M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Monday, November 23, 2009

Constituency Provisions and Intermediate Scrutiny Outside of Delaware

I have been giving some thought to how jurisdictions other than Delaware deal with the question of intermediate scrutiny.  Although Delaware leads the way in the M&A jurisprudence, other states have gone their own way in important respects.  One of them is the hesitance of other states to adopt the Unocal, or intermediate scrutiny, doctrine in the context of board responses to takeovers.

I think I understand why and how things developed this way.  It's an old story.  The 1980s LBO boom was a scourge for management.  They used whatever tools at their disposal to prevent an acquisition, lest they be shown the door by new management.  The Delaware courts stepped in to put a limit on unreasonable and draconian defenses.  In short, the message from the courts was that boards did not have a free hand to put off all takeover attempts. There were limits, albeit not always binding.  

Politically, I suppose it was okay for Delaware to take that position.  Other states, particularly in the Rust Belt, took another view.  For them the LBO meant nothing but massive unemployment and dislocation.  They responded by providing management tools to keep potential acquirors at bay, including writing fiduciary standards into their codes.  This is something Delaware has never done.  These standards often include constituency language: a director's actions to consider the impact of a board's actions on the corporation's various constituencies won't be inconsistent with a director's fiduciary obligations to the corporation.  Of course, nothing really prevents a director in a Delaware corporation from making the same considerations, but I'll come back to that later.

In any event, Ohio has what I think is a pretty typical constituency provision (GCL 1701.59):  

(E) For purposes of this section, a director, in determining what the director reasonably believes to be in the best interests of the corporation, shall consider the interests of the corporation’s shareholders and, in the director’s discretion, may consider any of the following:

(1) The interests of the corporation’s employees, suppliers, creditors, and customers;
(2) The economy of the state and nation;
(3) Community and societal considerations;
(4) The long-term as well as short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation.

Now, that's pretty management friendly language.    The interests of shareholders always have to be considered and in the director's discretion other interests can be weighed against that, just in case the interests of the shareholders and other constituencies don't entirely mesh. This isn't inconsistent with the liberty that a Delaware director is given to consider all sorts of factors before the corporation undertakes an action. That's the value of the business judgment presumption. 

Oregon takes the constituency language a step further and is more explicit in its application (60.357):

(5) When evaluating any offer of another party to make a tender or exchange offer for any equity security of the corporation, or any proposal to merge or consolidate the corporation with another corporation or to purchase or otherwise acquire all or substantially all the properties and assets of the corporation, the directors of the corporation may, in determining what they believe to be in the best interests of the corporation, give due consideration to the social, legal and economic effects on employees, customers and suppliers of the corporation and on the communities and geographical areas in which the corporation and its subsidiaries operate, the economy of the state and nation, the long-term as well as short-term interests of the corporation and its shareholders, including the possibility that these interests may be best served by the continued independence of the corporation, and other relevant factors. 

Message to directors:  don't be afraid to say no to an unfriendly offer and rationalize that by saying the offer would be bad for the local community or environment.  This kind of language makes a poison pill unnecessary.  This is very management friendly language.  I wonder why there aren't more Oregon corporations?

Indiana takes it to the extreme.  Indiana makes it clear that the Delaware approach -- that places limits on director discretion in certain circumstances goes too far.  Indiana disclaim intermediate scrutiny entirely and in a rather straightforward manner (IC 23-135-1):

Certain judicial decisions in Delaware and other jurisdictions, which might otherwise be looked to for guidance in interpreting Indiana corporate law, including decisions relating to potential change of control transactions that impose a different or higher degree of scrutiny on actions taken by directors in response to a proposed acquisition of control of the corporation, are inconsistent with the proper application of the business judgment rule under this article. Therefore, the general assembly intends:

 (1) to reaffirm that this section allows directors the full discretion to weigh the factors enumerated in subsection (d) as they deem appropriate; and
        (2) to protect both directors and the validity of corporate action taken by them in the good faith exercise of their business judgment after reasonable investigation.

Business judgment forever!

One thing is clear, I think.  These constituency statutes don't exactly do the work that legislators probably hoped they'd do when they were originally passed.  While such provisions might protect some constituencies, they leave discretion with management and, consequently, add to the tools management can rely on to resist offers in the event management wishes to entrench itself.  

Worse, from the point of view of constituencies, what if management simply uses the constituency provision to negotiate a better deal for itself without regard to the constituency at issue.  For example, if a rust belt company is approached with an offer to go private at $21, it could well respond, "I'm sorry, but at $21, this deal is not good for our employees, the local community or the environment."  Imagine the surprise of constituencies when at $25, the board changes its mind, and takes the offer.  In the end, the only constituency with standing is the shareholder community.  Consequently, one shouldn't be surprised if/when directors use these statutes as little more than bargaining levers at the expense of the communities they were meant to protect.  

Of course, if legislators were to give the various constituencies the same standing in courts as shareholders, I might come to a different conclusion.

Taking a break for the Thanksgiving holiday.  Be back early next week.



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