Corporate directors owe fiduciary duties to the corporation and its shareholders. These duties generally are characterized as:
- the duty of care -- that is, to act on an informed basis; and
- the duty of loyalty -- that is, to act in good faith and without a disabling conflict of interest.
In addition, Delaware law has developed a fiduciary duty of candor or disclosure requiring directors to make complete and accurate disclosure of material facts when they request shareholders to act. [See generally Block, Barton and Radin, "The Business Judgment Rule" (5th Ed. 1998).]
On occasion, Delaware courts also have recognized a claim of fiduciary breach based on a theory of inequitable coercion. Although the courts have not articulated a clear standard for a coercion claim, it would appear that it is rooted in the hybrid application of the duties of loyalty and disclosure. Claims based on improper coercion have arisen in various contexts:
- restructuring or recapitalization transactions;
- defensive measures in response to unsolicited takeover attempts;
- shareholder voting with respect to transactions involving controlling shareholders; and
- shareholder voting with respect to transactions or proposals not involving interested parties.
Restructuring And Recapitalization Transactions
In one of the earliest coercion cases, Kahn v. United Sugar Corporation, 1985 WL 4449 (Del. Ch. 1985), the board of directors of United States Sugar Corporation endorsed a transaction consisting of a self-tender offer by the issuer and a newly-formed employee stock option plan ("ESOP") for 75% of the outstanding common shares of the corporation. The purpose of the transaction was to enable the Mott family interests, holding an aggregate of 72% of the outstanding shares, to reduce a significant amount of its otherwise illiquid holdings while at the same time maintaining majority control of the corporation.
In order to facilitate the transaction, however, it was necessary for the corporation to significantly leverage itself. Notably, the corporation had no independent directors as all of them apparently had some relationship with the family interests. The transaction was challenged by minority public shareholders who claimed that the disclosures in the tender offer materials were false and misleading and that, in any event, the transaction was inequitably coercive.
The Delaware Court of Chancery concluded that the offering materials were inadequate in that they failed to disclose, among other things, that the board had received information from its advisors that the shares could have values substantially in excess of the offering price and that the offering price was not based on a true valuation of the shares but rather on what price the ESOP would be able to pay for the shares and the degree of leverage that the corporation could reasonably sustain in financing the transaction.
Ultimately, however, the court simply determined that the offering price was unfair and that the transaction, as structured, was coercive. In that regard, the court concluded that the minority shareholders had no effective choice but to tender their shares because the significant leverage necessary to accomplish the transaction would result in the dramatic decline in the value of their shares with no prospect for any dividends in the near term. Interestingly, the court observed that the disclosures regarding the potential adverse effect of the transaction to non-tendering shareholders was not itself coercive but rather a truthful explanation of the consequences of holding on to one's shares.
In Eisenberg v. Chicago-Milwaukee Corporation, 537 A.2d 1051 (Del. Ch. 1987), the Chancery Court also found deficient disclosures in offering materials accompanying an issuer tender offer designed to eliminate a class of publicly traded preferred stock so as to take advantage of historically low market prices for the stock as a consequence of the 1987 stock market crash. Separate and apart from the disclosure infirmities, the court held that the self-tender was inequitably coercive.
Preliminarily, the court observed that the standard applicable to a coercion claim "is whether the defendants have taken actions that operate inequitably to induce the . . . shareholders to tender their shares for reasons unrelated to the economic merits of the offer." In that regard, the court continued, so long as all material facts are candidly disclosed (and for purposes of this analysis, the court appeared to assume that to be the case notwithstanding its earlier findings to the contrary), transactions such as the one at issue ordinarily would be deemed voluntary and not subject to challenge.
Thus, the court suggested that the offer's arguably coercive characteristics -- the fact that the offer was made in light of the historically low market price for the preferred stock and against the background of an announced board policy of not paying dividends despite the ability to do so -- without more would not render the coercion actionable. Here, however, the court found that the board's disclosed intention to seek the delisting of the preferred shares constituted a sufficient threat to "tip the balance and impels the court to find that the offer, even if benignly motivated, operates in an inequitably coercive manner."
Issuer Tender Non-Coercive
In contrast to Kahn and Eisenberg, an issuer tender offer was held to be non-coercive, in Cottle v. Standard Brands Paint Company, 1990 WL 34824 (Del. Ch. 1990), where the offer was based on a "dutch auction" pricing mechanism. In a "dutch auction," the company establishes a range of prices within which shareholders can determine the price they would like to be paid. The company then determines the price at which it will be able to purchase the specified number of shares and buys such number of tendered shares at that price and declines to purchase shares tendered above that price.
The transaction in Cottle was challenged as being improperly coercive because the company intended to purchase shares only at the lowest price in the offered range, the anticipated market price for the remaining shares was estimated to be significantly lower than the tender offer price range and the company announced that it would cease paying dividends after completion of the offer.
Citing to the dictum in Eisenberg, the court observed that a self-tender offer at a premium to the market price is not inherently coercive, even if the market price for the remaining shares is adversely affected, as long as the offering materials fully disclose such adverse effects. Here, the court concluded, the tender offer did not subject the shareholders to a potentially adverse transaction freezing them out of their equity positions and, distinguishing Kahn, was not made at an unfair price.
Defensive Measures In Response To Hostile Takeover Attempts
Defensive actions by boards that are the target of a hostile takeover attempt portend a fertile opportunity for coercive conduct to prevent the successful completion of the unwanted bid. In Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334 (Del. 1987), for example, the board of directors of Newmont Mining adopted a three-prong defensive strategy in response to a two-tier unsolicited tender offer which the board found to be made at an inadequate price. At the same time, the board declared a $33 per share dividend, to be financed by the sale of Newmont's non-gold assets, for the purposes of:
- Providing immediate value to Newmont shareholders and preventing the hostile bidder from acquiring control of the non-gold assets without paying an adequate premium to all shareholders for control and
- Facilitating a "street sweep" of Newmont's publicly traded stock by Newmont's largest shareholder, Consolidated Gold Fields PLC ("Gold Fields"), at a price of $98 per share.
To effectuate the "street sweep," Newmont and Gold Fields amended an existing standstill agreement to enable Gold Fields to acquire up to 49% of Newmont's outstanding shares.
The hostile bidder brought an action seeking an injunction or rescission of the dividend and "street sweep," claiming that these actions were coercive and violated the fiduciary duties owed by the Newmont board to its shareholders. The Delaware Supreme Court upheld the Newmont board's strategy, applying the heightened scrutiny test adopted by that court in Unocal Corp. v. Mesa Petroleum Co.
The Unocal Test
Under the Unocal test, the court first inquires whether the directors had "reasonable grounds for believing that a danger to corporate policy and effectiveness existed" and, second, whether the defensive measures adopted were "reasonable in relation to the threat posed." If the directors meet the burden of satisfying these inquiries, their conduct will be reviewed under the business judgment rule, an evidentiary presumption that, in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the corporation.
The Ivanhoe court held that the Newmont board satisfied the first prong of the Unocal standard because the board reasonably perceived that the hostile bidder's offer was itself coercive and inadequately priced. The court also concluded that the second Unocal prong was satisfied because the defensive strategy provided immediate value to Newmont shareholders while at the same time ensuring Newmont's continued independence not only from the inadequate and unfair advances of the hostile bidder but from Gold Fields as well. Significantly, the court rejected the hostile bidder's assertion that Newmont shareholders were improperly coerced into selling into the "street sweep," finding no evidence that the hostile bidder's two-tiered tender offer would have been successful but for the amended standstill agreement and "street sweep."
Example of the Unocal Test
A target board's defensive actions were held to fail the Unocal test in AC Acquisitions Corp. v. Anderson, Clayton & Co., 519 A.2d 103 (Del. Ch. 1986.) In that case, the board of Anderson, Clayton proposed a recapitalization in response to a fully financed, all cash unsolicited tender offer for all shares of the company's common stock. The proposed recapitalization involved an issuer tender offer and the establishment of an ESOP. Although the self-tender offering price exceeded the all-cash price of the unsolicited bid, it was agreed that the value of the remaining shares would decline significantly.
But unlike the Newmont board in Ivanhoe, the Anderson board did not attempt to justify its recapitalization on the ground that it was necessary to deter a coercive or unfair hostile offer. Indeed, the unsolicited offer was conceded to be fairly structured and priced. The Anderson board, however, asserted that its objective was to provide the shareholders with an alternative transaction which permitted them to obtain immediate value while at the same time retaining their equity position in a recapitalized Anderson.
The Delaware Court of Chancery concluded that the board's rationale served a valid corporate purpose sufficient to satisfy the first prong of the Unocal test. The court was not persuaded, though, that the timing and structure of the defensive recapitalization met the second Unocal prong. Specifically, the court found that shareholders had no assurance that the hostile bidder would complete the tender offer in light of certain conditions to the offer that would not be satisfied absent favorable action by the Anderson board.
Thus, shareholders were at risk that if they tendered to the hostile offeror and it did not consummate its offer, they could not participate in the front-end loaded self-tender offer and would be left with an equity position the value of which would be diminished post-recapitalization. For that reason, the court held that "no rational shareholder could afford not to tender into [Anderson's] self-tender offer" because the value of Anderson stock would be materially less than the self-tender price following completion of the offer. Accordingly, the court found Anderson's response to the hostile tender offer to be unreasonable because "a defensive step that includes a coercive self-tender offer timed to effectively preclude a rational shareholder from accepting the . . . [hostile] offer cannot . . . be deemed to be reasonable."
Shareholder Voting Affecting Controlling Shareholders
Notwithstanding the temptation to undertake coercive action in a corporate control contest, the issue of shareholder coercion most often addressed by the courts appears to occur in connection with shareholder voting procedures, and, more specifically, in two general contexts:
- Where shareholders are called upon to vote on transactions involving directors or controlling shareholders and
- Where the "effect of corporate action which, in order to become operative, requires and receives both approval by the board of directors and stockholders." [Williams v. Geier, 671 A.2d 1368, 1379 (Del. 1996).]
At least one Delaware court has held that the effect of a fully informed shareholder vote, absent inequitable conduct, ratifying a transaction with an interested director both extinguishes any claims based on a breach of the duty of care and transforms the review of a claim based on a breach of the duty of loyalty from one based on entire fairness to a business judgment standard which limits review to issues of gift or waste with the burden of proof resting on the plaintiff. [In re Wheelabrator Technologies, Inc. Shareholders Litigation, 663 A.2d 1194 (Del. Ch. 1995).]
Where a fully informed shareholder vote ratifies a transaction with a controlling shareholder, the burden shifts to the plaintiff to establish the unfairness of the transaction. Notwithstanding shareholder ratification, however, the court will still review the transaction to ensure the absence of fraud, waste, manipulative or inequitable conduct. Thus, in Lacos Land Company v. Arden Group, Inc., 517 A.2d 271 (Del. Ch. 1986), the Delaware Court of Chancery enjoined the issuance of supervoting stock pursuant to an amendment to the corporation's certificate of incorporation, which had been approved by a vote of the shareholders. The stock issuance was intended to solidify the voting control of the chief executive officer, a 22% shareholder, who, it was conceded, held de facto control of the corporation.
The court's holding was not so much based on the issuance of the supervoting stock itself, but rather on the fact that the principal shareholder disclosed in the proxy materials soliciting the shareholder vote that "unless the proposed amendments were approved, he would use his power (and not simply his power as a shareholder) to block transactions that may be in the best interests of the Company, if those transactions would dilute his ownership interest in" the company.
Shareholder Voting Not Involving An Interested Party Transaction
In Williams v. Geier, 671 A.2d 1368 (Del. 1996), the Delaware Supreme Court articulated a test for determining if shareholders' votes had been wrongfully coerced by corporate management. In that case, shareholders had challenged a supervoting stock recapitalization plan, claiming that the information provided in their proxy statement was coercive and that the board had breached its fiduciary duties. The challenged proxy statements informed shareholders that:
- Approval of the recapitalization plan was "virtually assured" because the Geier family, who had a controlling interest in the corporation, would be voting in favor of the plan; and
- If the plan was not approved by a two-thirds majority, the stock was at risk of being "delisted" by the New York Stock Exchange.
Plaintiff argued that "[t]he effect of these two statements . . . was impermissibly to coerce the stockholders into voting for the Recapitalization." The court, in a 3-2 decision, held that because, under Delaware law, a board of directors that seeks shareholder action is under a duty "to disclose fully and fairly pertinent information within the board's control," the disclosures made in the proxy statement were "merely stating facts which were required to be disclosed," and thus were not coercive.
In so holding, the court adopted a test, which had been previously articulated in Chancery Court opinions, that wrongful coercion only exists "where the board or some other party takes actions which have the effect of causing the stockholders to vote in favor of the proposed transaction for some reason other than the merits of that transaction."
The court distinguished Lacos Land on the ground that that case involved blatant threats by the chief beneficiary of the supervoting stock issuance to oppose transactions in the best interests of the corporation if the issuance was not approved, whereas in Williams, the disclosures were untarnished by such threats. Significantly, and in contrast to Kahn, the court also treated the transaction as having been approved by disinterested directors without the influence of the controlling Geier family interests, finding that there was:
- No non-pro rata or disproportionate benefit which accrued to the Family Group on the face of the Recapitalization, although the dynamics of how the Plan would work in practice had the effect of strengthening the Family Group's control;
- No evidence adduced to show that a majority of the Board was interested or acted for purposes of entrenching themselves in office;
- No evidence offered to show that the Board was dominated or controlled by the Family Group; and
- No violation of fiduciary duty by the Board.
The Delaware Supreme Court reaffirmed the test articulated in Williams in Brazen v. Bell Atlantic Corporation, 695 A.2d 43 (Del. 1997). In Bell Atlantic, shareholders were asked to approve a merger between Bell Atlantic and NYNEX. One of the terms of the merger agreement was a $550 million termination fee that would compensate either party for damages incurred if the merger did not take place due to, among other things, the failure to obtain shareholder approval.
Plaintiff, a Bell Atlantic shareholder, claimed that this "enormous" termination fee was coercive and had "influenced" shareholder voting because shareholders knew that if they did not approve the merger, their company would probably have to pay NYNEX $550 million. The court held that because the termination fee was "a valid, enforceable part of the merger agreement, disclosure of the fee provision to stockholders was proper and necessary," and that consideration of that fee did not cause the shareholders to vote in favor of the merger "for some reason other than the merits of that transaction."
In two closely-related cases, the Delaware Court of Chancery ruled that shareholders of General Motors ("GM") Classes E and H Common stock had not been coerced into approving GM proposals to split-off two of its wholly-owned subsidiaries. In both cases, GM had sought class shareholders' waiver of a provision in its pre-split-off certificate of incorporation which entitled class shareholders to a 120 percent recapitalization ("Recap Rights") in the event of the "sale, transfer, assignment or other disposition by [GM] of . . . its subsidiaries and successors."
Solomon TRV v. Armstrong Ruling
In litigation brought by the Class E shareholders, Solomon TRV v. Armstrong, Civil Action No. 13515, plaintiffs claimed that statements made in GM's Consent Solicitation that GM would only seek a divestiture of its EDS subsidiary which did not trigger the Class E shareholders' Recap Rights was coercive. The court held that GM's solicitation had merely been informative, apprising shareholders that if they voted in favor of the split-off of EDS, they would forfeit some benefit to which their Class E stock would otherwise be entitled.
Citing both Brazen and Williams, the court noted that "[c]onsidering the legal imperative that all shareholders be armed with all material information, it cannot be that the mere potential to influence a shareholder's vote renders disclosed information actionable." While the information "may have had an effect on how shareholders voted . . . I cannot conclude that it was disclosed in order to force shareholders to vote on anything other than the merits of the transaction." Applying the Williams test, the court found that "whether . . . shareholder[s] voted for or against the transaction -- [they]would be voting on the merits and not because this disclosure introduced some other reason." Thus, the disclosure was held not to constitute wrongful coercion.
In the litigation brought by GM Class H shareholders, In re General Motors Class H Shareholder Litigation, Civil Action No. 15517, challenging complex recapitalization of GM's Hughes subsidiary, plaintiffs, holders of GM Class H securities, made similar allegations of coercion with respect to a solicitation statement asking stockholders to waive the "20% premium" provision in the certificate of incorporation. Plaintiffs asserted that they were "forced to choose between . . .
- Acquiescing in defendants' unilateral elimination of the lucrative recapitalization rights, or
- Blocking the [transaction] and thereby squandering the potentially enhanced values realizable from those transactions.
The court found no coercion based on the Williams test: the allegation did not state a claim that the shareholder vote was "influenced by matters unrelated to the merits of the [transaction]." The court also pointed out that if the proposed transaction was not approved, the stockholders would be in the same position as they were in before the vote. Thus, the stockholders were found to have had a "free choice" between maintaining their current status and taking advantage of the new status afforded by the proposed transaction, and were not coerced.
As Chancellor Allen observed in Lacos Land, "[F]or purposes of legal analysis, the term 'coercion' itself - covering a multitude of situations - is not very meaningful. For the word to have much meaning for purposes of legal analysis, it is necessary in each case that a normative judgment be attached to the concept ('inappropriately coercive' or 'wrongfully coercive,' etc.). But, it is then readily seen that what is legally relevant is not the conclusory term 'coercion' itself but rather the norm that leads to the adverb modifying it."
Thus, for example, the actionable coercive effect of stock exchange delisting can turn on whether the company intends to seek delisting -- as in Eisenberg -- as opposed to whether delisting is merely disclosed as a potential consequence of the transaction -- as in Williams.
Whether the relative differences in the risks of these transactions are of degree and not kind sufficient to tip the balance in the determination of improper coercion is not entirely clear. Perhaps the ultimate determining factor of improper coercion is to be found in the quality of the disclosure accompanying the proposed transaction.
In that regard, what does appear to emerge from the caselaw is that a fully informed shareholder vote, at least outside of the context of transactions with controlling shareholders, will likely result in a review under a business judgment rule standard and a finding that no actionable coercion has occurred.