RE

MERGER & ACQUISITIONS

BUSINESS ASSOCIATIONS II:

MERGERS AND ACQUISITIONS
ELLM Chicago 2018

OUTLINE AND SUMMARY

● Three main ways a business buys another business - stock deal, asset deal, and merger
○ Stock Deal
■ Acquirer buys all outstanding stock of Target from Target’s shareholders in exchange for
consideration paid by Acquirer to Target’s shareholders.
■ Buyer approvals needed: board approval is typically required, unless it is a very small
transaction relative to the size of Buyer. Buyer shareholder approval is typically unnecessary,
unless it would otherwise be required - for example if the articles of incorporation need to be
amended to authorize shares that will be paid as consideration in the deal
● If we’re in California or a similar state, if the transaction counts as an “exchange
reorganization” (which means consideration is acquirer stock and acquirer is getting
control of the target), buyer shareholder approval is required except where pre-deal
buyer shareholders will own more than five-sixths of the voting power of the buyer after
the transaction.
CA Corp Code § 181 (through 2012 Leg Sess)

Reorganization means either:

(a) A merger pursuant to Chapter 11 (commencing with Section 1100) other than a short-form
merger (a merger reorganization ).

(b) The acquisition by one domestic corporation, foreign corporation, or other business entity in
exchange, in whole or in part, for its equity securities (or the equity securities of a domestic
corporation, a foreign corporation, or an other business entity which is in control of the
acquiring entity) of equity securities of another domestic corporation, foreign corporation, or
other business entity if, immediately after the acquisition, the acquiring entity has control of the
other entity (an exchange reorganization ).

1201

No approval of the outstanding shares (Section 152) is

required by subdivision (a) in the case of any corporation if that
corporation, or its shareholders immediately before the
reorganization, or both, shall own (immediately after the
reorganization) equity securities, other than any warrant or right to
subscribe to or purchase those equity securities, of the surviving
or acquiring corporation or a parent party (subdivision (d) of
Section 1200) possessing more than five-sixths of the voting power of
the surviving or acquiring corporation or parent party.
1
 ■ Seller approvals needed: each shareholder can choose on their own whether to sell, and for
how much. There is no overall shareholder vote. Target board has no say in the transaction,
since Target itself is not engaging in any transaction.
■ Dissenters rights: do not apply in stock deals in Delaware, since each shareholder consents to
their individual sale
● One exception for states like California, if it is an exchange reorganization then
dissenters rights might apply as to acquirer shareholders
■ One added concept: can also have a shareholders agreement in which shareholders pre-agree
to sell their shares if a specified percentage of them agree to do so. These so-called “drag
along” agreements are enforceable.
■ One more added concept: Buyers sometimes start an acquisition with a stock deal and then,
after securing sufficient shares to guarantee the deal will go through, finish it up with a merger.
○ Asset Deal
■ Acquirer buys specified (or all) assets of Target from Target directly in exchange for an
agreement to assume specified (or all) liabilities of Target and other consideration which is paid
to Target
■ Buyer approvals needed: board approval is required, unless it is a very small transaction relative
to the size of Buyer. Buyer shareholder approval is typically unnecessary, unless it would
otherwise be required - for example if the articles of incorporation need to be amended to
authorize shares that will be paid as consideration in the deal.
● If we’re in California or a similar state, if the transaction counts as a “sale of assets
reorganization” (which means consideration is acquirer stock and acquirer is getting
control of the target business) buyer shareholder approval is required except where pre-
deal buyer shareholders will own more than five-sixths of the voting power of the buyer
after the transaction.
■ Seller approvals needed: Seller board approval is required where significant assets are sold.
Seller shareholder (majority of outstanding shares) approval is required where the transaction
involves the sale of “all or substantially all of the assets” of Target.
■ To know if the assets being sold constitute “all or substantially all” of the assets, we inquire as to
whether the transaction is “unusual,” “outside the ordinary course of business,” and represents
a “fundamental change.” Case law is all over the place on this inquiry, but for our purposes
check whether the assets “strike at the heart of the corporate existence.” Also consider
quantitative factors, such as the amount of the assets being sold, or the amount of revenue
attributed to the assets being sold. [In practice, you would do lots of research on this before
reaching a conclusion. On the final exam, I will not give you a close call - it will be pretty clear
whether or not the deal is for “all or substantially all” of the assets.]
● For purposes of determining the assets of the business, the state statute might explicitly
say, and in Delaware it does say, that assets of subsidiaries count as assets of the
business for asset deal analysis.
■ Dissenters rights: do not apply in asset deals in Delaware
● One exception for states like California, if it is a sale of assets reorganization then
dissenters rights might apply
■ De Facto Merger Doctrine
● Asset deals also raise the specter of the de facto merger doctrine
○ In states that recognize the de facto merger doctrine (which you will almost
2
 certainly never encounter), the court looks at the totality of the asset
transaction and asks whether the purposes of the deal, the provisions of the
contract and the consequences of the deal make the transaction look like a
merger. If so, it is a merger and the merger sections of the state statute apply,
including approval requirements and dissenters rights. If consideration is cash
that weighs against a finding that it was a de facto merger.
○ In Delaware, the doctrine of “independent legal significance” says the various
sections of the statute are of “equal dignity” and should be read as a menu of
choices for transactional lawyers - and as such, asset deals are just asset deals
and mergers are just mergers and there is no de facto merger doctrine.
■ Another issue that arises in asset deals is the issue of successor liability.
● As to specifically assumed liabilities, the Buyer is liable.
● As to impliedly assumed liabilities, like in the Antiphon case where Buyer paid bills of the
Seller and never told creditors the asset deal had happened, the Buyer is liable
● As to states with the de facto merger doctrine, if it’s a de facto merger then all liabilities
go along with the deal, just like in a merger, survivor is liable
● If it’s a product liability matter, most states follow the “continuation” doctrine, which
says that if the Buyer is a “mere continuation” of the prior business (like, it produces the
same product, through the same employees, in the same physical plant, under the same
supervision and under the same name, maybe even with the same shareholders or
maybe not) then buyer is liable
● In a small number of states (and on the final exam I would tell you if I wanted you to
apply this rule) product liability follows the product line
● There are also specialized statutes covering successor liability in certain areas, like
environmental liability or labor matters
● In addition, if a Seller dissolves post transaction it should be very careful to follow the
procedures in the statute to give comfort to the outgoing board that it will not be
personally liable for the debts of the business.
○ Mergers
■ Acquirer can also acquire Target’s business in a merger transaction
■ The two companies merging (which will probably be Target and either Acquirer or a subsidiary
of Acquirer (but not both)) are called “constituent corporations”
■ One corporation, the “merging” or “disappearing” corporation, merges “with and into” the
“surviving” corporation. All assets and liabilities of both constituent corporations wind up, by
operation of law, in the survivor. Shareholders of constituent corporations receive whatever
consideration the merger agreement says, which might be shares of the survivor, cash, or some
other consideration
■ As a reminder, check the state statute concerning approvals
■ Approval needed:
● Board approval will be necessary from both constituent corporations. Remember that
the constituent corporations are the ones doing the merging, so if it is a triangular
merger or a reverse triangular merger, we are talking about the merger subsidiary’s
board on the Acquirer side and the Target board on the other side
● A majority of the outstanding shares of the acquirer need to approve the deal, unless
shares issued as consideration in the merger do not exceed 20% of the shares
outstanding before the merger. On the target side, a majority of the directors and a
majority of the outstanding shares of the target need to approve the merger.
○ If we’re in California or a similar state, a merger is always considered a
“reorganization.” Merging company shareholder approval is always required,
and survivor shareholder approval is required except where pre-deal survivor

3
 shareholders will own more than five-sixths of the voting power of the survivor
after the transaction.
● Dissenters rights: In Delaware, appraisal rights are only available in merger transactions.
In mergers, appraisal rights only attach if a shareholder is a “dissenting shareholder,”
meaning they voted against or abstained from voting on the merger. Appraisal rights
are available to (i) dissenting shareholders of the merging company; and also to (ii)
dissenting shareholders of the surviving company. Dissenters rights do not apply (i) to
shareholders of the surviving company if they are not required by statute to vote on the
merger, or (ii) to shareholders of either company if the company’s shares are listed on a
national securities exchange (or the company has more than 2000 shareholders) and the
consideration is shares of another publicly traded company (or a company with more
than 2000 shareholders).
○ As a reminder, a shareholder asserting dissenters rights in accordance with the
statute can ask the court to get fair market value / fair value for the shares
○ Also:
■ don’t forget the vote-buying case (Schreiber v Carney), in which we saw that vote-buying is not
per se illegal, but is illegal where it defrauds or disenfranchises other shareholders

TYPES OF DEALS

CONTENTS
1) Deal Structure (stock deals, asset purchases, mergers, successor liability)
2) Shareholder consent (board approval, shareholder voting, appraisal rights)

Deal Structure

Types of M&A Deals

a. Stock Deal (acquirer buys all outstanding stock from target’s shareholders for consideration paid directly to
shareholders) (a/i: Shareholders’ Agreement)
Consideration can be cash, shares of another company
Stock deal as buyer may need to by buy corporate entity with license.
b. Asset Purchase (buyer buys all or substantially all of target’s assets and consideration paid to target)
buyer may not care about the corporate entity
c. Merger (one corporation merges with and into the surviving corporation; all assets and liabilities rest in the
surviving corporation)
i. Straight Merger (negotiated deal or hostile takeover; board of directors create plan of merger)
ii. Short-form Merger (between a parent and a 90% owned subsidiary; no shareholder vote necessary)
iii. Triangular Mergers (target merges into subsidiary)
iv. Reverse Triangular Mergers (subsidiary merging into the target)

Stock Deals:
a. Acquirer buys all outstanding stocks of target from T shareholders In exchange for consideration Paid by A
to T's shareholders
b. Buyer's approval needed; Buyer Bod approval typically required unless a small transaction relevant to the
size of the buyer
c. Buyer's SH approval is typically unnecessary unless it would o/w be required
a. e.g. Articles of incorporation need to be amended to authorize shares that would be paid as a
consideration (then SH approval is needed)
4
 b. or in CA, it's an exchange reorganization (consideration is A's stocks and A is getting control of the
T)
d. Seller's approval needed
a. Each SH can choose on their own whether to sell and for how much
b. T's bod has no say in transaction since T itself is not engaged in the transaction
e. Dissenter's rights
a. Do not apply since each SH consents to their individual sale
b. Exception: in CA, if an exchange reorganization, then dissenters' rights might apply (check statutes)
f. You can have a SH's agreement in which SHs preagree to sell their shares if a classified percentage of them
agreed to do so --> Drag-along agreements are enforceable
g. Buyers sometimes start an acquisition with a stock deal, and then after securing sufficient shares to guarantee
the deal will go through, finish up with a merger.

Asset Deals:
a. Acquirer buys specified or all assets of T from T directly in exchange for an agreement to assume specified
or all liab of T and other considerations which is paid to T (Asset deal: Company is the seller>< Stock deal:
SHs are the seller)
a. Each company participating in the transaction is governed by the state law of the state in which its
incorporated or organized
b. Buyer's approval needed
a. Bod approval can be required unless it’s a relatively small transaction relevant to the size of the buyer
c. Buyer's SH approval is typically unnecessary
a. Unless it would otherwise be required --e.g. Articles of incorp need to be amended to authorize shares
that would be paid as a consideration// or in CA, it’s a sale of asset reorganization (buyer issues
stocks as a consideration of the deal.)
i. Buyer SH is required Except pre-deal buyer's SH will own more than 5/6 of the voting power
after the transaction (in CA)
d. Seller's bod is required where significant assets are sold
e. Seller's SH approval is required where the transaction involves the sale of all or substantially all assets
( cases and statutes define)
a. States may have rules like in CA chestnut: preferred shares don’t get a vote if their rights are the
same after the transaction as they were before
f. To know if the assets being sold constitute "all or substantially all," we inquire whether the transaction is
a. Unusual
b. Outside the ordinary course of biz
c. Represent a fundamental change
d. ---------------------
e. Case law is all over the place on the inquiry. But for our purpose, check whether assets "strike at the
heart of the corporate existence." In practice, do research; in final exam, will not be a close call.
f. For purposes of determining the assets of the business, the state statues might explicitly say and in
DE it does say assets of subsidiary count as assets of the biz for asset deal analysis so selling those
can still be considered a merger if all are sold)

g. Add quantitative exam.

g. Dissenters rights apply if state statutes say so
a. In DE, SH in asset deals do not get dissenters' rights
b. In CA, they do if the transaction is a reorganization transaction
5
h. Successor liability
a. As to the specifically assumed liability, buyer's liable.
b. As to impliedly assumed liability, (like in Antiphon case where the buyer paid the bills of the seller
and never told the creditors the asset deal had happened), the buyer is liable.
c. As to the states with the de facto merger doctrine, if there is a de facto merger, then all the liabilities
go along with the deal and survivor is liable.
d. If it’s a product liability matter, many statues follow the continuation doctrine, which says if the
buyer is a mere continuation of the prior business (like producing the same products through the
same employees in the same physical plant under the same supervision and under the same name,
maybe even with the same SH or maybe not), then buyer is liable. (which focuses on the entire
business)
i. In small number of states, product liability follows the product line. (which focuses on the
product)

e. Rationale for Successor Liability: (1) Plaintiff has no other recourse for injuries, (2) buyer is in the best
position to reduce risk of injury from existing products (risk-spreading) and (3) having the benefit of
the target’s assets and goodwill should include potential liabilities
f. To avoid successor liab:
i. expressly provide in contract that certain debts are not assumed
ii. cause seller to notify creditors of the sale and identify those responsible for debts
iii. negotiate lower purchase price
iv. obtain insurance or indemnification agreements
g. Environmental liab and labor liab (not in final)
h. If a seller dissolves post transaction, it should be careful to follow the procedures in the statute to
give comfort to the outgoing bd that it will not be personally liable for the debts of the biz.

Mergers:
a. Acquirer can also acquire T's biz in a merger transaction. The two companies merging which will prob be a
T and either an A or a subsidiary A (the two companies are called constituent corps.)
a. One corporation, the merging or disappearing corporation "merges with and into" the surviving
corporation.
b. All the assets and liabilities of both constituent corps end up by operation of law in the survivor.
c. SHs of the constituent corps receive whatever consideration the merger agreement says, which might
be shares of survivor, cash, or some other consideration.
d. Shareholders may end up being 100% owner of target corporation, or may be controlling.
b. Bod approval will be necessary from both constituent corporations.
a. Remember the constituent corps are the ones doing the merging (whether triangular merger or
reverse triangular merger, we are talking abt the merger subsidiary's board on the A side and the
target board on the other side)
c. SH approval will be necessary for both constituent corps unless a statutory exception applies. Statutory
exceptions include
a. 20% rule in DE/IL,
b. the 5/6 rule in CA (SH of the surviving corp don’t get a vote if they own more than 5/6 of the
survivor following the merger)
c. or the CA rule that preferred SH of the survivor don’t get to a vote if their rights are unaffected
d. Dissenters' rights apply in every state for merger transactions unless there is an exception in the statute
a. e.g. may not apply for shares listed on a national securities exchange where the consideration is
shares of another public traded company
b. Dissenters' rights statutes are specific as to the procedure and must be followed to the letter

6
 i. Magner case: where he couldn’t tender his shares as permitted by the statute coz he
transferred them to an LLC and the LLC couldn’t assert dissenters' rights because they didn’t
own the shares on the record date
c. SHs asserting dissenters' rights according to the statues can ask the court for a fmv or fair value for
the shares.
e. Don’t forget the vote buying cases
a. Vote buying is not per se illegal
b. But is illegal if it frauds and disenfranchise other SHs (infringes other SHs’ rights)
c. also allowed when economic and voting interests are aligned (EMAK Partners v. Kurz)
f. Don’t forget the rules how corps can create holding companies without a SH vote, or move assets to the
subsidiary without a SH vote.
g. Policy for Triangular Mergers: Useful because (1) avoids buyer-side shareholder vote, (2) protects parent
company from target liabilities, (3) prevents union agreements from affecting the buyer’s workforce and (4)
allows 50% of consideration to be something other than buyer’s stock

Shareholder Consent

Stock Deal Asset Deal Merger

Buyer Board Approval Usually required, unless Can be required, unless Necessary for the
target is relatively small the transaction is small constituent corporations
relative to buyer relative to buyer
Buyer S/H Approval Usually not necessary Usually not necessary Necessary unless there is
unless lots of shares unless lots of shares are a statutory exemption
(20%+) are issued,
issued (20%+), amending (see below)
amending articles of
articles of incorporation,
incorporation, change to or change to share
share structure structure
Target Board Approval Not needed Only where a significant Necessary for the
amount of assets are sold constituent corporations
(all or substantially all)
Target S/H Approval Needed, Individual Only where a significant Necessary unless there is
decisions amount of assets are sold a statutory exemption
(all or substantially all) (see below)
Dissenters’ Rights None, except in CA when No unless the asset deal is Generally applies unless
consideration is stock considered a merger there is a statutory
exemption

Common statutory voting exemptions for mergers are (DE): surviving companies if (a/i: Vote Buying,
Corporate Transactions)
a. No change in the articles of incorporation in the surviving company
b. AND No change in the rights of the existing shareholders of the surviving company
c. AND Buyer issues small amount of stock (<20% of outstanding shares)
d. AND Consideration paid is cash

Common statutory exemptions for dissenters’ rights are: (a/i: Closely Read)
a. Shares bought or received listed on national exchange or widely held
b. OR No vote of the shareholders was necessary
c. OR voted yes

7
Steps for determining dissenters’ rights
a. Determine if the deal is a merger or reorganization
b. Determine if shareholders get to vote (on buyer and seller side)
c. Determine if any exceptions apply to dissenters’ rights (e.g. public market for shares)

Schreiber v. Carney
Delaware Court of Chancery
447 A.2d 17 (Del. Ch. 1982)

Rule of Law
Under Delaware law, corporate vote-buying is only per se illegal if done for the purpose of defrauding or
disenfranchising other shareholders.

Facts
A merger was proposed between Texas International Airlines, Inc. (TIA) and Texas Air. Jet Capital Corporation
(Jet) (defendant) owned 35 percent of TIA’s voting shares. Jet opposed the merger, because it would cause an
$800,000 tax liability for Jet. Jet threatened to block the merger, unless Jet was able to exercise stock warrants in
TIA. Jet did not have the money to exercise the warrants and claimed securing an outside loan was cost-
prohibitive. TIA appointed a committee of uninterested directors to consider a loan to Jet. The committee
consulted experts and determined the loan was “prudent and reasonable.” TIA loaned Jet $3,335,000 at 5 percent
interest, which increased to prime interest on the expiration of Jet’s warrants and had to be repaid immediately
on Jet’s exercise of the warrants. The deal had little financial impact on TIA. The board voted unanimously to
approve the loan and submitted it to shareholders. Passage was contingent on a majority vote of all outstanding
shares and a majority of uninterested shareholders (excluding Jet and its officers and directors). Full disclosure
was made beforehand, and shareholders passed the measure by an “overwhelming” majority. TIA shareholder
Leonard Schreiber (plaintiff) sued. Schreiber claimed the measure was void, because it was achieved through
vote-buying, and that the loan constituted corporate waste.
Issue
Is corporate vote-buying per se illegal?
Holding and Reasoning (Hartnett, J.)
No. Delaware law prohibits vote-buying done to defraud or disenfranchise shareholders. The issue is whether
vote-buying done without malicious intent is similarly barred. Vote-buying is an agreement by a shareholder to
cede her voting rights to another for personal consideration. Delaware case law sets forth two principles. First,
vote-buying is per se invalid when done to defraud or disenfranchise other shareholders. Fraud means “a deceit
which operates prejudicially on the property rights of another.” Second, the public policy basis is that
shareholders have a right to rely on the “independent judgment” of other shareholders, which ensures
shareholders act in their own interests and consequently protect the interests of minority shareholders. Cone v.
Russell, 21 A. 847 (1891). This is a duty owed by the shareholder to all others, and giving up those voting rights
works a fraud. Nevertheless, times have changed, and this reliance on personal judgment of shareholders is
obsolete in modern corporations. 5 Fletcher Cyclopedia Corporation (Perm. Ed.) § 2066. In the key case on vote-
buying, a shareholder opposed the sale of corporate assets, because the proceeds would only be sufficient to pay
off creditors, leaving shareholders in the lurch. Brady v. Bean, 211 Ill. App. 279 (1921). The shareholder agreed to
the sale after being bought off by a creditor, and the court refused to enforce the contract against the creditor’s
estate. Id. The court concluded that the vote-buying agreement violated public policy. Over time, Delaware
courts have loosened restrictions against shareholder voting agreements. Oceanic Exploration Co. v. Grynberg, 428

8
A.2d 1 (Del. Supr. 1981). There is no reason for rigidly adhering to rules against vote-buying where the purpose
is to benefit shareholders. Vote-buying is not per se illegal unless done for the purpose of defrauding and
disenfranchising other shareholders. Such agreements are voidable and must satisfy inherent fairness. Here, TIA
engaged in vote-buying when it gave Jet the loan, but TIA intended to benefit the company and its shareholders.
TIA made full disclosure to its shareholders, who ratified the act. The transaction stands.

9
.

Kirschner Brothers Oil, Inc. v. Natomas Company (CA, 1986): Plaintiffss, holders of Natomas’s preferred stock,
sought to enjoin a proposed merger. Diamond Shamrock commenced a hostile tender offer for Natomas
common stock and stated its intention to propose a merger. The two companies approved an agreement of
reorganization. New Diamond, a holding company, was formed. In two reverse triangular phantom mergers,
Diamond Sub merged into Diamond, and Natomas Sub into Natomas. New Diamond would become the sole
shareholder of Natomas’s common shares. Common and preferred would vote as separate classes. Upon their
approval, Natomas’s shares would be converted to New Diamond’s shares. Failure to obtain the approval of
Natomas’s preferred shareholders, however, would not prevent the consummation of the merger. Rather, they
would remain outstanding and continue to be convertible into Natomas common.

Kirschner Brothers Oil purchased 6K Natomas preferred shares, and argued that the merger cannot take place
without an affirmative vote of a majority of the preferred shareholders. Trial court denied the injunction, and a
majority of both Natomas common and preferred voted to approve the reorganization plan. Ps argued that their
affirmative vote was unlawfully coerced (no real choice but to approve the merger) because the reorganization
plan made it economically unfeasible for them to remain shareholders of N (vanished with the merger). Ps also
argued that, in negotiating the reorganization, the directors did not protect the interests and rights of the
preferred shareholders.
No approval of any class of outstanding preferred shares of the surviving or acquiring corporation or parent
party shall be required if the rights, preferences, privileges and restrictions granted to or imposed upon such
class of shares remain unchanged. The reorganization here was structured as a reverse triangular phantom
merger, which preserves the existing corporate entity of the target. N remained intact, so no changes. This is a
way to avoid a preferred stock veto by using a reverse triangular merger. Preferred shares are those that have a
preference over other shares either as to distribution of assets on liquidation or as to payment of dividends
(typically no meaningful ownership interest or voting power). The extent of their rights and preferences depends
on the terms of their contract. Here, the directors were under no duty to negotiate or structure the reorganization
such that the preferred shareholders would receive rights and privileges in excess of their entitlement under the
certificate of determination.
Starts as a hostile takeover. Structured in a reverse triangular merger so that preferred stock cannot veto the
merger. New Diamond creates 2 merger-subs. 1 merges with Natomas Co., and the other merges with Diamond
Shamrock. NC and DS become the operating subsidiaries of ND. NC needs to remain the existing company
because NC’s preferred shareholders might not like this deal (NC preferred into ND preferred). ND says that
NC’s dissenting preferred cannot hold up the deal, and their shares would not be converted. CA statute says
that preferred cannot kill the deal if not converted before the merger. If NC preferred have veto power they
would ask for more compensation in exchange for voting in favor and NC common would get less
compensation. CA court holds that NC preferred does not have a right to stop the transaction (strict language
and formalities). It is the deal that they negotiated.
SUPPOSE THE MANAGEMENT OF NATOMAS HAD GIVEN THE PREFERRED SHAREHOLDERS A “VETO
POWER” VOTE OVER THE REORGANIZATION. HOW DO YOU THINK THAT WOULD HAVE AFFECTED
THE TERMS OF THE REORGANIZATION? They would have needed the votes of the preferred stockholders.
HYPO: B, A PUBLICLY TRADED DELAWARE COMPANY, SEEKS TO ACQUIRE ALL THE SHARES OF
GAGGLE, AN INTERNET BASED HUMOR COMPANY, WHICH IS ALSO INCORPORATED IN DELAWARE
AND TRADES PUBLICLY ON NASDAQ. B HAS AGREED TO EXCHANGE 2 SHARES OF B STOCK FOR
EACH OUTSTANDING SHARE OF GAGGLE, WHICH WILL REQUIRE THE ISSUANCE BY B OF AN
ADDITIONAL 30% OF ITS AUTHORIZED SHARES. THE COMPANIES HAVE INFORMALLY AGREED ON
A PRICE. YOU ARE THE LAWYER FOR B. B’S CEO TELLS YOU SHE WANTS TO DO THE DEAL AS
QUICKLY AS POSSIBLE, WITH NO VOTE OF B SHAREHOLDERS. SHE ALSO WANTS TO AVOID GIVING
APPRAISAL RIGHTS TO GAGGLE’S SHAREHOLDERS, IF POSSIBLE. ALSO, GAGGLE LICENSES A GREAT

10
DEAL OF ITS TECHNOLOGY AND UNDER THE TERMS OF THOSE LICENSES, IF GAGGLE IS DISSOLVED
OR CEASES TO EXIST, THE LICENSE IS TERMINATED AND MUST BE RENEGOTIATED. HOW WILL YOU
ADVISE THAT THIS TRANSACTION SHOULD BE STRUCTURED? B can purchase 4.99% on the open market
for the lowest price. Then do a exchange tender offer (stock for stock exchange offer) to buy 51% before there is
a vote (only need 15% here because exchange is 2-1, so the NASDAQ rule is satisfied). Since it will be a majority,
don’t need G’s shareholder vote. Shouldn’t do straight merger because we want G to remain in its corporate
form. Reverse triangular merger between G and merger-sub. All shares of G converted to B shares. Shares of
merger-sub converted into 100% shares of G. B shareholders become part of the entire merged entity. 251(f) is
not applicable because it only deals with parties to the merger (B is not a constituent corporation). Under 251(h),
no B shareholder vote required because it is a national security exchange. Under NASDAQ 5635, voting by B
shareholders is required. Under 262(b)(1), no appraisal rights if merger is between parties listed on national
securities exchanges.

Gimbel v. Signal Companies, Inc.

Delaware Court of Chancery
316 A.2d 599 (Del. Ch. 1974)

Rule of Law
The sale of a wholly owned subsidiary by a conglomerate does not require majority stockholder approval if
the sale does not constitute a sale of all or substantially all of the conglomerate's assets.

Facts
Signal Companies, Inc. (Signal) (defendant) was incorporated as an oil business. Signal then became a
conglomerate that engaged in a variety of industries. Signal transferred its oil and gas business to its wholly
owned subsidiary, Signal Gas & Oil Co. (Signal Oil). Signal’s operation involved constant acquisition and
disposal of corporate branches. Signal’s board of directors approved a proposal to sell Signal Oil to Burmah Oil
Inc. (Burmah). Signal’s books showed that Signal Oil represented 26 percent of Signal’s total assets, 41 percent
of its net worth, and 15 percent of Signal’s revenues and earnings. Louis Gimbel (plaintiff), a Signal shareholder,
sought a preliminary injunction to prevent the sale. Gimbel alleged that the approval by the Signal board was
insufficient and that majority shareholder approval was necessary to authorize the sale, as it accounted for all
or substantially all of Signal’s assets.
Issue
Does the sale of a wholly owned subsidiary by a conglomerate require majority stockholder approval if the sale
does not constitute a sale of all or substantially all of the conglomerate's assets?
Holding and Reasoning (Quillen, J.)
No. Delaware statute requires majority stockholder approval for a sale of "all or substantially all" of the assets
of a Delaware corporation. Del. C. tit. 8, § 271(a). The sale of a wholly owned subsidiary by a conglomerate does
not require majority stockholder approval if the sale does not constitute a sale of "all or substantially all" of the
conglomerate's assets. A sale of assets should be measured both quantitatively and qualitatively. If the sale is "of
assets quantitatively vital to the operation of the corporation" and is "out of the ordinary and substantially affects
the existence and purpose of the corporation," it constitutes a sale of all or substantially all assets and majority
stockholder approval is required. In Philadelphia Nat’l Bank v. B.S.F., 199 A.2d 746 (1964), the court held the sale
of stock was a sale of substantially all assets, because the asset sold was the corporation's principal asset and
constituted at least 75 percent of the total assets. In this case, Signal Oil represents only about 26 percent of the
total assets of Signal. While Signal Oil represents 41 percent of Signal's total net worth, it produces only 15
percent of Signal’s revenues and earnings. Thus, quantitatively, the sale of Signal Oil does not constitute a sale
of all or substantially all of Signal's assets. Further, although Signal's original business was oil and gas, Signal is
now a conglomerate whose operation involves constant acquisition and disposal of its corporate branches. Thus,
acquisition and disposal of corporate branches, including the oil and gas subsidiary, has become part of Signal's

11
ordinary course of business. Therefore, the sale of Signal Oil by Signal does not constitute a sale of all or
substantially all of Signal's asset, both quantitatively and qualitatively. Accordingly, majority stockholder
approval is not necessary

Katz v. Bregman
431 A. 2d 1274 (Del. Ch. 1981)

Reiterated Gimbel:

“If the sale is of assets quantitatively vital to the operation of the corporation and is out of the ordinary and
substantially affects the existence and purpose of the corporation then it is beyond the power of the board of
directors.” Principal business of Plant Industries, Inc. has not been to buy and sell industries facilities but rather
to manufacture steel drums for use in bulk shipping, a business profitably performed by National. The proposal,
after the sale of National, to embark on the manufacture of plastic drums represents a radical departure from
Plant’s historically successful line of business. Sale of Plaint’s Canadian operations, which constituted over 51%
of Plant’s total assets and 45% of 1980 net sales would constitute a sale of substantially all of Plant’s assets.

If they were not selling assets, board of directors can change business.
1202 75-25 model act, you might sell 70% of business and its still in sale and substantially all of business, model
act
- States have not

Inequity: Cts generally don’t like attempts to thwart SH voting, they particularly hate them when they are
adopted with inequitable purposes and have inequitable effects.
i. Adoption of bylaws can be legal, but still fail due to being inequitable (Hollinger International v. Black)

Hollinger Inc. v. Hollinger International, Inc. (DE, 2004): P, controlling shareholder of HI, brought suit to secure a
shareholder vote on a proposed sale of the London Daily Telegraph, HI’s flagship newspaper.
i.No shareholder vote was required where the sale involved a business that was one of two
approximately equal in size, accompanied by other assets remaining in the business that were no more
than 10% of total assets. A fair and succinct equivalent to the term “substantially all” would be
“essentially everything.” Here, the Telegraph sale does not strike at HI’s heart or soul. In the course of
its existence, it frequently bought and sold a wide variety of publications. The trophy nature of the
Telegraph means that the buyers are willing to pay a higher price than expected cash flows suggest is
prudent.
ii.Court said that this was consistent with the plain meaning of DGCL 271.
iii.Not “all or substantially all.” Court effectively overrules Gimbel. However, it does not clarify DE law on
this issue.
Just get shareholders approval to be safe.

Asset Transactions & De Facto Mergers:

Firms may choose to purchase assets rather than engage in a merger because sellers are left with their own
liabilities, which do not transfer to the buyer, as they do in a merger. The buyer may not need to seek shareholder
approval. Appraisal is not available (DGCL 262) in asset sale.

Farris v. Glen Alden Corporation

Supreme Court of Pennsylvania
143 A.2d 25 (Pa. 1958)

12
Rule of Law
A shareholder may be entitled to appraisal rights even if a combination of two corporations is consummated
by contract and not in accordance with the statutory merger procedure.

To determine the nature of a corporate transaction, court must refer not only to the provisions of the agreement, but also to
the consequences of the transaction and to the purposes of the provisions.
Here, the reorganization agreement fundamentally changes Glen Alden’s corporate character and Plaintiffs’ interests as a
shareholder. Glen Alden is no longer a coal mining company. Glen Alden is now a company with assets of $169M
(previously 1/2) and a long-term debt of $38M (previously 1/7). List Industries would hold 11 of 17 directorships of Glen
Alden. The issuance of additional shares leaves Glen Aldens’s shareholders diluted to 2/5 th of what they previously had.
After the combination the shares were worth $21 (previously $38), which is a serious financial loss. Therefore, the
combination is a de facto merger. When a corporation combines with another so as to lose its essential nature, a shareholder
who does not wish to continue his membership therein may terminate it and have the value of the shares paid to him (rights
of dissent and appraisal).

Under the de facto merger doctrine, a shareholder may be entitled to appraisal rights even if a combination of
two corporations is consummated by contract and not in accordance with the statutory merger procedure.
Where the combination of two corporations results in the same consequences that a statutory merger would, a
shareholder is entitled to his opportunity for appraisal rights.

These results are akin to the results of a merger and the agreement in general is akin to a merger agreement. As
a result, proper notice of the merger and of the Glen Alden shareholders’ appraisal rights should have been
given to Farris and the other shareholders. Because such notice was not given, the annual meeting at which the
agreement was approved is invalid. The trial court is affirmed.

i. To determine the nature of a corporate transaction, court must refer not only to the
provisions of the agreement, but also to the consequences of the transaction and to the
purposes of the provisions. Here, the reorganization agreement fundamentally changes
G’s corporate character and Ps’ interests as a shareholder. G is no longer a coal mining
company. G is now a company with assets of $169M (previously 1/2) and a long-term
debt of $38M (previously 1/7). L would hold 11 of 17 directorships of G. The issuance of
additional shares leaves G’s shareholders diluted to 2/5th of what they previously had.
After the combination the shares were worth $21 (previously $38), which is a serious
financial loss. Therefore, the combination is a de facto merger. When a corporation
combines with another so as to lose its essential nature, a shareholder who does not wish
to continue his membership therein may terminate it and have the value of the shares paid
to him (rights of dissent and appraisal).
ii. WHAT WAS THE TRANSACTION INVOLVED IN GLEN ALDEN? Reorganization
agreement subject to stockholder approval between G and L. L previously purchased
38.5% of GA’s outstanding stock.
WAS THE DE FACTO MERGER DOCTRINE APPLIED? Yes, abolished.

Hariton v. Arco Electronics, Inc.

Delaware Supreme Court
188 A.2d 123 (Del. 1963)

Rule of Law

13
A sale of assets accompanied with a mandatory plan of dissolution and distribution is legal even if no
appraisal rights are given to shareholders.

Facts
Arco Electronics Corporation (Arco) (defendant) and Loral Electronics (Loral) entered into a “reorganization
agreement” under section 271 of Delaware corporation law. The agreement was subject to stockholder approval
and provided that Loral would acquire Arco’s assets; Loral would issue 283,000 shares of stock to Arco’s
shareholders; and Arco would dissolve. The agreement was approved by Arco shareholders. Hariton (plaintiff),
an Arco shareholder, brought suit, seeking to enjoin the “reorganization” on the grounds that it was illegal
because it resulted in the same thing as a merger, but he was not given a chance to invoke his right of appraisal.
The Delaware Court of Chancery granted Arco’s motion for summary judgment. Hariton appealed.
Issue
Is a sale of assets accompanied with a mandatory plan of dissolution and distribution legal even if no appraisal
rights are given to shareholders?
Holding and Reasoning (Southerland, J.)
Yes. A sale of assets accompanied with a mandatory plan of dissolution and distribution is legal, even if it
achieves the same results as a merger and no appraisal rights are given to shareholders. In Delaware,
corporations may combine by either a sale of assets under section 271 or under the merger statute. The types
of “reorganizations” are independent and both are legal although achieving the same results. A sale of assets
under section 271 does not involve the merger statute and so it is not necessary to give shareholders appraisal
rights under that type of reorganization. Consequently, the sale of assets agreement between Arco and Loral is
legal even though it did not offer Hariton and other shareholders their appraisal rights. The trial court’s grant of
summary judgment to Arco is affirmed.

i. Asset deals raise the De facto merger doctrine

a. In states that recognize the doctrine, the court looks the totality of the asset transaction and asks
whether the purpose of the deal, the provisions of the K and the consequences of the deal make
the transaction like a merger
i. If so it's a merger and the merger section of state statutes applies including approval
requirements and the dissenters' rights
ii. Consideration paid: If consideration is cash, that weighs against the finding that it’s a de
facto merger
iii. No exact percentage requirements (both quantitative and qualitative factors are important)
(Katz v. Bregman)
b. In DE, the doctrine of independent legal significance says the various sections of the statute are of
equal dignity and should be read as a manual of choices for transactional lawyers (asset deals are
asset deals and mergers are mergers, and there is no de facto merger doctrine).

For purposes of complying the approval requirements for transaction, each constituent corporation need to
comply with their own rules.

Hariton v. Arco Electronics, Inc.

Delaware Supreme Court
188 A.2d 123 (Del. 1963)

Rule of Law
A sale of assets accompanied with a mandatory plan of dissolution and distribution is legal even if no
appraisal rights are given to shareholders.

14
Facts
Arco Electronics Corporation (Arco) (defendant) and Loral Electronics (Loral) entered into a “reorganization
agreement” under section 271 of Delaware corporation law. The agreement was subject to stockholder approval
and provided that Loral would acquire Arco’s assets; Loral would issue 283,000 shares of stock to Arco’s
shareholders; and Arco would dissolve. The agreement was approved by Arco shareholders. Hariton (plaintiff),
an Arco shareholder, brought suit, seeking to enjoin the “reorganization” on the grounds that it was illegal
because it resulted in the same thing as a merger, but he was not given a chance to invoke his right of appraisal.
The Delaware Court of Chancery granted Arco’s motion for summary judgment. Hariton appealed.
Issue
Is a sale of assets accompanied with a mandatory plan of dissolution and distribution legal even if no appraisal
rights are given to shareholders?
Holding and Reasoning (Southerland, J.)

Yes. A sale of assets accompanied with a mandatory plan of dissolution and distribution is legal, even if it
achieves the same results as a merger and no appraisal rights are given to shareholders. In Delaware,
corporations may combine by either a sale of assets under section 271 or under the merger statute.

The types of “reorganizations” are independent and both are legal although achieving the same results. A sale
of assets under section 271 does not involve the merger statute and so it is not necessary to give shareholders
appraisal rights under that type of reorganization. Consequently, the sale of assets agreement between Arco and
Loral is legal even though it did not offer Hariton and other shareholders their appraisal rights. The trial court’s
grant of summary judgment to Arco is affirmed.

A sale of assets was effected under DGCL 271 in consideration of shares of the purchasing corporation. The
agreement of sale embodied also a plan to dissolve the selling corporation and distribute the shares received to
the stockholders of the seller, so as to accomplish the same result as would be accomplished by a merger. 80%
of A’s shareholders approved the plan. P, who did not vote, sought to enjoin because it was illegal and unfair.
iv. The several steps taken here accomplish the same result as a merger. No DE case has held
that such procedure is improper. A sale of assets, followed by a separate proceeding to
dissolve and distribute, would be legal, Even though the same result would follow. The
271 reorganization here is legal because the sale of assets statute and the merger statute
are independent of each other. The right of dissenting shareholders shall not apply to the
purchase by a corporation of assets.
v. The de facto merger doctrine is recognized only in very limited circumstances. DE allows
parties to choose whatever reorganization plan they wish, asset sale or merger, so long as
they follow the mechanical guidelines of the statute.
a. HYPO: Under DGCL 271, can a corporation avoid a shareholder vote in a business combination
by using the following strategies:
vi. The corporation will create a wholly owned subsidiary, and transfer substantially all of
its assets to the subsidiary, in return for all of its shares, leaving the corporation as a
holding company.
vii. The holding company will cause the subsidiary to merge into the acquiring corporation
for cash.
viii. Will a shareholder vote be required for transaction 1? No, pursuant to DGCL 271(c)
shareholder vote not required for a sale, lease, or exchange of property and assets of the
corporation to a subsidiary. If comply with DGCL 271, no appraisal rights.
ix. Who are the shareholders entitled to vote in transaction 2? Shareholders of the subsidiary
(holding company), which is solely the parent.

15
Purchase assets to avoid successor liability provisions of the merger statutes.
Where seller proceeds to liquidate after an asset sale, several protections are provided by corporate law to
creditors. Corporate dissolution requires corporation action similar to that for the fundamental changes-
approval by the board of directors, followed by a shareholder vote. Del. G.C.K. 275 filing of certificate of articles
of dissolution-begins the process of winding up the business and affairs of the corporation, which includes
payment of creditors.

Section 14.07 – continue liability for dissolved corporation for subsequent claims for a period of 3 years after it
publishes notice of dissolution. Reasonable compromise between competing considerations of providing a
remedy to injured plaintiffs and providing a period of repose after which assets distributed by dissolved
corporations to their shareholders are free of all claims and shareholders may hold them secure in the knowledge
that they may not be reclaimed.
Statute says which liabilities go along surviver.

Ramirez v. Amsted Industries, Inc.

86 NJ 332, A.2d 811 (NJ 1981)

Facts:

Suit filed against Amsteed Industries, successor of Johnson to recover damages on theories of negligence, breach
of warranty, and strict liability in tort for defective design and manufacturing of a power press. Machine was
manufactured in 1948. In 1956, Johnson transferred its assets and liabilities to Bontranger Construction Co.

General Rule governing the strict tort liability of a successor corporation for damages caused by defects in
products manufactured and distributed by a predecessor.

Product line doctrine- used by small number of states.

Test in Ray v. Alad Corp:

Where the successor corporation acquires all or substantially all of the assets of the predecessor corporation for
cash and continues essentially the same manufacturing operation as the predecessor corporation the successor
remains liable for the product liability claims of the predecessor.

Prior test: “Mere Continuation” test. Continuity of enterprise of the predecessor corporation. Amsted may be
held to be the mere continuation of Johnson for the purpose of imposing corporate successor liability for injuries
caused by defective Johnson products.

Ray test is concerned not with the continuation of the corporate entity as such but rather with the successor’s
undertaking to manufacture essentially the same line of products as the predecessor.

Three-fold justification for imposition of potential liability upon a successor corporation that acquires the assets
and continues the manufacturing operation of the predecessor
(1) virtual destruction of plaintiff’s remedies against original manufacturer because of successor’s
acquisition of business;
(2) successor ability to assume the original manufacturer’s risk spreading role, and
(3) the fairness of requiring the successor to assume a responsibility for defective products that was a burden
necessarily attached to the original manufacturer’s good will being enjoyed by the successor in the continued
operation of the business.

16
True worth of the corporation must reflect the potential liability that the shareholders have escaped through the
sale of the corporation. Reduction of sale price by an amount calculated to compensate successor corporation for
potential liability.

Antiphon, Inc. v. LEP Transport, Inc.

183 Mich. App. 377, 454 N.W. 2d 222 (Ct. App. 1990)

General rule: when one corporation sell its assets to another, the purchaser is not responsible for the debts and
liabilities of the selling corporation. However, as with the general rule, there are exceptions:

The law is well settled in regard to liability of the consolidated or purchasing corporation for the debts
and liabilities of the selling corporation. However, as with any general rule, there are exceptions:

The law is well settled in regard to liability of the consolidated or purchasing corporation for debts and
liabilities of the consolidating or selling corporation. Such obligations are assumed when

Promissory estoppel

We must determine whether Antiphon may be held responsible for the debts incurred by Seamco where neither
Seamco nor Antiphon may be held responsible for the debts incurred by Seamco where neither Seamco nor
Antiphon informed Seamco’s creditors, in this case LEP, of the same of some or all of the Seamco Enterprises’
assets and where Seamco and Antiphon engaged in activities that could reasonably lead LEP to believe that the
two companies were either related or that Antiphon had assumed responsibility for the liabilities incurred by
Seamco. Antiphon could be held liable.

Invoices paid
Seamco- bearing the name Seanco, Inc and address at Kendallville, Indiana (June 28, 1985)
Seamco Enterprises, Inc., Fort Wayne
Antiphon -Seamco, Fort Wayne
Antiphon, Inc., Fort Wayne Inc- paid by Antiphon in a check dated Febraury 12, 1986.

Friendly vs. Hostile Take Offer

Hostile takeover, buyer wants to buy the company but the company is resisting.
In a Friendly Transaction, target company decides that it is ready to be sold or buyer company decides to buy.
Motivated seller- probably what they will do is hire an investment banker and investment banker will put
together is an offering book, and shopping around and calling private equity, buyers. Sometimes, they put the
come up of an auction.

Bidding war-multiple letters of intent.

Memorandum of Understanding/Letter of Intent (with confidentiality agreement; exclusivity provision; non

poaching)
Letter of Intent- lays down the broad strokes
Binding? If it says it is binding, it is; if it is non-binding, non-biding. If there is a first step, i.e., paying-
binding.
DUE DILIGENCE- determine price, assets and liabilities, transitioning into integrate the two companies.

17
Acquisition Agreements - Definitive Purchase Agreement – finer details

Non-Disclosure Agreement
- Gives them enough secret information, enough to whet whistle.

Buying Public Company – always non-binding Letter of Intent because if its binding, it has to be published.

Usually,

● Deal Mechanics
○ Deal process (one way it might go in a friendly deal): company up for sale, buyers look with
confidentiality agreement, letter of intent/MOU, detailed due dilly, acquisition agreement with
conditions to closing, voting, locking in financing, close deal, closing dinner - and then the hard work of
integrating two businesses
○ [NOT ON EXAM: Letters of Intent
■ a key issue is whether letters of intent are binding - beyond confidentiality terms and exclusivity
agreements, which are intended to be binding and are less controversial
■ no single factor is dispositive, but courts will ask:
● whether a party stated it reserved the right to be bound by a subsequent written
contract
● whether one party has partially performed and the performance has been accepted by
the party disclaiming the contract
● whether there is literally nothing left to negotiate or settle, so that all that remains to be
done is sign the contract
● whether the subject of the agreement is so complex and substantial that a requirement
that the contract be in writing is the norm rather than the exception
■ courts will also look to the conduct of the parties in determining their intent to be bound
■ oral agreements are limited by the statute of frauds]
○ [NOT ON EXAM: Due diligence in more detail
■ A few key things to spot when conducting due diligence:
● Key business “deal” - primary deal terms, how much and when
● Issues that will impact the company following the closing of the transaction, such as:
○ Provisions governing assignment/successors, change of control
○ Deal terms that the buyer will need to comply with
● Clues that something else is going on or something is missing - references to absent
appendices, bracketed language, mismatched names, etc.
● Anything else weird
■ reasons not to rely on reps and warranties (including litigation is pricey, hassle, hard to prove
fraud (so just prove breach of contract (except: hard to show damages), seller may be gone)
■ there even might be some duty to do reasonable due diligence in certain contexts (a concept we
didn’t focus on in class)
■ due diligence checklists, due diligence memo, due diligence process]

DUE DILIGENCE

DD and an M&A agreement:

a. Steps:
 Confidentiality agreement
 Letter of intent

18
  Detailed DD
 Acquisition Agreement
 Shareholder voting
 Close the deal
b. Representations and warranties
1. Of the seller: Can claim for breach of contract. Let people focus in DD.
2. Of the buyer: the buyer is using shares as consideration, so the seller needs to make sure they are
getting valuable things; and buyer has authority and good standing to do it.
c. Covenants
1. In between when the contract is signed and when deal is closed, you will not destroy the business.
You will also go to the SH for approval/or any other third party that needs to approve this
2. You will also go to the SH for approval/or any other third party that needs to approve this

For earn-out provisions:

a. Definition: Fixed Price With Adjustments Keyed to Financial Statements, and the variable part is an earn-
out
b. Purpose:
1. Deal with uncertainties in privately-held business: allow deals to be done when there is some
disagreement on future earnings potential and aligns the buyer and seller economic interests
2. Keep the founders of the company involved as dedicated employees after the closing.
c. Rule: As a contract law matter, an implied covenant of good faith and fair dealing applies to Earn-outs.
When a buyer makes bad faith changes to the business as an acquirer to deprive the seller of the fair
opportunity to maximize earn-out compensation, the buyer breached implied covenant of fair dealing.
(O’Tool v. Genmar Holdings)
d. Genmar Facts: buyer loaded new expenses for unrelated product lines on the business, changed its brand,
hurt its ability to distribute products, and took away the authority from the business and CEO
e. Practice Point: When drafting earn-out provisions, be as explicit as possible, in the business deal of parties
concerning operation of the acquired business post-closing.
f. Buyer should:
1. put in "in reasonable business discretion"--we (buyer) can change everything but must be done with
careful implementation, because buyer can justify itself by saying it looks at the long-term business
goal rather than the short-term profit goals seller wants make sure it reaches
g. Seller should try to:
i. Be more specific in the contract
ii. Retain some operational decision-making authority
iii. Retain control over budget and expenses
iv. Get buyer to agree to affirmative and negative covenants
v. Retain control over accounting standards and metrics used for earn-out
h. Collars: For public companies, using a collar (cap and floor on share adjustments) accounts for changes in
share price between signing and closing

i. Acquisition Agreement
Acquisition Agreements
■ Price/Earn-out payments:
● as a contract law matter, the implied covenant of good faith and fair dealing applies to
earn-outs. When a buyer makes bad faith changes to the business it has acquired that
deprive the seller of a fair opportunity to maximize earn-out compensation, the buyer
has breached the implied covenant of good faith and fair dealing. In Genmar, the buyer
loaded new expenses for unrelated product lines on the business, changed its brand,
hurt its ability to distribute product and took away authority from the business’ CEO
19
 ● when drafting earn out provisions, be as explicit as possible in the business deal of the
parties concerning operation of the acquired business post-closing
■ Material Adverse Change clauses (or changes that would have a Material Adverse Effect on the
acquired business)
● Oftentimes, under the terms of the acquisition agreement, buyers can get out of a deal
post-signing, pre-closing if there is a so-called “Material Adverse Change” in the target.
In considering material adverse change clauses, courts seem reluctant to find a material
adverse change where the language of the contract suggests the parties did not intend
to cover the change at hand. For example, if there is a laundry list of items that all seem
related, and if the particular change does not appear on that list or is unrelated to the
issues covered by the list, it is unlikely the court will find a MAC. Courts are also not
sympathetic to changes in a business that are seasonal, or common to an industry, if the
buyer was in the same business and therefore had reason to know of the possible
change.
■ Best Efforts clauses
● In determining whether a party has met the obligation to use its best efforts, we should
consider the following:
○ a contract does not need to specifically define “best efforts” for such a clause to
be enforceable (but the contract may do so)
○ courts can consider extrinsic circumstances if the term “best efforts” is
ambiguous
○ in some circumstances, a company may be required to do something
commercially inadvisable to meet the best efforts standard, such as borrowing
money to shore up a declining brand - if the Company is to use its “commercially
reasonable best efforts,” this would not apply

j.
1. Price Term:
i. Due diligence discoveries of problems with the seller are often dealt with price adjustment.
Conversely, where a seller’s claims about future prospects for the business are not accepted
at face value by the buyer, one solution is to use the price term to make upward adjustments
should the seller’s projections turn out to be true.
ii. If a company wants to acquire, company can pay with cash, stock, debt securities, or bonds.
Problem with cash is that it is often a taxable event, and need to borrow money (which will
also charge interest). For stock, don’t need to borrow money, but can just issue more
authorized stock or amend certificate of incorporation. In debt securities transaction, you get
the assurance of cash, and at the same time you don’t have to borrow, which is the best of
both worlds. One problem is that when issuing new debt securities need to file a new
registration statement. These are done rarely.
iii. A problem with publicly traded companies is that a closing may be deferred for some period
of time, either to allow for completion of due diligence, to complete SEC filings, or to secure
regulatory approvals. Stock prices of both buyer and seller may vary between the time of the
execution of the agreement and the closing. If the deal is for cash, it’s very likely no adjustment
will be provided, and the cash offer will provide a floor that will keep the buyer’s stock from
sinking much below the merger consideration.
iv. More problems involve stock for stock mergers, where both stocks may vary. If a fixed
(predetermined) exchange ratio is used, and the buyer’s stock declines in value, this will cause
a similar decline in the value of the seller’s stock (if in a similar line of business), which is a
positive correlation. CVRs and earn-outs must be valued at a fair value as consideration in

20
 the sale or merger at the time of closing, and thus are subject to taxation. In some cases, no
adjustment is provided in case of a decline in the buyer’s stock. Where the buyer is in an
industry where stocks may fall in value, sellers want price protection to receive a price
reasonably close to the originally contemplated market value of buyer shares (so when buyer
stock declines, the exchange ratio will be adjusted to increase the number of buyer shares
received for each seller share). In an adjustment clause, parties can specify that the final
exchange ratio will be based on the stock prices at a particular time of the deal (shareholder
vote, closing, etc.).
1. If buyer’s share price drops, exchange ratio will increase. Buyers will argue that there
must be a limit to this adjustment (“cap”), on the theory that the buyer cannot afford
to pay that number of its own shares for the seller without diluting the investment of
its own shareholders.
2. If buyer’s share price rises, exchange ratio will decrease so that the sellers don’t receive
a windfall. Seller will want to put a “floor” on the adjustment.
v. HYPO: A IS SEEKING TO ACQUIRE B FOR CASH. B IS PUBLICLY TRADED. BECAUSE OF
THE NEED FOR EXTENDED DUE DILIGENCE AND CLEARANCES THAT MUST BE
OBTAINED FROM MANY FEDERAL AGENCIES, IT APPEARS UNLIKELY THE DEAL
WILL CLOSE UNTIL 9 MONTHS TO A YEAR AFTER THE MERGER AGREEMENT IS
SIGNED. UNDER THESE CIRCUMSTANCES, WOULD THE BUYER PREFER A FIXED OR
A VARIABLE PRICE TERM? IF VARIABLE, WHAT SHOULD BE THE FACTORS THAT
CONTROL THE PRICE? WHAT ABOUT THE SELLER’S PREFERENCES? Market is
probably not likely to fluctuate that much by changes in how well or poorly B is doing.
Variable is the probability that the deal will close. Market price will likely become similar to
the purchase price. Fixed sale price puts buyer on risk of poor performance. Buyer wants a
variable price in the event that the seller performs poorly against the market price. A’s
shareholders are on the hook with a fixed price, and will end up overpaying if the valuation
comes back less than projected.
vi. When it is a stock for stock exchange, however, the stock prices are more uncertain, so prefer
variable. Also it may be difficult in converting the stocks into each other. Can use average
existing market price to create a ratio to ensure fairness, in addition to collars. Factors that
control the price include the buyer’s and seller’s stock prices, their net incomes, etc. Should
also limit the adjustment amount by setting collars.
vii. HYPO: A IS SEEKING TO ACQUIRE B FOR CASH. B IS A NATURAL RESOURCES
COMPANY WHOSE STOCK PRICE VARIES CONSIDERABLY IN ACCORDANCE WITH
THE CURRENT PRICE OF GOLD AND OTHER METALS. A IS IN SIMILAR LINES OF
BUSINESS AND EXPECTS TO CLOSE THE DEAL WITHIN 6 MONTHS. UNDER THESE
CIRCUMSTANCES, WOULD THE BUYER PREFER A FIXED OR A VARIABLE PRICE
TERM? IF VARIABLE, WHAT SHOULD BE THE FACTORS THAT CONTROL THE PRICE?
WHAT ABOUT THE SELLER’S PREFERENCES? Same answer as above, especially in the
natural resources industry, where prices fluctuate all the time. Variable factors are tied
directly to the price of the metals—they include the prices of the various natural resources.
Don’t tie with A’s prices because they may not be the same. Buyer does not risk because he is
in the same line of business, and even if the value of the reserve goes up, that is a good thing.
A gets all the benefits in costs, and disadvantages in the losses. Risk is inherent in the price
because of the nature of the business.
2. Privately Held Sellers:
i. Closely held corporations often raise more difficult questions about value than publicly held
firms because they are not subject to the reporting requirements of the Securities Exchange
Act and the rigorous accounting control requirements of the Sarbanes-Oxley Act, where

21
 deficiencies must be disclosed in public filings. These companies may not even have audited
financial statements. Written internal analyses of the business, its prospects, and risks may be
nonexistent. Even with a detailed financial model, historical and projected growth, capital
budget, a marketing analysis of the company’s products, and levels of necessary protection
(patents or propriety information), buyers may be concerned that if the current owners exit
from management at the time of sale, it may be more costly to replace them (also connections
and business relationships).
ii. Fixed Price With Adjustments Keyed to Financial Statements: Some transactions call for
adjustments based on the seller’s net worth, either on the closing date or a specified date prior
to the closing, such as the close of a fiscal year or quarter. This protects the buyer from large
cash withdrawals by the seller prior to closing, once the price has been agreed on. An
adjustment in the purchase price can also be based on how much actual earnings exceed either
the most recent twelve-month earnings for those of the prior fiscal year. Whenever prices are
based on financial statements there is potential for disagreement, even where auditors are
involved, so provisions should be made for resolution of such disputes either through
arbitration or another device. Where price adjustments are to be made based on financial
statements as of the closing date, creation of an escrow account into which some part of the
purchase price is deposited is important. Sometimes these amounts are limited by a “cap”
(upper limit) or a “floor” (lower limit). A “collar” is where both devices are used.
1. A downward adjustment leaves the buyer bearing the risk that net worth or earnings
may be substantially less than expected, while an upward adjustment leaves the seller
bearing the risk that if the business does well in the period before the closing, the seller
may not be fully compensated for that improvement.
3. Earn-outs:

An Earn Out provision arises because the buyer and seller may have different views about the future prospects
of the business. In an earn-out provision, the buyer may agree to pay its valuation of the business as it stands
now in the buyer’s estimation, and agree to pay more if earnings increase as the seller projects.

In Otool v. Genmar Holdings, Inc. 387 F. 3d 1188 (2004)

Implied Covenant theory: In Delaware, an implied covenant of good faith and fair dealing inheres in every
contract.
As such, a party to a contract has made an implied covenant to interpret and to act reasonably upon contractual
language that is on its face reasonable. It is designed to protect the spirit of an agreement when, without violating
an express term, one side uses oppressive or underhanded tactics to deny the other side of the fruits of the
parties’ bargain. The term’s breach is treated as a breach of contract. The implied covenant cannot contravene
the parties’ express agreement and cannot be used to forge a new agreement beyond the scope of the written
contract.

Court found that Genmar breached an implied covenant of good faith and fair dealing. Genmar’s entire course
of conduct frustrated and impaired the realization of the Earn Out provided in the parties agreement.

Another purpose for the earn-out may be to keep the founders of the company, whose skill and relationships
may be critical to its success, involved as dedicated employees after closing. This is because it may take several
years before others can successfully take over the management without disrupting either employee relations or
customer relations. So, employment agreement, payment of salary, and large payment if the business goes well
as planned.

22
Buyers can keep reported earnings down by assigning the buyer’s expenses of purchase to the selling
corporation, by increasing administrative charges from the buyer to the newly acquired corporation, by
increasing employee fringe benefits to provide for uniform treatment of all employees, by shortening the useful
life of assets so annual depreciation expenses rise, etc.

A seller may prefer that the earn-out be based on gross income to avoid these problems, on the assumption that
the buyer does not reduce sales. Seller may want the buyer to disclose any accounting changes that it wishes to
make. One solution is for the buyer to covenant that it will use its best efforts to continue to operate the entire
business for the earn-out period. This restricts the buyer’s flexibility, so he will likely not agree. Most buyers are
only willing to commit to using “commercially reasonable” efforts to meet the targets that trigger contingent
payments. “Best efforts” and “commercially reasonable” are so vague as to be unenforceable. Need to be very
specific.

A sophisticated seller will want to specify a number of protections because it will occur to him that the buyer
may take actions to minimize the earn-out payment. Buyer will argue that they have the same goal—to make
the business successful. However, if a buyer can manipulate the operations to minimize the earn-out payment
without affecting the overall health of the enterprise, it would be in his best interest to do so. Moreover, once a
transaction is closed, the target will be part of a larger organization that may have a different future in mind
with a different measure of success. Seller should negotiate for some control over post-closing operations—
either actual control to a specified budget or indirect control through affirmative and negative covenants
(advertising, sales, avoiding extraordinary expenses, collection, intercompany expenses, price changes, or
discounts). Buyers are very reluctant to give a seller continuing control over the business or to place significant
restrictions on the business going forward. Also, buyer doesn’t want to be held liable for making reasonable
business decisions, even if they have a direct effect on the earn-out. Often sellers end up with far less protection
than they like. Sometimes the parties decide to forego an earn-out in favor of a simpler, more certain structure.

If the consideration is in buyer’s shares, there should be a cap on the earn-out, to protect against a seller’s
windfall if the buyer’s stock appreciates more than anticipated during the earn-out period.

O’TOOL V. GENMAR HOLDINGS, INC. (2004)

Pepper started a company, Horizon, which made recreational boats. Genmar, the world's largest maker of
recreational boats, approached him about buying Horizon. When the deal was made, Genmar created a
subsidiary, Genmar Manufacturing of Kansas, LLC (GMK), which was to acquire assets and liabilities of
Horizon, and made Pepper president. Genmar paid $2.3M for Horizon plus $3M to be “earned out” over a five-
year period based on sales levels of GMK products. Earn Out Consideration.

Pepper’s understanding of the earn-out provision was that the production of Horizon’s boats and accessories
would afford GMK the most potential for achieving gross revenues and in turn maximizing the earn out
consideration.

After GMK was formed, Genmar told Pepper to stop using the Horizon name (instead “Nova”) on its boats and
to focus on making other lines of boats (ranger and Crestliner), which was contrary to Pepper’s understanding
of the deal. The other boats were much more expensive to make, resulting in losses for GMK and an inability to
meet the sales levels needed to earn the additional $3M purchase price. Pepper complained and was fired. GMK
was closed. Pepper sued Genmar on various claims. Jury awarded P $2.5M. Genmar appealed. Affirmed.

In Otool v. Genmar Holdings, Inc. 387 F. 3d 1188 (2004)

23
Implied Covenant theory: In Delaware, an implied covenant of good faith and fair dealing inheres in every
contract.
As such, a party to a contract has made an implied covenant to interpret and to act reasonably upon contractual
language that is on its face reasonable. It is designed to protect the spirit of an agreement when, without violating
an express term, one side uses oppressive or underhanded tactics to deny the other side of the fruits of the
parties’ bargain. The term’s breach is treated as a breach of contract. The implied covenant cannot contravene
the parties’ express agreement and cannot be used to forge a new agreement beyond the scope of the written
contract.

Court found that Genmar breached an implied covenant of good faith and fair dealing. Genmar’s entire course
of conduct frustrated and impaired the realization of the Earn Out provided in the parties agreement.

It took actions that frustrated Pepper’s efforts to earn the $3M based on the agreement. There was sufficient
evidence that Genmar acted with dishonest purpose, by using the GMK plant in such a way as to reduce the
acquiring price and preventing P from realizing his sales-based consideration—based on their express terms,
the parties who negotiated would likely prescribe the acts complained of as breaches had they thought to
negotiate it previously. This is not a finding of fraud, deceit, or misrepresentation; rather it is bad faith applied
in cases of the acquisition of a business.

WHAT IS THE PROCEDURAL POSTURE OF THIS CASE? WHAT RULING IS BEING APPEALED? At trial
the verdict was in favor of Pepper (owner of Horizon) on claims of (1) breach of the express terms of the parties’
written purchase agreement, and (2) a breach of an implied covenant of good faith and fair dealing under DE
law. He received $2.5M in damages. Genmar is appealing this. These were not publicly traded companies. Earn-
out consideration is larger than the actual amount paid. Annual gross revenues and gross profits are in the
financial statements of the companies.

FROM WHAT FACTS DOES THE COURT CONCLUDE THAT GENMAR FAILED TO ACT IN GOOD FAITH?
Genmar’s entire course of action frustrated and impaired the earn-out provision. After GMK was formed,
Genmar told Pepper to stop using the Horizon name on its boats and to focus on making other lines of boats,
which was contrary to Pepper's understanding. The other boats were much more expensive to make, resulting
in losses for GMK and an inability to meet the sales levels needed to earn the additional $3M purchase price.
Pepper complained and was fired. GMK was closed. Genmar immediately
(1) changed the Horizon brand name of the boats (when earn out was based on the sale of Horizon or direct
successor brand boats),
(2) decided to emphasize the production of Ranger and Crestline boats over the production of Horizon boats,
which was more expensive,
(3) imposed significant design and production costs on GMK for Ranger boats,
(4) failed to give Pepper operational control over GMK.

Court said that Genmar had ulterior motives for acquiring Horizon, including the desire to remove a potential
significant competitor from the market and obtain a facility in the southern market,
(5) shutting down the GMK facility.

AS GENMAR’S LAWYER, COULD YOU HAVE NEGOTIATED TERMS FOR THE ACQUISITION THAT
WOULD HAVE AVOIDED THE RESULT IN O’TOOL? WHAT EFFECT WOULD THAT HAVE HAD ON THE
PURCHASE PRICE? Lay out any possible changes to the company, and make sure that they are on notice.
“Nothing stated herein shall in any way inhibit or prevent purchaser from doing one or more of the following.”
Have a laundry list of those things. Problem of a term like this is that the other side might not go through with

24
the deal, come up with their own provisions, or raise the purchase price. I would discuss with my client exactly
what he wanted to do with the new business.
I would negotiate that
(1) the boats would not necessarily be branded as Horizon boats,
(2) that production priority would be given to both brands at GMK,
(3) that GMK would bear the costs of designing and producing a new line of Ranger boats,
(4) discuss management and operational control that Pepper would retain, and
(5) a dispute resolution mechanism in case they ever has a falling out. Pepper would likely not have agreed to
these new terms, or if he would, he would raise the purchase price significantly.

DOES GENMAR INDICATE THAT EARNOUTS SHOULD NEVER BE USED?

Genmar does not indicate that earn-outs should never be used, it just suggests that sellers need to negotiate very
specific terms so that they can rest assure of the fact that the buyer will not manipulate the business to minimize
the earn-out consideration available. I think, most importantly, the seller should negotiate terms that will give
him enough control of the business that will allow him to make decisions to maximize the possibility of the earn-
out (spirit of the earn-out agreement).

WHAT ARE THE RELATIVE ADVANTAGES AND DISADVANTAGES OF EARNOUTS AND LONG TERM
EMPLOYMENT CONTRACTS WITH INCENTIVE PAYMENT TO KEY EMPLOYEES OF SELLER?

May want to keep key employees to keep the business running well during the transition period. Advantages:
Buyer purchases with a lower price now, with a possibility to pay more in the future if the business does well.
Buyer can manipulate the operations to minimize the earn-out payment without affecting the overall health of
the enterprise. Seller can negotiate for control over post-closing operations.
Disadvantages: Risk of the business failing. Buyer does not want to give seller continuing control over the
business, or place significant restrictions on the business going forward. Seller negotiating for less protection.

Lazard Technology Partners, LLC v. Qinetiq N. Am. Operations LLC (DE, 2015): Seller is the former stockholders of
C. Buyer paid $40M upfront and promised to pay another $40M if the company’s revenues reached a certain
level (earn-out risk distributed equally). Section 5.4 of their merger agreement prohibited the buyer from “taking
any action to divert or defer revenue with the intent of reducing or limiting the earn-out payment.”

When the earn-out period ended, the revenue did not reach the level required to generate an earn-out.
Seller sued, arguing that the buyer breached Section 5.4 and breached the implied covenant of good faith by
failing to take certain actions that the seller contended would have resulting in the achievement of revenue
sufficient to generate an ear-out. Lower court held the merger agreement could only be breached if the buyer
acted with the “intent of reducing or limiting the earn-out payment,” which the seller had not proven. P argued
that the lower court misinterpreted the language of the merger agreement.
The implied covenant of good faith and fair dealing should not be applied to give
plaintiffs contractual protections that they failed to secure for themselves at the bargaining
table—it is not a license to rewrite contractual language.
A party may only invoke the protections of the covenant when it is clear from the
underlying contract that the parties would have agreed to proscribe the act later
complained of had they thought to negotiate the matter. Thus, no breach via implied
covenant unless intent to limit earn-out.

For material adverse change provisions: (MAC/MAE)

25
a. Buyers can get out of a deal if there is a material adverse change in the target
b. Must be something the parties intended to not change
i. Look at the entire Material Adverse Change agreement and entire agreement to determine purpose
(John Borders v. KRLB)
ii. Obvious MACs (e.g. drop in market prices) that are not included are presumed to be waived (Esplanade
Oil & Gas v. Templeton Energy Income Corp.)
iii. Note: Court seems reluctant to find a Material Adverse Change where the language of the Contract
suggests that parties did not intend to cover the change at hand
1. For example, there is a laundry list of MAC items that all seem related, and the
particular change does not appear on the list, or is unrelated to the issues, then it's
unlikely that the Court will find MAC
2. If not enumerated, must be something that fits in with the “theme” of the enumerated
items

c. Changes outside of the control of seller are usually excluded from MACs; Courts that are unsympathetic to
changes that are seasonal or common to the industry, if the buyer is in the same business or has reason to
know any possible change
i. MACs Must be a serious harm to a company’s earning power over a substantial period of time (IBP
v. Tyson Foods)
i. The buyer knew the business is in a volatile industry, and the drop in earnings can be seasonal
rather than long-term
ii. E.g. Economic changes (Esplanade Oil v. Templeton)
iii. E.g. Unfavorable changes in laws or regulations
d. Buyer’s Drafting Strategy
i. Have MAC as broad as possible and limit only as required by seller: draft it broad enough to include
rating changes.
i. Say the lists is “by way of example”, or “non-exhaustive list”, “inclusion of one thing is not
exclusion of another”, “including, without limitation”. – making examples as examples.
ii. Put a clause in the purchase price clause, somewhat link that to the economic market, or make a collar
of price (Esplanade Oil v. Templeton)
iii. Take out language such as “MAC shall NOT include facts, events, changes or effects that are generally
applicable to the industry or the whole economy”
iv. Say in K operation loss to a certain amount (some projection and number) constitutes MAC (but may
raise problems of being too specific)

Both buyer and seller want their own MAE/MAC clause—certain condition precedents need to happen in order
for the deal to close (must either remain the same or not reduce in value). This is a representation of no material
adverse changes or effects between the time that certain statements about the company are made and the closing
time (representation & warranties about what the buyer is getting). If a representation or warranty is violated as
of the day of closing, the buyer has the opportunity to rescind the contract and not follow through. In reality,
this doesn’t have often—but is a good grounds for re-negotiation.

Today MAC clauses may cover material adverse changes in the seller’s business, financial condition, results of
operations, assets, liabilities, properties, operations and even prospects. Sellers have resisted, and have
negotiated a series of exceptions, for such things as adverse changes in the economy, financial markets, the
seller’s industry, in applicable laws and regulations, accounting standards, political conditions, war, terrorism,
or natural disaster—all things out of the control of the seller.

26
The most stringent term negotiated is that a MAC “has occurred” to the seller. The next strongest form is that
the event “would reasonably be expected to have been” a MAC for the seller. The next form is that the event
“could reasonably be expected to have been” a MAC. This allows a seller to withdraw if any reasonable person
might have thought it was a MAC.

For best efforts clauses: (a/i: Conditions to Close, Commercially Reasonable, Indemnification Agreements,
Third-Party Rights, Covenants, Merger Clause)
a. In determining whether a party has met its obligation to use its best efforts, consider the following
a. Contract does not need to specifically define best efforts for such clause to be enforceable
(USAirways Group v. British Airways) , but the contract may do so
b. Can take into both intrinsic sources (entire contract purpose) and if still ambiguous, then extrinsic
circumstances are considered
c. A company may be required to do something commercially inadvisable to meet the best effort
standard (if it’s within the firm’s capabilities, e.g. borrowing money to shore up brand. (Bloor v.
Falstaff Brewing Corp.)
i. But if the company uses commercially reasonable best effort, this does not apply
(Commercially reasonable: Lesser standard than best efforts; requires only actions that are
also commercially wise
b. To limit liability:
i. Negotiate for minimum and maximum expenditures that would satisfy the requirement
ii. Provide for timetables
iii. Specify if industry standards or individual subjective standard is to govern

I. Best Efforts Clauses:

Best efforts clauses generally require target boards to use their best efforts to secure shareholder approval of
mergers and sales, subject to their fiduciary duties to keep shareholders informed if a better offer appears. These
clauses also govern where the buyer commits to use its best efforts to secure third-party approvals, as from
antitrust or other regulatory authorities. Sellers may also commit to use their best efforts to secure consents from
various parties with whom the seller is in a contractual relationship, whether a loan agreement, long-term lease,
exclusive patent license, etc.

Don’t agree to Best Efforts Clause

Additional Information
1) Conditions to Close:
a. Courts not sympathetic to companies who claim they should be released from an acquisition
transaction because of failure of condition to closing, in situations where companies seeking to be
released from the deal is responsible for the failure of the condition.
b. Parties that purposefully fail to satisfy a condition to close in order to prevent the deal from
happening will still be required to close the deal (Esplanade Oil & Gas v. Templeton Energy Income Corp.)
in the oil and gas business, prices fluctuate, people should know.
2) Commercially Reasonable: Lesser standard than best efforts; requires only actions that are also
commercially wise
3) Indemnification Clause:
a. Representations and Warranties: There is a challenge of who should be responsible for the breach of
representation and warranties if the seller no longer exists.
b. Indemnification Clauses which are a contractual agreement to cover loss from breaching a Contract,
can be written to specifically to handle this issue. Can include limitations:
i. (1)baskets, minimum threshold for the indemnification to apply and
ii. (2)caps, which set the max amount that an indemnifying party can be set to pay

27
4) No Third-Party Benefit Clause:
a. If the contract contains a no third party benefit clause, then shareholders are not entitled to enforce
the contract unless they are explicitly given such right in the contract
b. Most agreements now do not allow third-party beneficiaries to sue (Consolidated Edison v. Northeast
Utilities)
5) Covenants:
a. If you convenant to use reasonable best efforts to consummate financing or to do other things to
make the deal happen, you need to do it. And if something is going wrong, tell the other side before
filing the lawsuit.
b. Must communicate any failures to satisfy covenants or any conditions to close to the other party as
soon as possible; boards should try to notify the other party of any potentially adverse conditions to
close (Hexion Specialty Chemicals v. Huntsman Corp.)
6) Merger Clause:
a. This document is it! Limits liability for any statements only to what is written in the contract (pre,
concurrent and post-agreement statements, oral or otherwise, are not to be relied upon) (One
Communications Corp. v. JP Morgan SBIC)
b. Doctrinal point: Courts enforce merger clauses especially if the party is sophisticated.

28
John Borders v. KRLB, Inc. (TX, 1987):

Acquisition deal by Borders of a local radio station. Borders signed contract, but does not go through with the
deal because a certain ratings metric dropped significantly (lost half of its listeners). This would lower the
amount of money advertisements it would make. Borders decided that this was an adverse effect and walked
away from the deal. KRLB sues for breach of contract.

Our primary goal when construing an instrument is to give effect to the intent of the parties. We ascertain intent
from the language of the contract.

Paragraph 3.5 is designed to prohibit KRLB management from raiding the corporation or seriously damaging
its ability to function as a business entity. It states, “there have not been any material adverse changes in the
business, operations…which would impair the operation of the radio station, and the business has been
conducted in the usual manner.” It also mentions specific condition precedents regarding loans, advances,
dividends, stock purchases, agreements, transfers, obligations, etc. Nowhere are ratings mentioned.

The court, through construction, cannot make a new contract. Court held that the drop in ratings was not an
event under the contract that would allow Borders to repudiate, either expressly or by implication. There is no
language guaranteeing or promising that KRLB would maintain its ratings and its audience. Para. 3.5
contemplates deliberate adverse action by management, and we cannot construe it to include an event over
which management has little control.

When parties agreed to MAC clause, they listed a series of things that KRLB’s management would and would
not do. The list shed light on the parties’ intention at the time of negotiating the deal. It is not the court’s place
to insert this provision if it was not contemplated by the parties. Seller is not promising consistent ratings, which
is presumably not in their control. Buyer knew risks of the radio world, but did not attempt or achieve to
negotiate provisions protecting it from those risks. Although there were big changes to KRLB’s “business,
operations, properties, and other assets,” the specific adverse effect that occurred was not in the contract (onus
on buyer to protect itself form risks)—need to be as specific and detailed as possible. What is left out is just as
important as things that are put in. Here, the risk was allocated to the buyer and he cannot now walk away from
the contract.

WOULD THE CASE HAVE COME OUT DIFFERENTLY IF THE RELEVANT PROVISION HAD BEEN SEC.
4.1(B) OF APPENDIX C?

Yes, it would be different because the clause includes changes in economic conditions, business, changes in the
industry, or results of operations (drop in ratings has an effect on these things). This would be considered a
material adverse effect. One should always draft a MAC provision that includes a “come Hell or high water”
agreement, which protects the buyer from a revenue decline of the kind that the drop in Arbitron ratings will
cause.

USAirways Group, Inc. v. British Airways PLC (NY, 1997):

Section 2.6 (c) provides that the BA must “use best efforts to obtain at the earliest possible time” the DOT
approval. BA argues that the “best efforts provision of the Investment Agreement is unenforceable because the
Investment Agreement does not provide objective criteria by which to measure performance.

29
New York law does not require best efforts to be defined to be enforceable. Contractual duties don’t have to be
definable to be enforceable—it means to pursue all reasonable means for obtaining the promised goal (factual
issue). The extent that the term “best efforts” in the Investment Agreement is ambiguous, and criteria by which
to measure the parties’ “best efforts” are lacking, the extrinsic circumstances concerning the parties
understanding of the term may be considered by the finder of fact.

REED: A contract may specify exactly what best efforts mean. Maybe we can’t say what it requires, but we can
say a few things about what it excludes. It doesn’t exclude self-serving behaviors by one of the parties.

I. Representations and Warranties:

a. While sellers give representations and warranties that what they state in the acquisition
agreement is complete and accurate, they negotiate to limit the potential adverse consequences
that might occur should things not turn out to be as represented.
i. Survival Provisions: In effect, the representations, warranties, and covenants of the target
expire at the closing. Assuming that there is an identifiable seller that survives the closing,
whether a corporation or major shareholders, the buyer wants to assure that the R&Ws
survive the closing and do not merge into it (for as long as possible). Surveys of
indemnification agreements show that R&Ws would survive the closing by periods
ranging from 15 months (the minimum required to obtain audited financials) to 2 years.
ii. Knowledge Clauses: A knowledge clause qualifies an absolute representation and
warranty, as in, “to the best of sellers knowledge, there are no liabilities except those listed
in schedule blank.” The purpose of a knowledge clause is to allocate the risk between the
parties. Buyers want an unconditional representation that there are no liabilities, whether
accrued or contingent. Sellers will want to define “knowledge” as the actual awareness of
a fact without any duty to investigate. Buyers, on the other hand, will want to define it as
knowledge after reasonable investigation. The buyer would like to provide that
knowledge by any person in the seller’s organization constitutes knowledge of the seller.
iii. Materiality Clauses: Absent some qualifying language, all representations and warranties
must be absolutely true and complete. Given the usual “bring down” clause that makes
their continuing accuracy a condition of the buyer’s obligation to close, any small
omission or minor inaccuracy could give the buyer an excuse to reject the contract.
Similarly, after a closing where the representations and warranties survive, the buyer can
bring a series of small claims against the seller. Materiality may refer to compliance with
laws or agreements, or to the effect of a breach of warranty, so that seller will warrant
compliance “except where the failure to comply will not have a material adverse effect on
the property, assets, or business.”
A “bring down” clause might provide that the representations in the aggregate must be
true and correct in all material respects. They may also require all representations that are
qualified as to materiality to be true and correct, and those that are not qualified as to
materiality must be true and correct in all material respects. This eliminates the ability of
a buyer to refuse to close because of an immaterial variation, but preserves the ability of
a buyer to seek indemnification for breaches. Many of the definitions simply contain a
dollar threshold, so that anything above the dollar limit is deemed material (or if there is
a substantial likelihood that a reasonable shareholder would consider it important in
deciding how to vote).
iv. Representations made by a corporation that disappears at the closing provides no
opportunity for post-closing protection for the buyer. Only when the seller or its
controlling persons—a parent corporation or majority shareholders—survive the closing,
can a buyer find someone to look to for responsibility for a breach of warranty claim.

30
 II. Indemnification Provisions:
a. Where assets are purchased from an entity that will continue in existence, as in the sale of a
division of a larger company, a seller remains after closing that can respond in damages. Where
a large company sells the stock of a subsidiary, a seller remains. In a purchase of privately held
companies, there are identifiable shareholders. Shareholder liability is different from a corporate
action. Even if securities laws are available, claims typically require a showing of scienter (state
of mind), which involves either deliberate falsehood or omission, or reckless disregard for the
truth. Therefore, agreements contain some provision for indemnification of the buyer for breach
of warranties.
b. Stock sales are the easiest case for the buyer because the seller survives and is the contracting
party making those representations and warranties. In a closely held corporation, Buyer should
seek damages from all the sellers who hold shares (rights against the shareholders via joint and
several liability).
c. Sellers want to avoid being sued for trivial amounts after the closing. A “basket” is an agreement
between the parties that the buyer will bear the first specified dollars in damages claims,
aggregated from all breaches of warranties in the agreement (exceeding some percentage of the
purchase price). Once the basket is “full,” the seller bears the additional liability. Buyer must be
clear that basket qualifications are separate from materiality qualifiers. Seller will argue that the
basket must, at a minimum, include the sum of the materiality qualifiers. However, once a certain
threshold is met, the seller becomes liable for the entire amount of liability.
d. The parties will negotiate over the survival of the indemnification obligations (sometimes key to
statutes of limitations). A buyer will want unlimited indemnification for all losses. This creates
considerable uncertainty about the extent of liability. Sellers want to limit or cap indemnification
losses to the purchase price, presumably on the theory that the buyer received something of net
value in the transaction. When there is subsequent litigation, seller may want to control the
defense on the theory that the buyer’s incentives to defend may be weakened by the
indemnification rights.
e. A subject not always covered in indemnification provisions is whether the buyer can obtain
indemnification post-closing if the buyer either knew or should have known about the
misrepresentation or omission prior to the closing, but closed without objection.
f. Insurance:
i. Sellers of private companies can reduce the risks of being liable for breaches of
representations and warranties under indemnification with representation warranty
insurance (coverage is over unknown liabilities). Absent fraud or other knowing or
intentional misrepresentation, this allows shareholders of the seller to get the stated
purchase price, less the cost of insurance. Examples include product liabilities where no
product defects have been discovered before closing. Coverage for known risks requires
additional premiums, but leaves sellers with potential liability for specified amounts
(“retention amounts”) in order to protect the insurer from the moral hazard that sellers
will be less concerned with the completeness and accuracy of the representations and
warranties due to the coverage.
ii. These policies do not provide any protection until the deal closes in the premium is paid.
III. Seller’s Remedies & Third Party Beneficiaries:
a. Consolidated Edison, Inc. v. Northeast Utilities (2005): CE agreed to purchase all of NU’s outstanding
shares for $3.6B ($1.2B shareholder premium). CE then declared that NU suffered a material
adverse change that dramatically lowered its valuation, and declined to proceed with the merger
unless NU would agree to a lower price. NU declined, arguing that this was an anticipatory
repudiation stunt (buyer’s remorse in a sinking stock market). CE sued for breach of contract,
fraudulent inducement, and negligent representation, while NU counterclaimed for breach of

31
 contract. Court held that shareholders of NU were not granted a right as third-party beneficiaries
to sue CE for losses over $1B that they allege resulted from CE’s breach of a contractual
undertaking to merge with NU. A contractual promise can be enforced by a third non-party who
is clearly an intended third party beneficiary of that promise. Here, that right was limited. The
intent of the contracting parties derives from the language in the contract. CE and NU did not
intend to confer NU’s shareholders a right to enforce CE’s promise to complete the merger. Here,
the only third party right conferred on NU’s shareholders is a right, arising upon completion of
the merger, to receive payment for their shares (none of the contractual provisions contemplate
NU shareholders’ third-party rights to sue for lost premium). Since the merger never commenced,
CE’s duty to pay the premium did not arise and the shareholders cannot sue to compel
completion of the merger or for damages resulting for a party’s refusal to merge. Court refuses
to use the “prevention doctrine” in a way that would transform a narrow right to secure payment
if and when the merger arises into $1B penalty for the failure to merge. The intent of the parties
to limit the third party right is manifested in the agreement’s context.
i. Seller should have put a reverse termination fee in the agreement, which would have
provided that if the buyer terminated the purchase agreement without cause they would
pay termination fees (liquidated damages) that are often the mirror image of the seller’s
termination fee commitments. Sometimes that is not enough, and sellers negotiate for
specific performance obligations on the buyer’s part.
ii. WHAT WAS THE ISSUE IN CON ED. V. NORTHEAST UTILITIES? CE was going to
acquire NU. CE found some problems with the company and offered a lower price. NU
rejected and they could not reach an agreement. It is unclear who has the right to walk
away—each side thinks that the other side did bad stuff, which gives them the right to
walk away. The question raised here is who gets to sue for what damages in these
situations.
iii. WHO HAD A RIGHT TO SUE UNDER THE AGREEMENT IN CON ED? WHAT RELIEF
COULD THEY SEEK? WHAT LEVEL OF CULPABILITY WAS REQUIRED? Shareholders
are not parties to the merger—they are third party beneficiaries. Do they have a right to
sue? If NU brought this lawsuit for breach of contract on CE’s side and succeeds, their
measure of damages would be expectation damages. After consummation of the contract,
CE would cease to exist. NU damaged by CE’s failure to perform (incurring costs to make
merger happen) and they have a right to at least damages to the extent of the expenditures
that they expended to make the merger happen (lawyer, investment bankers, due
diligence). Shareholders of NU would get the expectation damages. R is class action
lawyer, brings action on behalf of all NU shareholders (separate group suing for breach
of contract that injured us more than the NU company). Does R have the ability as a class
to join the litigation? Court says not able to sue. Shareholders don’t have a right until the
day of closing. There has not been a closing, and therefore there is no right at this point.
NU only has an actionable case.
b. HYPO: YOU AND THE LAWYER FOR THE ACQUIRING COMPANY HAVE BEEN
NEGOTIATING THE TERMS OF THE MERGER AGREEMENT FOR 42 HOURS STRAIGHT.
THE ORIGINAL PURCHASE PRICE WAS FOR $100 MILLION WITH AN ADDITIONAL 10%
“EARNOUT PROVISION” IF THE SELLER’S COMPANY BEAT NEXT YEAR’S EARNINGS
PROJECTIONS. 12 HOURS AGO, HOWEVER, THE ACQUIRING COMPANY’S LAWYERS
SAID THEY WERE DELETING THE EARNOUT PROVISIONS WITH NO INCREASE IN THE
PURCHASE PRICE. AFTER CONSULTATION WITH YOUR PARTNER, YOU RELUCTANTLY
AGREE TO LET THE OTHER SIDE’S LAWYERS DELETE THE “EARNOUT” LANGUAGE
FROM THE PURCHASE PRICE SECTION OF THE AGREEMENT. THEY DO SO. AT THE
CLOSING, HOWEVER, YOU NOTICE THAT A DESCRIPTION OF THE TRANSACTION IN

32
 ANOTHER SECTION STILL CONTAINS THE EARNOUT PROVISION, MAKING THE
MERGER AGREEMENT CONTRADICTORY. AFTER CLOSING, IF PROJECTIONS ARE MET,
CAN YOU SUE TO GET THE EXTRA MONEY FROM THE EARNOUT PROVISION? WHAT IS
YOUR BEST ARGUMENT? WHAT IS THE OTHER SIDE’S BEST ARGUMENT? Best argument
for other side is that there was no meeting of the minds because they negotiated not to have an
earn-out provision. Best argument to enforce is that they believed that there was an earn-out
provision. It is inconclusive because both sides have private subjective intents and
understandings. DE court declares the forthright negotiation principle, which considers whether
it is known or should be known to the other party. One party believed earn-out enforceable and
other didn’t, did you know it was intended to be deleted? If yes, you are not a forthright
negotiator, and so you lose.
IV. Employee Claims as Third Party Beneficiaries:
a. Acquisition agreements frequently provide for continuation of the employee benefits, employee
seniority credits, severance plans, annual bonuses, etc.
b. In Madison Realty Partners v. AG ISA, LLC, court held that to qualify as a third party beneficiary
of a contract, (i) the contracting parties must have intended that the third party beneficiary benefit
from the contract, (ii) the benefit must have been intended as a gift or in satisfaction of a pre-
existing obligation to that person, and (iii) the intent to benefit the third-party must be a material
part of the parties’ purpose in entering into the contract.
c. In Prouty v. Gores Technology Group, court held that the amendment (which provided that GTG
would not terminate any V employee in the first 60 days after closing, and for any employee
terminated in the next 90 days, would pay the same severance) was intended to grant former
employees benefits they could enforce, despite the amendment’s express incorporation of the “no
third party beneficiary” clause of the original agreement. When a general and a particular
provision are inconsistent, the particular and specific provision is paramount to the general
provision. The amended provision was an exception to the original provision, and so was
enforceable.

V. Representations and Warranties (cont’d) and the Role of Bankers:

a. The absence of financing outs, coupled with specific performance clauses, leaves buyers with only
limited excuses to escape from a deal when the buyer suffers from buyers remorse.

Hexion Specialty Chemicals, Inc. v. Huntsman Corp. (DE, 2008):

Hexion wanted to buy Huntsman. Hexion was eager to winning bid, so agreed to pay a substantially higher
price than the competition, committed to a “no financing out” (if the financing the buyer arranged is not available
at the closing, the buyer is not excused from performing under the contract), covenanted that it would use its
reasonable best efforts to take all actions and do all things “necessary, proper, or advisable” to consummate the
financing, and that it would not take any action “that would reasonably be expected to materially impair, delay,
or prevent consummation.” Financing Out- free pass to get out of the contract.
-
The agreement expressly provided for uncapped damages in the case of a “knowing and intentional breach of
any covenant” by Hexion and for liquidated damages of $325M in cases of other enumerated breaches (MAE
clause).

Huntsman had a disappointing quarter, and Hexion began feeling buyer’s remorse. Hexion got an insolvency
opinion indicating that Huntsman suffered a material and adverse effect that would not meet the condition to
get the bank’s financing. The insolvency option was presented to the buyer’s board of directors and then press
release that combined entity would be insolvent. Complaint was filed by Hexion the same day.

33
 Hexion sought a declaration that it is not obligated to consummate the merger and its liability for non-
confirmation cannot exceed $325M termination fee. Court found that the Huntsman did not suffer a material
adverse effect and Hexion knowingly and intentionally breached numerous covenants, thereby enforcing the
Hexion’s contractual obligations.

Hexion had a duty to explore many available options for mitigating the risk of insolvency (best efforts clause).
A “knowing and intentional” breach is a deliberate one—one that is a direct consequence of a deliberate act
undertaken by the breaching party, rather than one which results indirectly, or as a result of the breaching party’s
negligence or unforeseeable misadventure (even if breaching was not the conscious object of the act). Here, the
conditions precedent to Hexion’s obligation to close do not contain any requirement regarding the availability
of financing, neither is there a “solvency out.”

Hexion pursued a path designed to avoid consummation of financing (presented opinion to the board, filed a
public complaint, which killed any possibility that the banks would be willing to fund under the commitment
letter). Once Hexion became concerned about solvency, it should have approached Huntman’s management to
discuss potential resolutions (notification clause). Hexion’s defense was nothing more than “we were afraid they
might breach, so we breached first.” Court holds that Hexion has to specifically perform its obligations under
the merger agreement, other than the obligation to close.
It is important to know who wants the deal more. Hexion wanted the deal more because of their financial
situation and there were other bidders (HU was a wanted company). When you’re in an auction, there is the
winner’s curse (paying more than the market price). This leads to buyer’s remorse. Because Huntsman knew
Hexion wanted it, they added unusual provisions. They eventually settled for $1B.

WHY DID HEXION AGREE TO A DEAL WITH NO “FINANCING OUT?” Financing out is usually a condition
precedent to the closing. Hexion promised to go ahead with the deal whether they got financing or not. What
happens if they didn’t get financing and couldn’t close the deal? Hexion would breach and has an obligation to
pay a reverse, fixed $325M termination fee. Another question is whether Hexion didn’t want to get financing
(rather not being able to get it) to close the deal.

WAS THERE STILL SOME “OUT” RELATING TO FINANCING? Once deal is closed, it would be a transaction
for an insolvent entity, which violates a representation and warranty & material adverse effect clause. HX argued
that insolvency warranted them to just walk away from the deal.

WHO WAS BENEFITTING FROM THE “KNOWING AND INTENTIONAL” BREACH REQUIREMENT?
HOW DID YOU THINK IT CAME ABOUT? Huntsman wants court to grant it damages above the capped price
(liquidated damages)—the reverse termination fee—because of the knowing and intentional breach of the terms.
Requires Hexion to use its reasonable best efforts to get the financing. The knowing and intentional breach was
to use reasonable efforts, which required them to pay uncapped damage claims.

WHAT PROVISION OF THE MERGER AGREEMENT DID CHANCELLOR LAMB THINK WAS BREACHED?
5.12(b), which says that Hexion has to give notice if they’re not going to be able to obtain financing. The other
was the reasonable and best efforts covenant (did not submit all necessary paperwork to get the financing). All
they wanted was an opinion indicating that once they provided the money, the company would be insolvent
and they can just walk away. There are different insolvencies: financial statement insolvency and administrative
insolvency. Hexion wanted the insolvency determination.

WAS THE BREACH “KNOWING AND INTENTIONAL”?

34
Hexion argues that the breach was not “knowing” or “intentional”—they wanted it construed as knowing
violation of the law. Court interprets it as an intentional act. Judge says Hexion knowingly and intentionally
engaged in not best efforts actions—they knew that they weren’t trying to get the financing on purpose. Don’t
have to know you’re breaking the law, just need to know that you’re taking an action purposefully and
intentionally. Or the difference could be a negligent act. If they submitted the request, that might not have been
an intentional act, but mere sloppiness. Court writes in a notion of intentionality—must be an intentional act
known subjectively by the parties to be a violation of the parties.

WHAT IS THE EFFECT OF THAT FINDING ON HEXION’S POTENTIAL LIABILITY IN THIS CASE? Hexion
holds off on the obligation to close because the agreement didn’t provide for a consummation. What is the
remedy for the breach of a merger agreement? Some will provide for specific performance. If not specifically
included in the contract, can only get specific performance if there is no other adequate remedy at law.
Huntsman had all the power during negotiations, but failed to include a specific performance right—instead
they get damages.

WHY DID THE ALLEGEDLY FALSE STATEMENTS MADE AS PRE-AGREEMENT REPRESENTATIONS IN

THE ONE COMMUNICATIONS CASE FAIL TO STATE A CLAIM FOR SECURITIES FRAUD UNDER RULE
10B-5?

Before entering into a merger agreement, various representations were made in the initial course of negotiations
and terms. Those turned out to be false. Agreement gave right to walk. Whether either the prior representations
or the representations in the merger agreement can give rise to liability outside the realm of breach of contract?
If induced to buy my company and its shares, this is potentially securities fraud. The broadest of the securities
statutes is the 10-B5. Court says allegedly misleading statements made prior to the merger agreement could not
be an independent basis for 10-B5 claim because the merger agreement itself extinguished the 10-B5 claim.
Agreement is a waiver on the part of the buyer on any additional representations and warranties.

FIDUCIARY DUTIES OF THE TARGET

CONTENTS
1) Takeover Defenses (Unocal standard, golden parachutes, shark repellents, proxy fights, poison pills)
c. Target Reactions to Takeovers
a. Friendly means management of the target agrees with the deal and is helping. Hostile means management
hates the deal (or the buyer) and is fighting it.
b. The problem here is that directors have an inherent conflict in considering a hostile bid, because they are
likely to be canned. Thus, we cannot use standard Business Judgment Rule analysis in examining the board’s
reaction to a hostile takeover (and the inherent fairness test seems like “too much”). The Unocal test
provides the modern approach to analyzing the board’s actions.
c. As a starting point, Unocal notes that boards have the right, and sometimes the obligation, to defend the
corporation in the face of a takeover
d. Unocal is a two part test
i. First, the board must show it had reasonable grounds for believing there is a threat to corporate
policies and effectiveness, showing good faith and reasonable investigation
1) Coercive two-tiered tender offers are threatening
2) Inadequate price is threatening
3) An attempt to destroy everything the company stands for is threatening
ii. Second, the board must show the response was reasonable in relation to the threat posed / in light
of the circumstances at the time (Unocal calls this the “element of balance”)
e. After a defensive measure has met this standard, we “kick back” to the business judgment rule, meaning the
35
 court will defer to directors unless there has been some other breach of fiduciary duty, for example a breach
of the duty of care by being uninformed, or a breach of the duty of loyalty by acting selfishly to perpetuate
themselves in office, or doing something in bad faith, or committing fraud
f. Unocal only applies where boards have acted without shareholder approval
g. Selective self-tender offers are out due to SEC “all holders” rule

d. Golden Parachutes
a. A golden parachute is a provision in an executive employment agreement where the executive receives
multiples of their annual compensation as severance if terminated after a change in control
b. Parachute payments in excess of 3 years compensation are not deductible to the employer and are subject
to a 20% excise tax to the employee
i. employers have responded to the excise tax by agreeing to “gross up” golden parachute recipients
c. Key benefit is that managers stay engaged, to help deal close OR they’ll stick around if deal falls through -
also helps keep them neutral
d. California courts seem to be suspicious of golden parachutes, as shown in Gaillard v Natomas, but Delaware
is fine with them and applies the Business Judgment Rule (even if the golden parachute is given after hostile
bid commences)

Takeover Defenses
Why UnoCal:
a. Friendly: management of the Taget agrees with the deal and is helping; Hostile: management of the T hates
the deal and is fighting against it
b. Problem: directors have an inherent conflict of interest in considering a hostile takeover, since they are
likely to be fired. Therefore we cannot use Business Judgment Rule in analyzing the board’s reaction to a
takeover. The Unocal test provides a modern approach to analyzing boards actions.
c. Notes board has the right and sometimes an obligation to defend the corp in the face of a takeover

For management takeover defenses: Unocal Analysis (Unocal Corp. v. Mesa Petroleum) (a/i: Disinterested
Approval, Shareholder Restrictions)
a. Step 1: Upon good faith and after a reasonable investigation, the board must show it has reasonable
grounds for believing there is a threat to corporate policies and effectiveness
i. Coercive offers (e.g. coercive two-tier tender offer) are threatening
ii. Inadequate price is threatening
iii. An attempt to destroy everything the company stands for is threatening (e.g. asset stripping)
b. Step 2: The board must show the response is reasonable in relation to the threat//in light of the
circumstances at the time
c. If the defensive measure has met the standard, then judged by BJR, meaning the court will defer to the
directors unless there is some other breach of fiduciary duty
a. e.g. a breach of duty of care by being informed or a duty of loyalty by acting selfishly to perpetuate
themselves in the office or doing something in bad faith or in committing fraud
b. Note: Like in Blasius, it might be that the board's desire to perpetuate themselves in the office is not
selfish, maybe they truly believe in their heart that it's best for the company.
d. Unocal only applies when the board has acted without SH approval.
a. Why: (Because the statute lets us cleanse a potential conflict of interest with a fully informed good
faith vote by SH. If there is such a vote, then no longer need to worry about the potential conflict of
interest.)
e. (Self-tender by Unocal may have also been coercive too (no appraisal right in a self-tender.))
36
f. Blasius: If takeover defense involves interfering with shareholder voting powers, then requires compelling
justification even if it was reasonable in relation to the threat (Blasius Industries v. Atlas Corp.) (a/i: Voting
Power)
a. Lowering voting power when a shareholder owns more shares is okay since it does not change the
voting rights of the shares themselves, only particular shareholders (Providence and Worcester Co.
v. Baker)
b. Cannot be done solely to interfere with shareholder’s voting powers to stay in office (Condec
Corporation v. Lunkenheimer Co.)

g. Additional Information
a. Disinterested Approval: Approval by disinterested board members and/or shareholders will help
satisfy Unocal test (Williams v. Geier)
b. Shareholder Restrictions: Unless the articles of incorporation or state statutes say so, shareholders
can restrict the board’s ability to adopt takeover defenses (International Brotherhood of Teamsters
General Fund v. Fleming Companies)
c. Voting Power:

For golden parachutes:- What companies do to keep personnel in a friendly or hostile takeover. Especially high
ranking personnel. Companies provide compensation deals in order to keep/retaining then during the difficult
time of take-over.

a. Definition: A provision in an executive employment agreement where executive receives multiples of their
annual compensation at severance if change of control.
b. Gross Up: Parachute payments in excess of three years' compensation are not deductible by the employers,
and are subject to a 20% excise tax to the employee. Employers have responded to excise tax by agreeing to
Gross Up golden para recipients (keep giving you extra money until you get to the place where you thought
you were gonna be. )
c. A key benefit of the golden para: managers stay engaged to help the deal close or stick around if the deal
falls through, or it also keeps them neutral.
a. CA Courts seem to be suspicious to golden para. DE is fine with them and applies the BJR, even
if the golden para is given after the hostile bid commences.
d. Some concerns about golden parachutes (outside of Delaware are) are: (Gaillard v. Natomas Company)

Gaillard v. Natomas Company, California Court of Appeals. AO27033, October 18, 1985 (p 125)
1. This is a derivative action in California. Stockholder Gaillard challenged the goldern parachutes given to
directors of Natomas in view of a merger between Diamond and Natomas. Hadn’t written the optimal
compensation agreement yet and a bid came along.

e. Campbell v. Potash Corporation of Saskatchewan (PCS) United States Court of Appeals, Nos. 99-5074 and 99-5079,
February 20, 2001

One, golden parachutes are not void and is not against public policy.

PCS further argues that these golden parachutes violate public policy because they were approved after the
merger had been approved, and therefore served no legitimate corporate purpose. Though adopted after the
merger was approved, these golden parachutes were authorized later in the same meeting at which the
approval occurred. Thus, PCS’ argument that their adoption violated public policy because it came after the
approval of the merger is somewhat misleading. Moreover, the timing of the adoption of the golden

37
 parachute fits the rationale given for their adoption in deposition testimony by Arcadian’s then directors.
With a merger pending, the company feared that its top personel might seek lucrative jobs elsewhere. Not
only would the company then be deprived of the services of key personnel in the interim and potentially
receive less value from the merger if the firm suffered from having the managers who had brought so much
profit from Arcadian in the event that the merger was never consummated. To ensure that neither of these
situations occurred, Arcadian used goldern parachutes to entice nice of its top executives to remain with the
company until and unless there was both a change of corporate control and a decline in those executive
respective positions in the company. Five managers stated with the company for a time after the merger.
Four did not, including the three plaintiffs in this case.

Two, in the case of Gaillard, it was a violation of duty of care to approve the severance agreement. But a
California court of appeals case applying California law is not binding precedent for this circuits application
of Delaware law. And while the Gaillard case is factually similar in some respects, we do not find its
reasoning persuasive. The district court in this case found no gross negligence on the part of the Arcadian
Board, and our court is less willing than the California courts to question a corporate board’s business
judgment.

Even if we ourselves did not perceive a good rationale for these parachutes, courts should not be loath to
condemn a business practice simply because they do not perceive a good rationale for a given practice.
Evaluating the costs and benefits of golden parachutes is quintessentially a job for corporate boards and for
federal courts.
In Delaware, whose laws the parties agreed would govern disputes under this contract, a plaintiff must show
that the majority of the board acted in a manner that “rises to the level of gross negligence” before a court may
second guess its business judgment. PCS argues that the Arcadian board was misled by incomplete slides and
presentations made to it about the golden parachutes, and states that the board did not know the total possible
cost of the golden parachute at the time they approved them.
As evidence of neglect of the board’s dut)y of care, PCS points to the statement by Arcadian’s chairman about
the parachutes that “whatever they cost, they cost” and that it would be PCS’s responsibility to pay the severance
packages anyway. But even if deemed incriminating, these remarks had a reasonable amount of accurate
information about the severance packages before when they acted. The lack of a completely accurate total outlay
estimate before approval does not rise to the level of gross negligence.

1. Board realizes that hadn’t engaged in enough advanced planning and are afraid that managers won’t sell
or won’t stick around because of the stress. When Diamond made a tender offer, and CEO of both
Companies agreed in principle and then CEO of Natomas went bank to his Board to create the
Compensation Committee to craft golden parachute. They hired an expert (Flom) to craft golden
parachute.
2. Problem of negotiating the golden parachute the same time they are negotiating the acquisition price—
look like self dealing—give an extra $10m to officers and sell company for $1/share less.
3. Flom handles this by negotiating the golden parachute after they negotiate the price. Can you negotiate
this simultaneously with the deal? Golden parachute- here’s the reasons for the same; (1)executives will
align the interest of shareholders and company; (2)incentive for executive to stay. Committee level did
not ask questions; they did not do a deep dive. They should have asked more questions. Board rubber
stamped this. Board should have known and talked about this, specially since there was a huge amount
of money involved.

4. Have two contrasting cases—in Gaillard the court says no and in Campbell the court says yes.

38
f. Campbell v. Potash Corporation of Saskatchewan (PCS) United States Court of Appeals, Nos. 99-5074 and 99-5079,
February 20, 2001

One, golden parachutes are not void and is not against public policy.

PCS further argues that these golden parachutes violate public policy because they were approved after the
merger had been approved, and therefore served no legitimate corporate purpose. Though adopted after the
merger was approved, these golden parachutes were authorized later in the same meeting at which the
approval occurred. Thus, PCS’ argument that their adoption violated public policy because it came after the
approval of the merger is somewhat misleading. Moreover, the timing of the adoption of the golden
parachute fits the rationale given for their adoption in deposition testimony by Arcadian’s then directors.
With a merger pending, the company feared that its top personel might seek lucrative jobs elsewhere. Not
only would the company then be deprived of the services of key personnel in the interim and potentially
receive less value from the merger if the firm suffered from having the managers who had brought so much
profit from Arcadian in the event that the merger was never consummated. To ensure that neither of these
situations occurred, Arcadian used goldern parachutes to entice nice of its top executives to remain with the
company until and unless there was both a change of corporate control and a decline in those executive
respective positions in the company. Five managers stated with the company for a time after the merger.
Four did not, including the three plaintiffs in this case.

Two, in the case of Gaillard, it was a violation of duty of care to approve the severance agreement. But a
California court of appeals case applying California law is not binding precedent for this circuits application
of Delaware law. And while the Gaillard case is factually similar in some respects, we do not find its
reasoning persuasive. The district court in this case found no gross negligence on the part of the Arcadian
Board, and our court is less willing than the California courts to question a corporate board’s business
judgment.

Even if we ourselves did not perceive a good rationale for these parachutes, courts should not be loath to
condemn a business practice simply because they do not perceive a good rationale for a given practice.
Evaluating the costs and benefits of golden parachutes is quintessentially a job for corporate boards and for
federal courts.
In Delaware, whose laws the parties agreed would govern disputes under this contract, a plaintiff must show
that the majority of the board acted in a manner that “rises to the level of gross negligence” before a court may
second guess its business judgment. PCS argues that the Arcadian board was misled by incomplete slides and
presentations made to it about the golden parachutes, and states that the board did not know the total possible
cost of the golden parachute at the time they approved them.
As evidence of neglect of the board’s dut)y of care, PCS points to the statement by Arcadian’s chairman about
the parachutes that “whatever they cost, they cost” and that it would be PCS’s responsibility to pay the severance
packages anyway. But even if deemed incriminating, these remarks had a reasonable amount of accurate
information about the severance packages before when they acted. The lack of a completely accurate total outlay
estimate before approval does not rise to the level of gross negligence.

According to the deposition of independent board member Vanatta, the Board understood the nature of the
benefits, knew that PCS had approved the severance packages through its compensation committee. PCS also
suggests a measure of self-dealing in the approval of these severance packages, but Mr. Campbell is the only
plaintiff who was on board, and he acknowledged his conflict and abstained his vote.

39
 1. It looks like managers are being bribed to act in the best way for SHs.
2. If there is any problem today similar to the problem in the 1980s it is that managers are willing to sell
companies. Managers get a huge payout at a sale of control. Who is willing to say no? Outside directors;
in a mid-cap company costs about $150 to hire an outside director. People really like the money and have
usually worked hard to get there. Outside directors are arguably the ones who have the financial
incentives to ask hard question about whether right time to sell the company.

ii. Timing (providing it during a merger could be problematic because it may not service business-
justified purposes)
iii. Size (should not be too large  3x years compensation subject to 20% tax)
iv. Approval (independent directors should conduct their own examination to determine fairness)
g. In Delaware, standard is much lower (Campbell v. Potash Corporation of Saskatchewan (PCS)) It was discussed
during the negotiations, and formal approval of golden parachutes three days after signing for the executives
of Potash and the same are very high. After the merger, the Company did not pay the severance pay. The
CEO sued to get their severance pay.

Arguments against the severance pay:

One, golden parachutes are not void and is not against public policy.

PCS further argues that these golden parachutes violate public policy because they were approved after the
merger had been approved, and therefore served no legitimate corporate purpose. Though adopted after the
merger was approved, these golden parachutes were authorized later in the same meeting at which the
approval occurred. Thus, PCS’ argument that their adoption violated public policy because it came after the
approval of the merger is somewhat misleading. Moreover, the timing of the adoption of the golden
parachute fits the rationale given for their adoption in deposition testimony by Arcadian’s then directors.
With a merger pending, the company feared that its top personel might seek lucrative jobs elsewhere. Not
only would the company then be deprived of the services of key personnel in the interim and potentially
receive less value from the merger if the firm suffered from having the managers who had brought so much
profit from Arcadian in the event that the merger was never consummated. To ensure that neither of these
situations occurred, Arcadian used goldern parachutes to entice nice of its top executives to remain with the
company until and unless there was both a change of corporate control and a decline in those executive
respective positions in the company. Five managers stated with the company for a time after the merger.
Four did not, including the three plaintiffs in this case.

Two, in the case of Gaillard, it was a violation of duty of care to approve the severance agreement. But a
California court of appeals case applying California law is not binding precedent for this circuits application
of Delaware law. And while the Gaillard case is factually similar in some respects, we do not find its
reasoning persuasive. The district court in this case found no gross negligence on the part of the Arcadian
Board, and our court is less willing than the California courts to question a corporate board’s business
judgment.

Even if we ourselves did not perceive a good rationale for these parachutes, courts should not be loath to
condemn a business practice simply because they do not perceive a good rationale for a given practice.
Evaluating the costs and benefits of golden parachutes is quintessentially a job for corporate boards and for
federal courts.

40
In Delaware, whose laws the parties agreed would govern disputes under this contract, a plaintiff must show
that the majority of the board acted in a manner that “rises to the level of gross negligence” before a court may
second guess its business judgment. PCS argues that the Arcadian board was misled by incomplete slides and
presentations made to it about the golden parachutes, and states that the board did not know the total possible
cost of the golden parachute at the time they approved them.
As evidence of neglect of the board’s duty of care, PCS points to the statement by Arcadian’s chairman about
the parachutes that “whatever they cost, they cost” and that it would be PCS’s responsibility to pay the severance
packages anyway. But even if deemed incriminating, these remarks had a reasonable amount of accurate
information about the severance packages before when they acted. The lack of a completely accurate total outlay
estimate before approval does not rise to the level of gross negligence.

According to the deposition of independent board member Vanatta, the Board understood the nature of the
benefits, knew that PCS had approved the severance packages through its compensation committee. PCS also
suggests a measure of self-dealing in the approval of these severance packages, but Mr. Campbell is the only
plaintiff who was on board, and he acknowledged his conflict and abstained his vote.

Courts applying Delaware and California (hostile to golden parachutes)

Policy
h. Rationale for Golden Parachutes: (1) Helps recruit and retain talented managers, (2) aligns management
incentives with the shareholders and (3) retains managers if deal falls through
i. Disadvantages of Golden Parachutes: (1) May create barriers for useful mergers and (2) may cause
managers to seek out mergers that are not in the best interests of shareholders in order to get the cash payout

For shark repellents:

a. Definition: a collection of tools used to defeat or deter hostile bids. In this course, we focused on shareholder
voting type shark repellants.
i. E.g. super-majority SH voting requirements for deals with related stockholders (parties who already
own significant chunks of the target stock)
i. Higher threshold of approval for someone who already owns a majority of the Co.
ii. E.g. Independent Stockholder Ratification: Required approval of a maj of non-related shareholders
for deals with related stockholders.
iii. E.g. You get less voting power for a period of time after you buy the shares (is now not permitted
for publicly traded comp due to stock exchange rules.)
b. Exceptions: Shark Repellants May be drafted with exceptions. For example
i. There are No special voting requirements if they are waived by the board members (incumbent
directors) from before the related parties required significant stocks
ii. Or these special voting requirement are waived if every SH gets the same amount and type of
consideration, or both (Fair Price Provisions)
iii. BOD approves before the hostile bidder gets control (A Friendly Offer)
c. Generally, shark repellants are put in place by charter and bylaw amendments. They are fine under DE law
if you comply with the statutes.
i. Board approved transactions and board disapproved transactions can be two different things to vote
upon (Seibert v. Gulton Industries)
d. Unocal: But remember, shark repellants are subject to Unocal analysis too if they are challenged under
fiduciary duty grounds.

For proxy fights:

41
a. Defn: when the bidder typically before launching a TO, tries to get sufficient proxies in advance of a SH
meeting, to put its own people on the board.
b. Typical defenses Include things done in charter and bylaws
a. Such as staggered boards (directors serve multiple year terms but only a certain portion of the bd is
reelected each year),
b. rules that board members can only be removed by cause ( which is the default rule for staggered bds
in DE),
c. limits on board size,
d. long notice periods for nominating directors. (Requiring advance filing of any shareholder materials
in the proxy statement )
1. Requirements cannot be so onerous as to be preclusive (SEC v. Transamerica)
2. Distributing their own proxies does not require advance filing (Jana Master Fund v. CNET
Networks)
e. Blasius Case, where the bd increases the number of directors and fills vacancies with their own
people (without consulting the SH)
c. Compelling Justification:
a. Bd might be motivated by desire to keep themselves in office (in Blasius, it's clear). But that might
be ok if the bd is motivated by the best interests of the SH and company rather than their own self
interests.
b. But Even if the board is pure of heart and acting what they believe would be the best for the
company and even understanding that the bd can protect the Co. against takeovers, where
shareholding voting is involved there is something special at play.
c. The question of whether the board or SH is in charge is not a BJR question. It’s a fundamental
question abt SH franchise.
d. While thwarting SH voting is not per se invalid, but the board has a heavy burden to show a
compelling justification for their actions.
d. Blasius Analysis: The way Courts use Blasius and Unocal in contexts of action that affect SH voting is as
follows (only applies when SH disproves but Bd is acting on its own)
a. First , apply Unocal
b. Then, If they determine the response is proportionate under Unocal, they ask whether there is a
Blasius compelling justification for the action
c. Note: if relating to BOD’s power to control a transaction, use BJR; if relating to infringing SH voting
rights, use Blasius compelling justification
e. Inequity: Cts generally don’t like attempts to thwart SH voting, they particularly hate them when they are
adopted with inequitable purposes and have inequitable effects.
a. Adoption of bylaws can be legal, but still fail due to being inequitable (Hollinger International v. Black)
Policy
f. Allocation of Shareholder/Director Power: Shareholders are the principals and should not have their power
to remove or appoint managers infringed, while the directors are the agents and should have the power to
run the business in their best judgment (to overcome collective action problem)

For pills:

● Poison Pills
○ Shareholder rights plans in which shareholders are given the right to buy shares or something else like a
debt instrument if there is a takeover attempt.
○ “Flip in” pills give the shareholder the right to buy really cheap shares of their company if someone buys
a big block of company shares (say 15%) or if someone makes a tender offer for a big block (say 30%).
The rights are not exercisable by the bidder.
○ “Flip over” pills give shareholders the right to buy cheap preferred shares of their company, which then
42
 become convertible into bidder stock at a discount from market price if there is a merger, and the
triggers are the same (bidder gets big block of target shares or makes tender offer for big block of
target)
○ Generally poison pills can be redeemed by target board which means the board causes the company to
buy back the right (typically at a very low price)
○ Adoption of poison pills in the absence of a specified threat is analyzed with Unocal, and assuming the
board is informed and is at least slightly worried about takeovers, then the plans are generally
proportionate and are fine.
○ However, Unocal applies AGAIN when there is an actual takeover attempt and the board decides
whether or not to redeem the pill. A decision not to redeem a poison pill is considered a defensive
measure, and is subject to Unocal analysis.
○ Dead hand, no hand, and slow hand pills are all invalid. Unpacking that:
■ “Dead hand” pills, in which only the “incumbent” directors can redeem the pill, fail in a few
ways:
● they are arguably invalid under the statute, because they create different voting rights
among directors, and decisions like that are supposed to be made in the charter and by
shareholders
● they are disproportionate under Unocal, in that they indirectly affect shareholders’
voting rights because shareholders can only pick less powerful directors, AND they
arguably fail under Blasius because they disenfranchise shareholders without compelling
justification
■ “No hand” pills say that no board can redeem the pill - an even greater encroachment on the
directors’ ability to manage the business and affairs of the corporation
■ “Slow hand” pills are “no hand” or “dead hand” pills of limited duration; a 6 month delay will fail
for the same reasons as above

Generally, poison pills are redeemable by the Board for a low price. That’s wise, because if the company wants
the buyer, they can redeem the shares and sell the shares instead.

a. Def: shareholder rights plans in which shareholders are given the right to buy the shares or something else
when these is a takeover
Triggering event: for example, if any shareholder launches a tender offer
b. 2 types
a. Flip in poison pills: give the Shareholder the right to buy additional r shares of the discount of
their company if someone buys a big block of co.'s shares (15%) or if someone makes a tender
offer for a big block (30%). The rights are not exercisable by the bidder.
Company worth 5M and 1M shares and each share is worth $5. This company has a Flip In Poison
Pill, if trigged, each shareholder with one share can buy one more for half price. Triggering event:
buyer gets to 15%. Buyer has 150,000 shares, Buyer cannot exercise poison pill. 850,000 can buy
half off and they exercise. And new 850,000 shares are issued for half the price. So in the end
outstanding shares 1,850,000.
Company is now worth $5M plus 2,125,000 = $7,125,000. Shares will now be worth $3.85.
Shareholders will exercise because there is an economic benefit for them. $5-3.85, and now buyer
who used to own $15 % now owns – 8.1%.

That’s why it’s a good takeover defense.

Offer could be: I will buy if there is poison pill.

43
 b. Flip over pills: once it is been triggered, SH has a right to buy shares of the buyer corporation at
a discount. Basis: (1) buyer assumes all contracts. (2) Preferred stocks that are indestructible
On the buyer side, after its offer we have a company worth $15 M and each share worth $5

Target side:
Before the deal:
$5M
1M shares
= each share is $5

After the deal $5 (consideration for shares) + right to buy at half price
2.5 + 4.38
= 6.88 (Value after exercise of poison pill)

Buyer before deal: $15 M

3M shares
= each share $5
Buyer side: $15 M- pre-deal
- 5 M paid to shareholders
- 5 M value of Target
- 2.5M cash for exercise of rights
---------------------------------------
$17,500,000.00
Shares = 3M + 1M = 4 M
=4.37/share

c. Poison put – forces the target to repurchase shares from shareholders for a large premium upon
some triggering event

c. Features:
a. Can generally be redeemed by the Target board, which means the bd causes the company to buy
back the rights at a low price
b. Can be chewable meaning that SH can revoke them or they may automatically go away if there
is a great bid
c. DE allows poison pills and the IRS doesn’t tax shareholders who receive them at the time they
receive them
d. Unocal Analysis: (at both the adoption and the redemption stage)
a. In the absence of a threat: Adoption of PPs in the absence of a specified threat is analyzed with
Unocal. Assuming the bd is informed and is at least slightly worried abt takeovers, then the
plan is generally proportionate and fine.
b. With an actual threat: However Unocal applies again when there is an actual takeover attempt
and the bd decides whether or not redeem the pill. The redeem/don't redeem decision is subject
to Unocal.
c. STEP 1: Upon good faith and after a reasonable investigation, the board must show it has
reasonable grounds for believing there is a threat to corporate policies and effectiveness
1. Even abstract, remote threat of takeover is enough to be an adequate threat

44
 2. Difficult to argue for protection of corporate culture unless it’s really important (eBay Domestic
Holdings v. Newmark)
d. STEP 2: The response must be reasonable in relation to the threat
1. Since poison pills are redeemable, they are seen as a reasonable response
2. Even poison pills with very low triggering thresholds are reasonable (Selectica v. Versata
Enterprises)
3. The board can make their own determination for what is a fair price to redeem the pill (Unitrin
v. American General Corp.)
If this is satisfied (go through this filter), we go to BJR
e. Other poison pills:
i. Deadhand, nohand, slowhand, pills are all invalid
ii. Deadhand pills: only the incumbent directors can redeem; the pills fail in a few ways
1. Arguably invalid under the statute, because they create different voting rights among
directors. The decisions like that are supposed to be made in charters and by shareholders.
2. Disproportionate to the threat under Unocal, because it is preclusive/coercive
3. Arguably fail under Blasius because they disenfranchise SH without compelling
justifications, since they indirectly affect shareholders' voting right (since SH could elect
second class directors who cannot redeem and therefore are forced to vote for incumbent
directors if want to redeem)

iii. Nohand pills: no board can redeem the pill

iv. Slowhand pills: nohand or deadhand pills of limited duration
1. Board members must mandatorily Wait 6 months before they can redeem shares. – not
allowed.
2. These types of pills are invalid under DE law since they prohibit the ability of the bd to
govern.
3. E.g. There was a 6-month delay before newly elected bd could vote to redeem the pill-->
invalid for similar reasons. The delayed redemption limited the fundamental tenet of DE law
that the bd is in charge of managing the biz and affairs of a corp.

FIDUCIARY DUTIES IN TAKEOVERS:

RESISTING AN UNWANTED BID (DEFENSES)

The Target Board’s Duties in Reacting to Bids:

b. Under some circumstances, shareholders may want managers to act as their agents, either to
negotiate for a better price for all shareholders, or to resist the bid. In other cases, resisting a bid
may simply be evidence of management entrenchment, to preserve jobs and perquisites.
Managers who resist a bid will claim that they’re acting in the best interest of their shareholders
and other “constituencies” of the corporation, such as its employees, its suppliers, or the
communities in which it operates.
c. When directors have a sufficient economic interest in a transaction, their approval of the
transaction is deemed to be infected by a conflict of interest. DGCL 144 specifies exactly what
decisions involve prohibited conflicts of interest. If their decision is not approved by independent
decision-makers, the burden is on the directors to prove the entire fairness of the transaction.
Decisions not involving a conflict of interest are subject to the deference of the business judgment
rule. DE courts struggle to locate an appropriate standard of review when dealing with
intermediate sets of decisions—where directors may receive indirect benefits as a result of their
decisions, but do not themselves deal with the corporation.
d. Before Unocal, there were 2 standards of review that could be applied to an action by the board:
(1) BJR, and (2) intrinsic/entire fairness standard. Board member like the BJR review better.
45
 Conflict of interest and self-dealing subjects board members to intrinsic/entire fairness review
(divided loyalties-direct conflict) using entire fairness is a little high handed so entire fairness not
right.

Unocal Corporation v. Mesa Petroleum Co. (DE, 1985):

Mesa Petroleum, who owned 13% of Unocal Corporation’s stock, commenced a two-tier “front-loaded” cash
tender offer for 37% of Unocal’s outstanding stock (64 M shares) at a price of $54 per share in cash. It then issued
a supplemental proxy statement to Unocal’s stockholders disclosing that the securities it offered in the second-
step merger would be highly subordinated (“junk bonds”). (High Yield debt, very risky debt, very subordinated
debt)

13 directors met, were given no agenda or written materials, but were given detailed presentations discussing
that Mesa Petroleum’s proposal was wholly inadequate. (your company is $60 at liquidation: Golman Sachs)

They were also presented various defensive strategies available if the board concluded that Mesa Petroleum’s
two-step tender offer was inadequate, including a self-tender by Unocal Corporation for its own stock with a
reasonable price range of $70 to $75 per share (it would cost the company $6.5B in debt). They also excluded
Mesa Petrolem from the proposal, the stockholder making a hostile tender offer for the company’s stock. Self -
tender is a defensive strategy because stockholders will sell to Unocal and not to lower bid Mesa Petroleum.

Court held that Unocal’s board, consisting of a majority of independent directors (disinterested), acted in good
faith, and after reasonable investigation found that Mesa Petroleum’s tender offer was both inadequate and
coercive.

The board had both the (1) power and duty to oppose a bid it perceived to be harmful to the corporate enterprise.
The powers are conferred under DGCL 141(a), respecting management of the corporation’s business and affairs,
DGCL 160(a), conferring board authority upon a corporation to deal in its own stock, and the board’s
fundamental duty and obligation to protect the corporate enterprise. The device that Unocal adopted is
reasonable in relation to the threat posed, and (2) the board acted in the proper exercise of sound business
judgment.

The business judgment rule is a “presumption that in making a business decision the directors of the corporation
acted on an informal basis, in good faith, and in the honest belief that the action taken was in the best interests
of the company.” Courts will not substitute their views for those of the board if the latter’s decision can be
“attributed to any rational business purpose.”

WHY IS MESA’S BID DESCRIBED AS A “TWO-TIER FRONT LOADED TENDER OFFER?” WHAT WERE ITS
TERMS AND WHAT WAS IT DESIGNED TO DO? Two-tier front loaded tender offer is when pay cash for 51%,
followed by a back-end merger. People stuck on the back end, get stuck with junk bonds. It is front-loaded
because everyone would rather have cash. Even if the actual amount is too low, a small shareholder will prevent
small amount of cash to a junk bond (believe you have no choice—all shareholders have the same thought
process and the offer is successful). This is somewhat coercive. Deal is not successful, and TB sues Unocal and
Unocal’s board for creating defensive tactics (waste a lot of money and time). What standard of review is the
court going to apply in this type of case?

WAS THE BUSINESS JUDGMENT RULE APPLIED TO THE BOARDS ACTIONS IN THIS CASE? WHY NOT?
Yes, in the end if you pass the enhanced scrutiny.

46
No, enhanced scrutiny was applied because there is an inherent bias that the board will be acting in self-interest.
In a controlled situation, the boards’ own status is on the line, so the court needs to look hard. 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 that calls for judicial examination at the threshold
before the protections of the business judgment rule may be conferred. Directors must show that they had
reasonable grounds for believing that a danger to corporate policy existed. They satisfy that burden by showing
good faith and reasonable investigation. Such proof is materially enhanced by the approval of the board
comprised of a majority of outside independent directors.

WAS THERE A “THREAT TO CORPORATE POLICY?” WHAT WAS IT?

1. Reasonable grounds for believing to actually believe that there is a threat.
2. Element of Balance- reasonable in light of threat
(1) Threats imposed by takeover bids include threats to shareholders to take less than they can get form
the free market (too low a price & coercion to sell), foreclosure to better long-run alternatives, damage
to the business (loss of quality, firing employees, etc.)
(2) There is another element of balance, which means that the defensive tactic must be reasonable in
relation to the threat posed. If threat is too low a price, then cannot sell off all assets, because the threat
is not strong enough for such a drastic defense mechanism. (
3) Can the defensive tactic be construed as draconian or preclusive?
If can isolate the tactic, and it is reasonable, we have met enhanced scrutiny, and the BJR come back.
Court holds that the defensive tactic is reasonably related to the threat posed.

Directors have a fiduciary duty to protect the corporation and its shareholders from perceived harm
whether a threat originates from third parties or other shareholders. A corporation, however, does not
have unbridled discretion to defeat any perceived threat by any draconian means available. The
restriction placed upon a selective stock repurchase is that the directors may not have acted solely or
primarily out of a desire to perpetuate themselves in office. Examples of such concerns may include:
inadequacy of the price offered, nature and timing of the offer, questions of illegality, the impact on
constituencies other than shareholders (creditors, customers, employees, and perhaps even the
community generally), the risk of non-consummation, and the quality of securities being offered in
exchange.
Here, the threat posed was viewed by the Unicol board as a grossly inadequate two-tier coercive tender
offer coupled with the threat of greenmail (classic coercive measure designed to stampede shareholders
into tendering at the first tier, even if the price is inadequate, out of fear of what they will receive at the
back end of the transaction).

ii. WHAT KINDS OF DEFENSIVE TACTICS WOULD THE “PROPORTIONALITY” STANDARD

PROHIBIT?

Using the enhanced scrutiny standard of review (not BJR and not intrinsic fairness). (1) Must be
reasonable in relation to the threat posed, meaning that there is a threat. (2) Responses must not be
draconian (harsh and unforgiving), these include defensive measures that are coercive and preclusive.

If a defensive measure is to come within the ambit of the business judgment rule, it must be reasonable
in relation to the threat posed. This entails an analysis by the directors of the nature of the takeover bid
and its effect on the corporate enterprise. There is no support in DE law for the proposition that, when
responding to a perceived harm, a corporation must guarantee a benefit to a stockholder who is
deliberately provoking the danger being addressed.

47
Williams v. Geier (DE, 1996): Board recommended an amendment to articles of incorporation to adopt a plan that
would assure a controlling family group or a management team sufficient votes to defeat any uninvited bidders’
attempts to purchase the corporation’s shares. W attacked the amendment as a management entrenchment
device and argued that the defendants were subject to the strict standard of review of Unocal. Court applied the
business judgment rule, arguing that a Unocal analysis should be used only when a board unilaterally (without
stockholder approval) adpts defensive measures in reaction to a perceived threat. Here, it is inapplicable because
there was no unilateral board action.

48
10. Protecting the Deal
 664-679 (ACE Limited v. Capital Re Corporation)
 690-700 (In re Lear Corporation Shareholder Litigation)
 700-707 (Samjens Partners I v. Burlington Industries, Inc.)
 725-748 (Omnicare, Inc. v. NCS Healthcare Inc.)

I. Takeover Defenses II:

a. Rule against interference with shareholder votes. It is not a per se rule, but the standard is a
“compelling need” for the board to interfere with the shareholder vote. This is a tough standard
to meet. It is hard to define the parameters under which to apply it. All things have an effect on
shareholder votes (can change bylaws or election rules). There has been a move to majority voting
(majority of voting shares or outstanding shares) for the board elections. Result is that
shareholders have more power.
b. Poison pills interfere with shareholder voting—cannot vote on the merger that the offeror is
proposing because the pill wards off the tender that leads to the merger vote. Is this a Blasius-type
interference (defensive tactic to interfere with voting)? This is an indirect interference.
Nonetheless, almost everything interferes with the voting standards, so the Blasius standard only
applies when the inference is very direct. What is a direct enough interference that would
constitute a Blasius interference?
c. Board can appoint its own members, thereby gaining control of the entire board. DGCL 228
allows shareholders to act without a shareholder meeting is critical (need 51% of consensus). Can
you amend a certificate of incorporation at a DGCL 228 proceeding? No because need first a
positive vote by the board of directors and then shareholders—but not for bylaws.
d. HYPO: Management & Insurgent. Shareholders’ appointed proxy gives agent power to vote on
your behalf, either for M or I. M proposes bylaw amendment that requires 50% of the outstanding
shares. M gets 40% of the outstanding shares as of the end of the day. Does the bylaw amendment
pass? At the end of the meeting, proxy says to adjourn meeting. Is this a Blasius violation?
Probably not because there is no change of the rules—just a delay. Blasius does not apply all that
often.
Condec Corporation v. Lunkenheimer Co. (DE, 1967): C undertook a tender offer for 5% of L and then a subsequent
tender offer for a majority ownership of L. L’s management then negotiated a share exchange with USI, a white
knight,” in which L issued 75,000 shares of its common stock in exchange for preferred stock of USI, which had
the effect of diluting the interest of C to less than majority ownership (negated its effective veto power). Chancery
court held that, without a business purpose for the issuance of the new common shares, L’s board had violated
its fiduciary duty to this shareholder to deny it control. There was no reason to believe that C represented a
threat to the company or its shareholders. L could not show a business purpose to justify its actions. This rather
is a case of a stockholder with a contractual right to assert voting control being deprived of such control by what
is virtually a corporate legerdemain. Manipulation of this type is not permissible. Court implied that not even a
good faith dispute over corporate policy could justify a board in acting for the primary purpose of reducing the
voting power of a controlling shareholder.

Blasius Industries, Inc. v. Atlas Corporation (DE, 1988)

Atlas’s board amended the bylaws to add 2 new members to the 7-member board in response to Blasius
Industries’(A’s majority 9.1% shareholder) stockholder consent form, which proposed to increase the board from
7 to 15 members and the election of members of Blasius’s choice.
Blasius also proposed obtaining control of Atlas and restructuring to enhance shareholder value (asset sales and
distribution of cash and corporate debentures to shareholders). Atlas’ representatives argued that the restructure

49
was infeasible. Blasius sued, arguing that Atlas adoption of new bylaws was an unlawful restraint on the
shareholders’ right, created by DGCL 228, to act through consent without undergoing a meeting.
In increasing the board to 9, Atlas was precluding the holders of a majority from placing a Blasius majority of
new directors on the board through Blasius’ solicitation. Blasius argues this was a selfishly motivated effort to
protect the incumbent board from a perceived threat to its control of Atlas. Court held there was no self-
interested motive—the board saw the “threat” of B’s recapitalization as posing vital policy differences—and
acted from fear that the company would be injured.

Creates a new standard. Blasius is using a written consent pursuant to DGCL 228 to get Atlas. Blasius had 9.1%
of stock, but circulate a petition to expand the board from 7 seats to 15 and restructure the company. The have
specific people they want to appoint. As soon as get another 41% of shares to sign up, they get it. This is a useful
procedure when the board of directors doesn’t want to take a meeting.

A board may take certain steps that have the effect of defeating a threatened change in corporate control when
those steps are taken advisedly, in good faith of corporate interests, and are reasonable in relation to the threat
posed (Unocal).

WHY WAS THE BJR NOT APPLIED? The deferential business judgment rule does not apply to board acts taken
for the primary purpose of interfering with a stockholder’s vote, even if taken advisedly and in good faith.
Shareholders have only two protections against perceived inadequate business performance:

(1) they may sell their stock, or

(2) vote to replace incumbent board members.

The ordinary considerations to which the BJR originally responded are not present in the shareholder voting
context since a board’s decision to act to prevent the shareholders from creating a majority of new board
positions and filling them does not involve the exercise of the corporation’s power over its property, or with
respect to its rights or obligations. Rather, it involves allocation, between shareholders as a class and the board,
of effective power with respect to governance of the corporation. Actions designed to interfere with the
effectiveness of a vote involves a conflict between the board and a shareholder majority. Judicial review of such
action involves the determination of the legal and equitable obligations of an agent toward his principal.

WHAT WAS THE DEFENSIVE TACTIC INVOLVED IN BLASIUS? WAS THERE A THREAT TO CORPORATE
POLICY INVOLVED? Board acts fast. They made the power to amend the board in both the directors and
shareholders. The power to fill vacancies is also a simultaneous power. By moving more quickly, expanding the
board, and putting in their own members, B cannot get their people in (wont have control). This is a defensive
tactic.
WHY WAS THE BJR NOT APPLIED? The deferential business judgment rule does not apply to board acts taken
for the primary purpose of interfering with a stockholder’s vote, even if taken advisedly and in good faith.

WHAT WOULD HAVE BEEN THE RESULT IF THE UNOCAL STANDARD HAD BEEN APPLIED? This is just
a policy dispute. Filling in a couple of board seats as a defensive measure would pass muster under the Unocal
standard.
WHY WAS THE UNOCAL STANDARD NOT APPLIED? Voting is special, and rules somewhat
disenfranchising might need to be scrutinized. What does it mean to effect an election? A lot of things that a
board can do effects elections (such as buying back shares for control). No one knows why the Blasius standard
was applied—it is applied rarely.

50
UNDER BLASIUS, WHEN CAN MANAGEMENT INTERFERENCE WITH A SHAREHOLDER VOTE BE
JUSTIFIED? DOES THE COURT ANNOUNCE A PER SE RULE? Yes it can be justified in some circumstances.
Instead of “reasonable in relation to the threat posed,” need to have a “compelling interest” to mess around with
the voting machinery. B argued for a rule of per se invalidity once a plaintiff has established that a board has
acted for the primary purpose of thwarting the exercise of a shareholder vote. In Condec, the transaction
unjustifiably caused a stockholder with an equitable right to a majority of corporate stock to have his right to a
proportionate voice and influence in corporate affairs to be diminished by the simple act of an exchange of stock,
which was obviously designed for the primary purpose of reducing its stockholdings below a majority. A per se
rule that would strike down any board action taken for the primary purpose of interfering with the corporate
vote, however, (though would enforce corporate democracy) may sweep too broadly. Therefore, there is no per
se rule, but a rule where the board bears a heavy burden of demonstrating a compelling justification for its
actions.

WHAT IS THE BLASIUS STANDARD?

Compelling justification to infringe right to vote.
The corporate election process, if it is to have any validity, must be conducted with scrupulous fairness. In the
interests of corporate democracy, election machinery must be held to the highest standards of providing for and
conducting corporate elections. The BJR does not confer any presumption of propriety on the acts of directors in
postponing an annual meeting. When the election machinery appears to have been manipulated, those in charge
of the election have the burden of persuasion to justify their actions (Condec).
Here, Alas has demonstrated no sufficient justification for the action which was intended to prevent an
unaffiliated majority of shareholders from effectively exercising their right to elect 8 new directors. Board was
presented with a consent solicitation, and it had some time to inform the shareholders of its negative views on
the merits of the proposal subject to stockholder vote. The only justification that can be offered for the action
taken is that the board knows better than the shareholders what the corporation’s best interest is. That premise
is irrelevant when the question is who should comprise the board of directors. There is a vast difference between
informing the electorate, and exercising power for the primary purpose of foreclosing effective shareholder
action. Atlas bylaw amendment constituted a violation of the duty of loyalty owed to the shareholders.

Moran v. Household International, Inc. (DE, 1985):

TO WHAT “THREAT” WAS THE POISON PILL A RESPONSE?

It was a generalized nervousness, but no actual offer, bid, or threat. To protect yourself because you are a good
target (advise by experts

Reasonable grounds on belief of threat: Unocal analysis

The BJR is a 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 taken was in the best interests of the company. When
used in the context of a defense mechanism, the initial burden will lie with the directors, who must show that
they had reasonable grounds for believing that a danger to corporate policy existed and the mechanism was
reasonable in relation to the threat posed. (It’s a defensive measure, you have to use Unocal analysis)

Unocal: Use Unocal analysis : (1) adopting a poison pill, and (2) also when you get a buyer. Any defensive
measure if approved by Shareholders, fully informed good faith vote of shareholders – will not require Unical
analysis.

51
Adopting of a poison pill is a light response to a hint of a threat.

Then, the burden shifts back to the plaintiffs, who have the ultimate burden of persuasion to show a breach of
the director’s fiduciary duties.

Here, a majority of the board favoring the proposal consisted of outside independent directors, there are no
allegations of bad faith in the adoption of the pill, and the plan was in reaction to what the board perceived to
be a threat in the marketplace of coercive two-tier tender offers. To determine whether a business judgment
reached by the board was an informed one, court determines whether the board was grossly negligent.

Here, board was not grossly negligent because they were given a summary of the plan along with articles on the
current takeover environment, discussed the plan with Lipton and Goldman Sachs, indicating a full and candid
evaluation of the plan.

Carmody v. Toll Brothers, Inc. (DE, 1998):

A “dead hand” rights plan is one that cannot be redeemed except by the incumbent directors (“continuing
directors”) who adopted the plan or their designated successors.

Not valid under Delaware because:

(1) 141(d) mandates no distinctions in board voting power, which is an issue because it makes directors
more powerful than others (those in place when the pill was made).

141(d) provides that the power to create voting power distinctions among directors exists only where there is a
classified board (different categories of directors, staggered), and where those voting power distinctions are
expressed in the certificate of incorporation. Distinctions should be in certificate of incorporation.

It is illegal in Delaware to have same directors have different powers. It is only okay when it says it’s legal in
the certificate of incorporation. Here, there was nothing in the certificate about this. Need both board and
shareholder vote for amending certificate of incorporation.

(2) 141(d) further provides that the right to elect 1 or more directors who shall have greater voting powers
is reserved to the stockholders, not the directors. Vesting the pill redemption power exclusively in continuing
directors transgresses the statutorily protected shareholder right (especially by unilateral board action).

(3) Also an invalid exercise of power by the board because the dead hand pill would interfere with the
newly-elected directors’ statutory power to manage the affairs of the business conferred by 141(a) (if none of the
directors are authorized to redeem the pill, there can be no managing the corporation if they actually want to
achieve a business combination in the future, even if it would fully be in the corporation’s interest). Therefore,
the board here did not have this power—violation of 141(a)&(d). This pill is a preclusive right legally impossible
to achieve until it expires. DIRECTORS ARE SUPPOSED TO BE ABLE TO GOVERN THE COMPANY, AND
THESE LIMITATIONS LIMIT THE POWER OF THE DIRECTOR OF THE GOVERNING OF THE COMPANY.

WHAT WERE THE FIDUCIARY DUTY ARGUMENTS AGAINST ITS VALIDITY?

52
Standard of review is Unocal, but court used Blasius as well. Court treats this as a Blasius violation.
Unitrim/Unocal claim is dead hand pill is preclusive. Dead hand pill, unlike the original pill, is illegal.

The duty of loyalty claim has two prongs: (1) the dead hand provision purposefully interferes with the
shareholder voting franchise without any compelling justification (Blasius). The shareholders are powerless
to elect a board that is both willing and able to accept the bid, and they may be forced to vote for incumbent
continuing directors whose policies they reject because only they have the power to change them (purposeful
disenfranchisement of their only recourse to corporate democracy). (2) the dead hand provision is a
disproportionate defensive measure, because it precludes and materially abridges the shareholders’ rights
(coercive) to receive tender offers and makes waging a proxy contest to replace the board realistically
unattainable (Unitrim/Unocal).

SUPPOSE A DEAD HAND PILL WAS APPROVED BY A FULLY INFORMED SHAREHOLDER VOTE.
WOULD IT BE INVALID UNDER DELAWARE LAW?

Power is based on DGCL 141(a)&(d). Need to amend the certificate of incorporation. If need to change the voting
rights, need to have an amendment to the certification. So if fully informed shareholder vote would be invalid
under the circumstances that it is not a director-approved proposal to amend the certificate of incorporation.
“The certificate of incorporation may confer upon holders of any class or series of stock the right to elect 1 or
more directors who shall serve for such term, and have such voting powers as shall be stated in the certificate of
incorporation.” “In addition, the certificate of incorporation may confer upon 1 or more directors, whether or
not elected separately by the holders of any class or series of stock, voting powers greater than or less than those
of other directors.”

BOARD’S DUTIES
Informational Duties
 Briefly skim 553-558 (Smith v. Van Gorkom)
 558-569 (Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.)
 569-581 (Barkan v. Amsted Industries, Incorporated)
 593-603 (In re Dollar Thrifty Shareholder Litigation)
 622-641 (Paramount Communications, Inc. v. Time Incorporated)

CONTENTS
1) Deal Protections (non-Revlon deals, deal protections, Revlon triggers, Revlon duties, termination fees)
2) Letter of Intent (binding factors, oral contracts)

Deal Protections

For a non-Revlon deal:

a. Board has duties to:
i. INFORMED: Be reasonably informed as to the merits of the deal (Smith v. Van Gorkom); Duty of care:
Boards need to meet their fiduciary duty of care in MA transactions
a. Concerning price, a fairness opinion from i-bankers is not mandatory. If there is a fairness
opinion and the board relies on it in good faith, it's very helpful for the board to satisfy its duty
of care on price.
b. Collective expertise (no matter how impressive) is no substitute for fully informed reasonable
deliberation.
53
 c. Suggestions:
1. Have meetings to discuss the deal
2. Retain experts to get fairness opinions on the price and terms
3. Negotiate with the purchaser
4. Evaluate any alternatives
ii. BEST DEAL: Board still has a fiduciary duty to terminate a merger agreement when it no longer
believes it is the best deal for the company (Ace Limited v. Capital Re Corporation)
b. DEAL PROTECTIONS: Will be judged under the Unocal standard (Omnicare v. NCS Healthcare) (a/i:

Go-Shop Provisions)

i. After good faith and reasonable investigation, the board must show it has reasonable grounds for
believing there is a threat to corporate policies and effectiveness from a rival bid
1. Rival bidder is not good for the long-term strategy of the company

ii. May need to determine first if deal protections are coercive or preclusive prior to reasonableness
analysis (Omnicare v. NCS Healthcare)

1. Could use a fiduciary out with freeze on sale or topping fee to avoid
preclusiveness/coerciveness

iii. Defensive measures must be reasonable in relation to the threat

1. Board cannot delegate its judgment for when to negotiate with superior bidders (e.g. to
lawyers); need to still be able to consider other deals (Ace Limited v. Capital Re Corporation)
2. No-shop provisions that allow for fiduciary out is okay (In re IXC Communications Shareholders
Litigation)
3. Lock-ups cannot be too onerous (Paramount Communications v. QVC Network)

iv. BJR: If reasonably informed and deal protections are reasonable, then judged under BJR

For a Revlon situation: (Revlon v. MacAndrews and Forbes Holdings)

a. DEFINITION: Broadly stated, we have a so-called Revlon moment when a corporation undertakes a
transaction which will inevitably cause a change in corporation control or a breakup of the corporate entity.
b. We have a Revlon moment when:

a. the corporate initiates an active bidding process seeking to sell itself or to effect a business
reorganization involving a break-up the company
b. Or in response to a bidders offer, a Target abandons its long-term strategy and seeks an alternate
transaction involving the breakup of the Co.
c. Or the board is pursuing a change of control, such as assets that have been owned by the public
will come under control of a dominant shareholder (public: means this is a publicly-traded co.
and no one in theory is a dominant shareholder--> but afterwards, there's a dominant
shareholder)
d. Or the board is pursuing a change of control, such that the business that has been owned by SH
will be sold mostly for cash rather than equity in a public company (not in exams)

c. Specific examples where we don’t have a Rev Moment:

54
 a. The bd of a widely held publicly-traded co. agrees to a stock-for-stock merger with another
widely held publicly-traded co. (Itself is not a Rev Moment, but if proceeded with an auction
may cause a Revlon Moment)
b. A company pursues a strategic transaction according to a well-developed established plan
1. (Time Warner case in which the board decided in advance to do a strategic transaction and
looked at all possible candidates. Warner seems like the best option and we will go with
them.)
2. (Itself is not a Revlon Moment, but if proceeded with an auction may cause a Revlon Moment)
3. Engaging a banker to look for options not necessarily a trigger unless it’s to find a white
knight
c. The co. in question is the acquirer cause there the board is not agreeing to a change of control, it’s
just buying another company (like in Time Warner)
d. A going-private transaction (i.e. from public ownership to private ownership) in which the
controlling shareholders will control the Co. both before and after the transaction (Since no
change of control, no break-up of the co.)
e. Hostile Bidder:
1. Also we do not automatically have a Revlon moment, just because the hostile bidder wants
to buy the co. and my Co. fights off the hostile bidder (but Unocal applies to defensive
measures.)
2. But is a Rev moment when my Co. tries to find a White Knight
3. Nobody can put a Co. to a Rev Moment, only the Co's own board can make it happen

d. Revlon DUTIES: In a Rev Moment, the duties of the directors shift such that they no longer defend the
corporation (corporate policy and effectiveness), but rather become auctioneers charged with getting the
best price for stockholders. Board action is judged at that duty to get the best price. When Rev Moment is
triggered, we use the modified Unocal approach:
1. Firstly, the board must show it uses good faith and reasonable investigations in its actions
(considering all info is reasonably available to them)
2. Secondly, the board must show the response was reasonable in relation to the circumstances of
the time. (remember their duty is to get the best price for SH)
a. Thirdly, after the board has met the standard, we kick back to the BJR., meaning the Court will
defer to directors unless there is some other breach of fiduciary duty or possible breach of
fiduciary duty
1. like a breach of duty of care by being informed
2. or a breach of duty of loyalty by acting primarily to perpetuate themselves in office or doing
something in bad faith, or committing fraud.
e. How to Satisfy the Duties:
a. An auction in which no bidder is favored is a nice way to meet Rev duties.
1. An auction is not however mandatory. In other words, there is no duty to shop in a Rev
moment.
b. But there's a duty to get the best deal for shareholders acting reasonably.
1. If the director has possessed enough info and reasonably conclude the price is the best
shareholders could get, they've met their duties.
2. Can favor one bidder over another if it would be in the shareholders’ best interests but
cannot completely preclude rival bidders (In re Fort Howard Corp. Shareholders Litigation)
3. For example, where a Co has been in play because a known takeover began to acquire lots of
stock and no other bidder has come forward, the bd may have had enough info to analyze
competing offers with an option.

55
 4. For Example, Can accept a price without an auction if the company has already been on
sale for a while and it has received few bids (Barkan v. Amsted Industries)
5. For example, board reasonably believes it would jeopardize the current deal in favor of
alternatives that are not concrete or not likely to be as good (In re Dollar Thrift Shareholder
Litigation)
6. Example  when one bidder refuses to sign confidentiality agreements, uses inside
information and does not withdraw hostile offer, the Co. could favor another bidder (Samjens
Partners I v. Burlington Industries)

c. They can also consider the quality of consideration-- reasonableness not perfection is the
standard. In considering competing bids, the bd is allowed to consider the respective bidders'
ability to close the transaction, including getting financing and securing required govt consent.
1. the likelihood of the deal closing, the highest price isn't enough
2. The long-term value for SH (long-term success), not only the short term money and shares
coming in at closing (more applicable to a stock deal rather than a cash deal)
3. Example: board reasonably believes the other party cannot put together a real offer or has
financing/regulatory issues (In re Dollar Thrift Shareholder Litigation)

d. Careful with Deal Protections: Given the bd is supposed to be working to maximize the price
when Rev duties are triggered, they must be particularly careful in agreeing to no-shops, lock-
ups or high breakup fees. However if these protective measures which likely favor one bid over
another are reasonably designed to increase shareholder price, and the bd reasonably
concludes it’s a best way to further SH interests, they could be acceptable even in a Rev
Moment.

Deal Protections (ALWAYS USE UNOCAL)

a. No-shops
a. Unenforceable with a fiduciary duty: If a no-shop is drafted in such a way that it prohibits the
target bd from considering competing offers when the target bd is obligated by its fid duty to do
so, then the no-shop clause is invalid and unenforceable. Same for no-talks
1. No-shop: you cannot go out and look for a better deal
2. No-talk: if someone comes to you, you cannot engage in a conversation
b. Fiduciary-outs: To avoid this outcome, these clauses are drafted with fiduciary-outs. The Target
bd has the right to consider competing offers if it is obligated by its fid duty to do so. Even if the
T is not in Rev land, the bd cannot sit idly by and fail to terminate its merger agreement that is
tied to the voting agreement, if the bd no longer believes the present deal is a good transaction
and another available transaction is better.
c. Agreeing to a no-shop or a no-talk at the end of an auction is prob ok if the bd has otherwise met
its duties. A go-shop is helpful too.
1. Go-shop: firstly, first we have a period of time for us to go shop for better deals before
agreeing to a No-shop/No-talk.
d. Suggestions: have fiduciary-outs and at the end of an auction

b. Termination fees:
a. A reasonable structured fee can be ok even in a Rev Moment. (Remember in Rev Moment, the
board is supposed to maximize price, use Unocal analysis to do the three-step analysis).
b. Considerations: Consider the size of the fee, (2% of company value isnt that much) and when it
kicks in (after a go-shop period or some other delay of the deal).

56
 c. Liquidated Damages: Termination fees might as well be treated as liquidated damages clauses
especially when a K identifies them as such and it kicks in at a time when the T is breaching
covenants. In that context, we ask (1) whether damages would be uncertain; (2) whether the
amount agreed upon is reasonable.
1. The first part of the test will be satisfied in almost all MA transactions.
2. To fail the second part of test, the amount at issue must be unconscionable or not rationally
related to any measure of damages a party might conceivably sustain. (hard to fail the second
part)
d. Termination fees are only coercive if they have the effect of causing stockholders to vote in favor
of the transaction for reasons other than the merits of the transaction.
1. Hard to show too.
2. The chance of a term fee being rejected because it's too high is low.

c. Lock-ups
a. Two kinds:
1. Stock lockups: if the deal does not go through, you as the first buyer whose merger agreement
terminated can buy shares of the Target before the second transaction goes through at a good
price, so you can at least participate in the transaction.
2. Crown-jewel Lockups: the favored bidder can still get our product line or R&D at a lower
price if it does not get the deal
b. Assume that Unocal should always be applied in analyzing deal protections. (In Revlon, you
used a revised Unocal.)
1. (Another interpretation would be to only use Unocal where the director faces an inherent
conflict of interest in adopting the protective measures.)
c. A complete lockup of the deal that is coercive and preclusive is not acceptable. The bd needs an
effective fiduciary-out.

Policy
1) Rationale for Deal Protections: Initial bidders have to expend resources to investigate and negotiate the
deal, which subsequent bidders can free-ride off of; therefore, initial bidders will need deal protections to
justify the risk

Letters of Intent

Factors to consider for determining if a letter of intent is binding: (United Acquisition Corp. v. Banque Paribas)
a. Whether or not either party indicates an intention only to be bound by a formal merger document (a/i: Non-
Binding)
b. Whether or not either party has accepted partial performance from the other
c. Whether or not there is enough left to negotiate
d. Whether or not the subject matter is something customarily handled by a final written agreement
e. ORAL CONTRACTS: A preliminary oral agreement is binding when:
i. There is clear evidence that an agreement has been reached (Turner Broadcasting System v. McDavid)
1. No terms left to negotiate
2. Parties acting as if deal is done (e.g. press conferences, saying that the deal is closed)
ii. Promissory estoppel – still enforceable even if oral contracts not enforceable generally (California
Natural v. Nestle Holdings)
1. One party made a clear promise with the expectation that the other would rely on it
2. The other party reasonably relied on the promise and was harmed by such reliance
Additional Information
57
1) Non-Binding: In order to avoid having an LOI be binding, add in language stating that the agreement is not
binding until the execution of a final written merger agreement

● Revlon
○ Broadly stated from a high level, we have a so-called “Revlon moment” when a corporation undertakes
a transaction which will inevitably cause:
■ A change in corporate control; or
■ A break up of the corporate entity.
○ Put another way, we have a Revlon moment when:
■ A corporation initiates an active bidding process seeking to sell itself or to effect a business
reorganization involving a breakup of the company; or
■ In response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternate
transaction involving the breakup of the company; or
■ The board is pursuing a change of control such that a business which had been owned by the
public will come under the control of a dominant shareholder.
○ Some specific examples where we do not have a Revlon moment:
■ the board of a widely-held publicly traded company agrees to a stock-for-stock merger with
another widely-held publicly traded company
■ a company pursues a strategic transaction according to a well-developed established plan
■ the company in question is the acquiror
■ a going private transaction in which the controlling shareholder will control the company both
before and after the transaction
○ Also, we do not automatically get a Revlon moment just because a hostile bidder wants to buy the
company (although remember Unocal will apply to defensive measures in that case)
○ In a Revlon moment, the duties of directors shift such that they no longer defend the corporation
(corporate policy and effectiveness), but rather become auctioneers charged with getting the best price
for stockholders
○ Board action is then judged against that duty to get the best price. When Revlon duties are triggered,
we use this modified Unocal approach:
■ First, the board must show it used good faith and reasonable investigation in its actions
■ Second, the board must show the response was reasonable in relation to the circumstances at
the time, remembering the duty is to get the best price for shareholders
■ After the board has met this standard, we “kick back” to the business judgment rule, meaning
the court will defer to directors unless there has been some other breach of fiduciary duty, or
possible breach of fiduciary duty, like a breach of the duty of care by being uninformed, or a
breach of the duty of loyalty by acting primarily to perpetuate themselves in office, or doing
something in bad faith, or committing fraud
○ An auction in which no bidder is favored is a nice way to meet Revlon duties. An auction is not,
however, mandatory. There is no duty to shop in a Revlon moment (but there is a duty to get the best
deal for shareholders, acting reasonably).
○ If directors possess enough information and reasonably conclude the price is the best shareholders can
get, they have met their duties. For example, in a situation where a company has been “in play”
because a known takeover artist began acquiring blocks of stock, and no other bidders have come
forward, the board may have enough information to analyze competing offers without an auction
○ In considering competing bids, the board is allowed to consider the respective bidder’s ability to close
the transaction, including getting financing and securing required governmental consents. They can also
consider the quality of consideration.
○ Reasonableness, not perfection, is the standard

58
 ○ Protective Measures and Revlon
■ Given that the board is supposed to be working to maximize price when Revlon duties are
triggered, they must be particularly careful in agreeing to no-shops, lock-ups, or high break-up
fees. However, if these protective measures, which likely favor one bidder over another, are
reasonably designed to increase shareholder price and the board reasonably concludes it is the
best way to further shareholder interests, they can be acceptable, even in a Revlon moment
■ More on no-shops:
● If a no-shop clause is drafted in such a way that it prohibits the target board from
considering competing offers when it is obligated by its fiduciary duties to do so, then
the no-shop clause is invalid and unenforceable. Same for no-talks.
● To avoid this outcome, these clauses are drafted with a so-called “fiduciary out” - which
means the target board has the right to consider competing offers if it is obligated by its
fiduciary duties to do so
● Agreeing to a no-shop or no-talk at the end of an auction is probably OK if the board has
otherwise met its duties. A go-shop is helpful too.
■ More on break-up/termination fees
● A reasonably structured fee can be OK, even in a Revlon moment
● Consider size of fee (2% of company value is OK) and when it kicks in (i.e. after a “go
shop period” or after deal delayed or whatever)
● Termination fees are only coercive where they have the effect of causing the
stockholders to vote in favor of the proposed transaction for a reason other than the
merits of the transaction

● Shareholder Voting
○ Shareholders of a target are permitted to agree to vote in favor of a particular transaction in a voting
agreement. However, in that situation, if the target board agrees to a merger agreement that does not
allow for a meaningful fiduciary out (for example, by agreeing to a Delaware 251(c) provision requiring
the merger agreement to be submitted to stockholders even if the board later withdraws its support of
the agreement), then the deal is a fait accompli and the board cannot stop the transaction even if it is
later determined to be inadvisable. This arrangement fails as it is disproportionate under Unocal as it
precludes other possibly better deals.
■ Put another way, a complete lock-up of a deal that is coercive and preclusive is not acceptable.
The board needs an effective fiduciary out.
○ A proxy contest in the context of this course is when a bidder, typically before launching a tender offer,
tries to get sufficient proxies in advance of a shareholder meeting to put its own people on the board
■ Typical defenses to proxy contests include things done in the charter or bylaws, such as
staggered boards, rules that board members can only be removed for cause (which is the
default rule for staggered boards in Delaware), limits on board size, long notice periods for
nominating directors, or (like in the Blasius case) increasing the number of directors and filling
vacancies with sympathetic directors
○ Boards might be trying to keep themselves in office, but that can be OK if the board was motivated by
the best interests of shareholders and the company. That said, even if the board is pure of heart, and
even understanding that boards can protect the company against takeovers, where shareholder voting
is involved there is something special at play. The question of whether the board or the shareholders
are in charge is not a business judgment rule question - it’s a fundamental question about shareholder
franchise and who is really in charge. While thwarting shareholder voting is not per se invalid, Blasius
tells us that the board has the (heavy) burden to show a compelling justification for their action.
○ The way courts use Blasius and Unocal in the context of a defensive action that affects shareholder
59
 voting can vary. Sometimes, they apply the tests separately. Sometimes, the apply Unocal and use
Blasius to determine whether the response was proportionate (it being understood that actions without
a compelling justification under Blasius are disproportionate under Unocal). Sometimes, they just apply
Unocal or just apply Blasius.
■ On the exam you should apply both Unocal and separately apply Blasius.

Smith v. Van Gorkom

Delaware Supreme Court
488 A.2d 858 (Del.Sup.Ct. 1985)

Yes. Under the business judgment rule, a business determination made by a corporation’s board of directors is
presumed to be fully informed and made in good faith and in the best interests of the corporation. However,
this presumption is rebuttable if the plaintiffs can show that the directors were grossly negligent in that they did
not inform themselves of “all material information reasonably available to them.”

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.

Delaware Supreme Court
506 A.2d 173 (Del. 1986)

Rule of Law
When the break-up of a corporation is inevitable, the duty of the corporation’s board of directors changes
from maintaining the company as a viable corporate entity to maximizing the shareholders’ benefit when the
company is eventually and inevitably sold.

Facts

Pantry Pride, Inc. (Pantry Pride) (plaintiff) sought to acquire Revlon, Inc. (Revlon) (defendant) and offered $45
per share. Revlon determined the price to be inadequate and declined the offer. Revlon’s investment banker
explained that Pantry Pride’s financial strategy for acquiring Revlon would be through “junk bond” financing
followed by a break-up of Revlon and disposition of assets. With proper timing, according to experts, such
transaction could produce a return to Pantry Pride of $60 to $70 per share, while a sale of the company as whole
would be in the mid 50 dollar range.

Martin Lipton, special counsel for Revlon, recommended two defensive measures:
First, that Revlon repurchase up to 5 M of its nearly 30M outstanding shares.

Second, A Note Purchase rights Plan. Each Revlon shareholder would receive a dividend One Purchase Note
Right for each share of common stock. The Right entitle the holder to exchange one common share for a $65
principal Revlon Note at 12% interest with a one-year maturity. The rights would become effective whenever
anyone acquired beneficial ownership of 20% or more of Revlon’s shares, unless the purchaser acquires the
company’s stock for cash at $65 or more per share.

Pantry Pride $47.5 for common shares. Revlon told shareholders to reject the plan. Revlon undertook defensive
measure, including Despite defensive efforts by Revlon offer to exchange up to 10 million shares of Revlon stock
for an equivalent number of Senior Subordinated Notes (Notes) of $47.50 principal at 11.75 percent interest.
Revlon tendered 87% of shares. Despite this, Pantry Pride remained committed to the acquisition of Revlon.
60
Pantry Pride raised its offer to $50 per share and then to $53 per share.

Meanwhile, Realize that they need a white knight—the friendly takeover that company prefers. Revlon would
rather be sold to Forstmann than to Pantry Pride. Revlon was in negotiations with Forstmann Little & Co.
(Forstmann) (defendant) and agreed to a leveraged buyout by Forstmann, subject to Forstmann obtaining
adequate financing.

Under the agreement, Revlon stockholders would receive $56 per share and Forstmann would assume Revlon’s
debts, including what amounted to a waiver of the Notes covenants.

unlike Pantry Pride, who would fire management, Forstmann is willing to work with the incumbent
management of Revlon
management had golden parachute provisions which allowed them to buy shares into new coapny.

Upon the announcement of that agreement, the market value of the Notes began to drop dramatically and the
Notes holders threatened suit against Revlon. At about the same time, Pantry Pride raised its offer again, this
time to $56.25 per share.

Upon hearing this, Forstmann raised its offer under the proposed agreement to $57.25 per share, contingent on
two pertinent conditions.

First, a lock-up option giving Forstmann the exclusive option to purchase part of Revlon for $100-$175 million
below the purported value if another entity acquired 40 percent of Revlon shares. Revlon’s Vision CaaCrown-
jewel Lockups: the favored bidder can still get our product line or R&D at a lower price if it does not get the
deal

Second, a “no-shop” provision, which constituted a promise by Revlon to deal exclusively with Forstmann.

In return, Forstmann agreed to support the par value of the Notes even though their market value had
significantly declined.

The Revlon board of directors approved the agreement with Forstmann and Pantry Pride brought suit,
challenging the lock-up option and the no-shop provision. The Delaware Court of Chancery found that the
Revlon directors had breached their duty of loyalty and enjoined the transfer of any assets, the lock-up option,
and the no-shop provision. The defendants appealed.
Issue
When the break-up of a corporation is inevitable, does the corporation’s board of directors violate its duty of
loyalty to the shareholders if its first consideration is not maximizing the shareholders’ benefit when the
company is eventually and inevitably sold?

Holding and Reasoning (Moore, J.)

Yes. In cases where a board implements “anti-takeover measures,” the burden is on the directors to prove that
their actions were reasonable. However, the business judgment rule kicks in if they prove a good faith and
reasonable investigation resulted in their decision.

In the present case, the Revlon board’s initial defensive measures—its exchange offer for Notes—was reasonable
under the holding in Unocal Corporation v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), given the board’s

61
determination that Pantry Pride’s offer was less than adequate. However, when Pantry Pride continually
increased its offer, the court determines that it became obvious that “the break-up of [Revlon] was inevitable.”

At that point, the Revlon board’s duty was changed from maintaining Revlon as a viable corporate entity to
maximizing the shareholders’ benefit when the company was eventually and inevitably sold. Revlon moment,
defensive measures no longer important but shareholder’s benefit, get the best price.

By granting the lock-up option to Forstmann that in turn guaranteed par value for the Note holders who were
threatening litigation against Revlon, it is apparent that the Revlon board of directors had their own legal
interests in mind, rather than the maximization of Revlon shareholders’ benefits. There was essentially an
auction ongoing between Forstmann and Pantry Pride for Revlon’s shares and the granting of the lock-up option
effectively ended the auction rather than letting the auction play out to obtain the highest bid for the Revlon
stockholders. The Revlon board put its own legal interests first to the detriment of the stockholders. This
constitutes a breach of the board’s duty of loyalty and therefore the board is not entitled to the deference of the
business judgment rule. The lock-up option should be enjoined and the Delaware Court of Chancery is affirmed.

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. (DE, 1986):

If management determined to sell, there are requirements to seek best price. If run auction, need to hold a fair
auction (this is a Revlon duty). Revlon duties only occur in situations in which the potential for more than one
offeror is a real possibility.
Plaintiff was original NY corporate raider. Comes in with a self-tender to soak up some of the people (everyone
has subjective valuations). Bunch of the folks tender into this debt offering and they sell their shares in exchange
for $57.50 in debt (subordinated non-asset backed debt, which can lose value rapidly), and become the note
holders. Pantry Pride did not go away. He comes back and offering $42 in cash because the company is worth
less (since it has big debt offering to support). Realize that they need a white knight—the friendly takeover that
company prefers. Revlon would rather be sold to Forstmann than to Pantry Pride. They agree to an Leveraged
Buy Out (unlike Pantry Pride, who would fire management, Forstmann is willing to work with the incumbent
management of Revlon).

Forstmann is the white knight, which competes at a higher price and dis-incentivizes Pantry Pride to come back
with a higher price. However, when bring in another buyer, need to remove the poison pill (cannot have a pill
against one and not the other). Pill is redeemed against Forstmann because of a high price. Pantry Pride then
offers a higher price. Pantry Pride goes to court in DE and seeks enjoin the lock up. Court enjoined (1)
consummation of an option granted to F to purchase certain R assets (lock-up option), (2) a promise by R to deal
exclusively with F in the face of a takeover (no-shop provision), and (3) the payment of $25M in cancellation fees
to F if the transaction was aborted. Also, the exercise of the rights and notes covenants. R’s directors breached
their fiduciary duty of care and loyalty to the stockholders by effectively ending an active auction for the
company. Favoritism for a white knight to the total exclusion of a hostile bidder might be justifiable when the
latter’s offer adversely affects shareholder interests, but when bidders make relatively similar offers, or
dissolution of the company becomes inevitable, the directors cannot fulfill their enhanced Unocal duties. Market
forces must be allowed to operate freely to bring the shareholders the best price available.

DATE PP BID REVLON FORSTMANN

8/23 47.50 CASH
8/29 57.50 DEBT
9/16 42 CASH
9/27 50 CASH
10/1 53 CASH

62
10/3 56 CASH+
10/7 56.25 CASH
10/12 57.25 CASH+
10/22 58 CASH+

i. WHAT WERE THE DEFENSIVE MEASURES USED IN THE REVLON TAKEOVER

CONTEST? Threat was that $45 initially was a grossly inadequate price & junk bond
financing, followed by a breakup of Revlon and disposition of its assets. Revlon wants to
sell assets and bust up the company to get some money to help raise the price higher than
what Pantry Pride is offering. Company would repurchase up to 5M of its nearly 30M
outstanding shares, and adopt a note purchase rights plan, where each Revlon
shareholder would receive a dividend one note purchase right for each share of common
stock, with the rights entitling the holder to exchange one common share for a $65
principal Revlon note at 12% interest. The rights would become effective whenever
anyone acquired beneficial ownership of 20% or more of Revlon’s shares, unless the
purchaser acquired all of the company’s stock for cash at $65 or more per share. Revlon
agreed to $56 per share from Forstmann, along with a golden parachute, and Forstmann
would assume the debt incurred by the issuance of the notes, and Revlon would redeem
the rights and waive the notes. When the merger was announced, the market value fell.

ii. WHY IS A “LOCK-UP” A DEFENSIVE TACTIC? Lock-up option was to purchase several
of Revlon’s crown-jewel departments. Get to buy best assets of Revlon at a bargained price
if you make this higher offer. The point is to disincentives Pantry Pride from wanting the
company (makes the remainder of the company less valuable). Makes Pantry Pride less
inclined to bid higher because he knows he is not getting the good assets. Pantry Pride
raises the price conditioned on removing the lock-up.

A lockup is not per se illegal—it has been approved to entice other bidders to enter a
contest for control of the corporation, creating an auction for the company and
maximizing shareholder profit. Measures that end an active auction and foreclose further
bidding operate to the shareholder’s detriment. Here, the result of the lock up was not to
foster bidding, but to destroy it. Revlon’s ending of the auction in return for little actual
improvement in the final bid, benefited the directors, who avoided personal liability to a
class of creditors to whom the board owed no further duty.

iii. IS THE BJR APPLICABLE?

No. If the BJR applies, there is a presumption that in making a business decision, the
directors acted on an informed basis, in good faith, and in the honest belief that their action
was in the best interests of the company. When a board implements anti-takeover
measures, there arises the omnipresent specter that a board may be acting in its own
interests. This potential conflict places the burden of proving on the board that they had
reasonable grounds for believing there was a danger to corporate policy, and that their
response was reasonable in relation to the threat posed (Unocal).

iv. ARE THESE DEFENSIVE TACTICS GOVERNED BY THE UNOCAL STANDARD, OR

SOME OTHER STANDARD?

Directors owe fiduciary duties of care and loyalty to the corporation and shareholders,
applicable with equal force when a board approves a corporate merger pursuant to 251(b).

63
 If applying Unocal, would board’s actions violate Unocal duties (require an analysis of a
threat posed and if reactions reasonable in relation to the threat)? The price was not
inadequate because they accepted a deal from Forstmann, and Pantry Pride offered a
higher price. Can argue that there was just a personality clash and that he’s a bust-up
takeover artist. This is a threat to the shareholders because they would no longer have
shares to hold (sold-out)—threat of company being broken up into pieces.

Another threat was that the debt instruments were in some jeopardy (value of
subordinated bonds will decrease if Pantry Pride takes over the company because debt is
valued based on risk of repayment).

Debt is substantially riskier than at the time it was issued because where is Pantry Pride
going to get the money to do this deal? He will borrow lots of money and will secure those
loans with the assets of the company (as collateral).

Now we have more debt added to Revlon’s balance sheet secured by Revlon’s assets.
Where did junk bonds go? Bottom of the list. These bonds that are publicly traded, as a
risk of their non-payment, their price drops on the trading market. This is a concern.

R needed to support the F deal because of the threat posed to the notes by the P deal (F
would support the notes and remove that threat by guaranteeing those notes). This case
passed muster on a Unocal analysis. However, board’s ending of auction did not pass
Unocal’s enhanced scrutiny.
v. WHAT TRIGGERED THE NEW “REVLON” STANDARD? When already know that need
to sell, the only duty of directors is to get highest selling price.

At what point did the obligations go from Unocal obligations to Revlon obligations?

When R agrees that it will be sold (not a question of wanting to be sold, but knowing that
they will be sold (inevitability of a sale)). When recognition that the company will be for
sale, get most money you can. When P increased its offer, it became apparent that the
break up of the company was inevitable.

R’s board’s authorization permitting management to negotiate a merger or buyout with a

third party was recognition that the company was for sale. The duty of the board thus
changed from the preservation of Revlon as a corporate entity to the maximization of the
company’s value at a sale for the shareholders’ benefit. The question of defensive
measures became moot—directors’ role changed to auctioneers charged with getting the
best price. Therefore, lock-up and no-shop provisions are impermissible.
vi. IS THE REVLON STANDARD A GOOD IDEA? IF SO, SHOULD IT APPLY TO ALL
DEFENSIVE BOARD ACTIONS? Not everything triggers a Revlon deal and not every
break up is inevitable. Unocal standard (when board wants to remain independent) and
the Revlon standard may be contradictory. Does it make sense to have 2 different
standards? Why not have a shareholder maximization standard in all circumstances? The
threat is not always protecting the shareholders, but may be for other constituencies.
When there is a direct conflict with a shareholder’s interest and another constituency’s
interest, board is not allowed to favor the other constituency’s interests. Why are
shareholders the owners? They have less risk than employees because their money is
diversified.

64
 vii. While concern for various corporate constituencies (note holders) is proper when
addressing a takeover threat, that principle is limited by the requirement that there be
some rationally related benefits accruing to the stockholders. Revlon cannot make the
requisite showing of good faith by preferring the note holders and ignoring its duty of
loyalty to shareholders—the rights of the former were already fixed by contract.

In re Fort Howard Corp. Shareholders Litig., Del. Ch., C.A. No. 991, 1988 WL 83147 (Aug. 8, 1988). When, however,
the directors possess a body of reliable evidence with which to evaluate the fairness of a transaction, they
may approve that transaction without conducting an active survey of the market. As the Chancellor
recognized, the circumstances in which this passive approach is acceptable are limited.

“A decent respect for reality forces one to admit that . . . advice [of an investment banker] is frequently a pale
substitute for the dependable information that a canvas of the relevant market can provide.” In re: Amsted Indus.
Litig., letter op. at 19–20. The need for adequate information is central to the enlightened evaluation of a
transaction that a board must make. Nevertheless, there is no right method that a board must employ to acquire
such information. Barkan, 567 A.2d at 1286–87.

No shop provision- reasonableness not perfection is standard. No shop valid.

In re Dollar Thrifty S'holder Litig., Cons. C.A. No. 5458-VCS (Del. Ch. Sept. 8, 2010) (Vice Chancellor Strine)
September 9, 2010

The Court reiterated that fiduciary duties under Revlon do not require any specific roadmap, only that
directors choose a reasonable route to obtain the best immediate value for the stockholders.

The analysis involves two prongs:

“(a) a judicial determination regarding the adequacy of the decisionmaking process employed by the
directors, including the information on which the directors based their decision; and

(b) a judicial examination of the reasonableness of the directors’ action in light of the circumstances then
existing.”

The Court noted the factual distinctions between this case and Revlon, in that the board had engaged in the past
in extensive and somewhat frustrating negotiations with the two major industry suitors and was willing to sell
to the bidder that could offer deal certainty and the highest value, rather than preferring one bidder over
another. Observing that Van Gorkom was essentially a Revlon case, Vice Chancellor Strine found that the board
was fully informed and exercised properly motivated due care.

With respect to plaintiffs’ claim that the board’s failure to engage Avis was unreasonable, the Court disagreed.
It concluded that the decision not to initiate an auction process with Avis was reasonable because the board was
not firmly committed to selling at that time, the board had substantial and legitimate concerns regarding Avis’s
ability to obtain financing or clear antitrust hurdles, and the board had recent experience where Avis was
reluctant to even make a firm bid at a much lower price. The board also considered and reasonably concluded
that there was substantial risk that Hertz would withdraw from the process if Dollar Thrifty pursued Avis
because Hertz had requested exclusivity and had previously withdrawn from prior negotiations.

65
Although reasonable directors could have pursued a bidding contest, the board chose this particular path
following reasonable deliberation, and, importantly, obtained a deal structure that allowed a later higher bid
after securing a firm deal with Hertz.

With respect to plaintiffs’ claim that the Dollar Thrifty directors acted unreasonably in failing to appropriately
respond to a meeting request from the CEO of Avis, again the Court disagreed. It found factually that prior to
the signing of the merger agreement, Avis’s CEO attempted to arrange a call with Thompson through a banker.
Thompson and Avis’s CEO later spoke and agreed to meet for dinner, but Avis’s CEO did not indicate an interest
in a deal. The dinner was cancelled after announcement of the Hertz deal. The Court found that there was
nothing in the record showing that Avis had expressed interest in a deal.

Finally, the Court rejected plaintiffs’ claims that the decision to enter into the merger agreement was
unreasonable because the price was insufficient to justify the deal protections. Vice Chancellor Strine rejected
the challenge to the price based on the low market premium, noting that both the Dollar Thrifty stock price and
Hertz offers consistently increased during the protracted negotiations. The Court refused to accept an unsound
discounted cash flow analysis offered by plaintiffs that included the synergy value from the merger and
recognized the real risks to continuing to press for a higher price given that Hertz’s last offer was contingent on
reaching agreement in five days and Hertz’s history of walking away. In analyzing the extent of the premium,
the Court also observed that the Dollar Thrifty stock price had increased significantly during the negotiations
with no fundamental changes to Dollar Thrifty’s future outlook, and held that a well-motivated board is not
obligated to refuse an offer that it reasonably believes appropriately meets or exceeds the fundamental value
of the company merely because it includes a relatively small market premium.

The Court rejected plaintiffs’ claims that the termination fee was preclusive or coercive, in part because plaintiffs’
calculation of the termination fee failed to include in the total transaction value a $200 million special dividend
that would be paid to stockholders. As adjusted, the Court found that the termination fee of 3.5%, although “a
relatively robust fee,” was an insubstantial barrier to a topping bid. In this determination the Court also relied
on the fact that Dollar Thrifty acquiesced to this fee only as part of a package where Hertz increased the price
and agreed to divest significantly more assets to satisfy antitrust issues, obtaining value in both price and deal
certainty in exchange for such a termination fee. This termination fee would only be payable if the Hertz deal
was rejected and Dollar Thrifty accepted an alternative transaction within a year. The Court found that the
record showed that the board considered whether the deal protections in the merger agreement would have a
chilling effect and obtained a lenient no-shop that would accommodate a serious bidder in a post-signing market
check. In this regard, the board arguably achieved its goal as Avis ultimately made a bid that was not conditioned
on invalidation of the termination fee. Therefore, Vice Chancellor Strine found that the deal protections were
not preclusive. The Court also found that the deal was not coercive because the merger agreement allowed the
stockholders to consider a floor price with the option to reject the deal if a higher bidder emerged or if they
determined that it was more advantageous to continue as an independent enterprise. The Court also expressed
skepticism regarding Avis’s seriousness in bidding for Dollar Thrifty, noting that Avis could easily revise its bid
to provide the deal certainty that the board valued. Vice Chancellor Strine observed that plaintiffs’ arguments
ignored the economic reality regarding deal certainty, implicitly approving of the board’s decision to weigh deal
certainty in evaluating its options.
Consequently, the Court denied plaintiffs’ request for an injunction preventing consummation of the merger
with Hertz, finding that plaintiffs had failed to show a likelihood of success on the merits and that, even if they
had, it would be difficult to find that the balance of harms was in favor of granting the injunction where the
stockholders had yet to vote and the substantial uncertainty an injunction would interject into the transaction
and Dollar Thrifty’s ongoing business.

66
Dollar Thrifty shareholders sue to enjoin Hertz’s purchase of Dollar Thrifty’s shares for $41 per share. Plaintiffs
criticize the Dollar Thrifty board for failing to conduct a pre-signing auction and for agreeing to a deal at a
modest premium over the closing price when a higher offer was available by A. Board determined that A’s offer
would only be superior to H’s offer if it could assure actual closing by agreeing to a reverse termination fee
($44M) and to a matched level of divestitures ($335M) (if they have antitrust approval problems). A refused to
do so, and took 3 months to secure financing. Board figured that since the company did not have a strong long-
term growth, it would be useful to lock in a price with H at a time when its stock was valued well. Board gave
stockholders the chance to take a floor price that was very attractive in light of the estimate of the company’s
value, left them uncoerced to turn down the deal if they preferred to remain independent or go with A, and left
the door open to a higher bidder. These actions are deemed reasonable and the court has no basis to intervene.
Court said A acted like a child (when it argued that it would be unfair to offer a RTF if DT could consider a post-
signing topping bid). A was not serious, and DT’s disinterested board was reasonable in using the deal
protection measures because it was promoting the shareholders’ interests.

AT THE TIME OF THIS DECISION, WHAT WERE THE RELEVANT DIFFERENCES BETWEEN THE HERTZ
AND AVIS BIDS? DT is in car rental business. H wants to acquire them. They have a merger agreement, under
which H gets to buy DT for $41 per share. A also wants to buy DT, and made a bid for $46 per share. The problem
with the A bid is that they did not want to pay a reverse termination fee.
WHAT IS A “REVERSE TERMINATION FEE?” If merger doesn’t go through, buyer has to payer termination
fee to seller. This is a guarantee by the buyer that they are serious with the merger (putting money on the line).
Car companies will not be able to do this type of deal because of anti-trust issues. Hart Scott Rodino might kill
the deal. The difference between H’s and A’s deals was that H was willing to put in a divestiture clause in their
agreement (to divest the company if the justice department says its necessary to not violate anti-trust laws). If
companies are too big, letting go of some of their outlets will lessen anti-trust issues. H was also willing to have
a reverse termination fee, but A wasn’t.
DOES THE CHANCELLOR THINK IT DETERS COMPETING BIDDERS IN THIS CASE? DT goes with H, and
DT shareholders argue that A presented a better offer. Ps argue this is a Revlon duty case. Court says DT’s actions
are valid—H proved that it was serious with the merger, unlike A. Board did what was best for the company. H
says that if DT doesn’t give them exclusivity, they would walk away. This is a gentler version of the Revlon duty.
The deal protections in the agreement did not prevent A from presenting a competing bid—it did not constitute
a material impediment for any topping bidder who wished to make a serious superior offer. A was not well
positioned financially to make the deal (state of credit markets & anti-trust risk) and DTs worried about H’s
demand for exclusivity, that a public auction could damage the company, and create anxiety among the
employees. DT decided to go with H, but reserved the opportunity to consider a post-signing topping bid.
viii. WHAT LEGAL STANDARD IS THE CHANCELLOR APPLYING IN THIS CASE? It
applied a relaxed Revlon standard that defers to managerial discretion in cases where there
is no clear conflict of interest, and where both parties are negotiating hard with substantial
diligence. Court cites Fort Howard, which cited Revlon. Deal measures are to prevent other
bidders, and to get the first bidder to sign on the dotted line. To the extent DT getting
value from H, H gets value by giving them deal protection measures. Sometimes you see
if there is a second bidder by signing a deal with the first bidder. As long as you’re
exercising reasonable measures, the deal doesn’t have to be the highest value ever
mentioned. When directors who are well motivated, have displayed no entrenchment
motivation over several years, and who diligently involve themselves in the deal process
choose a course of action, court should be reluctant to second-guess their actions as
unreasonable. Board bargained hard with H, shut down the process a few times, and
raised the price $11 per share from the initial offer. Board extracted real closing certainty,
while leaving room for a topping bidder to act with definitiveness because if it did not

67
 move now, it would never be able to again. This approach was reasonable as a product of
considerable deliberation.
b. In In re Family Dollar Stores, Inc., board was allowed to reject an $80 bid in favor of a $74.50 bid
because the “expected value” of the Tree bid was higher than the expected value of the General
bid since financing was uncertain (Tree bid would be approved 100%, whereas General would be
approved only 40%).

Paramount Communications, Inc. v. Time Incorporated

Delaware Supreme Court
571 A.2d 1140 (Del. 1989)

Rule of Law
A board of directors may enter into a transaction in order to defeat a reasonably perceived threat to the
corporation’s business so long as the board’s decision is reasonable in relation to the threat posed.
May a board of directors enter into a transaction in order to defeat a perceived non-economic threat to the
corporation’s business?

Holding and Reasoning (Horsey, J.)

Yes. Under Unocal, a board of directors may enter into a transaction in order to defeat a reasonably perceived
threat to the corporation’s business so long as the board’s decision is reasonable in relation to the threat posed.
Such perceived threats include, but are not limited to inadequate value of the tender offer. In this case,
Paramount’s claim is misguided as Time’s conclusion that inadequate value was not the only possible threat to
its future is reasonable. There was the threat that Time shareholders would accept Paramount’s tender offer
without knowing the long-term benefits of the Paramount deal; there was the threat to the Time “Culture”; and
there was a general threat to Time’s business model moving forward since it would be entering the new field of
entertainment.

Time Culture- part of the well baked strategy to maximize its identity and the determination that merger with
an entertainment company would best serve its culture. Long term value.

There is no Revlon moment.

1. They set up a merger where Time is the surviving company. Time is the Buyer although in the end it is
60% Paramount. Time wants to maintain its structure as a news agency.

2. The Board never abandoned the Company. This has been part of a long term strategy, where they
identified Warner, as a buyer because Warner is good fit.

No shop clause.

Unocal Analysis

Similarly, Paramount’s claim that Time did not fully investigate its offer is misguided. Before deciding on
Warner, the Time board fully investigated other options for mergers—including a merger with Paramount—
and determined that Paramount was not as good of a fit as Warner.

Moving to the second prong of the Unocal analysis, the court determines that Time’s response to the threat posed
by Paramount’s offer was reasonable. The defensive restructuring of the Time-Warner merger, including the
change to an all-cash/securities merger, was a way for Time to achieve its goal of the “carrying forward of a pre-
existing transaction in an altered form.” It was merely a way to achieve its initial goal of the Time-Warner merger
68
through another means, without interference from Paramount. Accordingly, the Time board’s response to the
Paramount threat was reasonable and the business judgment rule granting deference to the board’s decision is
invoked.

Additionally, the Time shareholders’ Revlon claim must fail because there is no evidence that the dissolution or
break-up of Time was inevitable, as is required by Revlon. The Time board’s defensive reaction to Paramount’s
hostile tender offer was not a step towards the end of Time’s existence. Therefore, Revlon duties did not attach
to the board. The Delaware Court of Chancery’s ruling in favor of the defendants is affirmed.

10. Protecting the Deal

 664-679 (ACE Limited v. Capital Re Corporation)
 690-700 (In re Lear Corporation Shareholder Litigation)
 700-707 (Samjens Partners I v. Burlington Industries, Inc.)
 725-748 (Omnicare, Inc. v. NCS Healthcare Inc.)
 Deal Protection Measures:
o The following are cases discussing deal protection measures. With respect to vulnerability, it is
the point at which the company agreed to a deal (today was have the poison pill). Once you’ve
said yes to someone, you cannot say no to others that offer a comparable or better deal. There is
a duty to consider other offers. However, if sign a contract that says that you’re not allowed to
have a deal with anyone else, buyer says they will sue for breach of contract. This is an invalid
provision and is void because have a fiduciary duty. When negotiating, need to come up with
provisions that protect the deal—if they become too protective, they become invalid due to
fiduciary duties. Need provisions that function as “deal protections,” but not too protective.
o What is a valid way to protect deal without making it unenforceable? The following are all a
matter of degree, and when they become coercive or preclusive, there become issues. Lawyers
must be smart when negotiating.
 Termination fees: The selling company has to pay in the event that it refuses to go through
with the deal. This is probability not considered as a violation of fiduciary duty to demand
that the seller enter into such a provision because (1) it is a contract terms that has an
independent economic justification (it is expensive to negotiate with the risk of it ending).
At very least, need liquidated damages to be made whole—reimbursement costs are a
minimum level. If go up to 3% of the value of the acquired company, this is typically what
happens. Maybe it is just convenience because easier to compute and enforce. Also,
compensation is only part of its purpose—the other purpose is to deter other bidders from
bidding or negotiating for a higher purchase price. Termination fees are a matter of
degree. If too high, it becomes problematic because it prevents other bidders from coming
in.
 Reverse termination fees: A fee paid by the buyer if it breaches the acquisition agreement
or is unable to consummate the transaction due to lack of financing and the seller
terminates the agreement in accordance with its terms.
 No-shop clause: Seller cannot actively sell or solicit other bidders. This is a good protection
because it protects the deal, but does not invalidate it.
 No-talk clauses: Seller cannot talk to other bidders unless reasonably believe it will offer
a higher price.
 Lock-ups: Seller is not free to sell the stock to a party other than the designated party
(potential buyer). Creates disincentives for other bidders.
 In some cases, parties utilize a “go-shop” clause, which allows the seller to see if there is
a better offer available (for 30 days or so). This is similar to conducting a market test.

69
 Termination fees protect the buyer in the event that the seller terminates the deal and goes
with someone else.

 No Shop Clauses and Fiduciary Outs:

o Boards feel an obligation to keep listening to new prospective buyers even after they have signed
a definitive agreement due to the continuing duty to inform shareholders if a better offer comes
along. This means that a definitive agreement is little more than a “put option” for targets—they
can sell at the agreed price if it suits them, or take the higher price a later bidder offers.
o M&A practitioners have significantly cut back on the use of “no talk” provisions that bar a target
company from having discussions with a competing bidder. Lawyers are requiring that targets
retain greater flexibility under the merger agreement to opt for superior competing bid, even
where the original deal is a stock merger that does not trigger Revlon duties. This flexibility is
being provided either by requiring a meaningful fiduciary out, so that the target can terminate
the original deal in favor of the competing bid, or by assuring that the target’s shareholders have
the ability to vote down the original deal if a better one comes along, which requires that the first
bidder not be allowed to “lock up” too many target shares so as to prevent a meaningful vote.

Ace Limited v. Capital Re Corp.

Delaware Court of Chancery
747 A.2d 95 (2000)

Rule of Law
Under Delaware law, a “no-talk” provision in a merger agreement that requires a corporation’s board to
breach or abdicate its fiduciary duties will not be enforced.

No. Under the Restatement (Second) of Contracts § 193, a fiduciary may not agree to breach a fiduciary duty.
Such an agreement or an agreement likely to cause a breach is unenforceable. A contractual provision that would
require a corporate board of directors to entrust the determination of its fiduciary duties to an outsider rather
than its own judgment is suspect.

In the case of a prospective merger, a board should not enter an agreement that would prevent it from
considering a better offer.

It is common for corporations seeking mergers to include “no-talk” or other defensive provisions designed to
stop a competing offeror from preventing the deal.

A merger agreement containing an absolute bar to consideration of any other offers would likely be
considered “an unreasonable preclusive and coercive defensive obstacle within the meaning
of Unocal.” Unocal v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985).

In this case, the “no-talk” provision should not be construed as taking the final “good faith” determination
about the duties of Capital’s board away from the board. Capital’s board was aware that the merger with Ace
was almost certain unless it terminated the agreement and that XL Capital’s offer would not be considered. This
alone is likely sufficient for Capital’s board to make a good faith finding that it was required to negotiate.

Though Capital did not get a written opinion from outside counsel, the advice of in-house counsel is likely
sufficient given the necessity for speed in this case. Interpreting the provision to forbid any discussions with a
competing offeror without a written opinion from outside counsel would likely render it unenforceable.

70
Capital’s board still owed duties of care and loyalty to its shareholders and was required to protect its
shareholders’ interests in a merger. Entering a self-disabling merger agreement would be a breach of the duty
of care. Ace should have known that the “no-talk” provision in this case might not be valid. Ace’s motion for
a temporary restraining order is denied.

ACE Limited v. Capital re Corporation (DE, 1999):

ACE Limited (buyer) requested temporary restraining order against Capital re Corporation (seller) from
terminating their merger agreement. Capitals’s board wants to terminate and accept a financially superior offer.
ACE argues that under the agreement, Capital validly terminate (pursuant to the no-talk and termination
provisions). ACE owns 12.3% of Capital’s shares. Capital encouraged 33.5% of its holders to sign an agreement
obligating them to support a merger between ACEand Capital if Capital ’s board did not terminate the
agreement in accordance to its provisions. Therefore, Capital knew when it executed the agreement that unless
it terminated, ACE would have enough votes to consummate the merger even if a materially more valuable
transaction became available. However, Capital claims that it was careful to negotiate sufficient flexibility for
itself to terminate the agreement if necessary to protect its stockholders.

WHAT WERE THE BASIC TERMS OF THE MERGER AGREEMENT BETWEEN ACE AND CAPITAL RE? WAS
IT A “MERGER OF EQUALS?” DID REVLON DUTIES APPLY TO IT?

Yes it was a merger of equals stock for stock transaction—similar business and Capital shareholders would
receive .6 of an ACE share for each Capital share (.6 share worth $17). ACE and Capital have a deal and Capital
is now seeking to move out of that deal in order to accept a different deal with XL. In addition to a merger, we
have an almost “locked-up” deal because it controls 46% of shareholders. As a sole shareholder, can be greedy
(shareholders have no duty to other shareholders—only shareholders that have roles as directors or officers have
fiduciary duties). The contract is, therefore, binding. The only way out of the contract is to terminate the merger
agreement. Since this is a merger of equals (not a change in control), it does not trigger Revlon duties, so
Unocal applies. This is also a case of contract negotiation.

WHAT DEAL PROTECTION MEASURES DID ACE PUT IN PLACE?

No talk & fiduciary out.

The “no talk” operates to prohibit Capital from soliciting or taking any action knowingly to facilitate the
submission of any inquiries or proposals from any person—it restricted Capital from participating in discussions
or even providing information to a third-party in connection with an unsolicited proposal unless

(1) the board, in good faith and based on advice of its outside financial advisors, believed that such proposal
was reasonably likely to result in a superior proposal;

(2) the board, in good faith and based on the written advice of outside legal counsel, believed that participating
in such negotiations or furnishing such information was required in order to prevent breaching its fiduciary
duties to its stockholders;

(3) the competing offeror enters into a confidentiality agreement no less favorable to Capital than its agreement
with Ace; and

71
 (4) Capital provide Ace with notice of their intent to negotiate or furnish information with a competing offeror.
This was the only way through which Capital could terminate the agreement, in addition to a $25M termination
fee.

UNDER WHAT CIRCUMSTANCES COULD CAPITAL RE TALK TO OTHER POTENTIAL BIDDERS? XL

offered a substantial premium. WHAT IS THE INTERPRETATIVE ISSUE RAISED BY THE NO-TALK CLAUSE?
WHAT ADVICE DID CAPITAL RE’S LAWYER GIVE?

C decided that XL’s offer was more advantageous, and got written advice from outside lawyers that entering
into discussions with XL was “consistent with” the board’s fiduciary duties because it was a superior proposal—
it did not say that the board was “required to” discuss the new offer to fulfill those duties. C sent written notice
to A that it considered a superior proposal and intended to terminate unless A increased the merger
consideration within 5 business days. XL raised and then sued. Turns out that discussions were in fact
“required” because the board was deemed to have breached their fiduciary duties. However, lawyer saying that
there will absolutely be a violation of fiduciary duty is questionable (this area of the law is based on the facts
and has not been determinative). TW says you don’t always have to get the higher bid if there is a pre-existing
strategic plan. Lawyer is utilizing a Revlon standard. However, Revlon duties depend on which offer is better.
Financial advisors make the decision that is the better offer, not the lawyer. A’s position is that C breached their
contract because they terminated the vote on the deal, which A was going to win, and they did so without
satisfying the terms of the merger agreement. C argues that if interpret this contract the way A interprets it, it is
invalid because it violates DE fiduciary duty.
i. WHAT IS THE SIGNIFICANCE OF THE SHAREHOLDER’S AGREEMENT IN THIS CASE? WOULDN’T
THE SHAREHOLDERS VOTE DOWN THE INFERIOR ACE MERGER DEAL? If board did not terminate
now, the 46% of the shareholders were contractually bound to vote in favor of the A merger despite its
inadequate price. Calling off the vote was important for C, and A argued that it was a breach of contract.
ii. HAVING DETERMINED THAT CAPITAL RE’S INTERPRETATION OF THE CONTRACTUAL
CLAUSES WAS THE BETTER ONE, WHY DOES THE CHANCELLOR GO ON TO CONSIDER ACE’S
INTERPRETATION OF THE CONTRACT? WOULD ACE’S INTERPRETATION LEAD TO A
JUDGMENT IN ITS FAVOR? WHY NOT? A argued that C violated the plain language of the agreement
because it was forbidden to engage in discussions within the specific legal notice from their lawyers
regarding C’s fiduciary duties, which C did not get. A further argues that the only remedy should be an
injunction against termination because of their binding contracts with C’s stockholders. Courts consider 4
factors when examining whether an acquirer’s contract rights should give way to the need to protect
stockholders from fiduciary breach (contract unenforceable if infringes board’s fiduciary duties): (1)
whether the acquiror knew, or should have known, of the target board’s breach of fiduciary duty, (2)
whether the transaction remains pending or is already consummated at the time judicial intervention is
sought, (3) whether the board’s violation of fiduciary duty relates to policy concerns that are especially
significant, and (4) whether the acquiror’s reliance interest under the challenged agreement merits
protection in the event the court were to declare the agreement unenforceable. A unlikely to prevail on the
merits, even if it is right about what the merger agreement means, because it knew that the provision
would likely be deemed invalid. A contractual promise by a fiduciary to violate his duty (by not
considering other offers unless lawyer says it is required) is unenforceable on public policy grounds. The
merger agreement anyway provided for a $25M termination fee and has not even closed yet (court
therefore may enjoin). The risk of harm to C’s shareholders outweighs the need to protect A from
irreparable injury (equities usually weigh against undoing the transaction). Shareholder rights of value
maximization outweighs 3rd party suitor contract rights (especially if the contract has still yet to be
performed). The judgment regarding fiduciary duties is left to C’s board, though they must base the
judgment on the written advice of counsel. The economic disparity between both offers was so great that
the board could not, in good conscious, fail to consider it (not in best interests of stockholders) (and

72
 stockholders would be forced to consummate the merger). C wins regardless of which interpretation that
the court adopts.
1. Court uses the looser interpretation of the issue, and whether it violates public policy. It was up to the
board to determine whether their fiduciary duties would be breached if they did not review the other offer.
C seeking preliminary injunctions, so court doesn’t decide the case. He expresses just that he favors C’s
side (A’s arguments have some merit to them). Contract was so restrictive, that it was unenforceable, and
A should have known this.
iii. DOES THE CHANCELLOR AGREE THAT THE DIRECTORS IN THIS CASE WERE “NOT IN REVLON-
LAND.” WHAT FIDUCIARY DUTIES DID THEY HAVE? They were in Unocal-land because the merger
agreement included provisions that intentionally were designed to prevent another bidder from
preventing the consummation of the transaction (unreasonable defensive barrier & Unitrin’s coercive and
preclusive). Board had fiduciary duties of care and loyalty, which they breached by agreeing to the “no
talk” clause and the effectively “no fiduciary out” clause (no “escape clause”) (they did not inform
themselves). But such clauses were deemed invalid for the above 3 reasons. Board violated their duties of
due care by entering into a non-change of control transaction, thereby affecting stockholder ownership
rights, and embedding in that agreement provisions that guarantee that the transaction will occur (merger
was tied to voting agreements ensuring consummation). The board and stockholder’s inability to consider
another offer was preclusive—there was almost no “out” at all. The fact that the board has no Revlon (non-
change of control transaction) duties does not mean that it can contractually bind itself to sit idly by and
allow an unfavorable and occlusive transaction to occur.

In re Lear Corporation Shareholder Litigation (DE, 2007):

Here, the Chancery Court also granted preliminary injunctive relief because the Lear ¨proxy statement [did] not
disclose that shortly before Icahn expressed an interest in making a going private offer, the CEO had asked the
Lear board to change his employment arrangements to allow him to cash in his retirement benefits while
continuing to run the company.¨ However, the Court refused to grant injunctive relief on the plaintiffs´ other
claims stating that ¨the Lear Special Committee made an infelicitous decision to permit the CEO to negotiate the
merger terms outside the presence of Special Committee supervision, [but] there is no evidence that that decision
adversely affected the overall reasonableness of the board's efforts to secure the highest possible value.¨

Lear was engaged in restructuring to keep itself solvent (restructuring debt and divesting underperforming
business units). Icahn purchased $200M of Lear’s stock, raising the stock price up 24%. Icahn suggested that a
private transaction was in Lear’s best interest. Board formed special committee, which authorized R (CEO) to
negotiate merger terms with Icahn.

Icahn’s highest price was $36 per share. Icahn allowed a pre-signing auction, but he would pull his offer.

Lear could freely shop for bidders after signing, during the “go-shop period” so long as Icahn would receive 3%
termination fee.
Board feared that if they rejected Icahn’s bid, the stock would fall back down and he would come in at a lower
price. Lear’s financial advisors engaged in a quick search for other buyers, but no serious interest appeared. JP
Morgan gave opinion that $36 was fair. Board approved go-shop, window-shop, and termination fee provisions.
Lear’s shareholders seek to enjoin the merger, arguing that the board breached its Revlon duties and failed to
disclose material facts necessary for the stockholders to cast an informed vote.

WHY DID ICAHN’S PURCHASE OF LEAR STOCK “BOLSTER ITS FLAGGING STOCK PRICE”? WHY WAS
HIS PURCHASES PUBLIC KNOWLEDGE?

73
He had a lot of stock in the company and was not opposed to having the company be sold to someone else.
When Icahn made the purchases publicly (bought more than 5% of public company, so have disclosure
obligations), its stock raised. They had a go-shop provision and eliminated their poison pill. Even if Icahn does
not get the deal, he will get 3% as a termination fee.

R had personal pecuniary interest in the transaction ($25M), and negotiated a change to his employment
agreement & severance payments.

WHAT IS THE “GO-SHOP” PROVISION?

Go shop provision permitted Lear’s board to actively solicit interest from third parties for 45 days, and a
fiduciary out permitted the board to accept an unsolicited superior third-party bid after the go shop period
ended.

WHAT DEAL PROTECTION MEASURES WERE USED?

Board obtained Icahn’s agreement to vote his equity position for any bid superior to his own that was embraced
by the board (voting agreement), thus signaling Icahn’s own willingness to be a seller at the right price.
Termination fee and matching rights (ability to match superior bid within 10 days) protected Icahn, since his
offer was used as a stalking horse, if a superior offer was presented.

The amount of the fee depended on the timing of the termination. If terminated during go-shop period, Lear
pays $73M plus up to $6M in reasonable expenses. If terminated after go-shop period (“no-shop” or “window-
shop” period), Lear pays $85M plus up to $15M in reasonable expenses. (capital tied up)

WHY DOES THE CHANCELLOR EQUATE IT WITH A “BID INCREASE OF ROUGHLY $1.25 PER SHARE.”
WHAT WAS THE REVERSE TERMINATION FEE?

$250M reverse termination fee was payable if Ichan breached the merger agreement, failed to satisfy closing
conditions, or was unable to secure financing.

WHAT LEGAL STANDARD DOES THE CHANCELLOR APPLY TO THIS TRANSACTION?

Court looks to whether board got the highest price reasonably available. CEO and his top subordinates had
economic interests that were not shared by Lear’s public shareholders. Although special committee was
deprived of deliberative time, there is no evidence that the decision adversely affected the overall reasonableness
of the board’s efforts to secure the highest possible value. Board could shop the company after signing, and
negotiated deal protection measures that did not present an unreasonable barrier to any other bidder. The
board’s post signing market check was a reasonable one that provided adequate assurance that no bidder willing
to top Icahn existed. Board’s fears of conducting an auction were reasonable.

COULD HE HAVE APPLIED THE ENTIRE FAIRNESS STANDARD? WITH WHAT RESULT?
Courts applying enhanced judicial scrutiny should be deciding whether the directors made a reasonable
decision, not a perfect decision. If a board selected in one of several reasonable alternatives, a court should not
second-guess that choice even though it might have decided otherwise or subsequent events may have cast
doubt on the board’s determination (QVC). R CEO would have to prove that the deal is entirely fair. They could
not have done that here—all presumptions are against them. However, court does not apply this entire fairness

74
standard because special committee approved the deal (it wasn’t only R CEO, who had suspect motives)—court
applies the Revlon standard.
HOW DOES THE COURT DETERMINE THE REASONABLENESS OF THE TERMINATION FEE?
These fees are standard during these transactions (not significant or unreasonable)—1.8% and 2.9% are not of
the magnitude to deter a serious rival bid. Matching rights are hardly novel. These are not unreasonable.

Samjens Partners I v. Burlington Industries, Inc.

Courts recognize that on the one hand, break-up fees may enhance the bidding process by encouraging the first
bid. Break-up fees may "be legitimately necessary to convince a 'white knight' to enter the bidding by providing
some form of compensation for the risks it is undertaking." Samjens Partners I v. Burlington Industries Inc., 663
F.Supp. 614, 624 (S.D.N.Y. 1988)
2. The Merger Agreement
Plaintiffs claim that the Board violated its duty to Burlington shareholders by failing to conduct a required
auction for Burlington and by considering the Morgan merger agreement in a hasty, perfunctory, and biased
manner. Plaintiffs claim that in approving the break-up fees, expense arrangements, and the no-shop provisions,
the Board breached its fiduciary duty to the shareholders.[8]
In discharging its function of managing a corporation, a board of directors owes a duty of care to act in the best
interests of the shareholders. Revlon, Inc. v. MacAndrews & Forbes Holdings, 506 A.2d 173, 179 (Del.1986). This
duty of care also requires the board to protect the corporate enterprise from "harm, reasonably perceived,
irrespective of its source." Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del.1985). Such a threat includes
a hostile takeover at a price below a company's value. Revlon, 506 A.2d at 181.
The "business judgment rule" protects the decisions of the board in carrying out its duty of care if certain
requirements are met. Id. at 180. Both the duty of care and the business judgment rule apply when the board is
responding to a hostile tender offer. Id.; Unocal, 493 A.2d at 954. The board's decisions, however, are subject to
closer scrutiny in such a context. "[T]here is an enhanced duty which calls for judicial examination at the
threshold before the protection of the business judgment rule may be conferred." Unocal, 493 A.2d at 954.
Directors must show "that they had reasonable grounds for believing that a danger to corporate policy and
effectiveness existed because of another person's stock ownership." Id. at 955. The board can satisfy this burden
by showing good faith and reasonable investigation, and such proof is enhanced when a board is comprised of
a majority of outside directors. Id.
In the midst of a takeover battle, when it becomes obvious that a company is for sale when, for example, the
board authorizes management to negotiate a merger or buyout with a third-party the duty of the board shifts.
"The directors' role *624 change[s] from defenders of the corporate bastion to auctioneers charged with getting
the best price for the stockholders at a sale of the company." Revlon, 506 A.2d at 182.
In coordinating the bidding process, the board can institute strategies, such as granting a "lock-up" agreement,
a breakup fee, or a no-shop agreement to a "white knight", but only if their strategies enhance the
bidding. Id.at 183, 184. Such arrangements may also be legitimately necessary to convince a "white knight" to
enter the bidding by providing some form of compensation for the risks it is undertaking. Id. Arrangements
which effectively end the auction, however, are generally detrimental to shareholders' interests and not
protected by the business judgment rule. Id. at 181, 183.
The board is under a further duty, when conducting the auction, to deal fairly with the bidders. It cannot deal
selectively to fend off a hostile bidder. Id. at 182.

Favoritism for a white knight to the total exclusion of a hostile bidder might be justifiable when the latter's offer
adversely affects shareholder interests, but when bidders make relatively similar offers, or dissolution of the
company becomes inevitable, the directors cannot fulfill their enhanced Unocalduties by playing favorites with

75
the contending factions. Market forces must be allowed to operate freely to bring the target's shareholders the
best price available for their equity.
Id. at 184. Applying these factors to this case yields the following results.
a. The Composition of the Board
The evidence indicates that the Board is composed of 13 directors, ten of whom are outside directors.
Negotiations between the Board and Morgan were carried out by the senior outside director. All relevant
decisions were made by the outside directors, and they were advised by outside counsel and investment
bankers. There is no evidence of self-dealing or bad faith on the part of the Board and its members.
b. The Board's Response to Takeover Rumors
The Board was first informed of the rumors that Edelman was interested in Burlington at a meeting on April 15,
1987. It approved the hiring of investment bankers and counsel. The Board did not instruct management to
approach Edelman, nor had Edelman contacted management.
c. The First Samjens Tender Offer
The Board met five days after the first Samjens offer. After viewing a long, division-by-division presentation
about the value of Burlington, the Board rejected the $67 offer as inadequate. The Board then authorized the
investment bankers to negotiate with other parties, and authorized the self-tender offer. The self-tender did not
foreclose bidding, and in fact seemed to enhance it Samjens followed soon after by raising its initial bid to $72
per share. At this point, the auction had not yet begun. Although the Board had authorized its investment
bankers to negotiate with interested parties, it still preserved the right to seek other alternatives to maximize
shareholder value. The Board was still entitled to act in a defensive posture to ward off what it deemed, after
due deliberation, to be an inadequate tender offer.
d. The Approval of the Morgan Stanley Merger Agreement
On May 19, the Board was informed that approximately 25 entities had expressed interest in Burlington. Only
Morgan, however, was willing to make a bid. When the Board decided to enter into negotiations with Morgan,
it was clear that Burlington would be sold, the auction began (REVLON MOMENT), and the Board was no
longer defending the company, but attempting to get the best bid for it. The evidence indicates the Board
fulfilled its duty to do so.
The negotiations with Morgan lasted for two days. The Board members read the merger agreement carefully
and went through it with outside counsel. The price the Board secured from Morgan was $76 per share, $4 per
share higher than the highest outstanding bid.
*625 The Board negotiated strictly with Morgan about the other terms of the agreement. It rejected the $7 million
hello fee. The Board was not happy with the breakup fee, but after investigating it, the Board realized that such
a fee was standard, and that the amount of the fee was fair and within the normal range. The Board also realized
that Morgan would back out of the deal without the fee, and justifiably decided to agree to it. The Board also
insisted on changing the no-shop clause to a "window-shop" clause. The new clause allows the Board to look at
other bids, but not solicit them. If the Board sees a higher bid, it can accept it.
The merger agreement is not so onerous as to end the auction or exclude other bidders. The breakup fee and
related expenses total approximately 2 percent of the value of the company, leaving other parties free to bid.
There is also no auction-ending lock-up agreement. In fact, the merger did not end the auction: in response to
the merger, Samjens increased its bid to $77, and Morgan has responded with a bid of $78. Thus, the merger
agreement has increased the value to the shareholders by $6 per share, and Samjens has hinted that it might
make a higher bid.
The evidence also indicates that the Board reached all of its decisions after thorough consultation with its
financial and legal advisors. Its decisions were based on reasonable and thorough investigations, and its
conclusions were justifiable and in good faith. The Board did not rush. Its investment bankers solicited bids over
an eight day period. When the Board was assured that Morgan's bid was the best, it pursued its negotiations
with Morgan over a two-day period. The Board fulfilled its duty of care in the takeover contest, and its decision
is entitled to the protection of the business judgment rule. In short, if the procedure the Board followed and the
merger agreement it approved were not protected by the business judgment rule, the Court doubts that any

76
merger agreements would ever be allowed in the context of takeover contests. This case indicates that this would
be detrimental to shareholders.
The merger agreement approved in this case has resulted, so far, in an increase of $6 per share in the price that
will be paid to shareholders.
Plaintiffs' version of how the auction should have been conducted is unrealistic and ignores a number of
important factors. First, the Board was operating under time pressure caused by Samjens. The Samjens offer was
to expire on June 3. Thus, when the Board met on May 19, it had only two weeks to find an alternative to an
inadequate bid. Morgan was the only party ready to make a bid, all other parties needed additional time. Second,
although Morgan might have been Burlington's white knight, it was not Burlington's patron saint. Morgan
was involved in negotiations with Burlington because it saw an opportunity to make money. Thus, it wanted a
response to its bid quickly, it wanted compensation for the risk it was undertaking in tying up its capital, and it
did not want to serve as a "stalking horse" and have its bid shopped around. In light of this, however, the Board
spent two days negotiating the merger agreement, and bargained vigorously with Morgan.
e. Dealings with Edelman of Samjens.
Plaintiffs claim that the Board was biased, and should have contacted Edelman before accepting the bid from
Morgan. The reasons the Board did not contact Edelman were stated earlier.
Even if the Board was incorrect in understanding that Samjens did not plan to make another offer, the failure to
contact him was still justified. Management had offered to provide Edelman with the same information it had
given other interested parties, but Edelman refused to sign a confidentiality agreement. Edelman wanted to be
informed of other bids before he bid, but the Board justifiably thought it would be unwise to do so. The Board
did not deal selectively with Edelman. Instead, he dealt selectively with the Board, according to his own rules.
Nor did the Board freeze Edelman out of the auction. The merger agreement the Board signed did not end the
auction, it provided a starting point for further bidding. Edelman was free to *626 and did raise his bid after it
was signed. If the Board was unfair with Edelman, it was only because it forced him to dig deeper into his
pockets to the benefit of Burlington shareholders.
Samjens also complains that the Board has not offered it a break-up fee and therefore has treated it unfairly. It
complains that if it purchases Burlington, it must pay a $50 million penalty due to the expense and break-up fee
provisions. Samjens forgets, however, that it has purchased approximately 13 percent of Burlington shares in
the pre-tender offer market at an average price of $50 per share. Thus, Samjens enters the bidding process with
a nearly $80 million advantage over other prospective bidders who must pay at least $78 per share for all
outstanding shares. Denying Samjens a break-up fee thus helps to even the playing field.
Edelman also complains that the Board has opted out of the North Carolina Shareholder Protection Act for the
Morgan offer but not for his offer. It is clear that the Board could not have reached agreement with Morgan had
it not opted out of the Act. By opting out, the Board was not acting selectively to freeze Edelman out. Rather, it
was enhancing the bidding by securing a $76 bid from Morgan. Although Burlington has refused to opt-out for
Edelman's bid so far, there is no evidence that it would continue to do so if Samjens approved its bid.
3. The Self-tender offer
The plaintiffs claim that the self-tender offer violates the Board's fiduciary duty. They did not bring this claim in
their complaint. Nevertheless, the Court will consider it because many of the allegations regarding the breach
of duty are related to plaintiffs' securities law claims involving the self-tender. Furthermore, the failure to plead
it has worked to the plaintiffs' detriment, as they have not developed the factual record necessary to sustain the
claim. See AC Acquisitions v. Anderson, Clayton and Co., 519 A.2d 103, 113-114 (Del.Cha.1986) (ruling based, in
part, on well-developed factual record as to the post self-tender share price).
Defensive measures enacted by a board of directors in response to a hostile tender offer must meet a two-part
test: there must be a basis for the board to have concluded that the defensive measure served a proper corporate
purpose and the measure must be reasonable in light of the threat posed. Id. at 112.
When the Burlington Board first issued the self-tender offer, it was in response to a threat to Burlington
shareholders: an inadequate tender offer.

77
 The self-tender was designed so that if the maximum number of shares were tendered, the inadequate tender
offer would be defeated. The self-tender was thus enacted for a legitimate purpose. It also was reasonable in
light of the threat. It was designed to allow the Board time to consider alternatives that would maximize
shareholder value. There is also no evidence that the original tender offer was structured such that no rational
shareholder could turn it down. There is no evidence that the price of Burlington shares would have dropped
drastically after the self-tender such that a shareholder would have to tender into it to preserve any value.
Furthermore, the self-tender was to expire on June 11, eight days after the first Samjens offer expired. This
allowed shareholders more time to consider their options.
The original status of the self-tender offer, however, is not relevant. After Burlington entered into the merger
agreement with Morgan, it extended the self-tender offer until after the Morgan offer expired. Burlington also
announced that if the offer for Morgan were successful, Burlington would terminate the self-tender offer.
Burlington also recommended that shareholders accept the Morgan offer. In light of the preliminary injunction
against Samjens' offer, shareholders have the choice between tendering into the Morgan offer or, against the
recommendation of Burlington, tendering into its self-tender. The self-tender is thus out of the picture.

*627 CONCLUSION
The Court has found that the plaintiffs are not threatened with irreparable injury and are not likely to succeed
on the merits of their claims. The motion for a preliminary injunction is thus denied.
SO ORDERED.

Plaintiff acquired parts of Defendant, and wanted to take it over. Defendant then started discussions with
Morgan Stanley to come in as a "white knight" in a management sale. Board refused to do an auction out of fear
of losing Morgan Stanley. Defendant did a self-tender, and then agreed to deal protections for Morgan Stanley,
including a termination fee and a no-shop clause.

HELD: Court says that protective measures are proper when necessary to secure a higher bidding white knight.
The board was well informed and behaved reasonably, and did not shut down other options for sale. Protections
may be necessary to compensate a bidder for tying up capital.

Omnicare, Inc. v. NCS Healthcare, Inc.

Delaware Supreme Court
818 A.2d 914 (Del. 2003)

Rule of Law
A board of directors may enter into a transaction in order to respond to and defeat a reasonably perceived
threat to the corporation’s business so long as the board’s response is reasonable in relation to the threat
posed and not coercive or preclusive.

Facts
Genesis Health Ventures, Inc. (Genesis) (defendant) entered into negotiations to acquire NCS Healthcare, Inc.
(NCS) (defendant). At the urging of Genesis, the parties entered into an exclusivity agreement, which prevented
NCS from engaging in any negotiations in regards to a competing acquisition or transaction.

Subsequently, Omnicare, Inc. (Omnicare) (plaintiff) contacted NCS about a proposed transaction, but NCS did
not respond due to the exclusivity agreement with Genesis.

Complementary to Genesis’s merger proposal was a voting agreement under which Jon Outcalt, Chairman of
the NCS board, and Kevin Shaw, NCS President and CEO, agreed to vote all of their shares (65%)—combined,
a majority of NCS shares—in favor of the merger agreement.
78
This voting agreement effectively meant that NCS shareholder approval of the merger was guaranteed even if
the NCS board did not recommend its approval. The merger agreement, which contained a clause restricting the
rights of NCS to discuss an alternative merger with a third party, was then executed. The merger agreement did
not contain a fiduciary out clause, which would have given the NCS board the opportunity to opt out of the
agreement if it needed to do so to discharge its fiduciary duties to the corporation. Meanwhile, before the
official—although futile—NCS shareholder vote on the Genesis merger proposal, Omnicare submitted a merger
proposal that was superior to that of Genesis. At that point, the NCS board withdrew its recommendation that
the shareholders vote in favor of the Genesis merger agreement. However, the Genesis merger agreement
provided that the proposal still must be submitted to a shareholder vote and, because of the Outcalt/Shaw
voting agreement and the omission of a fiduciary out clause, that meant that the merger agreement was going
to be approved no matter what. Omnicare brought suit.
Issue

Is a board’s response to a merger proposal coercive or preclusive if the board enters into an agreement which
does not afford the shareholders an opportunity to oppose the merger and effectively predetermines the
outcome of the shareholder vote?

Holding and Reasoning (Holland, J.)

Yes. Under Unocal Corporation v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), and its progeny, a board of
directors may enter into a transaction in order to respond to and defeat a reasonably perceived threat to the
corporation’s business so long as the board’s response is reasonable in relation to the threat posed and not
coercive or preclusive.

A response is coercive if it forces stockholders to accept a “management-sponsored alternative to a hostile

offer,” and a response is preclusive if it prevents stockholders from hearing and voting on all available tender
offers.

Here, the combination of the Outcalt/Shaw voting agreement, the Genesis merger terms, and the omission
of a fiduciary out clause amounted to a lock-up that prevented any other merger proposal besides Genesis’s,
including Omnicare’s, from succeeding no matter how much better it was for NCS and its stockholders. This
response to Genesis’s merger proposal was both coercive and preclusive.

As a result, the defensive measures taken by NCS are invalid and unenforceable in that they failed to allow the
NCS board to discharge its fiduciary duties to the corporation. The court rules in favor of Omnicare.

Dissent (Veasey, C.J.)

By always requiring a fiduciary out, the majority opinion effectively deters bidders from engaging in merger
negotiations with corporations, which will inevitably reduce the pool of potential bidders that would benefit
stockholders in corporate transactions. The NCS board of directors reached its decision to agree to the lock-up
provisions in good faith and the court should generally respect the “reasoned judgment” of corporations’ boards
of directors and majority stockholders.
Dissent (Steele, J.)
The court should not establish proscriptive rules that ban negotiation strategies adopted by a corporation’s board
of directors believing that such strategies are the best way to achieve the maximum benefit to the corporation.

Omnicare, Inc. v. NCS Healthcare, Inc. (DE, 2003):

Omnicare seeks to invalidate the merger agreement between NCS Healthcare, Inc. and Genesis Health Services,
Inc., and Omnicare challenges the voting agreements between Genesis and Outcalt &Shaw, two majority NCS
79
Healthcare, Inc. stockholders, which commit them to vote for Genesis’s merger. Omnicare made clear that it was
not interested in any transaction other than an asset sale in bankruptcy. Genesis Health Services, Inc. and NCS
Healthcare entered into a merger agreement in exchange for (1) an exclusivity agreement, preventing NCS
Healthcare from accepting a higher bid from Omnicare, (2) a provision, authorized by DGCL 146, requiring the
Genesis agreement to be placed to a stockholder vote even if NCS’s board no longer recommended it, (3) a voting
agreement for purposes of DGCL 203, requiring Outcalt & Shaw to vote their majority shares in favor of Genesis’
agreement, and (4) no fiduciary out clause.

OM faxed NCS a proposal at the 11th hour. Independent committee decided that discussions with OM created
an unacceptable risk of G terminating negotiations, while OM’s deal was filled with uncertainty. Fully informed
board voted unanimously to recommend the merger.
iv. NCS is in trouble because the healthcare system is not giving them any money for their
billables (no government reimbursements) and having trouble getting their account
receivables (taking a while to be paid for its services). NCS deals with long-term
healthcare (pharmacy services and nursing facilities). NCS began to explore strategic
alternatives by hiring an investment bank to find someone to provide cash infusion.
Indentured trustee said there is financial pressure for bankruptcy. O shows up and
proposes for NCS to go bankrupt, and then O will buy them out of bankruptcy (buying
just the assets, and not the shares & liabilities; in a bankruptcy sale, shareholders don’t
have much rights and so no fiduciary duties). In bankruptcy, the bondholders (creditors)
get the money from the bankruptcy sale, and shareholders get nothing until the
bondholders get all their value.

WHAT IS THE DIFFERENCE BETWEEN A “STALKING HORSE” MERGER AND ONE WITH
“EXCLUSIVITY”? G is interested. NCS forms a special committee. Stalking horse is using one buyer to make
the second buyer’s price higher. It might be good to be a stalking horse when there is a termination fee and/or
lock-up (and other deal protection measures). Exclusivity (cannot negotiate with anyone else) makes winning
the deal easier. G wanted to win (G and O have a history of G losing).
DID GENESIS HAVE LEGITIMATE REASONS FOR SEEKING THE “NO SHOP” AND OTHER DEAL
PROTECTION MEASURES IT SOUGHT? COULD IT HAVE OBTAINED THEM IN OTHER WAYS?
The board gave up its right to have a meaningful shareholder vote because 2 shareholders are contractually
obligated to vote in favor. Minority shareholders have no power. The deal is locked-up. This is problematic. G
has legitimate reasons for their actions—unless they had the exclusivity provision, they would not be able to
win. NCS had legitimate reasons to agree to exclusivity because they were desperate. NCS wants G to make its
offer better. Termination fee was a concession on G’s part because if the deal doesn’t go through they get less.
This is a very tough case (court justices are split).
WHY DID THE BOARD WITHDRAW ITS SUPPORT FOR THE NCS DEAL?
They were not sure if it was the better proposal (financial advisors withdrew the fairness opinion regarding G’s
agreement), and they felt that they were unfairly restricted from speaking to OM (“no shop” provision). Board
member would go through with the deal, but a lawyer would be more cautious since the defensive measures,
along with the majority voting shares, prevented NCS from engaging in any superior transactions in the future.
Board no longer wants to support the deal, but the success of that deal had already been predetermined by (1),
(2), (3), and (4).
WHAT STANDARDS DID THE COURT CONSIDER IN EVALUATING THIS TRANSACTION? WHICH ONE
DID IT ADOPT?
Deal Protection Devices will be evaluated against Unocal
A board’s decision to adopt defensive measures may implicate the stockholders’ right to effectively vote contrary
to the merger (“omnipresent specter” requiring a balance of power). These defensive devices must withstand
enhanced judicial scrutiny under the Unocal standard even when the merger transaction does not result in a

80
change of control. Court applied Unocal standard because there was no change in control (stock for stock deal).
Deal does not pass Unocal muster because of the majority shareholder votes belonging to the directors—minority
shareholders had no say and board could not intervene anymore (it was a done deal due to the protective
measures). This was a coercive and preclusive tactic. Court says these deals are not per se illegal. However, if
this deal was not a violation, then it is hard to imagine what kind of deal would.
A board’s decision to use defensive devices against uninvited competing bids is analogous to a board using
devices to protect against dangers to corporate policy and effectiveness.
However, the board does not have discretion to use draconian means (coercive and preclusive), and the devices
must be reasonable in proportion to the danger to the corporation and its stockholders if the transaction does
not consummate. The threat was losing G’s bid and being left with no comparable alternatives. The 4 devices
here completely locked up G’s merger. The minority stockholders (who preferred OM) were forced to accept G’s
merger because of the devices approved by the board (cohesive group deciding the outcome creates the
diminution of the minority’s voting power). Any vote would be robbed of its effectiveness due to the
predetermined outcome without regard to the merits. Despite the fact that the board withdrew its
recommendation for G’s merger, the deal protection devices approved by the board previously operated in
concert to have a preclusive and coercive effect—it made it mathematically impossible for any other superior
proposal to be considered. The devices were not within a reasonable range of responses to the perceived threat
of losing G’s offer, and therefore they are unenforceable. The defensive measures completely disabled the board
from discharging its fiduciary responsibility to the minority stockholders in considering OM’s superior offer.
DGCL 146 cannot be used to limit the board from carrying out its fiduciary duties. Board AWLAYS must have
a fiduciary out to protect the stockholders (in the case that G’s offer becomes the inferior one), even if the only
company that wants to do a deal wants one without a fiduciary out. NCS board breached their fiduciary duties
by entering into such agreements with G to create an absolute lock up in the absence of a fiduciary out.
v. WHAT DO YOU THINK THE NCS BOARD DID WRONG? 2 directors gave up their
fiduciary duties when making decisions by being majority shareholders. DGCL 203
takeover statute prevents acquiring 50% without board approval. Penalty for violations,
any shares over minimum lose their votes until restores by shareholder or director votes.
They were wrong in agreeing to the no fiduciary out provision (need some way to break
out of the box).
vi. WHAT RESULT IF THE TWO LARGEST STOCKHOLDERS HAD SIMPLY SOLD THEIR
SHARES TO GENESIS? G would have lost those voting rights unless approved by the
board, which would have destroyed exclusivity.
vii. SUPPOSE THE TWO LARGEST SHAREHOLDERS OF NCS ONLY CONTROLLED 40%
OF THE OUTSTANDING SHARES, BUT ALL THE SAME ARRANGEMENTS WERE
AGREED TO. DO YOU THINK THE CASE WOULD HAVE BEEN DECIDED THE SAME
WAY? No because they don’t have a majority, which is not controlling. If board says not
to vote for it, there is a chance that it might not go through (rescues it from being coercive
and preclusive).

11. Majority Decisions

Conflicts Among Shareholders
f. Fiduciary Duties: As a general rule, SH are allowed to behave as selfishly as they want, without regard to
the company and other SH. However, dominant and controlling SHs have a limited fid duty to the Co
and the other SHs.
g. Entire Fairness: If the controlling SH engages in a transaction with the company, the transaction will be
reviewed with an entire fairness standard. The entire fairness inquiry encompasses two interrelated issues:
a. (1) fair dealing, which is procedural
b. (2) fair price.
h. Controlling SH:

81
 a. You don’t have to own a majority of the outstanding stocks to be a dominant SH. But you have
to own enough to control SH voting.
b. Dom SHs are allowed to sell their interests even with a control premium. (The buyer is paying
extra per share coz they are getting the control of the Co.).
i. A dom SH who sells to a looter may be liable for breach of fiduciary duty if there is a subsequent injury to
the Co. and the dom SH
a. (1) either knew the person was a looter,
b. (2) or was aware of circumstances that would alert a reasonable prudent person to the risk that
the buyer was dishonest or in some material respect not truthful.
c. That said absent either of those factors (knowledge and awareness of the alerting circumstances),
dom SHs do not owe a duty of care that would suggest they should investigate a buyer's intention
when they decide to sell their stake of the biz.
j. When Not Apply Entire Fairness: If the bd is independent and not influenced by the dom SH, the entire
fairness rule will not apply. Here are some additional things that can eliminate concerns about dominant
SHs.
a. The deal is conditioned on the fully informed approval of a majority of the minority SHs
(meaning the majority all minority SHs, not just the majority of those voting at a particular SH
meeting)
b. A special committee of independent directors approved the transaction.
c. There is a fiduciary-out for the board.
d. Other things that make the deal not coercive. ( Coercive: means something that causes SHs to
vote in favor of the proposed transaction for some reason other than the merits of the transaction.)
k. Equity Argument: Also, we can apply an analysis based on equity to dominant SH actions, like in Holinger,
where Black's actions were permitted by the statute but had inequitable purpose and inequitable effects.
l. In a Rev. Moment where a dominant SH has indicated there's only one transaction for which he will vote
(which means it will be the only deal that could possibly happen), the bd can meet its Rev duties by
determining through good faith reasonable investigation that the deal yields the best price for SHs. If the
bd finds it does not, the bd can meet Rev duties by recommending minority SHs to vote against the
transaction and seize dissenters' rights (i.e. the only way to get the right price).
m. Thoughts on conflicts among SHs:
a. You cannot sell a corp office, but agreeing that a new majority owner can replace the bd with
their own people at closing is just fine.
b. If the only complaint SHs have is price, Cts will tell them to look to an appraisal proceeding.
(Most of the time, not just about price.)
n. Go private transactions
a. When a dom SH takes a Co. private, there is no Rev moment since there's no change of control.
b. Where directors sit on the bd of both the dom SH and the target, they owe normal fid duties to
both companies and should do what's best for both companies, which can be hard to figure out,
esp. when one considers a director who has knowledge of the negotiating strategies on both sides.
1. The director should tell me the negotiating strategy on the other side. But if he does, he is
breaching the confidentiality with the other side.
2. Advice: step out and not participate.
c. Special committees need real bargaining power to be effective. For committee member,
independent means truly independent. Economic dependence is not independence.
d. Thanks to the very recent DE decision, we know that a going private transaction can avoid the
entire fairness test and be protected by the BJR if the transaction is subject to two things:
1. The approval of an attentive special committee comprised of independent directors, which
has the money to choose its own lawyers, financial advisors and other advisors and has the
power to reject the transaction

82
 2. The fully informed approval of a majority of the minority SHs (majority of all minority SHs,
not the majority of those voting).

● Transfer of Control and Going Private Transactions

○ As a general rule, shareholders are allowed to behave as selfishly as they want, without regard to the
company or other shareholders. Accordingly, dominant shareholders are allowed to sell their interests,
even with a control premium.
○ Dominant or controlling shareholders have a limited fiduciary duty of loyalty to the company and the
other shareholders. If a controlling shareholder engages in a transaction with the company (known as a
“self dealing” transaction), the transaction will be reviewed with an “entire fairness” standard. The
entire fairness inquiry encompasses two interrelated issues: fair dealing (which is procedural), and fair
price. Actions that have “inequitable purpose and inequitable effect” will constitute a breach of duty by
the dominant shareholder.
■ You don’t have to own a majority of the outstanding stock to be a dominant shareholder, but
you have to own enough to control shareholder voting
■ A dominant shareholder who sells to a looter may be liable for breach of fiduciary duty if there
is a subsequent injury to the company and the dominant shareholder either (i) knew the person
was a looter, or (ii) was aware of circumstances that would alert a reasonable prudent person to
a risk that the buyer was dishonest or in some material respect not truthful. That said, absent
either of those factors, dominant shareholders do not owe a duty of care that would suggest
they should investigate a buyer’s intentions when they decide to sell their stake in a business.
■ In a Revlon moment, where a dominant shareholder has indicated there is only one transaction
for which it will vote, the board can meet its Revlon duties by determining, through good faith
and reasonable investigation, that the deal yields the best price for shareholders. If the board
finds it does not, it can meet its Revlon duties by recommending minority shareholders vote
against the transaction and seek dissenters’ rights.
■ You can’t sell a corporate office, but agreeing that a new majority owner can replace the board
with their own people at closing is just fine
○ Freeze-Out Mergers
■ A “freeze-out”, or “squeeze-out”, or “cash-out” merger is when a controlling block of
shareholders forces minority shareholders out by causing a merger that results in a cash
payment to the minority.
■ Some jurisdictions require a legitimate business purpose before they allow the minority to be
cashed out. Eliminating transaction and litigation costs associated with large numbers of
shareholders is generally considered a legitimate business purpose.
■ In Delaware, they quickly jettisoned the business purpose test in favor of an overall fairness test
inquiring as to fair dealing and fair price. Fair dealing embraces questions of how the
transaction was timed, how it was initiated, how it was negotiated, how it was structured, how
it was disclosed to directors and shareholders and how approvals of the board and shareholders
were obtained.
■ If a public company is cashing out shareholders such that the company will no longer be
publicly-owned, we call that transaction a “going private” transaction. Some going private
transactions involve the controlling shareholder squeezing out the minority (which is our focus
in the course), but some “friendly” going private transactions are conducted by a third party and
all shareholders are being cashed out.
○ Thoughts on going private transactions/cash out mergers
■ When a dominant shareholder takes a company private, there is no Revlon moment since there
is no change in control.
■ A going private transaction can avoid the entire fairness test and be protected by the business

83
 judgment rule if:
● the controller conditions the procession of the transaction on the approval of both a
Special Committee and a majority of the minority stockholders; AND
● the Special Committee is independent (truly independent, and economic dependence is
not independence); AND
● the Special Committee is empowered to freely select its own advisors and to say no
definitively; AND
● the Special Committee meets its duty of care in negotiating a fair price; AND
● the vote of the minority is informed; AND
● there is no coercion of the minority
■ If you do not meet the criteria to avoid the entire fairness test, then some combination of these
factors will help reduce concerns about dominant shareholders:
● the deal is conditioned on the fully-informed approval of a majority of the minority
shareholders - and specifically a majority of all of the minority shareholders, not just a
majority of those voting at a particular shareholder meeting,
● approval/recommendation by a special committee of independent directors,
● there is a fiduciary out for the board, and a fiduciary out with a low termination fee is
great,
● an agreement by the dominant shareholder to vote for superior proposals, perhaps
after a limited one-time matching right,
● other things that make the deal not coercive (coercive = something that causes
shareholders to vote in favor of a proposed transaction for some reason other than the
merits of that transaction)
To show that a director is not independent, plaintiffs must demonstrate that a director is beholden to the controlling
party or is so under the controller’s influence that he or she can’t exercise independent discretion. The director’s
connections to the controlling person must be material, which is to say sufficiently substantial that the director cannot
objectively discharge his or her fiduciary duties. Bare allegations about running in the same social circles or past
business relationships are insufficient without a showing of materiality, in the sense that these facts affect the
impartiality of the dir
 779-804 (Hollinger Inc. v. Hollinger International, Inc., Orman v. Cullman)
Sale of Control
 804-815 (Abraham v. Emerson Radio Corp.)
Fairness Tests
 879-922 (Weinberger v. UOP, Inc., Kahn v. Lynch Communication Systems, Inc., Kahn v. M&F Worldwide Corp.)

Hollinger Inc. v. Hollinger International, Inc.

Hollinger International, the publishing division of Hollinger Inc, is an organisation based in the USA that owns
many newspapers. Lord Conrad Black was the Chairman and Chief Executive of Hollinger International
who along with his friend David F Radler, controlled Hollinger Inc's operations through Ravelston, their
private equity vehicle. In 2003, Tweedy Browne Co, a New York-based investment firm approached the
Securities Exchange Commission to conduct a corporate governance review of Hollinger International.
Black was forced to resign in November 2003. The report accused Black and his associates of robbing the
company of millions of dollars. The final outcome of the Hollinger case is far from decided. The case study
gives an insight into how an inactive board, an ineffective audit committee and a dominant CEO (Chief
Executive Officer) can damage the corporate governance structure, which can be detrimental to
shareholders' interests. The case also offers scope to debate the role of directors and whether they should
be held financially accountable for neglecting their responsibility to protect the interests of minority
shareholders

84
Conrad Black - Hollinger International

Canadian Conrad Black created Hollinger Inc., the parent company of Hollinger International, in the mid-
1980s with the purchase of the controlling interest in the Daily Telegraph. With a number of other purchases
throughout the following 15 years, Hollinger became one of the largest media groups in the world. As CEO of
Hollinger International, Black had substantial control over the company's finances.

The board of directors confronted Black in 2003 over payments the company made to him and four other
directors in the $200 million range. The board called in the SEC to investigate the validity of the payments and
the accounting transactions created to account for them. Charges were laid against Black for fraud, tax evasion
and racketeering, among others. In 2007, Black was convicted of four of the 13 charges against him and was
sentenced to 78 months in prison, of which he served 42. He was released from prison in 2012. (Read
More: The Uneven Consequences Of Corporate Misbehavior)

Orman v. Cullman

Delaware Court of Chancery

794 A.2d 5 (Del. Ch. 2002)

Rule of Law
A disinterested director is not necessarily independent.

Facts
[Information not provided in casebook excerpt.]

Issue
Is a disinterested director necessarily independent?

Holding and Reasoning (Chandler, J.)

No. Interest and independence are two separate concepts. A disinterested director is not necessarily
independent. Under Delaware law, a director is interested in two situations: (1) the director personally receives
a benefit or would suffer a detriment from the challenged transaction that is not shared with other shareholders
of the corporation, which is material to the director; or (2) the director sits on both sides of the transaction. A
director is dependent if the director makes a decision under the control of another. A director is controlled by
another if: (1) the director is "dominated by" the other party because of a special relationship or force of will; or
(2) the director is "beholden to" the other party, because the other party has the power to decide whether the
director continues to receive a material benefit. Similar facts may implicate both concepts, only one, or neither.
For example, assume director A is a director and officer of company X. Company X is to be merged into company
Z. Director A voted in favor the merger and is being sued by a shareholder. In this scenario, assume that director
A is to be an officer in the surviving company Z and that maintaining the officer position is material to director A.
Then, the court may conclude that director A is interested. In the next scenario, assume that director C is both a
director and majority shareholder of company X and that director A's officer position is material to director A.
Director C has the power to threaten director A's officer position if director A votes against the merger. In that
case, the court may find that director A is controlled by director C, because director A is beholden to director C
for his job. Accordingly, the court may find that director A is not independent. If all facts in the two scenarios were

85
combined, director A may be found both interested and dependent. If all facts in the two scenarios were
combined, except for the materiality of director A's officer position (maybe because director A is very rich and
does not care about the salary), director A may be found both disinterested and independent. The key issue is
not whether a director receives a benefit from a transaction, but whether the benefit is so important to the director
that it might harm his sound business judgment.

Difference with Omnicare

Fiduciary Out
Minority Vote
Abraham v. Emerson Radio Corp.

the duties of a controlling shareholder selling its shares for a premium:

The essence of the argument about why the complaint failed to state a claim, according to the court “is
simple: under Delaware law, Emerson [the majority shareholder and seller] was free, as a general matter, to sell
its majority bloc in Sports Supply for a premium that was not shared with the other Sport Supply stockholders.”
The complaint failed to allege adequate circumstances to support the suggestion that Emerson knew, suspected
or should have suspected that the buyer was either a looter or was dishonest, and had improper plans for Sports
Supply. The court was dubious that the common law of corporations would recognize a duty of care-based claim
against the controlling stockholder for failing to (in the judgment of the court) examine the bona fides of a buyer,
at least when the corporate charter contains an exculpatory provision authorized expressly by DGCL Section
102(b)(7) [of Title 8 of the Delaware Code.]

Thus, the court reasoned, when the board itself is exempt from liability for violations of the duty of care,
pursuant to the DGCL, by what logic would the judiciary extend liability to a controlling shareholder exercising
its ordinarily unfettered right to sell its shares? The court concluded its reasoning in dismissing the claims by
observing that, when opposing the basic right of every stockholder to sell its shares: “a plaintiff seeking to
support the claim must plead facts that indicate that the controller knew there was a risk that the buyer was a
looter or otherwise intended to extract illegal rents from the subsidiary, at the expense of the subsidiary’s
remaining stockholders.”
As a controlling stockholder of a corporation, it is important to remember that Delaware law imposes a
duty upon a selling controlling stockholder
(i) to make such inquiry of a proposed buyer’s plans for the target company as a reasonably prudent person
would make, and
(ii) to generally exercise care.
These actions should be taken to insure that the non-selling stockholders and others who will be affected
by the selling controlling stockholder’s actions will not be injured by any resulting wrongful conduct (e.g.,
looting of the company by the buyer).

Based upon this duty, the general rule is that a controlling stockholder is free to sell its stock for a
premium not shared with the other stockholders except under very narrow circumstances.

In a recent Delaware case, Abraham v. Emerson Radio Corp., the Delaware Chancery Court addressed a claim
against a sporting goods company’s controlling stockholder that sold its control block for a premium to a
strategic buyer that also operated in the same market space. The complaint alleged that

(i) the controlling stockholder had received payments in excess of the value of stock from the buyer, not for its
majority interest, but as a payment for permitting the buyer to usurp the assets of the target company to the
detriment of the minority/remaining stockholders, and
86
 (ii) the controlling stockholder had breached its duty of loyalty by permitting, aiding and abetting the buyer’s
unfettered use and enjoyment of the target’s assets without fair compensation. Plaintiff’s allegations of buyer’s
intent to plunder the target company were based, in part, on statements in the buyer’s press release to the
effect that “this transaction places a multitude of valuable assets under (the buyer’s) managerial umbrella.”

Background

Sport Supply Group, Inc. (“Sports Supply”) was 53.2% owned by Emerson Radio Corp. (“Emerson”). Sport
Supply voluntarily delisted its stock in early 2004 but continued to trade on the pink sheets. By late 2004, Sport
Supply’s share price had risen from the $1-$2 range to $3 per share. By mid 2005, it was trading at $3.65 per
share. On July 5, 2005, Emerson announced that it had sold its majority stake in Sports Supply for $32 million
or $6.74 per share, an 86% premium to the prior day’s closing price, to Collegiate Pacific, Inc. (“CPI”), a
competitor formed by Sport Supply’s founder and former CEO.

On September 8, 2005, CPI announced that it had agreed to a stock-for-stock merger with Sport Supply
pursuant to which the minority holders of Sport Supply (of which the plaintiff was one) would receive 0.56 of
a share of CPI stock that was valued at the time of announcement at $6.74. Unfortunately, CPI’s share price
began to drop as a result of increased acquisition costs and earnings dilution resulting from the conversion of
outstanding notes into common equity, and the merger agreement was ultimately terminated. In the interim, a
large institutional shareholder sold a significant block of Sport Supply stock to CPI for $5.50 per share in cash.
By the time the complaint was filed, Sport Supply shares were trading at only $4.85 per share.

Scope of Duty

While quickly dismissing the complaint for failing to state a cause of action on which relief could be granted,
the decision is of interest for various reasons including those set forth in dicta. First, the Court confirmed the
general right of a controlling stockholder to sell its majority bloc for a premium not shared with other target
stockholders, and second, the Court suggested additional limits on the potential liability of a controlling
stockholder where the target’s certificate of incorporation contains an exculpatory provision authorized by
Section 102(6)(7) of the Delaware General Corporate Laws (“Section 102(6)(7)”). This provision prohibits
recovery of monetary damages from directors for a successful stockholder claim, either direct or derivative,
that is exclusively based upon establishing a violation of the director’s duty of care. The Court held that, while
the plaintiff had established that the controlling stockholder knew it was selling to a strategic buyer who
would attempt to capitalize on possible synergies, this was not a breach of fiduciary duty.

In reaching its conclusion, the Court conceded that the precedent suggests that a selling controlling
stockholder has the duty to make such inquiry as a reasonably prudent person would make, and generally to
exercise care so that others who will be affected by his actions should not be injured by the wrongful conduct.
Vice Chancellor Strine, however, went on to state that he was “dubious that our common law of corporations
should recognize a duty of care-based claim against a controlling stockholder for failing to (in a court’s
judgment) examine the bona fides of a buyer, at least when the corporate charter contains an exculpatory
provision authorized by Section 102(b)(7).”

Vice Chancellor Strine noted the rule that the controlling stockholder owes fiduciary duties in its capacity as a
stockholder is based upon the premise that such stockholder exerts its will over the enterprise in the manner of
the board itself. When the board itself is exempt from liability for violations of the duty of care, as under a
Section ‘102(b)(7) exculpatory provision, the Court suggested that it would be illogical to extend liability to a

87
controlling stockholder exercising its ordinarily unfettered right to sell its shares. Vice Chancellor Strine
continued, noting that the unthinking acceptance that a greater class of claims ought to be open against
persons who are ordinarily not subject to claims for breach of fiduciary duty at all - stockholders - than against
corporate directors is inadequate to justify recognizing care-based claims against sellers of control positions.

Vice Chancellor Strine also carefully noted that “drawing the line at care would do nothing to immunize a
selling [controlling] stockholder who sells to a known looter or predator, or otherwise proceeds with a sale
conscious that the buyer’s plans for the corporation are improper. But it would impose upon the suing
stockholders the duty to show that the controller acted with scienter and did not simply fail in the due
diligence process.”

Practical Take-Aways

The Court’s opinion gives some guidance for controlling stockholders and practitioners alike:

1. Include a Section 102(b)(7) exculpatory provision in the corporate charter. The Court’s analysis of how a
Section 102(6)(7) provision may impact the duties of a controlling stockholder is significant. While most
corporations include such a provision in a Delaware corporate charter, it is not unusual for this to be
overlooked and inadvertently left out. Any company without a Section 102(b)(7) exculpatory provision should
promptly seek to amend its charter so that its directors and, if applicable, controlling stockholder(s) can have
the benefits of such a provision.

2. Know your buyer. While a controlling stockholder will not incur liability for an incomplete due diligence
process regarding the buyer of its majority stake, controlling stockholders should be aware that they are not
immune from liability where the buyer’s plans for the controlled company rely on a strategy of seeking
corporate synergies. Regardless of whether an exculpatory provision is included in the charter, a duty of care
claim may stick in situations where the controlling stockholder knows that its stake is being sought by a
“looter” or where it is aware that the buyer is dishonest and may injure the remaining stockholders.

3. Know your duties and obligations. Prior to initiating a sale, selling controlling stockholders should be sure
to review any applicable stockholder agreements for provisions precluding or otherwise restricting their
ability to sell or the terms on which they may sell their stock. In addition, in order to avoid conflicts of interest
with the company itself or the other stockholders, a controlling stockholder should engage its own
independent counsel. In such situations, the interests of the controlling stockholder are frequently at odds with
those of the other stockholders, and often the company as well.

Weinberger v. UOP, Inc.

Delaware Supreme Court
457 A.2d 701 (Del. 1983)

Rule of Law
Minority shareholders voting in favor of a proposed merger must be informed of all material information
regarding the merger for the merger to be considered fair.

Facts

The Signal Companies, Inc. (Signal) acquired 50.5 percent of UOP, Inc.’s (Universal Oil Products UOP)
(defendants) outstanding stock.

88
 Signal elected six members to the new board of UOP (13 members), five of which were either directors or
employees of Signal.
After the acquisition, Signal still had a significant amount of cash on hand due to a sale of one of its subsidiaries.
Signal was unsuccessful in finding other good investment opportunities for this extra cash so it decided to look
into UOP once again.
At the instigation of Walkup and Shamway, Signal Chairman and President, Charles Arledge and Andrew
Chitiea, two Signal officers who were also UOP directors, conducted a “feasibility study” for Signal and
determined that the other 49.5 percent of UOP would be a good investment for Signal for any price up to $24
per share.
The study found that the return on investment at a purchase price of $21 per share would be 15.7 percent,
whereas the return at $24 per share would be 15.5 percent.
Despite this small difference in return, the difference in purchase price per share would mean a $17 million
difference to the UOP minority shareholders.

Shumway and Walkup spoke to Crawford, President, and told him of Signal’s plan to acquire at a proposed
price range of $20-21 before executive meeting. UOP market price US$14.5. Lehman brothers said that $20-21
price would be fair in their fairness opinion.
This information was never passed along to Arledge and Chitiea’s fellow UOP directors or the UOP minority
shareholders. The UOP board agreed on a $21 per share purchase price. The UOP minority shareholders
subsequently voted in favor of the merger.
Weinberger, et al. (plaintiffs) were UOP minority shareholders and brought suit, challenging the merger. The
Delaware Court of Chancery found in favor of the defendants. The plaintiffs appealed.
Issue
Is a minority shareholder vote in favor of a proposed merger fair if the shareholders were not given information
on the highest price that the buyer was willing to offer for the shares?
Holding and Reasoning (Moore, J.)

No.

There is no “safe harbor” for such divided loyalties in Delaware corporation are on both sides of transactions,
they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the
bargain. (footnote: fairness could be equated to a wholly independent, BOD, independent negotiating
committee).

The concept of fairness has two basic aspects: fair dealing and fair price.

The former embraces the questions of when the transaction was timed, how it was initiated, structured,
negotiated, disclosed to the directors, and how approvals of the directors and stockholders were obtained.

Fair price relates to economic and financial consierations, including all relevant factors: assets, market value,
earnings, any other elements that affect the intrinsic value or inherent value of the shares.

Test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be
examined as a whole since the question is entire fairness.

Part of fair dealing is the duty of candor. One possessing superior knowledge ma not mislead any stockholder
by use of corporate information to which the latter is not privy.

89
Minority shareholders voting in favor of a proposed merger must be informed of all material information
regarding the merger for the dealing to be fair. Failure to provide the minority shareholders with all material
information is a breach of fiduciary duty.

Here, although Arledge and Chitiea had prepared their study for Signal and were actually Signal officers, they
still owed a duty to UOP because they were also UOP directors. The feasibility study and, more specifically, the
possible sale price of $24 per share and the resulting $17 million difference in amount paid to the UOP minority
shareholders clearly constitute material information that the shareholders were entitled to know before voting.

Arledge and Chitiea’s failure to disclose that information was a breach of their fiduciary duties and their actions
thus cannot be considered fair dealing.

The basic concept of value under the appraisal statute is that the stockholder is entitled to be paid for what
which has been taken from him; true and intrinsic value of his stock which has been takin in the merger. In terms
of fair price, to determine whether the price of a cash-out merger was fair, a court is to consider “all relevant
factors,” all relevant factors, ie., market value, asset value, dividends, earnings prospects, nature of the
enterprise, facts which throw into light on future prospects on the merged corporation are not only pertinent to
an inquiry as to value but must be considered by the agency in fixing the value, something that the Delaware
Court of Chancery did not do.

Section 262 now mandates the determination of “fair”value based on all “relevant factors” Only speculative
elements of value excluded, i.e., future value.

On remand, all relevant factors concerning the value of UOP should be considered in determining whether the
price was fair. As a result of the foregoing, the Delaware Court of Chancery’s findings that the circumstances of
and price paid for the merger were fair are reversed and the case is remanded.

Going Private transaction- there has to be a reason why you need to squeeze out the minority. There was to be
business purpose. Like regulations have changed requiring that company has to be private. Now-business
purpose not needed but you do it in an entirely fair manner.

Kahn v. Lynch Communications Systems, Inc.

Delaware Supreme Court
638 A.2d 1110 (Del. 1994)

Rule of Law
The use of an independent committee shifts the burden of proving the entire fairness of a cash-out merger
by a controlling or dominating shareholder to the challenging shareholder if: (1) the controlling shareholder
did not dictate the terms and (2) the committee was empowered to negotiate at arm’s length.

Facts

This is a case regarding the fiduciary duties of a controlling shareholder, in the person of Alcatel, to the
parent corporation Lynch and its shareholders.

Compagnie Generale d’Electricite’s (CGE) (defendant) indirect subsidiary, Alcatel U.S.A. Corporation (Alcatel)
(defendant) held 43.3 percent of Lynch Communication Systems, Inc. (Lynch) (defendant). Alcatel selected five
90
of Lynch’s directors. As part of the agreement on Lynch acquisition of these shares, Lynch amended its articles
of incorporation to require a supermajority (80% affirmative vote of SHs) for approval of any business
combination.

Lynch wanted to acquire Telco Systems, Inc. (Telco) because in order to remain competitive int would need to
obtain fiber optics technology to complement its existing digital electronics capabilities. Alcatel pushed Lynch
to acquire Celwave Systems, Inc. (Celwave), another CGE subsidiary, instead. Same Parent with Alcatel. Lynch’s
directors wanted the Telco deal, but Alcatel’s designated directors on Lynch’s board refused, saying, “We are 43
percent owner. You have to do what we tell you.” Because of supermajority provision, Lynch needed Alcatel’s
vote to approve acquisition.
Fayard, declared “you are pushing us very much to take control of the company. Our opinion is not taken into
consideration.”
Lynch’s board created an independent committee to negotiate with Celwave. The committee balked after
Alcatel’s investment bank suggested an unacceptable ratio for a stock-for-stock merger.

Alcatel withdraw Celwave proposal and instead offered to acquire the rest of Lynch for $14 a share. The same
committee was charged with negotiating the cash-out merger.
Kertz, Wineman and Beringer and as confirmed with legal counsel, to review alternatives.

The committee countered and got Alcatel up to $15.50, but Alcatel threatened to make a tender offer.

The committee felt it had no choice but to approve, though it believed the price unfair. Lynch’s board approved,
with Alcatel’s designated directors abstaining. Kahn and other minority shareholders (plaintiffs) challenged the
merger in the Delaware Court of Chancery. The chancery court concluded that Alcatel had dominated the Lynch
board’s business decisions. The court further found that the independent directors “deferred” to Alcatel and the
committee accepted the $15.50 offer under Alcatel’s threat of a tender offer. Nevertheless, the chancery court
found for the defendants, holding that the committee negotiated at arm’s length and without compulsion. The
plaintiffs appealed to the Delaware Supreme Court.
Issue
Controlling shareholder status?

The Court has held that a “shareholder owes a fidicuary duty only it if owns a majority interest in or exercises
control over the business affairs of the corporation.

A shareholder who owns less than 50% of a corporation’s outstanding shares does not, without more, become
a controlling shareholder of that corporation, with a concomitant fiduciary status. For a dominating
relationship to exist in the absence of controlling stock ownership, a plaintiff must allege domination by a
minority shareholder through actual control of corporation conduct.

Alcatel held 43.3 percent minority shares of stock of Lynch-despite minority, did it exercise control?

Does the use of an independent committee shift the burden of proving the entire fairness of a cash-out merger
by a controlling or dominating shareholder to the shareholder challenging the merger?
Holding and Reasoning (Holland, J.)

No. Alcatel dominated the committee, and the burden of proof remains on Alcatel. There is a danger in parent
subsidiary mergers that the controlling shareholder could retaliate against shareholders who vote no. Thus,

91
entire fairness is the appropriate standard of review. “A controlling or dominating shareholder standing on both
sides of a transaction, as in a parent-subsidiary context, bears the burden of proving its entire fairness.”

The Court holds that the exclusive standard of judicial review in examining the propriety of an interested cash-
out merger transaction by a controlling or dominating shareholder is entire fairness.

The initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction.

However, an approval of the transaction by an independent committee of directors or an informed majority of

minority controlling or dominating shareholder to the challenging shareholder shifts the burden of proof on the
issue of fairness from the controlling or dominating shareholder to the challenging shareholder – plaintiff.
Nevertheless, even when an interested cash-out merger transaction receives the informed approval of a majority
of minority stockholders or an independent committee of disinterested directors, an entire fairness is the only
proper standard of judicial review.

Entire fairness may established if an independent committee of outside directors negotiated the deal at arm’s
length. See Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983).

The committee stands in for an independent board, providing strong evidence of fairness. The burden of proving
unfairness shifts to the challenging shareholder. Simply appointing an independent committee is not enough to
shift the burden.

Two things must be shown: (1) the controlling shareholder did “not dictate the terms” and (2) the committee
had authority to negotiate at arm’s length. Here, Alcatel dominated the business judgment of Lynch’s board.
The issue is whether the committee “neutralized” that control. The committee’s independence was doubtful,
because it had already succumbed to Alcatel on the Celwave deal.

The fact that the same directors had submitted to Alcatel’s demand on August 1, 1986 was part of the basis for
the Court of Chancery’s finding of Alcatel’s domination of Lynch. Therefor, the Independent Committee’s ability
to bargain at arms length with Alcatec was suspect from the outset.

The committee did not believe $15.50 was fair, but was afraid that Alcatel would make an even less favorable
tender offer. The committee thus believed it had no choice. The committee did not negotiate at arm’s length. The
chancery court’s ruling is reversed, and the case is remanded for a determination of the entire fairness of the
cash-out merger.

Kahn v. M & F Worldwide Corp.

92
Delaware Supreme Court
88 A.3d 635 (Del. 2014)

Safe harbor provision for a Going Private Transaction

Rule of Law
The business judgment rule is the appropriate standard of review for a merger between a controlling
stockholder and its subsidiary that is conditioned upon: (1) the approval of an independent, adequately-
empowered special committee that fulfills its duty of care and (2) the uncoerced, informed vote of a majority
of the minority stockholders.

Facts

MacAndrews & Forbes Holdings, Inc. (M & F) (defendant) was a 43 percent stockholder in M & F Worldwide
Corp. (MFW). M & F proposed to buy the remaining common stock of MFW to take the corporation private. The
transaction was subject to two stockholder-protective procedural conditions: (1) the approval of a special
committee to be appointed by the MFW board of directors, and (2) the approval of a majority vote of MFW
minority stockholders. The MFW board established the special committee, which approved the transaction. The
minority stockholders voted to approve the merger. Kahn, et al. (plaintiffs) brought suit, arguing that even both
protections combined are inadequate to protect minority stockholders, because directors on the special
committee may be inept or timid and MFW minority stockholders may be subject to improper influence. The
plaintiffs claimed that the entire fairness standard should apply to the merger. In addition, the plaintiffs alleged
that the special committee was not independent because of various relationships between members of the special
committee and M & F. The Delaware Court of Chancery ruled in favor of M & F. The plaintiffs appealed.
Issue
Is the business judgment rule the appropriate standard of review for a merger between a controlling stockholder
and its subsidiary that is conditioned upon (1) the approval of an independent, special committee that fulfills its
duty of care and (2) the informed vote of a majority of the minority stockholders?

Holding and Reasoning

Yes.

The standard of review for a merger between a controlling stockholder and its subsidiary that is from the outset
conditioned upon: (1) the approval of an independent, adequately-empowered special committee that fulfills its
duty of care or (2) the uncoerced, informed vote of a majority of the minority stockholders is entire fairness.

However, when a merger between a controlling stockholder and its subsidiary is conditioned upon both
protections, the business judgment rule applies. There, the entire fairness standard is not necessary to adequately
protect minority stockholders’ interests, because the two procedural protections offer the merger “the
shareholder-protective characteristics of third-party, arm’s-length mergers, which are reviewed under the
business judgment standard.” This standard will only apply, however, if each characteristic of the special
committee and stockholder vote is met. The special committee must (1) be independent, (2) be empowered to
choose its own financial and legal advisors, and (3) exercise its duty of care. The minority stockholder vote
must be: (1) informed and (2) uncoerced. In the present case, the court determines that the business judgment
rule is the proper standard on which to review the merger, because each of the prerequisites involving the two
stockholder protections is met. First, the special committee was independent. While certain members of the
committee may have had social or business relationships with M & F, such bare allegations are not enough to
rebut the presumption of independence. To establish a lack of independence, a plaintiff must show that a director
93
is beholden to the acquiring interests. The plaintiffs in this case did not make such a showing. Additionally,
there is no evidence that the special committee was not empowered or did not meet its duty of care. Similarly,
there is no evidence that the MFW stockholder vote was coerced or uninformed. As a result, the business
judgment rule is the proper standard of review for the merger. The judgment of the Delaware Court of Chancery
is affirmed.

94