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E-MailFranklin Gevurtz is Distinguished Professor of Law at the University of the Pacific McGeorge School of Law. This post is based on a recent paper authored by Professor Gevurtz, and is part of the Delaware law series; links to other posts in the series are available here.
Corporate mergers and acquisitions are big business and so is the constant stream of litigation challenging board decisions to enter such transactions. Plaintiffs cast these actions as a contest between victimized shareholders and faithless directors. Yet, merging or selling a corporation normally requires approval by the shareholders, who rarely vote down the deal. This apparent incongruity between what plaintiff shareholders assert and how most shareholders vote, in turn, raises the question of what impact shareholder approval should have on judicial scrutiny when dissenting shareholders sue.
Simple policy might suggest that shareholders okaying a corporate merger or sale should radically reduce, if not eliminate, the willingness of a court to say that directors breached their duty to the shareholders in saying yes to the deal. After all, if most of the shareholders vote in favor of a merger or sale, who is a judge to say the deal is not good enough? In Corwin v KKR Financial Holdings, the Delaware Supreme Court took a seemingly major step toward this conclusion. The Court stated that an informed and un-coerced vote by the shareholders to approve a merger or sale of a company invokes the deferential business judgment rule in litigation challenging the deal, at least when the deal does not involve a controlling shareholder on the other side.
For defendant directors, Corwin has become a veritable wishing well, whose magic they invoke to shield them in litigation arising out of corporate mergers and sales. Yet, the prerequisites for Corwin’s favorable treatment and the precise interactions of Corwin with the various standards developed by Delaware courts for reviewing board decisions to merge or sell the corporation create a panoply of unintended consequences, unanswered questions and at least one outright conundrum.
The unintended consequences flow from the first prerequisite for awarding favorable impact based upon shareholder approval: that the shareholders be fully informed. While the necessity of this prerequisite is obvious—otherwise directors could hide behind approval procured through misleading the shareholders—the result of this prerequisite is to channel even more litigation into a path criticized for its potential to enrich lawyers with little gain for shareholders.
Unanswered questions generated by Corwin already have popped up in decisions by Delaware courts. Some arise from omissions and casual language in the opinion. Others are more fundamental. For example, the requirement that the shareholder vote be un-coerced can force courts to ask what is coercion. Unfortunately, Delaware courts have yet to come up with a workable definition.
Beyond this, the exclusion of transactions involving a controlling shareholder from Corwin’s favorable treatment has predictably set off even more disputes about whether a party is a controlling shareholder. Lost, however, in these disputes is the question of why it should matter: Specifically, if most of the other shareholders approve the deal made with the controlling shareholder, why should courts give their decision any less weight in the absence of approval also by independent directors than if the shareholders approve a deal in which all the directors, rather than a controlling shareholder, have a conflict?
Perhaps most mysterious of all is a conundrum at the heart of Corwin. In the same analysis in which the court stated that a shareholder vote of approval lowers the standard for reviewing the deal to the minimalist guidelines of the business judgment rule, the court also suggested that greater scrutiny of whether directors picked the best deal remains available for actions seeking to enjoin the transaction before the shareholders vote. The result is that the courts either apply heightened scrutiny to prevent shareholder votes that would have lowered the level of scrutiny under Corwin or else hold off applying heightened scrutiny until shareholders vote, in which case there will never be occasion for applying this heightened scrutiny. Moreover, if shareholder approval adequately protects shareholders from bad deals, why should a court ever apply heightened scrutiny to block a shareholder vote except based upon non-disclosure or coercion?
This paper argues that the solution for cracking this conundrum and other mysteries regarding the impact of shareholder approval begins by asking what a shareholder vote to approve a corporate merger or sale is really telling us. The answer is that a shareholder vote on a merger or sale presents a narrowly constructed binary choice on the deal placed before the shareholders, whereas much of the ground for imposing greater scrutiny than the business judgment rule involves opportunities lost that could have presented a better deal to the shareholders. Voting in favor of the deal at hand as better than no deal at all does not remove the case for judicial intervention when there are grounds to suspect that directors might have sacrificed an even better deal along the way.
The complete paper is available for download here.
