The Geography of Revlon-Land

In Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., [1] the Delaware Supreme Court explained that when a target board of directors enters Revlon-land, the board’s role changes from that of “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.” [2]

Unfortunately, the Court’s colorful metaphor obfuscated some serious doctrinal problems. What standards of judicial review applied to director conduct outside the borders of Revlon-land? What standard applied to director conduct falling inside Revlon-land’s borders? And when did one enter that mysterious country?

By the mid-1990s, the Delaware Supreme Court had worked out a credible set of answers to those questions. As for the borders of Revlon-land, the Court had explained that:

The directors of a corporation have the obligation of acting reasonably to seek the transaction offering the best value reasonably available to the stockholders, in at least the following three scenarios: (1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (3) when approval of a transaction results in a sale or change of control. In the latter situation, there is no sale or change in control when “[c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.” [3]

In my article The Geography of Revlon-Land, I refer to these three scenarios as “checkpoints” through which one enters Revlon-land. The third scenario — i.e., checkpoint #3 — gets particular attention, as it is the one I argue the Delaware Chancery Court has consistently misapplied in recent years.

Outside those three situations, which do not even encompass all corporate control auctions, the Court’s older Unocal test remains the defining standard, as the court elsewhere emphasized by flipping the Revlon metaphor around:

When a corporation is not for sale, the board of directors is the defender of the metaphorical medieval corporate bastion and the protector of the corporation’s shareholders. The fact that a defensive action must not be coercive or preclusive does not prevent a board from responding defensively before a bidder is at the corporate bastion’s gate. [4]

Turning to the directors duties once they enter Revlon-land, that Court made clear that Revlon is properly understood as a mere variant of Unocal rather than as a separate doctrine. [5] Having said that, however, application of the reasonableness standard does differ somewhat in cases falling within the borders of Revlon-land than in those governed by Unocal. As the Delaware Chancery Court has observed, this is so because in the former a court must assess “a director’s performance of his or her duties of care, good faith, and loyalty in the unique factual circumstance of a sale of control over the corporate enterprise.” [6]

In this article, I argue that these seemingly settled rules made doctrinal sense and were sound from a policy perspective. Indeed, my thesis herein is that Revlon and its progeny should be praised for having grappled — mostly successfully — with the core problem of corporation law: the tension between authority and accountability. A fully specified account of corporate law must incorporate both values. On the one hand, corporate law must implement the value of authority in developing a set of rules and procedures providing efficient decision making. U.S. corporate law does so by adopting a system of director primacy. [7]

In the director primacy (a.k.a. board-centric) form of corporate governance, control is vested not in the hands of the firm’s so-called owners, the shareholders, who exercise virtually no control over either day-to-day operations or long-term policy, but in the hands of the board of directors and their subordinate professional managers. [8] On the other hand, the separation of ownership and control in modern public corporations obviously implicates important accountability concerns, which corporate law must also address.

Academic critics of Delaware’s jurisprudence typically err because they are preoccupied with accountability at the expense of authority. In contrast, I argue herein that Delaware’s takeover jurisprudence correctly recognizes that both authority and accountability have value.

Achieving the proper mix between these competing values is a daunting — but necessary — task. Ultimately, authority and accountability cannot be reconciled. At some point, greater accountability necessarily makes the decision-making process less efficient. Making corporate law therefore requires a careful balancing of these competing values. Striking such a balance is the peculiar genius of Unocal and its progeny, including Revlon.

In recent years, however, the Delaware Chancery Court has gotten lost in Revlon-land. A number of Chancery decisions have drifted away from the doctrinal parameters laid down by the Supreme Court. [9] In this article, I argue that they have done so because the Chancellors have misidentified the policy basis on which Revlon rests. Accordingly, I argue that Chancery should return to a correct understanding of Revlon that recognizes it is based on a conflict of interest-based approach, which focuses on where control of the resulting corporate entity rests when the transaction is complete.

As a doctrinal matter, such an approach would recognize that checkpoint #3 is not dependent on the form of the consideration paid by the acquirer. If dispersed shareholders own the post-transaction combined entity in “a large, fluid, changeable and changing market,” Revlon does not apply. If the post-transaction entity has a controlling shareholder, however, regardless of whether the corporation goes private or remains listed on a stock market, Revlon does apply. In other words, there must be a change of control, whether by sale or otherwise.

The full paper is available for download here.

Endnotes

[1] 506 A.2d 173 (Del. 1986)
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[2] Id. at 182.
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[3] Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1289-90 (Del. 1994) (citations, footnotes, and internal quotation marks omitted).
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[4] Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361, 1388 (Del. 1995). In Unitrin, the target’s board had adopted a poison pill, amended the bylaws to add additional defenses, and initiated a defensive stock repurchase. The Chancery Court found the latter “unnecessary” in light of the poison pill, but the Supreme Court reversed. Id. at 1367. The Supreme Court held that “draconian” defenses — i.e., those that are “coercive or preclusive” — are invalid per se. Id. at 1387. Defenses that are not preclusive or coercive, however, are to be reviewed under QVC’s “range of reasonableness” standard. Id. at 1387-88.
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[5] QVC Network, Inc. v. Paramount Commc’ns Inc., 635 A.2d 1245, 1267 (Del. Ch. 1993) (“The basic teaching of Revlon and Unocal ‘is simply that the directors must act in accordance with their fundamental duties of care and loyalty.’”), aff’d, 637 A.2d 34 (Del. 1994).
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[6] In re Lukens Inc. Shareholders Litig., 757 A.2d 720, 731 (Del. Ch. 1999)
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[7] On my theory of director primacy, see Stephen M. Bainbridge, The New Corporate Governance in Theory and Practice (2008). On director primacy in the context of corporate takeovers, see id. at 134-54.
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[8] See Stephen M. Bainbridge, Director Primacy and Shareholder Disempowerment, 119 Harv. L. Rev. 1735 (2006). In that article, I respond to Lucian Bebchuk’s recent article The Case for Increasing Shareholder Power, 118 Harvard Law Review 833 (2005). In that article, Bebchuk put forward a set of proposals designed to allow shareholders to initiate and vote to adopt changes in the company’s basic corporate governance arrangements.

In response, I make three principal claims. First, if shareholder empowerment were as value-enhancing as Bebchuk claims, we should observe entrepreneurs taking a company public offering such rights either through appropriate provisions in the firm’s organic documents or by lobbying state legislatures to provide such rights off the rack in the corporation code. Since we observe neither, we may reasonably conclude investors do not value these rights.

Second, invoking my director primacy model of corporate governance, I present a first principles alternative to Bebchuk’s account of the place of shareholder voting in corporate governance. Specifically, I argue that the present regime of limited shareholder voting rights is the majoritarian default and therefore should be preserved as the statutory off-the-rack rule.

Finally, I suggest a number of reasons to be skeptical of Bebchuk’s claim that shareholders would make effective use of his proposed regime. In particular, I argue that even institutional investors have strong incentives to remain passive.
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[9] In this article, I specifically focus at length on In re Smurfit-Stone Container Corp. S’hlder Litig., 2011 WL 2028076 (Del. Ch. 2011); In re NYMEX Shareholder Litig., 2009 WL 3206051 (Del. Ch. 2009); In re Lukens Inc. Shareholders Litig., 757 A.2d 720, 725 (Del. Ch. 1999).
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