Responding To Hostile Takeovers
Elizabeth M. McGeever and Eric M. Andersen
A. Introduction
1. Directors of corporate takeover targets are frequently sued by hostile bidders
or their own stockholders, or both. Frustrated bidders and/or the target’s
stockholders typically allege that the directors are breaching their fiduciary
duties by either opposing the bid or promoting an alternative transaction. The
legal standard that is applied to the directors’ conduct may be outcome determinative of the suit including, as is often the case, whether an injunction is
entered with respect to any defensive maneuvers in which the target may
engage. In the litigation, the directors will argue for application of the protective business judgment rule. Bidders and stockholders, on the other hand,
will argue for one of the stricter judicial standards of review.
2. In Delaware, the actions of the target’s board will be measured under one
(or sometimes a combination) of the following standards: (a) the business
judgment rule; (b) an “enhanced scrutiny” standard (either Unocal, Blasius,
Elizabeth M. McGeever is a partner in the Wilmington, Delaware, law firm of Prickett, Jones &
Elliott, P.A. Eric M. Anderson is an associate with Prickett, Jones. © Copyright 2005 Elizabeth M.
McGeever.
A complete set of the course materials from which this outline was drawn may be purchased
from ALI-ABA by calling 1-800-CLE-NEWS and asking for customer service. (Have the order code
CK080 handy). Or order online at www.ali-aba.org/aliaba/CK080.htm.
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February 2006
or Revlon); or (c) the entire fairness standard. The business judgment rule
and the entire fairness standard are deeply engrained corporate law concepts used to evaluate many types of directorial conduct, not just defensive
measures. The various “enhanced scrutiny” standards, on the other hand,
are products of the 1980s takeover decade. In 1985, the Delaware Supreme
Court decided the seminal case of Unocal Corp. v. Mesa Petroleum Co., 493
A.2d 946 (Del. 1985). Unocal created a review standard that enables courts to
do something that is ordinarily not permitted under Delaware law: examine the substantive reasonableness of directorial decisions. Moreover,
Unocal requires that the board justify the reasonableness of actions taken in
response to a takeover threat.
3. In the last 15 years, courts in Delaware and elsewhere have applied Unocal in
a variety of factual situations. Variations on the Unocal theme were developed
in two other significant and often cited cases, Revlon, Inc. v. MacAndrews &
Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), and Blasius Indus. Inc. v. Atlas
Corp., 564 A.2d 651 (Del. Ch. 1988). At this point, there are hundreds of cases
analyzing directorial responses to takeover bids. For those who practice in the
area, the jargon and legal analyses are familiar. For others, however, an
overview of the legal principles that come into play when directors respond
to a hostile takeover may be useful. Section B of this outline attempts to do
that and discusses recent cases. Section C discusses the Delaware Business
Combination Statute, 8 Del. Code Ann. Tit. 8, §203, and recent decisions involving that important statute.
B. The Standards Of Review
1. The Business Judgment Rule
a. One of the fundamental principles of the Delaware General Corporation
Law is that the business affairs of a corporation are managed by the board
of directors. 8 Del. Code Ann. Tit. 8, §141(a). The business judgment rule is
a corollary common law precept. It creates 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.” McMullin v. Beran, 765 A.2d 910, 916 (Del.
2000) (quoting Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)).
b. The business judgment rule applies when a majority of the board is not
personally interested in the transaction before it and the board exercises
due care by making an informed decision.
Responding To Hostile Takeovers 45
c. When the business judgment rule applies, a reviewing court will not disturb the board’s decision by substituting its own view of what is best for
the corporation. Aronson, 473 A.2d at 812.
d. The business judgment rule applies to certain board action taken in the
context of a corporate takeover. Pogostin v. Rice, 480 A.2d 619, 627 (Del.
1984).
e. The business judgment rule may apply even if the board’s action hinders
a corporate takeover.
i. A prime example is when a board rejects an offer, even a premium
offer, based on a good faith, informed decision that the offer is not in the
company’s best interest. See e.g., Pogostin, 480 A.2d at 627; Gagliardi v.
Trifoods, Int’l, Inc., 683 A.2d 1049, 1055 (Del. Ch. 1996).
ii. In Williams v. Geier, 671 A.2d 1368, 1375-76 (Del. 1996), the Delaware
Supreme Court held that the business judgment rule applied to a board’s
decision to approve and recommend that stockholders adopt a recapitalization plan that provided for “tenure voting.” Under the recap plan,
shares held by stockholders of record were given 10 votes per share; however, if the shares were sold or transferred, they would revert to one vote
per share until held by the purchaser for at least three years. Although the
plan made a takeover more difficult by putting greater voting power in the
hands of long-term stockholders, the court applied the business judgment
rule because the board did not act unilaterally in implementing the recap.
Rather, the board submitted the plan to stockholders for their approval.
2. The “Enhanced Scrutiny” Standards. There are a variety of circumstances when
the business judgment review standard gives way to a more direct and active
judicial review of directors’ conduct. In these situations, directors’ conduct is
subject to enhanced scrutiny to ensure that it is reasonable before the protections of the business judgment rule may be conferred. As explained below, the
enhanced scrutiny standards are usually referred to by the names of the cases
in which they were initially articulated.
a. The Unocal or “Intermediate” Standard
i. Board action that is taken in direct response to a takeover bid will be
subject to enhanced judicial scrutiny under a standard that is sometimes
called the “intermediate” standard of review or the “Unocal” standard.
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February 2006
This standard was first articulated in Unocal Corp. v. Mesa Petroleum Co.,
493 A.2d 946 (Del. 1985), a case involving Mesa Petroleum’s attempt to
take over Unocal Corp. through a two-tier, front-end loaded tender offer.
Unocal reacted to Mesa’s bid by making a self-tender for its own shares
which excluded Mesa. The Supreme Court reversed the issuance of an
injunction against the self-tender and held that the selective stock repurchase was reasonable in relation to the threat posed by Mesa’s coercive,
inadequate offer and, therefore, Unocal’s directors’ action should be measured by the business judgment rule.
(1) Under Unocal, the business judgment rule does not automatically apply to the board’s action even if a majority of the board is disinterested and the board acts in an informed manner.
(2) Rather, the Unocal standard requires that the board meet a twoprong threshold: first, the board must show that the takeover posed a
threat to the corporation; second, the board must show that its
response was reasonable and proportionate to the threat posed. Id. at
955. If these elements are satisfied, the business judgment rule will
apply and deference will be accorded to the board action unless the
plaintiff shows that the business judgment rule is inapplicable
because the board action results from breaches of its duty of care or
loyalty. Id. at 958; see also Omnicare, Inc. v. NCS Healthcare, Inc., 818
A.2d 914, 930-32 (Del. 2003); Unitrin, Inc. v. American General Corp., 651
A.2d 1361, 1373 (Del. 1995). Conversely, if the board action fails to satisfy Unocal’s heightened scrutiny, it may still be upheld if the board
shows the action was entirely fair. Unitrin, 651 A.2d at 1377 n.18; but
see In re Gaylord Container, 753 A.2d 462, 477 (Del. Ch. 2000) (questioning the logic of further judicial review of board action after a
Unocal analysis has been made and noting that, in practice, a Unocal
analysis usually disposes of all issues).
(3) In examining the “threat analysis” prong of Unocal, courts look
to see if the board acted in good faith and made a reasonable investigation of the perceived threat. Under the “proportionality” prong,
courts review the importance of the corporate objective that is
threatened and the impact and the economic rationality of the
defensive action. E.g., Mentor v. Quickturn, 728 A.2d 25, 40 (Del. Ch.
1998), aff’d. on other grounds, sub nom., Quickturn v. Shapiro, 721 A.2d
1281 (Del. 1998).