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Judicial Review of Board Rejection of a Merger Bid

"In statutory acquisitions, such as mergers or asset sales, the target’s board of directors’ gatekeeping function is established by statute. If the board rejects a proposed transaction, the shareholders are neither invited to, nor entitled to, pass on the merits of that decision.” Stephen M. Bainbridge, Unocal at 20: Director Primacy in Corporate Takeovers, 31 Del. J. Corp. L. 769 (2006).

“Modern corporation statutes give considerable responsibility and latitude to target directors in negotiating a merger agreement. Initially, the target’s board possesses broad authority to determine whether to merge the firm and to select a merger partner. See, e.g., CAL.CORP.CODE § 1101 (West 1990). The initial decision to enter into a negotiated merger transaction is thus reserved to the board’s collective business judgment, with shareholders having no statutory power to initiate merger negotiations. Jewel Cos., Inc. v. Pay Less Drugstores Northwest, Inc., 741 F.2d 1555, 1560 (9th Cir.1984). The board also has sole power to negotiate the terms on which the merger will take place and to arrive at a definitive merger agreement embodying its decisions as to these matters. Id. at 1561. Shareholders have no statutory right to amend or veto specific provisions, their role being limited to approving or disapproving the merger agreement as a whole, with most statutes only requiring approval by a majority of the outstanding shares. See, e.g., Revised Model Business Corp. Act §§ 11.03(e), 12.02(e) (1984).”— Stephen Bainbridge, Interpreting Nonshareholder Constituency Statutes, 19 Pepp. L. Rev. 971, 975 n.18 (1992).

The logical import, of course, is that the business judgment rule provides the appropriate standard of review when shareholders challenge a board decision to turn down a merger proposal.

Delaware Business Litigation Report:

Gantler v. Stephens, C .A. No. 2392-VCP (February 14, 2008) ... illustrates the confusion that exists over the scope of review of a board’s decision to not pursue a merger and largely eliminates the uncertainty. Briefly, the board here decided not to pursue a merger opportunity and the potential acquirer then withdrew its offer. The court held that the business judgment rule applied to the decision not to take the offer. In doing so, the court declined to apply the heightened scrutiny used under the Unocal decision as the board did not take any defensive steps to stop the suitor from going forward on its own.

Instead, the court held that to invoke a higher level of review, the plaintiff must show the board acted in bad faith or was not properly advised. Mere allegations that the board made the wrong decision are insufficient.

What the Delaware Business Litigation Report doesn’t tell you is that Vice Chancellor Parsons kindly cited yours truly in the opinion:

… a less exacting standard comports with Delaware’s broad allocation of power to directors. As one commentator has observed, in spite of the significant potential for conflicts of interest stemming from directors’ entrenchment motives and side benefits frequently present when a board acts on a proposed merger, “Delaware corporate law definitively allocates decision-making authority to the board and, moreover, provides both substantive and procedural mechanisms ensuring a substantial degree of judicial deference to the board.” FN66

FN66. Stephen M. Bainbridge, Unocal at 20: Director Primacy in Corporate Takeovers, 31 Del. J. Corp. L 769, 789 (2006). Examples of side benefits include: “an equity stake in the surviving entity, employment or noncompetition contracts, substantial severance payments, continuation of existing fringe benefits or other compensation arrangements.” Id. at 788.

2008 WL 401124 at *10.