The Twilight of Enhanced Scrutiny in Delaware M&A Jurisprudence

Iman Anabtawi is Professor of Law at UCLA School of Law. This post is based on a recent article by Professor Anabtawi, forthcoming in the Delaware Journal of Corporate Law,  and is part of the Delaware law series; links to other posts in the series are available here.

In Corwin v. KKR Fin. Holdings LLC, the Delaware Supreme Court held that shareholder ratification—in the form of a disinterested, fully informed, uncoerced stockholder vote—in favor of a merger or sale that would otherwise trigger enhanced scrutiny gives rise to the business judgment rule standard of review with respect to post-closing money damages claims for director breaches of fiduciary. Under this standard, the directors’ actions lead to liability only if they constitute corporate waste. It does not matter whether the stockholder vote was required by statute or was sought voluntarily by the board. Nor does it matter whether board approval of the transaction was independent and disinterested.

In Corwin, the Delaware Supreme Court took the position that, rather than overruling Delaware law outright or answering a question of first impression, it was settling an uncertain area of the law that had arisen from a line of cases associated with In re Santa Fe Pacific Corp. Shareholder Litig. and Gantler v. Stephens. Writing for a unanimous Delaware Supreme Court sitting en banc, Chief Justice Strine affirmed the Chancery Court’s holding that Gantler was “a narrow decision focused on defining a specific legal term, ‘ratification.’” The Delaware Supreme Court also made a number of policy arguments to support its decision. First, it argued that enhanced scrutiny is not “designed with post-closing money damages in mind” but instead “to give stockholders and the Court of Chancery the tool of injunctive relief to address important M&A decisions in real time, before closing.” Second, the Court placed weight on the fact that the vote must be fully informed and uncoerced; if material facts are not disclosed, ratification has no effect. Finally, the Court reasoned that stockholders deserve a free and informed chance to decide on the economic merits of a transaction, stating that such a policy “best facilitates wealth creation” by reducing the costs of litigation and removing the specter of judicial second-guessing.

I argue in my forthcoming article in the Delaware Journal of Corporate Law, The Twilight of Enhanced Scrutiny in Delaware M&A Jurisprudence, that Corwin represents not only a departure from pre-existing Delaware law but also a questionable expansion of case law in which procedural mechanisms are deemed to serve as an adequate substitute for substantive judicial review of board decisions.

In Gantler, the Delaware Supreme Court set forth two preconditions for giving ratification effect to a stockholder vote approving an M&A deal: First, only “classic,” or non-statutorily required, ratification was to have cleansing power and, second, pursuant to the Delaware Supreme Court’s holding in Santa Fe, for shareholder ratification to have any impact on the standard of review for board action, a unitary vote on whether or not to approve the transaction would not do; i.e., the stockholders must also vote separately to approve the decision-making process of the board. In Corwin, the Delaware Supreme Court eliminated both Gantler’s preconditions for giving ratification effect to stockholder approval of an M&A transaction.

In contrast to Gantler, Corwin interprets a stockholder approval obtained pursuant to a statutorily required vote to mean that a company’s stockholders have concluded that the deal is a product of a value-maximizing sale process. However, given the option of only a unitary vote, stockholders could rationally consent to a sale to protect themselves against uncertainty regarding the company’s future despite having misgivings about the board’s conduct. While the new limits on the ability of the Delaware courts to apply enhanced judicial scrutiny to M&A transactions contribute to reduced deal litigation, such limits also generate costs for target stockholders. Reduced standards of review will weaken direct judicial monitoring of target boards. Moreover, with fewer M&A fiduciary duty cases to decide, the Delaware judiciary—historically a potent force in disciplining and guiding the conduct of M&A transactions—will enjoy less influence over the sale process.

My article suggests a mechanism for allowing target stockholders to ratify M&A transactions without requiring them to bless simultaneously the deal presented to them and the sale process associated with it—a bifurcated vote on each of the sale of the company and the sale process. Such an approach would preserve the integrity of the enhanced scrutiny standard of review while acknowledging the Delaware courts’ increasing willingness to embrace shareholder ratification as a substitute for substantive judicial review of the fairness of M&A transactions.

The full article is available for download here.

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