Edgio, Match, and Trusting Delaware Judges to “Get It Right”

On November 8, 2023, I had the honor of guest lecturing Professor Jesse Fried’s Harvard Law School M&A Litigation Class.  The lesson title was “The Vitality of the Unocal Doctrine and In re Edgio, Inc. Stockholders Litigation.”  The presentation addressed various tactical issues in identifying and prosecuting breach of fiduciary duty suits, but focused on the Court of Chancery’s legally significant discussion of the interplay between the Corwin doctrine, Unocal standard, and form of relief sought.

When I was recently asked to turn that presentation into a note, I returned to a question the lecture left unanswered: Why did the Court feel compelled to address such complex – yet avoidable –issues?

The recent oral argument in In re Match Group, Inc. Derivative Litigation shed light, albeit indirectly, on the Edgio opinion’s complexity.  Wachtell Lipton legend Ted Mirvis told the Delaware Supreme Court that they could safely adopt his clients’ proposed bright-line and rigid rule requiring dismissal of most conflicted-controller transactions, since the Chancery Court judges “are not so easily fooled” and can avoid unjust outcomes.

Ted’s insight (ironic as applied to Match) may explain why the Edgio ruling grappled with the Corwin doctrine the way it did.  If so, perhaps the broader lesson is that Delaware should rely less on rigid dismissal doctrines and revert to trusting its judges.

Standards of Judicial Review and Delaware’s Common Law Driven Approach to Oversight of Fiduciary Conduct

When filed, Edgio was not a likely candidate to be taught at Harvard Law School.  The alleged facts strongly suggested self-interested entrenchment.  The board of Limelight (later renamed Edgio) used a stockholders’ agreement to appropriate for itself a 35% voting block, which seemed facially less appropriate than the anti-activism poison pill that the Chancery Court had just nullified.[1]

Edgio is classroom fodder because the Court grappled with the interplay between the Corwin doctrine, the Unocal standard of judicial review and the form of relief sought. Why, we might ask, did the Court feel a need to take on such complex issues instead of simply letting the case proceed based on alleged self-interested entrenchment?

Much has been written about the distinction between Delaware’s standards of conduct and standards of review.[2]  Perhaps understanding Edgio rests on a different distinction — between standards of review and decision-mandating doctrines.

Two questions answer almost any corporate law case:  (1) Did the defendants comply with fixed legal obligations, i.e., operating in compliance with the Delaware General Corporate Law (“DGCL)?  (2) Did they comply with their fact-specific equitable duties, i.e., act in good faith.[3]

Standards of judicial review play little role in statutory interpretation, since a person either complied with the DGCL or they did not.  If fiduciary duty compliance typically comes down to good faith, why does Delaware need so many levels of judicial review?  As former Chancellor Allen used to teach, Delaware’s core advantage in the competition for corporate business lies in the Chancery jurists’ unparalleled experience with corporate cases and resulting knack for “sniffing out” whether fiduciaries are acting in good faith.[4]  Delaware’s standards of review give guideposts to help non-Delaware judges reach the “right” outcome despite less experience with corporate disputes, but were structured to give Delaware’s judge tools flexible enough to achieve the right result, without rigidly dictating outcomes.

Standards of review, tools helping judges exercise discretion, are distinct from outcome-dispositive legal doctrines limiting judicial discretion.  The Unocal enhanced scrutiny standard lets the court perform the proverbial “kicking of the tires” to test whether the defendants had a reasonable basis to act defensively (and not merely to entrench themselves) and did so in a proportionate manner.  In contrast, when the Corwin doctrine applies, the judge must dismiss breach of fiduciary suits.

The Edgio Case:  A Simple One Made Complex By Competing Standards and Doctrines

The facts giving rise to the Edgio case are unusual, but not complex.  Limelight, a network services provider for digital content, had underperformed for years.  Market analysts predicted some form of stockholder activism targeting the CEO, and perhaps the whole board of directors.

Limelight identified the opportunity to acquire Edgecast, a network business principally owned by Apollo Global, for $300 million worth of newly issued Limelight shares, representing 35% of the pro forma company’s voting power.  Acquiring Edgecast was strategically beneficial.  Shareholders overwhelmingly approved the share issuance needed to effect the acquisition.

Since the deal gave Apollo so much voting power, the parties signed a stockholders agreement containing a typical three-year standstill.  Embedded into the agreement, however, were three unusual terms, restricting Apollo from:

(a) voting for any director candidate not nominated by the incumbents (“Director Voting”);

(b) voting against a Board recommendation on non-routine matters, except in proportion with how the remaining shares are voted (“Vote Neutralization”); or

(c) selling Edgio shares to any of the top 50 activist stockholders in the most recent “SharkWatch 50” list (“Transfer Restriction”).

The July 2022 Edgio complaint challenged the Director Voting, Vote Neutralization and Transfer Restriction provisions (together, the “Challenged Provisions”) as breaches of fiduciary duty, seeking to permanently enjoin their enforcement.  The 23-page complaint’s thesis was simple:  Limelight’s board improperly entrenched itself via the Challenged Provisions.

Along with the complaint, plaintiffs filed a motion to expedite seeking narrow discovery and an injunction hearing in advance of the upcoming director nomination deadline.  The Court denied expedition but permitted prompt motion to dismiss briefing.  Oral argument on the resulting dismissal motion took place on October 12, 2022.

In December 2022, the Court asked for supplemental briefing regarding “the specific question of whether this type of claim – a post-close claim to enjoin enduring entrenchment devices – is a claim that Corwin can or is intended to cleanse.”  The Court denied the motion to dismiss on May 2, 2023.

The Court answered the question on which it sought supplement briefing as follows:

The claim here—a claim to enjoin enduring alleged entrenchment devices—is not a type of claim that Corwin was designed to cleanse …. Applying Corwin to such claims would not serve its underlying policy rationale of allowing stockholders to make free and informed choices based on the economic merits of a transaction. Rather, our law has consistently recognized that the harm caused by entrenching measures is irreparable and evades economic valuation. I interpret Corwin to stop short of cleansing claims seeking to enjoin defensive measures.”  Op. at 3.

The Court further explained as follows:

[T]he rationale underlying Corwin—that the business judgment rule should apply when stockholders “have had the free and informed chance to decide on the economic merits of a transaction for themselves”—is not served in the context of a Unocal claim seeking to enjoin an enduring entrenchment device….  Unocal scrutiny is inspired by concerns that directors may act to “thwart the essence of corporate democracy by disenfranchising shareholders,” which prototypically causes irreparable injury.  Because a dollar value cannot be affixed to the harm caused by unjustifiably entrenching actions, it cannot be said that a stockholder can consider wrongfully entrenching actions as part of the “economic merits” of a transaction….  Because the injuries Unocal is designed to prevent elude valuation, they cannot inform a stockholder vote on the economic merits of a transaction.  Op. at 30-33.

The class considered numerous hypotheticals testing the Edgio court’s distinction based on the relief sought and the implication that had plaintiffs pursued money damages, Corwin dismissal could be proper.  A simple twist on Edgio’s actual facts illustrated the issue:  Suppose Apollo agreed to sell Edgecast to Limelight for $250 million, but raised its selling price to $300 million when it asked to agree to the Challenged Provisions.  A strict reading of the Edgio opinion suggests that the Challenged Provisions could be enjoined, but the $50 million in damages would not be recoverable if Corwin was otherwise satisfied.

What none of this author, nor Professor Fried, nor any of the students could answer was why the Court chose the harder road of addressing whether the Corwin doctrine could extinguish a Unocal claim seeking injunctive relief at all.  The Court easily could have held that whether or not Corwin could apply, the lack of a vote on the Challenged Provisions and/or plainly inadequate disclosures precluded dismissal.

A Leading Litigator’s Insightful Answer During the Match Oral Argument May Answer the Edgio Conundrum, But Also Highlights Why Delaware Should Trust Its Judges

While Edgio addressed the relationship between Unocal and Corwin, a more consequential (and high-profile) issue emerged this summer, when the Delaware Supreme Court solicited the parties to brief an argument raised by defendants on appeal that they concededly had not preserved below.  In In re Match Group, Inc. Derivative Litig., the defendant-appellees asked the Delaware Supreme Court to rule that outside the context of a controller-led squeeze-out, trial judges should be compelled to dismiss stockholder challenges to conflicted-controller transactions as long as the deal was approved by either an independent special committee or an informed majority of the minority vote.

During the second oral argument before the Supreme Court, Chief Justice Seitz asked Wachtell Lipton’s Ted Mirvis: “So how do we draw the line between squeeze-outs and things that look or operate like squeeze-outs but aren’t technically squeeze-outs?”  In response, Ted discussed the “reality that our courts are not so easily fooled” and that if controllers “get to the same place by a different means, I think the court will be able to understand that and will be able to protect the doctrine.”

While (ironically) supporting a rule that would push the trial judges into a presumed dismissal except in cases of such “subterfuge,” Ted’s answer may explain why the Edgio opinion grappled with Corwin in such detail.  Ted’s insight about trusting the judgment of the Chancellor and Vice Chancellors highlighted, to this author at least, that Delaware jurisprudence of the last decade has shifted away from the state’s historic reliance on flexible standards of judicial review that “trust the judges to get it right” in favor of rigid and mandatory dismissal doctrines that unduly limit judicial discretion.

Delaware’s ability to trust the skill and sophistication of its judiciary to get to the right answer is one of the First State’ key advantages in the competition among states for corporate charters.  It would be very easy for Nevada—or any other state—to copy and paste the Delaware General Corporation Law into its own corporate code. It is impossible to replicate the skill and sophistication of the Delaware bench and bar in applying Delaware’s nuanced, flexible, “you-know-it-when-you-see-it” standards.

Before 2014, Delaware law provided numerous standards of review to assist the judicial decision-making process.  For example, when the stark difference between the BJR and the entire fairness standard of review proved insufficient for adjudicating the hostile takeover fights of the 1980s, Delaware conceived of the intermediate standard of review under Revlon and Unocal.  Enhanced scrutiny gave the Chancery judges leeway to assess the reasonableness of conduct by potentially conflicted fiduciaries without the skepticism of the entire fairness review standard.

Since the adoption of the MFW doctrine in 2014 and the Corwin doctrine in 2015, Delaware has seemingly moved away from giving judges room to exercise nuanced judgment in achieving the “correct” outcome, instead adopting more rigid checklists mandating dismissal.  While corporate counsel may prefer a roadmap for their clients to avoid judicial scrutiny entirely, rigid doctrines are ill-suited to account for the plethora of ways that corporate actors engage in business activities that do not fit neatly into a checklist-driven decision-making process.

Which brings us back to Edgio.  A system empowering trial judges could easily reach the right result.  The Court seemed comfortable concluding that Unocal was triggered by the facts alleged.  Absent the prospect of appellate second-guessing under Corwin, the Court could deny dismissal in short form and let focused discovery confirm or refute that Defendants sought entrenchment.

Yet the Court grappled with the countours of the Corwin doctrine.  Perhaps the real lesson from Edgio is that narrowing the room for flexible standards of review that empower the trial judges has a cost.  The corollary to Ted Mirvis’s comment at the Match oral argument about the judges not being easily fooled is that trial judges should be trusted to do justice within the structure of flexible standards of review.

That flexibility lies at the heart of Delaware’s competitive advantage.  Rigid doctrines requiring dismissal where certain boxes are checked is the antithesis of trusting the trial judge’s not to be fooled.

Endnotes