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Stakeholders and the Bear Stearns Litigation

The complaint filed by certain Bear Stearns shareholders to block to Bear Stearns’ acquisition by JP Morgan includes the interesting allegation that the defendant directors “weighed the affect [sic] the Transaction would have on numerous constituencies and decided to go forward in the face of the extremely negative effect on the one constituency whose interests they were duty bound to place first—Bear Stearns’ stockholders.” It’s hard to see this claim getting the plaintiffs very far.

To be sure, when they are selling the business, the board of directors “must focus on one primary objective—to secure the transaction offering the best value reasonably available for all stockholders.” McMullin v. Beran, 765 A.2d 910, 918 (Del.  2000).

Whether directors who take into account the interests of nonshareholder constituencies in making merger decisions will be held liable for doing so (or whether their doing so gives rise to grounds to stop the transaction) depends very much on the applicable standard of review. Although the business judgment rule is not intended to allow directors to make trade-offs between the interests of shareholders and nonshareholder constituencies, in some cases that is the unitended consequence of the rule. This is so because, assuming the preconditions for application of the rule are met, the business judgment rule requires the court to abstain from reviewing the substantive merits of the directors’ conduct unless the plaintiff can rebut the business judgment rule’s presumption of good faith. See, e.g., Shlensky v. Wrigley, 237 N.E.2d 776, 779 (Ill. App. 1968) (holding that: “In a purely business corporation ... the authority of the directors in the conduct of the business of the corporation must be regarded as absolute when they act within the law, and the court is without authority to substitute its judgment for that of the directors.”).

As Gordon Smith has pointed out, however, the relevant global standard of review in this case likely will be one of Unocal’s progeny; i.e., either Omnicare or Blasius. In Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), the Delaware Supreme Court held that the board could consider “the impact of the bid on ‘constituencies’ other than shareholders (i.e., creditors, customers, employees, and perhaps even the community).” In that case, however, a “corporate raider with a national reputation as a ‘greenmailer’” faced Unocal’s board with a structurally coercive bid.  Accordingly, the directors reasonably believed that the bid was not in the best interests of any corporate constituency and, on the facts before the court, there arguably was no conflict between shareholder and stakeholder interests.

If one believes the allegations in the Bear Stearns’ complaint (or at least treats them as true for purpsoes of ruling on the pleadings), however, there are serious conflicts between the interests of the shareholders and at least some of the stakeholders. Does Unocal really permit a target board to make trade offs between those interests?

In Revlon, Inc. v. MacAndrews and Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), the Delaware Supreme Court answered that question in the negative, adding two crucial provisos to Unocal. The first is of general applicability, forbidding the target’s board from protecting stakeholder interests at the expense of shareholder interests. Rather, any management action benefiting stakeholders must produce ancillary shareholder benefits.  In other words, directors may only consider stakeholder interests if doing so would benefit shareholders.  Second, where a corporate control auction triggering the so-called Revlon duties has begun, stakeholders become entirely irrelevant. Instead, shareholder wealth maximization is the board’s only appropriate concern.

Is Bear Stearns in Revlon-land? No. According to 150Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1289-90 (Del. 1994), Revlon duties trigger in 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.’”

Nobody seems to think any of those scenarios are present in this case (yet). As such, while Unocal will permit the Bear Stearns board to give some consideration to the interests of stakeholders, the board will have to be prepared to show that their structuring of the deal (and the decision to sell in the first place) benefits both shareholders and stakeholders. The amended deal terms, which raised the implied value of the deal from $2 to $10 per share will help, and the involvement of the Fed throws an interesting wrinkle into the mix, but it’s interesting that even the revised deal is being pitched as a winner for stakeholders as well as shareholders:

“Our Board of Directors believes that the amended terms provide both significantly greater value to our shareholders, many of whom are Bear Stearns employees, and enhanced coverage and certainty for our customers, counterparties, and lenders,” said Alan Schwartz, President and Chief Executive Officer of Bear Stearns. “The substantial share issuance to JPMorgan Chase was a necessary condition to obtain the full set of amended terms, which in turn, were essential to maintaining Bear Stearns’ financial stability.”

The invocation of an exception to the NYSE rule requiring shareholder approval of stock issuances exceeding 20% of the outstanding shares, so as to allow JP Morgan to buy 39.5% of the stock (effectively a lock up), will further complicate the board’s efforts to prove that the shareholders come away from this deal at least as well off as the stakeholders.