, Vice Chancellor Lamb acknowledged this concern in a footnote to the trial court opinion in Unocal Exploration, in which he stated his belief that certain structures involving an ultimate merger under Section 253 might nevertheless implicate entire fairness review, including situations where the short-form merger was the second step in a two-step acquisition approved by the board of the target corporation. In Re Unocal Exploration Corp. Shareholders Litig., C.A. No. 12453, 2000 WL 823376, at *6 n.26, V.C. Lamb (Del. Ch. June 13, 2000). Such transactions might well be viewed by a court as a unitary transaction requiring entire fairness review, with the merger viewed as the final step in a conspiracy to accomplish a lawful end by unlawful means. See Braasch v. Goldschmidt, 199 A.2d 760, 764 (Del. Ch. 1964). See also Andra v. Blount, 772 A.2d 183, 197 n.30 (Del. Ch. 2000) (distinguishing a case in which a majority stockholder owns 90% of the outstanding shares before any of the challenged conduct occurred from "an essentially unitary tender offer/back-end [Section 253] merger transaction").
[72] Standards of Review, 56 Bus. Law. at 1298. See also Lyman Johnson, The Modest Business Judgment Rule, 55 Bus. Law. 625 (2000) (arguing that the substantive aspect of the business judgment as a policy of non-review should be emphasized and that the duty of due care should be the primary vehicle by which board decisions not involving divided loyalties are reviewed.)
[73] On the other hand, these cases arguably run counter to the theme of simplification sounded by the Chancellors in that they may create yet another analytical "box" into which deal planners will attempt to fit their transactions.