Saturday, July 1, 2023
Here's the recap: The case involved a closely-held corporation where voting power was split 50-50 between two shareholders, one being a founder of the company, the other being the widow of another founder. After the two deadlocked, and the widow sought to appoint a custodian that would throw the company into disarray, the founder caused the company to issue a slug of new stock to a longtime employee. That broke the deadlock; the founder and the employee sided against the widow. The widow then alleged that the sale had been effectuated to dilute her voting power in violation of the founder's fiduciary duties. Chancellor McCormick concluded that the sale occurred at a price and on terms that were entirely fair; on appeal, the Delaware Supreme Court affirmed the entire fairness holding, but remanded for Chancellor McCormick to consider whether the dilution of voting control had violated Blasius Industries, Inc. v. Atlas Corp, 564 A.2d 651 (Del. Ch. 1988).
That alone, I said at the time, was sort of weird, because it suggested that a sale could be both entirely fair and represent an inequitable interference with voting rights.
On remand, Chancellor McCormick held that Blasius was satisfied because the widow's actions were harming the company, and because the stock sale had long been in the works regardless. I noted that this was unusual, not merely because it showed that Blasius's "compelling justification" requirement could be satisfied, but also because it appeared to be the first and only time a Delaware court had approved a stock issuance intended to dilute the voting power of an existing holder due to that holder's threats. Delaware, of course, permits poison pills, but pills are adopted before a hostile actor acquires a certain voting threshold and are only activated once that threshold is crossed - they are a warning shot. Delaware had not before approved actions to dilute the voting power of someone who already had their stake at the time the controversy arose, at least as far as I could tell.
Anyhoo, long story short, on appeal, this week, the Delaware Supreme Court affirmed Chancellor McCormick's holding. And in so doing, it appears to have resolved a longstanding tension in Delaware law, namely, the degree to which Blasius represents its own standard of review, or whether it represents a specific application of Unocal review. And the Delaware Supreme Court appears to have held it's the latter. To wit:
Experience has shown that Schnell and Blasius review, as a matter of precedent and practice, have been and can be folded into Unocal review to accomplish the same ends – enhanced judicial scrutiny of board action that interferes with a corporate election or a stockholder’s voting rights in contests for control. When Unocal is applied in this context, it can “subsume the question of loyalty that pervades all fiduciary duty cases, which is whether the directors have acted for proper reasons” and “thus address issues of good faith such as were at stake in Schnell. Unocal can also be applied with the sensitivity Blasius review brings to protect the fundamental interests at stake – the free exercise of the stockholder vote as an essential element of corporate democracy.
As we explained in our earlier decision in this case, the court’s review is situationally specific and is independent of other standards of review. When a stockholder challenges board action that interferes with the election of directors or a stockholder vote in a contest for corporate control, the board bears the burden of proof. First, the court should review whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit.” The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interests of the stockholders.
Second, the court should review whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to
the stockholder franchise. To guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control, a board that is
properly motivated and has identified a legitimate threat must tailor its response to only what is necessary to counter the threat. The board’s response to the threat
cannot deprive the stockholders of a vote or coerce the stockholders to vote a particular way.
So there you have it. There no longer appears to be a Blasius - there is only Unocal. Blasius's key point - that directors cannot interfere with a stockholder vote solely because they think stockholders will vote wrong, even if they hold that belief in good faith - now is part of Unocal's first prong, namely, whether the directors have identified a threat justifying action. The threat has to be something other than stockholders choosing to vote for against the Board, and, in Coster, that threat was the damage that a custodian would do to the corporate enterprise under the specific circumstances of this case. Next, even if such a threat is identified, the actions taken to thwart the stockholder vote cannot be preclusive or coercive under Unocal's second prong. That standard, too, was met in Coster, because, while the stock issuance broke the deadlock, it meant that in the future, the widow could perhaps have more influence by forming a coalition with the employee against the founder. I.e., without the stock sale, the widow would be pitted against the founder with no resolution; with the stock sale, the employee - who could vote as he pleased - represented a means by which either side could exercise control.
Now, I gotta be honest, I think this analysis of what counts as "preclusive or coercive" raises more questions than it answers, but, also, it's been almost three decades since Mendel v. Carroll, 651 A.2d 297 (Del. Ch. 1994), where a Delaware court first raised the hypothetical possibility that maybe a dilutive stock issuance against a threatening controller might be justified under some set of facts, and yet this is the first time such an issuance has in fact been approved, so it might be another 30 years or so before we have to worry about it.
Even more interesting is how the Coster decision follows naturally from Chancellor McCormick's earlier holding in The Williams Companies, where she effectively merged Blasius and Unocal by holding that a board could not adopt an anti-activist poison pill out of fear shareholders would engage with the board in the "wrong" way. Generally, though, commenters have noted the tension between Unocal/Unitrin - which allow boards to block shareholder sales out of fear shareholders will act out of ignorance - and Blasius, which does not allow boards to block shareholder votes out of that same fear. Now that we know for sure Blasius is an aspect of Unocal, will Delaware confront that tension more directly?