Standards of Review
Categorical Confusion: Deal Protection Measures in Stock-For-Stock Merger Agreements
Vice Chancellor Leo E. Strine, Jr. , 56(3): 919 (May 2001)
In this Article, Vice Chancellor Leo E. Strine, Jr. explores several practical and doctrinal issues bearing on the standard of judicial review applied to the deal protection measures commonly contained in stock-for-stock merger agreements. In particular, the Article asks searching questions about whether the world of mergers and acquisitions can be divided neatly into two categories: (i) change of control transactions subject to searching judicial review under the Revlon doctrine; and (ii) stock-for-stock mergers subject only to deferential business judgment rule review, even as to deal protection measures. Instead of this binary approach that treats economically similar transactions in markedly different ways, the Article suggests that the case law may articulate a more nuanced and coherent approach that permits a closer, but still deferential, judicial examination of all objectively defensive measures-including deal protection measures-under the Unocal standard. The Article closes with the suggestion that a judicial focus on whether target stockholders have a free and uncoerced opportunity to turn down the stock-for-stock merger at the ballot box reconciles many of the arguably divergent policy values articulated by key mergers and acquisitions decisions of the last decade, such as Time- Warner, QVC, and Quickturn.
Function over Form: A Reassessment of Standards of Review in Delaware Corporation Law
William T. Allen, Jack B. Jacobs & Leo E. Strine, Jr. , 56(4): 1287 (Aug. 2001)
One of the most profound transformations in Delaware corporation law since 1985 has been the development of new standards of judicial review, as well as novel applications of existing standards. Although the result of these developments has been positive, the developments have also, in some instances, become dysfunctional in the sense that their articulation and/or application has not adequately taken into account the policies underlying the standards and thus has failed to advance the core values of corporation law. In this Article, the authors explore these post-1985 doctrinal problems in five separate areas: (i) the review standard misapplied in duty of care cases; (ii) the improper linkage of the duty of care to entire fairness review; (iii) the failure of courts to defer to effective intra-corporate fairness procedures; (iv) the unnecessary linkage of the intermediate "reasonableness" standard of review to the business judgment and entire fairness standards; and (v) the "compelling justification" test and the unnecessary proliferation of review standards. The authors conclude that some doctrinal reformulation is needed in these areas to make the existing standards of review truly functional, i.e., adequately aligned with their underlying policy purpose so as to provide directors with incentives to act so as to advance corporate and shareholder interests, and simplified and rationalized to make the standards useful tools for judicial decisionmaking. The authors propose three basic reformulated review standards that would achieve these goals.
Delaware's Going Private Dilemma: Fostering Protections for Minority Shareholders in the Wake of Siliconixand Unocal Exploration
Bradley R. Aronstam, R. Franklin Balotti, and Timo G. Rehbock, 58(2): 519 (Feb. 2003)
This Article responds to two recent Delaware cases, In re Siliconix Inc. Shareholders Litigation and Glassman v. Unocal Exploration Corp., which confront the issue of the appropriate standard of review when a majority shareholder purchases the minority shares in a subsidiary. The Article examines the foundations upon which the two decisions rest and questions their validity. It then suggests alternative fairness mechanisms in the context of going-private transactions and invites the Delaware Judiciary to apply a "limited fairness" test to short-from merger transactions that requires majority shareholders to demonstrate how the price was arrived at and whether the transaction was timed or structured in a fashion designed to take undue advantage of the minority. Alternatively, the Article proposes that the Delaware General Assembly amend the appraisal statute so as to compel parent corporations to pay all minority shareholders (including those who failed to exercise their appraisal right) the court's appraised share value should that value exceed that which the corporation offered to pay.
Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.
In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
Reinterpreting Section 141(e) of Delaware's General Corporation Law: Why Interested Directors Should Be "Fully Protected" in Relying on Expert Advice
Thomas A. Uebler, 65(4): 1023–1054 (August 2010)
Directors of Delaware corporations often rely on lawyers, economists, investment bankers, professors, and many other experts in order to exercise their managerial power consistently with their fiduciary duties. Such reliance is encouraged by section 141(e) of the General Corporation Law of the State of Delaware, which states in part that directors "shall . . . be fully protected" in reasonably relying in good faith on expert advice. Section 141(e) should provide all directors of Delaware corporations a defense to liability if, in their capacity as directors, they reasonably relied in good faith on expert advice but nevertheless produced a transaction that is found to be unfair to the corporation or its stockholders, as long as the unfair aspect of the transaction arose from the expert advice. The Delaware Court of Chancery, however, has limited the full protection of section 141(e) by confining it to disinterested directors in duty of care cases. That limitation, which is not expressed in the statute, unfairly punishes interested directors who act with an honesty of purpose and reasonably rely in good faith on expert advice because it requires them to serve as guarantors of potentially flawed expert advice. This Article concludes that Delaware courts should reconsider the application and effect of section 141(e) and allow directors, regardless of their interest in a challenged transaction, to assert section 141(e) as a defense to liability in duty of care and duty of loyalty cases if they reasonably relied in good faith on expert advice.
Standing at the Singularity of the Effective Time: Reconfiguring Delaware’s Law of Standing Following Mergers and Acquisitions
S. Michael Sirkin; 69(2): 429-474 (February 2014)
This article examines the doctrine of standing as applied to mergers and acquisitions of Delaware corporations with pending derivative claims. Finding the existing framework of overlapping rules and exceptions both structurally and doctrinally unsound, this article proposes a novel reconfiguration under which Delaware courts would follow three black-letter rules: (1) stockholders of the target should have standing to sue target directors to challenge a merger directly on the basis that the board failed to achieve adequate value for derivative claims; (2) a merger should eliminate target stockholders’ derivative standing; and (3) stockholders xi of the acquiror as of the time a merger is announced should be deemed contemporaneous owners of claims acquired in the merger for purposes of derivative standing. Following these rules would restore order to the Delaware law of standing in the merger context and would advance the important public policies served by stockholder litigation in the Delaware courts.
Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.
As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.
As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.
As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.
Finding the Right Balance in Appraisal Litigation: Deal Price, Deal Process, and Synergies
Lawrence A. Hamermesh and Michael L. Wachter, 73(4) 961-1010 (Fall 2018)
This article examines the evolution of Delaware appraisal litigation and concludes that recent precedents have created a satisfactory framework in which the remedy is most effective in the case of transactions where there is the greatest reason to question the efficacy of the market for corporate control, and vice versa. We suggest that, in effect, the developing framework invites the courts to accept the deal price as the proper measure of fair value, not because of any presumption that would operate in the absence of proof, but where the proponent of the transaction affirmatively demonstrates that the transaction would survive judicial review under the enhanced scrutiny standard applicable to fiduciary duty-based challenges to sales of corporate control. We also suggest, however, that the courts and expert witnesses should and are likely to refine the manner in which elements of value (synergies) should, as a matter of well-established law, be deducted from the deal price to arrive at an appropriate estimate of fair value.