M&A – Rock
1.11.07
Self-dealing
Basic self dealing
Executive compensation
Corporate opportunity
Kors v. Casey (DE Chanc. 1960) –
L&F is cosmetics manufacturer, UW is a customer who buys up over 10% of LF stock;
UW notorious for coercing suppliers into giving it better deals than anyone else...LF
suspects that UW is buying up stock to have some sort of control to get this done  is
this illegal? No, so long as UW is just voting their shares. Plus it’s not exactly clear how
UW could use their 16% to exert influence, certainly not as clear as if they had 51%.
LF’s concern is probably that UW will eventually accumulate more than 16%. If UW did
get majority control and UW’s directors began to throw their weight around, that would
be a violation of the duty of loyalty.
Aggressive controlling shareholders can make life miserable for other shareholders or
executives without directly violating the duty of loyalty (imperfect system that catches
some cases but not all)
So LF is worried about UW taking a substantial position that would hurt minority
shareholders; LF buys back their shares from UW
Cheff v. Mathes (DE Sup. Ct. 1964) –
Cheff is CEO and 18.5% shareholder (effective control) of Holland, Maremont owns
11% and wants to merge, but turns out Maremont is notorious for acquisition and
liquidation. Cheff buys back Maremont shares, he says it’s because Maremont
represented a threat to Hollandl shareholders beef is that Maremont is offering a
premium for their shares and don’t like that Cheff is buying back shares with corporate
funds
Possible problems:
Extortion
BOD entrenchment
Court says reasonable grounds to believe that a danger to corporate policy existed and
held that BOD had good faith belief that Maremont represented a threat
In both Kors and Cheff, some shareholders are able to sell their shares back for higher
price than other shareholders would get (UW and Maremont)
Unocal v. Mesa Petroleum Co. (DE 1985) – (Discriminatory self-tender) Two-part
Unocal std (std of review for most hostile takeover cases): good faith belief in true threat
to corporation + proportional defensive response to threat posed
FACTS: Mesa owns 14% of Unocal, and wants to take over Unocal. This is a two-tier
front-loaded tender offer: Mesa offers the shareholders $54/share for 37% of the shares
and the rest would be financed through junk bonds (highly leveraged debt) (the back end
debt would be deeply subordinated debt that would not trade on the open market value:
not $54/share, much less). The Unocal board responds with a discriminatory self-tender,
offering $72/share to anyone but Mesa (a defensive measure), which cannot tender its
14% (a discriminatory self-tender) – would leave Mesa the sole SH of severely diluted
shares, making it economic suicide for Pickens to proceed.
 ISSUE: (1) Did the Unocal BOD have the power and duty to oppose a takeover
threat it reasonably perceived to be harmful to the corp’n? YES (2) Is the action
entitled to the BJR? YES
o Mesa arg: violation of fiduciary duty. Directors receiving benefit by
tendering own shares and treating SH differently.
o Unocal arg: no duty of fairness to Mesa in situation. Reasonable,
informed, GF, independent etc.
 HELD: Findings show that the BOD, consisting of a maj of independent
directors, acted in good faith after reasonable investigation (long mtg, w/ bankers
& Del lawyers) found that Mesa’s tender offer was inadequate and coercive. The
BJR applies as long as…there is a danger to corporate policy due to a threatening
shareholder. Here, the threat was that the shareholders were being coerced into
accepting the front-end cash to avoid having to accept the back-end junk bonds.
o RULE:
 The BOD must believe in good faith, after reasonable review
there is a true threat to the corporation; and
 Proportionality review: reasonable reaction in relation to the
threat posed.
o §141(a), BOD manages the corp, so if standard met  BJR
o Two-tier front-loaded tender offer is structurally coercive. Since these
types of tender offers coerce the shareholders to sell, self-tender excluding
Mesa was reasonable response. By allowing Mesa to participate, BOD
would essentially be financing the hostile offer
o Under Del: *MAY deal selectively w/ SHs provided that the directors are
NOT acting w/ primary purpose of entrenching themselves
o BJR IS applicable in takeover context – BOD duty to protect corp here is
NO different than its other responsibilities
 Although inherent COIs exist (b/c if taken over, BOD would lose
jobs), IF BOD satisfies burden of GF and reasonable investigation,
still get BJR
 The court is asserting this is similar to a duty of care case: if the Unocal Standard
is met then the BJR standard is applied. Court applies an intermediate level of
scrutiny before allowing the presumption of the BJR to apply. Entrenchment is
not viewed as classical self-dealing: you are not on both sides of the transaction.
Once you get the BJR, hostile bidder would likely not be able to rebut the selfinterested portion of the BJR.
Today: While this discriminatory self-tender was judicially approved, in response, an
irate SEC passed Rule 14d-10 (William’s Act), which opens tender offers to all
shareholders equally: the tender offer must be open to all security holders. The bidder
under this rule does not include issuer.
Tender offer of issuers Rule 13e-4(f)(8)(i) no issuer or affiliate shall make a tender offer
unless open to all security holders.
NOTE: court relies on Cheff v. Mathes, Bennett v. Propp, Johnson v. Trueblood --- the
old ideas we have discussed.
 The reiteration of 2 common principles: (1) sole or primary purpose to perpetuate
control is impermissible AND (2) technically permissible action can’t be taken for
inequitable purposes
Applying Unocal Proportionality Standard to Unocal
 Threat: inadequate price, back-end threat, offer is structurally coercive
 Defense: Self Tender ($72 in own junk bonds). BUT was this self-tender
coercive? YES – coercive & dilutive!
o If Mesa goes thru, then they have to take U’s better offer
o If Mesa doesn’t go forward, but Unocal self-tender’s anyways, they still
have to take it bc the remaining shares will STILL be diluted
 Court just seems to glide over this fact
 Maybe the difference is that ownership doesn’t change. Sort of
like a dividend that makes the pie smaller
 Goal of action: protect SH that wind up in the back end – give them what they are
due
o Court found that “Mesa started it” so BOD had to protect other holders --Mesa cant then equitably complain about being mistreated
Questions left after Unocal
 What is a cognizable threat justifying defensive action? What counts?
o What makes a bid “bad”?? From Unocal:
 inadequate offer
 structurally unfair/awkward
 lack of voluntariness
 nature of timing
 questions of illegality
 EX: antitrust
o could mean a problem stalling the deal, harming the
SHs by not allowing sale, linked with nonconsummation
o BUT this may not really be enough to justify such a
harsh action on its own
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Constituencies other than shareholders – what are these, and how
do you weigh these?
 risk of non-consummation
 quality of securities
 (and also basic stockholder interests, like those of short term
speculators)
o Who determines offer price inadequacy?
o How is it determined? What is the measure? Ask an investment banker?
Do what is done in appraisal actions – appraise fair value of the shares…
 does the board just make it up, believe anything an Ibanker says?
 going concern value? Current 3rd party sale value? Anticipated
future sale value? Even if current offer is fair according to present
standards, board may see timing for sale as bad due to cyclical
downturns or whatever.
Is burden of proving “good faith, reasonable investigation” meaningful? Couple
of bankers and board members and lawyers come together and decide? How does
the court decide? when will good faith and reasonable investigation really the
same as BJR?
Is proportionality subjective or objective? Should ct. look to their own opinion or
just look to what board decided.
does it include a “least drastic means” requirement? Ct. looking to see that a
lesser step would have sufficed.
whose interests can be considered?
When does Unocal apply?
 EX: anti-takeover voting charter provision – such as tenured voting
o subject to Unocal scrutiny? It is clearly defensive.
 BUT Williams v. Geier – NO – only applies to unilateral board
action
 EX: sale of key division of a company – one that a bidder would care
o initiated/approved after tender offer – YES
o initiated/approved before tender offer but after rumors about bids in the
industry - ???
o approved after tender offer, but sale process initiated “on a clear day”
 directors do/do not invoke offer threat – what if they don’t say that
they did it in response to a threat, that it was part of ordinary
business
 EX: golden parachutes
o approved following tender offer
o approved “on a clear day” as part of general planning of defensive
measures (pill, etc)
o approved “on a clear day” by compensation committee in review of
executive compensation
Criteria for invoking Unocal scrutiny
 director’s subjective defensive intent


objective threat of takeover
objective defensive effect – impact of director action
Timeline:
4/8/85 – Mesa acquires 13% and commences tender offer for 37% of outstanding stock
for 54/share (in excess of current MP, prob around 45), 54 in bonds for the latter 49%
4/13/85 – Unocal BOD meets to consider tender offer; meets w Goldman Sachs and
determines that stock is worth at least 60, offer inadequate and perceives offer as threat
and puts defensive measures in place
 reasonable conclusion?
 Structure of the tender offer was coercive
o First 37% to sell get 54 in cash, the rest get 54 in bonds, but bonds will
essentially be junk bonds that are only purportedly worth 54, BOD knows
they’re really only going to be worth market price (prob something more
like 45)
Minority shareholders who can’t get 54 might bring 10b5 (fraud) claim against
Mesa…Mesa said in an SEA disclosure that the bonds issued would be worth 54 and that
turned out not to be truthful. However, if properly drafted, Mesa could skirt liability so
long as factors used to determine price were noted and estimated in good faith
Suppose BOD is right about junk bonds; also suppose that Pickens would be a better
manager and that under his mgmt the company would be worth 60 a share, and
everybody knows this because of his record; if you’re a shareholder, you’d want NOT to
sell at 54. Stay in the company and wait for the value of your shares to go up. If each
shareholder thinks the same way, Pickens won’t get control.
Collective action problem that the bidder for control faces: shareholders will have an
incentive not to tender in order to take a free ride on the bidder’s efforts
 SOLUTION: front end loaded, two-tiered tender offer
o Get rid of the possibility that remaining shareholders will get 60…give
them bonds for 54
o Or acquire 51% and do freeze-out merger – essentially same effect as first
option
Mills Acq’n Co v. MacMillan (Del 1989) – Management should stay out of the bidding
process; when “favoritism” = lockup options + bidding scripts + tip-offs (and unfavored
hostile offer is not coercive), the corporate auctioneers are breaching their duty of care
under Unocal (and maybe duty of loyalty) by unjustifiably messing with the process
FACTS: Bidding contest btwn hostile bidder (Maxwell) and MBO group (KKR/senior
execs) for MacMillan. Maxwell wants to enjoin lockup agmt between MacMillan and
KKR (lockup refers to the option granted by seller to buyer to purchase a target
company’s stock as a prelude to a takeover, major or controlling shareholder is then
effectively locked up and is not free to sell the stocks to a party other than the designated
buyer); Auction deadline set (Revlon kicks in) – “scripts” to tell bidders. Max at $89;
KKR $89.50 (blended) with lockup conditions. Advisors decide to continue b/c bids just
too close. Macmillan’s CEO & COO tip KKR as to what Max’s bid is. Pirie (Maxwell’s
rep) asked Wasserstein if his bid was tops, and Wasserstein refuses to tell him BUT leads
him to believe that they are tops and they shouldn’t bid against themselves. KKR bids
$90, w/ lockups; no new Maxwell bid. Next day, BOD approves KKR w/ lockups; no
disclosure of tip to BOD despite Evans/Reilly sitting there. BOD presents offer to SHs.


o Reaction: Maxwell bids $90.25 after announcement (conditioned on
lockup invalidation)
o Chancery: disgusted by conduct of CEO BUT “no harm, no foul”:
Maxwell had last clear chance to bid – and the auction must end at some
point.
 Implicit view: Maxwell is effectively seeking to use the concluded
auction as a “tip”
ISSUE: validity under the circumstances of the lockup option given to KKR
HELD: injunction granted: CEO breached fiduciary duties of care, loyalty under
Unocal, Revlon by playing favorites with contending bidders
o Unocal – Maxwell’s offer was not coercive and not shown to adversely
affect shareholders interests, so BOD’s action completely unjustified
o Revlon – favoritism not justified, BOD has duty to get highest value
reasonably attainably for SHs
LESSONS of MacMillan
 BOD must be actively involved in sale process, especially if mgmt participates in
bidding
 If reliance is on outside directors, watch for mgmt selection of/influence on
advisors (fin & legal)
 Auctions do NOT need to be formulaic – not all disparate treatment of bidders is
bad
o HOWEVER – ALL auctions are governed by Unocal standards
 Explicit premise: shift of control
 Implicit premise?: deal responds to hostile bid
 Recasting Unocal standards for this case
o Favoring a bidder is a trigger for application of Unocal in the company
sale context:
 First prong: did directors properly perceive that disparate
treatment would enhance SH interests?
 Second prong: was BOD action “reasonable in relation to the
advantage sought to be achieved?”
 Was giving the lockup to get extra $1/share reasonable??
Gaillard v. Natomas Company – Valid uses of Golden Parachutes and Directors’ duty of
inquiry regarding their adoption and implementation
FACTS: Merger of Natomas into Diamond Shamrock; SHs of each complain about
golden parachutes and other benefits provided to 5 inside Natomas directors as part of
merger; during negotiations, DS agreed to withdraw hostile TO and instead agreed to
friendly stock for stock merger and Natomas wanted golden parachutes packages for its
key execs like the ones DS execs had, even though Natomas execs already had golden
parachute agmts in place; Natomas BOD approved, with 5 inside members present but
abstaining, sent proposal to SHs and they approved; all 4 key execs who got the GP
agmts as incentive to stay terminated employment shortly afterward (they say it’s because
DS was going to install a new COO that they didn’t know about or agree to beforehand)
SHs allege that adoption of GP agmts constituted a breach of fiduciary duty by all 19
Natomas directors, waste, mismanagement, negligence, conversion
RULE: BJR for does not immunize director from liability in the case of his abdication of
corporate responsibilities – director cannot close eyes to what is going on about him in
the conduct of the business of the corp and have it said that he is exercising business
judgment ; uses CA Corp. Code §309 to review conduct of outside directors
2 principle recognized functions of golden parachutes:
1) to foster executive objectivity toward merger and tender offers
2) to attract top execs to companies and industries where the odds of takeover are
high
 however, a parachute conferred following a tender offer will likely have little
value in creating executive objectivity because the execs generally already will
have taken an initial position on the takeover before the GPs are adopted, so to
serve the first purpose, GP agmts should be offered as part of the executive’s
overall compensation package before negotiations take place

outside directors’ actions will be reviewed by §309 (whether the record discloses
controverted issues of fact as to whether the directors acted in a manner they
believed to be in the best interests of Natomas and with such care, incl. reasonable
inquiry, as an ordinarily prudent person in a like position would use under similar
circumstances; and, whether, in relying on various sources, they made reasonable
inquiry if the need therefore was indicated by the circumstances)
o Court says outside directors were not justified in relying to the extent
they did upon Natomas’ outside counsel in approving the golden
parachutes, and that the circumstances warranted further inquiry
 The GPs would not serve recognized valid functions of GPs, they
were provided to existing execs, so function of attracting top level
mgmt was not served, either
 The “good reason” condition of leaving Natomas was so broad as
to provide execs with a ready justification to terminate their
employment and collect the benefits
 The GPs payable to 3 of the officers would be considered
excessive for tax purposes (more than 3 times salary)


Compensation committee members should have been aware that
one of the inside directors who was to benefit from the GP had
proposed the amendment of the employment agreement
o All of the above should have tipped off the compensation committee to
something fishy, unreasonable to think further inquiry was
unnecessary
Even though those not on the compensation committee were entitled under §309
to rely upon compensation committee’s recommendation, they should still have
been on alert to the suspicious circumstances under which proposal of GPs
occurred (after tender offer and in midst of merger negotiations)
NOTE: Tin parachutes – severance plans for lower level employees; can be justified as
having business purpose of preserving morale and stability of highly trained and mobile
staff that is crucial to company’s success
INFORMATIONAL DUTIES OF DIRECTORS: Duties of a BOD in exchange for the
power to bind assets of the Corporation
RMBCA § 2.02(b)(4) and § 8.30; DGCL § 102(b)(7): Corps can write out duty of care
liability (for acting stupidly/sloppily) in the incorporation documents, and usually do, but
may NOT write out liability for breach of duty of loyalty, intentional misconduct or
knowing violation of law, paying unlawful dividends, or any transaction where director
receives improper personal benefit
Smith v. Van Gorkom (Del 1985) - (Direct suit) Directors held personally liable for a
rational decision (no allegations of bad faith or self-dealing) on claim that they were
grossly negligent in failing to inform themselves of the details of the merger by failing to
do a market test for price of shares (defect in the decisionmaking process…decision made
by a board of directors must be reasonably informed to gain protection under the BJR.)
FACTS: Πs, shareholders sue Directors after merger of their company into another. Van
Gorkom, CEO, about to retire, decided to look into getting bought out. He shared the
idea with senior management and a very small amount of research was done; CFO saw
$50/share as a good price. He determined a price of $55/share while talking only with
one officer and consulting with one outside advisor. No study was done to determine the
value that the share could reach. Senior management entirely opposed the deal. A deal
was signed on this basis, and no other firm offers came up. The Board approved it after a
two hour meeting, without seeing the specifics of the deal and relying entirely on Van
Gorkum’s oral presentation. No market test of the stock was done. Van Gorkum was a
pal with Pritzker, the individual who was in charge of the purchasing company
 the DE SC finds that there was no fraud or bad faith on the part of the Board, but
that it was grossly negligent in failing to inform themselves as to the
transaction they were approving
o if Van Gorkum had done a market test and had presented sound evidence
to the Board, his opinion as to the deal could be relied upon via §141(e)
o the uninformed state of the Directors means that the BJR does not apply
here
 the problem here was not that the price was bad; it was that the decision-making
process was defective
 BOD breached duty of care by allowing Van Gorkum, an insider, to promote the
deal & set the price, while never making an effort to uncover corporation’s value:
o (a) CEO provided only a 20-minute presentation regarding the merger
(didn’t even review the documents,
o (b) the BOD failed to inquire into Van Gorkum’s role in the merger,
o (c) BOD didn’t inquire into whether the price was fair (no opinion from an
I.B.) and
o (d) the BOD signed merger agreement very quickly (approved in a 2-hour
meeting).
 although there was a shareholder vote here, it does not operate as effective
ratification because it was itself defective
 on remand, the fair value of the company had to be assessed so as to determine
damages
The point here is that the court will look at the process, not the substance, of the deal
 with this finding of the duty of care, Chancery on remand had to determine
whether there were damages; it did this under entire fairness scrutiny
o it found damages, and Pritzker, the buyer, ended up paying them
This decision threatened the very fabric of corporate law; Directors like to think
that if they make a decision in good faith, the courts will not reverse it
 Directors began having trouble getting insurance to cover themselves
So the DE legislature stepped in to save the day, effectively overruling this decision:
DGCL §102(b)(7) noted that the certificate of incorporation could include:
 a provision eliminating or limiting the personal liability of a director to the
corporation or its stockholders for monetary damages for breach of
fiduciary duty as a director  except for the breach of loyalty, good faith,
or for any improperly-derived personal benefit
 this effectively removes duty of care liability
 a Π would now have to claim that the Director acted in bad faith or
with an intent to harm the corporation, and not just stupidly or
sloppily (must show more than breach of duty of care)
o Must be in the articles of incorporation, the corporation cannot just put it in, the
shareholders are going to have to vote for it.
 NO shareholder group voted down a § 102(b)(7) amendment to the articles of
incorporation – virtually EVERY corporation has it! Otherwise no one would
serve as a director, or they would always make risk-averse decisions
What are the enduring lessons from Smith v. Van Gorkom?
o Stock market premium does not validate a deal.
o The market price almost always prices a corp’s stock at 55-60% of what a
hostile bidder would pay for it. All that market price tells you is how
stocks match up with other stock based on all available outsider
information, but it’s no gauge on what you can get for your shares. The
winning bidder has always paid too much.
o Even if you get a better price, the rule can’t be premised on market price
alone
o Shareholder ratification matters.
o Need to do things correctly, even if no foul. Everything the board did was wrong
in terms of today’s norms.
o RULE: More deliberation and inviting in an ibanker to tell you what the value of
the company is would help, but to be fully informed, a court will want to see that
the BOD contacted a sufficient number of prospects (in Revlon, 100) and made a
good faith attempt to solicit the highest price offer
Revlon, Inc. v. MacAndrews & Forbes Holdings: “end-game”/all cash tender offer
(shareholders have no further interest in corp) and it is clear management is selling the
company, duty of care requires the BOD sell to the highest bidder. The defensive
measures taken in this setting must be made in order to attain the highest price.
FACTS: Revlon’s BOD took several actions to thwart a hostile takeover attempt by
Pantry Pride/Perelman, who was willing to bid highest price necessary to gain control of
Revlon. MacAndrews, controlling shareholder of PP, sought injunction to enjoin Revlon
BOD’s lockup option to white knight Forstmann (no-shop option agreements designed to
enhance Forstmann’s efforts at a friendly “White Knight” takeover).
 BOD of a target may conclude a takeover is not in best interests of corp, and they
are free to take defensive actions to prevent the takeover as long as they act with
due care.
o BOD may consider other constituencies (white knights) as long as they are
rationally related to benefits accruing to the shareholders
o HOWEVER, once corporate dissolution becomes inevitable, BOD
must allow the market to operate freely to bring shareholders of the
target to gain the best value for their equity. In a cash-out tender
offer setting the BOD should let the highest bidder take control.
o As applied: Revlon was going to be dissolved, but the BOD still favored
the “White Knight,” and this decision to favor Forstmann does not gain
the presumption of the BJR.
NOTES: This is a duty of care case – Court imposing process requirements on corps in
certain kind of situation (“end-game”)
 Lockup options are probably OK so long as they’ve done an adequate search for
competing offers when an attractive bid is received
Barkan v. Amsted Industries (DE 1989): Revlon does not demand that every change in
control be preceded by a heated bidding contest – when BOD has body of reliable
evidence to evaluate fairness of transaction (e.g., bidding period open for a while but no
bids, ESOP sought as way to maximize benefit to SHs, financing hard to get at proposed
deal price), it may approve the transaction w/o market survey
FACTS: Hurwitz (interested acquirer) was a known shark/greenmailer to ibankers:
bought stock and sought control of the company; in defense, BOD considered mgmtsponsored LBO (MBO) involving an ESOP (most of purchase financed on borrowed
funds from Banks, who give lower interest rates). Found an MBO house to buy the
company at a higher bid, but the original shark agreed to accept the MBO’s price if the
suit involved with this case were settled. Further, there was an opinion from Goldman
stating the offer was at the high end of what the company was worth.
 HELD: approved the settlement – when the offer was made, the directors could
conclude, in good faith, that they had approved the best possible deal for SH
o Revlon does NOT demand that every change in control be preceded by a
heated bidding contest – or even an explicit market check
 When the directors possess a body of reliable evidence with which
to evaluate the fairness of a transx, they MAY approve that transx
w/OUT conducting an active survey of the market
o Pertinent circumstances for when you may not need a mkt test (wont be
okay every time):
 Company was “in play” for a long period of time, with no bids
 ESOP participation enabled MBO group to pay more (tax
advantages)
 Financing was hard to get, at the ultimate deal price (indication
that bid was probably the upper limit)
 Significance of disparity b/w face value and trading value of debt
in deal package (company was high risk – probably close to Ch.
11)
In re Fort Howard Corp (Del Ch 1988) – “meaningful” market test will satisfy Revlon
FACTS: MBO bid ($53) developed in secrecy, accepted w/out exploration of other bids,
and no effort or ability to seek other bids; BUT… Special Committee rejects demand for
bidding deterrents beyond $1/sh termination fee, insists on publicizing ability to receive
competing bids during 43-day “market test” period.
 ISSUE: Is a market check sufficient as an approach to value maximization or
does BOD/Committee have to do more?
 HELD: Market Test sufficient here  to satisfy Revlon duty, directors do NOT
need to affirmatively “shop” the company before accepting a bid.
o A meaningful market test CAN satisfy Revlon
 Cf. Van Gorkom where the mkt check (going a little above market
price) was really a sham b/c there were so many obstacles that
would prevent another bid
o Termination fees of at least 2% (maybe more) do NOT per se violate
Revlon or director duties, even if granted w/out a prior mkt check
In re RJR Nabisco (Del Ch 1989) – Business decision to choose one bidder over another
in Revlon-like auction situation will not be scrutinized if directors acted with care and
good faith pursuant to SH interests (IOW – Revlon only applies to interested directors?)
FACTS: RJR CEO Johnson drops the flag, Special Committee formed, KKR counters.
Public Nov 18 deadline extended to Nov 29; negotiation w/ KKR over securities terms.
Still hard to determine b/w the bids, so one last round of bids extends to Nov 30. KKR is
started to get annoyed (its last bid has been “leaked”) and impatient – offer new bid with
a strict time limit. KKR bid $109, Mgmt group stands on prior $112 (worth $109) bid.
Spec Comm still thinks that bids are substantially equivalent BUT they know that their
time is up, are worried that KKR might simply w/draw. Spec. Comm then accepts KKR
bid. Considerations:
o KKR offered greater equity share, less cash
o Less of paid-in-kind (PIK) preferred shares
o Greater asset continuity (?)
 Maybe this makes sense – allows for them to share equity sale later
o KKR will provide benefits for execs that will be terminated as a result of
business divestitures (?)
 Shouldn’t they not be worried about this? Aren’t they only
supposed to be concerned with the SHs and no one else? Maybe
b/c the bids were “essentially the same” they were now trying to
consider what would make the most other people happy to decide
b/w (pareto optimal)
 HELD: Spec. Comm. satisfied duty of care. Since the deal seemed completely at
arm’s length  BJR. Revlon did not provide independent set of duties in
auction-setting if no other breach of duty of care/loyalty exists. Application of
earlier lessons to guide the process:
o With MBO bidder, let outside directors supervise the auction
o Mgmt takes no role in selecting committee members or their advisors
o Keep mgmt out of the auction process
o Establish, communicate and apply evenhandedly bidding rules and
deadlines
o Overriding goal – get the highest current value for SH
 Push other constituencies to the side
In RJR – bondholders take a beating; creative destruction of labor force
What is missing from RJR?
 Who are the s – where are the competing bidders (who sued in the other cases)?
This is purely a claim from SH
 Where is the lockup?
 Where’s the post-auction topping bid?
o A (big) bird in hand, none in the bush
o Plaintiffs want an injunction – stop this for what?
 Risk?
 Actions “said to be brought” on behalf of the SH of RJR? Is this a
joke?
o Fraidin theory: Del law protects the bidder-litigant w/ the top bid
Doctrinal analysis of RJR
 What happened to Unocal? Seems to have disappeared
 Due Care: no second-guessing decision not to accept the risk of losing KKR by
extending the auction
 Absent breach of care or loyalty duties in fulfilling value maximization duty 
NO violation of Revlon
 Good faith, well-advised action IS protected by BJR
SO – what is left of Revlon??
 QVC: Revlon applies to all control-shifting transactions BUT…
o The Unocal framework becomes even more generic than in MacMillan
 (1) was the directors’ decision-making process adequate?
 (2) was their decision reasonable in light of existing circumstances
o Level of deference becomes more generous
 Reasonable decision not perfect decision
 Courts not substitute their judgment for business judgment where
in range of reasonableness
 Compare evolution of Unocal to Unitrin
IF anything is left of Revlon, when should it function—triggers revisited?
 When should any kind of enhanced scrutiny happen?
o Director conflict of interest/loyalty issues? (Revlon could be explained
this way)
o The “omnipresent specter” in responses to hostile bids? (Unocal –
directors motives called into question when they react)
o Favoritism b/w bidders? (Macmillan)
 Effect of special committee involvement (compare Kahn v. Lynch)
o Probably doesn’t eliminate the need for enhanced scrutiny – in sale of
control – Sp. Comm. nice but not enough
 Does the form of the transx matter?
o 1 step merger requiring vote of SH? View vote as informed ratification?
o Tender offer response (voting with feet)?
 Should there be any enhanced judicial scrutiny of a control-shifting merger
approved by disinterested directors and disinterested SH, voluntarily and upon
full info? Prob not.
In Re Holly Farms Corp Shareholders Litigation – Auctioneer must at least talk to
hostile bidder – let him know an auction is happening; Merger between Holly and white
night enjoined because Holly never made a serious effort to negotiate with Tyson and
never told Tyson it had determined to sell Holly
Protecting the Deal
Hammer: Revlon doesn’t matter. What if the Forstmann deal had been simply a deal for
BOD to approve a merger, and SH would then approve. No lock-ups etc. W/out all the
attachments that make it difficult for others to come in (deterrents) there should have
been no judicial concern whatsoever. SO – there, in general, is little reason for courts to
get into it UNLESS there is something that creates a large deterrent to other bidders or
coerces SH. IF SH exercise free will and are disinterested – should be no enhanced
scrutiny. SO – Revlon as an abstract is much ado about nothing. The real things to care
about are the actions by the BOD that intrude upon legit domain of SH decision making -- here courts should take more aggressive review.
Option Value
HYPO: I own a house, you want to buy it. Agree on closing date (sign K) after
negotiations on price. Someone else comes along later and offers me 10K more. Am I
free to toss you aside and talk to the other guy? I could – but you would come after me for
breach of K.
 With equivalent contractual commitment, both buyer and seller share market risk
during the executory period.
 IF the seller’s commitment is weaker, the seller’s rights resemble a put option.
o You have the right to buy my house at specific price at specific time, BUT
I have more.
o Option is valuable – I have your deal in hand (protection against
downside) but I retain the option to participate if the mkt increases in
value
 The value of the option increase with duration of the option period
What does this have to do with mergers?
 Buyer commitment is usually strong
o They’ve gone thru diligence, etc.
o Buyer corp SH approval is NOT usually required, EXCEPT in large stock
for stock deals
o Buyer market risk protection is limited to bargained for MAC/MAE
clauses (Material adverse change/event)
o In the absence of fraud/misinformation of course
 In comparison, Seller/target commitment is relatively weak
o SH vote is basically ALWAYS required
o Duration of executory period can be very long
 RESULT: buyer’s cost of “granting put option” may reduce deal price (leave insr
on the table for later) OR preclude deal altogether, UNLESS buyer can increase
the seller’s commitment
o Enter lock-up, no-shop etc.
Deal Protections & Bid Deterrents
“Direct” Options to prevent a bidder
 Merger K terms limiting Target’s ability to take alternative bids

o Commitment to recommend deal to SH
o Commitment to submit deal to SH vote (even if don’t think it’s a good
deal anymore)
o No-shop agreement: Buyer says target cant go out and stir up alternative
bids. No soliciting
o Agreement not to provide proprietary info
o No-talk agreements: Seller agrees not to look, provide info AND not even
to talk to some unsolicited bidder who comes to the door
Shareholder voting/sale commitments
o Voting agmts in support of deal
o Purchase options/agmts
Economic deterrents to alternative bids (aka -- put option compensation)
 Termination fees: payable upon termination following alternative bid
announcement
 Topping fees: % of incremental superiority (part of the amount by which my bid
is topped)
 “Hello” fees: just upon signing a merger agmt – obligation to pay some amount
of $$
o can be seen as direct payment for value of the option
 Expense reimbursement: at least make bidder whole for out of pocket outlays
(pretty typical)
 Stock options: bidder gets X% of shares of target if target cancels to go with
another bidder. Original bidder is able to extract compensation from the higher
bid price – but represents some dilution to another bidder
 Asset options: (seen in Revlon – considered not inherently bad)
Paramount v. Time (DE 1989): The BJR applies when an independent BOD acts within
its sphere of competency in adopting a defensive measure, proves reasonable grounds for
believing a danger to corporate policy and effectiveness exists, and the defensive
measure is reasonable in relation to the threat posed.
FACTS: Time had been considering vertical integration for a while, found Warner to be a
great fit, and started extensive negotiations which resulted in Time’s BOD approving a
stock for stock merger w/ Warner. Time publicized lack of debt in the deal as being one
of chief benefits of the merger. Before the SH vote on Warner merger, Paramount offers
surprise bid of $175/share contingent on removal of poison pill; Time’s BOD rejected.
Time’s BOD believed Paramount’s offer threatened Time’s control over its destiny and
“Time Culture.” In response, Time’s BOD ends up funding the acquisition of Warner
through $7-10 billion in debt instead of SH vote on merger, despite the original assertion
that the debt-free nature of the deal was the attraction. Time’s BOD later rejected
Paramount’s $200/share offer, because it was inadequate and Time’s acquisition of
Warner offered greater long-term value w/o threatening “Time Culture.” Paramount and
2 Time shareholder groups sought to enjoin the merger.

ISSUE (Ct of Ch): Revlon Claim – SH plaintiffs


o ARG: Time was “in play” AND Original merger rendered Time take-over
proof (T-W is just too big), precluding any future control premium
o Chancery Ct: control remained in a “fluid aggregation of unaffiliated SH
representing a voting majority”
 NO change of control or loss of future premium  NO Revlon
ISSUE (SC of Del): Did Time put itself up for sale? NO.
o *2 triggers*
 Sale or reorganization involving a break-up
 In response to hostile bid, target abandons long-term strategy and
pursues a breakup
o Effect of “in play” concerns
 None - defensive actions don’t trigger Revlon
o Effect of recasting
 None – not abandonment of future plan
ISSUE: Unocal claims
o March merger agmt (stock for stock)
 Generally – BJR applies
 Mutual option, dry up fees, no shop
 Structural safety devices --- subject to Unocal
o Evaluation of revised deal under Unocal
 Revision was in response to Paramount’s hostile bid
 Plain defensive intent and consequence: P walks if revised
deal goes forward
 Nature of perceived threat from Paramount offer
 No structural coercion. Inadequate value?
o Predicted range of future stock values with the
Warner merger were extremely broad - ”$208-402”
(pg. 206)
o (pg. 211) – Unocal provides flexible standard –
“not just a simple mathematical exercise,” Court
won’t crunch the numbers if BJR should apply
 Substantive coercion – tendering in ignorance of true value
of Warner combo
 Uncertainty due to timing and conditions
 Threat investigation/assessment
 Failure to explore/negotiate on Paramount bid?
o Been there done that. BOD had already thought
about P combo when it was shopping, and rejected
it.
o BUT $200 cash offer is pretty different than any
perceived combo before
 Importance of BOD composition (independent)
 Good faith; not dominated by entrenchment or selfinterest
 Proportionality


NO duty to abandon a deliberately conceived plan
UNLESS NO basis to sustain the strategy
Coercive/preclusive?
o Court says NOT coercive b/c it carries forward the
pre-existing BUT they are forcing Warner onto the
SH w/out their vote
o Court says not preclusive b/c Paramount can always
later buy whole company
HELD: Time BOD’s decision upheld. The BJR applied, b/c reason to believe a merger
with Paramount would harm the “Time Culture,” and not provide long-term value, and
the defensive measures were proportionate to the threat posed.
 When the BOD’s reaction to a hostile tender offer is only a defensive response
and not an abandonment of the corporation’s existence (as in Revlon), the duties
established in the Revlon case don’t apply here.
 But the duties established in the Unocal case do apply.
o Here, the threat posed by Paramount was significant, because it could have
prevented the merger with WB.
o Further, the defensive measure undertaken was proportionate to the harm
 Paramount wasn’t precluded from bidding on the combined TimeWarner assets or from changing the terms of its offer and
eliminating the requirement that the Time-Warner deal not be
consummated
 Fact that Time was required to have much debt as a result of taking
up WB’s offer did not alone make Time’s decision unreasonable.
Subtext: what was the remedy sought??
 Paramount and SHs trying to prevent an acquisition, not about
overcoming/eliminating poison pill
o Does it make a difference?
 Business content
 Allocation of corporate authority
 Examine Chancery opinion: SEE slides – the “real rationale”
o “electing to continue with long-term plan” and NOT a new/defense
mechanism
 No evidence of corrupt or venal motive in continuing plan
o BOD in approving the acq’n of Warner in face of P offer – is exercising
typical/conventional powers given by corp’n law
o It may have been that the Time SH would have opted for the $200 offer
BUT the directors were acting in their “sphere of competency” – and are
thus not obliged to follow “polls”
 Challenging the transx interferes with the effectuation of BOD
business judgment --- no reason to do this here b/c they were w/in
their boundaries
NOTES: Time’s distinction between current share value maximization and long-term
share value maximization  BOD gets to consider the latter so long as it’s not an endgame situation
o False distinction? In any large, active, informed market, current value of stock
has already taken into account the future financial prospects of the firm
o But who knows the corp’s present and future conditions better than the directors?
Should trust them
Paramount v. QVC (Del 1994) – Revlon applied to sale of a controlling interest in a
corporation
FACTS: Paramount and Viacom enter stock for stock merger agmt after extensive
negotiations – P SHs get V stock. Several defensive provisions designed to prevent the
success of a competing bid. However, QVC proposed a merger with Paramount.
Viacom and QVC enter a bidding war for Paramount, and QVC offered the highest
amount in the end. Paramount’s BOD turned down the more lucrative offer from QVC,
because the BOD believed Paramount’s future would be affected more favorably by
merging with Viacom (this was not an “end game,” and Paramount was not dissolving
according to Paramount’s BOD). But post-merger, Redstone (V’s controlling SH) will
retain control of the combined company.
 Paramount argues: this merger is NOT a breakup (company assets intact) and
NOT an abandonment of pre-existing strategy
 Therefore – this is NOT the Time v Paramount list of “sale” circumstances
HELD: court disagrees  this is a sale of control!
o This is a sale of control b/c irrespective of the present Paramount BOD’s
vision of a long-term strategic alliance with V, the proposed sale of
control would provide a new controlling SH, with the power to change that
vision
 Emphasized acq’n of control by Redstone of Paramount
o Paramount SHs lose opportunity to achieve future sale premium
o Paramount BOD could NOT treat this as merger of equals – must treat as
sale  could NOT treat QVC bid as threat to long-term strategy
o Revlon duties exist – enhanced scrutiny is required (as in any sale of
control)!
Mendel v. Carroll (Del Ch 1994) – Revlon duties for acquisition of the corp by the
controlling SH? Nope – control is the same.
ISSUE: Does a merger agmt prescribing cash acq’n of 100% ownership by a control SH
trigger Revlon duties?
HELD: NO! Control remains unchanged – family is already in control.
o BOD had duty to protect minority in the takeout merger BUT this doesn’t
mean Revlon
o Control SH is entitled to veto outside bids
o NO duty under Revlon to obtain highest currently available value for all
SH
Essex Universal Corp. v. Yates (2d Cir. 1962): It should be OK to sell immediate
transfer of mgmt control (guarantee resignations) by selling a majority share that
corresponds
o BL: If there’s a classified board and purchaser of controlling shares would not get
to appoint majority of BoD for long time, may be able to put provision in contract
of sale that seller’s BoD people will resign.
o FACTS: Yates was president and chairman of board of Republic Pictures (was
listed on the NYSE). Essex agreed to buy his controlling interest (28.3%) in
Republic from Yates. The contract contained a provision which stated that Seller
will deliver to buyer the resignations of the majority of the directors of Republic
and will cause the nominees of buyer to be elected. Yates backed out of deal and
argued that the resignation provision violates public policy.
o HOLDING: It is definitely illegal to sell corporate office or management control
by itself (e.g. not accompanied by stock or insufficient stock to carry voting
control). Court here thinks 28.3% is significant enough amount of stock to create
a sufficient enough ownership interest that can legally warrant a guarantee control
of majority of Board. The premium here for “immediate control” was also ok
since it’s ok for a controlling shareholder to derive a premium for a controlling
block of stock. Can purchase stock and make side agreements where current
directors agree to resign and replace them with directors of purchaser. The easy
and immediate transfer of corporate control to new interests is ordinarily
economically beneficial, plus, purchaser has greater incentive to maximize
shareholder value than lame-duck directors.
o NOTE: 28.3% might not be enough. Another guy who had 39.9% and tendered
for 10% more couldn’t gain control of Board for 3 years b/c of Board and Officer
entrenchment. So not sure if Essex is supposed to stand for what is enough to
warrant majority mgmt control or what should be enough to warrant majority
mgmt control….?