Saturday, May 14, 2022
So of course, after I drafted this post about Chancellor McCormick’s decision in Coster v. UIP Companies, the Ninth Circuit came down with a decision affirming the district court opinion in Lee v. Fisher. I blogged about that case here; the short version is, the district court enforced a forum selection bylaw that required derivative 14(a) claims to be litigated in Delaware Chancery, despite the fact that Delaware Chancery has no jurisdiction to hear 14(a) claims. Based on Ninth Circuit precedent, the district court held that the Exchange Act’s antiwaiver provision was not a clear enough statement of a federal public policy against forum selection to prohibit enforcement of the bylaw. The Ninth Circuit, on appeal, agreed (you know the drill by now; no one engaged the question whether the bylaw is the equivalent of a contractual agreement, naturally). By affirming the district court’s decision, the Ninth Circuit sort of - but not exactly - created a split with the Seventh Circuit’s decision in Seafarer's Pension Plan v. Bradway; I say “sort of” because – as I explained in my post about the Bradway decision, here – most of the Seventh Circuit’s logic refusing to enforce such a bylaw was rooted in its interpretation of Delaware law, rather than federal law. The Ninth Circuit largely refused to engage with the Delaware law analysis, and instead focused on federal law, because it concluded that the Lee v. Fisher plaintiff had waived arguments about Delaware law.
Upshot: In the Ninth Circuit, it is now possible for a company to completely opt out of Exchange Act liability by unilaterally adopting a bylaw saying so, as long as the bylaw doesn’t use the word “waiver” and instead uses the words “forum selection” and “Delaware Chancery.”
That’s probably all I have to say about that for now, despite my general creeping horror, unless I change my mind (saving it for a ranting article that one day will go up on SSRN), so back to what I originally intended to post about....
Recently, Chancellor McCormick issued her opinion in on remand in Coster v. UIP Companies. Coster is a somewhat unusual case for Delaware, in that it involves a closely-held corporation governed via longstanding personal ties, rather than a public entity, or at least one sponsored by arm’s length VC/PE capital. Two founding members of UIP each held 50% of its stock; when one died, his widow, Marion Coster, received his share. The remaining founder and UIP employees tried to negotiate with Coster to buy her out, but they could not reach a deal; the parties deadlocked and could not agree on board members; and finally, Coster sought the appointment of a custodian. In response, the remaining founder caused UIP to sell a chunk of stock to a longtime employee/holdover director. Once the sale was complete, the founder and the employee together had majority voting control, breaking the deadlock and diluting Coster’s stake.
Coster challenged the sale and, after a trial, McCormick concluded that though the defendants were interested in the sale, and had effectuated it to break the deadlock and thwart Coster’s move for a custodian, the transaction had nonetheless been “entirely fair” to Coster and the company because the board ran a reasonable process and the employee had paid a fair price.
On appeal, the Delaware Supreme Court seemed to leave undisturbed McCormick’s conclusion that the transaction had been “entirely fair,” but nonetheless held that, given the board’s entrenching motives, McCormick should additionally have evaluated whether the defendants had engineered the sale in order to entrench themselves and thwart Coster’s voting rights, in violation of Blasius Industries, Inc. v. Atlas Corp, 564 A.2d 651 (Del. Ch. 1988) – adding an interesting footnote acknowledging that while some have questioned the relationship of Blasius to Unocal, none of the parties had made that argument and so the court would not engage it, see Op. at n.66.
That in and of itself highlights a very odd aspect of the doctrine: the Delaware Supreme Court’s decision may be read to mean that a transaction can both be “entirely fair” and represent an inequitable interference with voting rights. If that’s right, and since “entire fairness” is usually described as the most rigorous standard of review, the Supreme Court decision may mean that Blasius exists on something like a different scale, independent of the financial aspects of corporate action. Or maybe the Delaware Supreme Court, recognizing that conceptual oddity, left the relationship of Blasius to “entire fairness” somewhat vague. In the Court’s words:
the Court of Chancery fully supported its factual findings and legal conclusion that the board sold UIP stock to Bonnell at a price and through a process that was entirely fair. Thus, we will not disturb this aspect of the court’s decision. But the court also held that its entire fairness analysis was the end of the road for judicial review. …In our view, the court bypassed a different and necessary judicial review where, as here, an interested board issues stock to interfere with corporate democracy and that stock issuance entrenches the existing board. As explained below, the court should have considered Coster’s alternative arguments that the board approved the Stock Sale for inequitable reasons, or in good faith but for the primary purpose of interfering with Coster’s voting rights and leverage as an equal stockholder without a compelling reason to do so….
And later in the opinion
under Blasius, even if the court finds that the board acted in good faith when it approved the Stock Sale, if it approved the sale for the primary purpose of interfering with Coster’s statutory or voting rights, the Stock Sale will survive judicial scrutiny only if the board can demonstrate a compelling justification for the sale. That the court found the Stock Sale was at an entirely fair price did not substitute for further equitable review when Coster alleged that an interested board approved the Stock Sale to interfere with her voting rights and leverage as an equal stockholder.
So I suppose this could be read to mean that Blasius is, in fact, part of the entire fairness analysis, and McCormick erred by stopping with process/price. I’m not really sure, and I’m not sure the Supreme Court wanted me to be sure.
In any event, on remand, Chancellor McCormick elaborated on her factual findings. In particular, she highlighted that the board’s actions were defensive moves intended to thwart the damaging actions of Coster, who was the aggressor. Specifically, after insisting on a buyout at an unreasonable price, Coster sought to have unqualified nominees seated on UIP’s board. When the board refused, she sought a custodian who would have had significant powers to upend UIP’s entire business model and damage its revenue streams. Along the way, she refused meaningful negotiation with board members who tried in good faith to accommodate her. At the same time, the stock sale to the employee had been in the works for a while, so by going ahead with it, the board managed to both address the Coster problem and reward someone who had long been a critical asset to the company. Under these circumstances, McCormick felt that the board had shown it had a compelling justification for its actions under Blasius.
So, this is interesting because it speaks to a hypothesized but – as far as I can tell – never before seen set of circumstances in Delaware law. Namely, when is it okay to issue stock to dilute someone’s existing voting power because they threaten to use that power in a damaging way? Note that this is not the same as a poison pill; the pill gives advance warning to investors that if they acquire more shares, they may be diluted. Here, by contrast, the dilution was to an existing interest, with no warning, based solely on the inequitable actions they sought to take.
The possibility that a board might be justified in taking such action has been raised before. Specifically – as I blogged when discussing CBS’s proposal to take similar action with respect to Shari Redstone – in Mendel v. Carroll, 651 A.2d 297 (Del. Ch. 1994), the court held that maybe a board might under some circumstances be justified in taking such an action against a threatening controller. The Mendel dicta has been repeated over the years, but this is, to my knowledge, the first time that a Delaware court has actually approved a board in fact taking such action. Though, as I highlighted in that earlier blog post, a New York court interpreting Delaware law approved a dilutive issuance intended to force the sale of Bear Stearns to JP Morgan at the height of the financial crisis – which, among other things, demonstrated that Delaware was happy to pass that hot potato to New York in order to avoid taking responsibility for throwing America’s markets into chaos by blocking the action.
But until now, no Delaware court (I think) has actually given the go-ahead in a particular set of facts; the court in CBS itself held that it was not necessary for the board to dilute Shari Redstone’s interest because any fiduciary breaches on her part could be remedied on a case-by-case basis.
Which means the lesson here is not simply that there are some corporate actions that survive Blasius review, but also that there is at least one set of facts that permits the issuance of new shares for the explicit purpose of diluting an existing holder who represents a threat to the company’s future.