This is an appeal from the Court of Chancery's entry of a preliminary injunction on October 13, 1994, upon plaintiffs' motions in two actions: American General Corporation's ("American General") suit against Unitrin, Inc. ("Unitrin") and its directors; and a parallel class action brought by Unitrin stockholders.
American General, which had publicly announced a proposal to merge with Unitrin for $2.6 billion at $50-3/8 per share, and certain Unitrin shareholder plaintiffs, filed suit in the Court of Chancery, inter alia, to enjoin Unitrin from repurchasing up to 10 million shares of its own stock (the "Repurchase
Unitrin has raised several issues in this appeal. First, it contends that the Court of Chancery erred in assuming that the outside directors would subconsciously act contrary to their substantial financial interests as stockholders and, instead, vote in favor of a subjective desire to protect the "prestige and perquisites" of membership on Unitrin's Board of Directors. Second, it contends that the Court of Chancery erred in holding that the adoption of the Repurchase Program would materially affect the ability of an insurgent stockholder to win a proxy contest. According to Unitrin, that holding is unsupported by the evidence, is based upon a faulty mathematical analysis, and disregards the holding of Moran v. Household Int'l, Inc., Del.Supr., 500 A.2d 1346, 1355 (1985). Furthermore, Unitrin argues that the Court of Chancery erroneously substituted its own judgment for that of Unitrin's Board, contrary to this Court's subsequent interpretations of Unocal in Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34, 45-46 (1994), and Paramount Communications, Inc. v. Time, Inc., Del. Supr., 571 A.2d 1140 (1990). Third, Unitrin submits that the Court of Chancery erred in finding that the plaintiffs would be irreparably harmed absent an injunction (a) because the Court of Chancery disregarded Unitrin's proffered alternative remedy of sterilizing the increased voting power of the stockholder directors and (b) because there was no basis for finding that stockholders who sold into the market during the pendency of the Repurchase Program would be irreparably harmed.
This Court has concluded that the Court of Chancery erred in applying the proportionality review Unocal requires by focusing upon whether the Repurchase Program was an "unnecessary" defensive response. See Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d at 45-46. The Court of Chancery should have directed its enhanced scrutiny: first, upon whether the Repurchase Program the Unitrin Board implemented was draconian, by being either preclusive or coercive and; second, if it was not draconian, upon whether it was within a range of reasonable responses to the threat American General's Offer posed. Consequently, the interlocutory preliminary injunctive judgment of the Court of Chancery is reversed. This matter is remanded for further proceedings in accordance with this opinion.
American General is the largest provider of home service insurance. On July 12, 1994, it made a merger proposal to acquire Unitrin for $2.6 billion at $50-3/8 per share. Following a public announcement of this proposal, Unitrin shareholders filed suit seeking to compel a sale of the company. American General filed suit to enjoin Unitrin's Repurchase Program.
Unitrin is also in the insurance business. It is the third largest provider of home service insurance. The other defendants-appellants are the members of Unitrin's seven person Board of Directors (the "Unitrin Board" or "Board"). Two directors are employees,
The record reflects that the non-employee directors each receive a fixed annual fee of $30,000. They receive no other significant financial benefit from serving as directors. At the offering price proposed by American General, the value of Unitrin's non-employee directors' stock exceeded $450 million.
American General's Offer
In January 1994, James Tuerff ("Tuerff"), the President of American General, met with Richard Vie, Unitrin's Chief Executive Officer. Tuerff advised Vie that American General was considering acquiring other companies. Unitrin was apparently at or near the top of its list. Tuerff did not mention any terms for a potential acquisition of Unitrin. Vie replied that Unitrin had excellent prospects as an independent company and had never considered a merger. Vie indicated to Tuerff that Unitrin was not for sale.
According to Vie, he reported his conversation with Tuerff at the next meeting of the Unitrin Board in February 1994. The minutes of the full Board meeting do not reflect a discussion of Tuerff's proposition. Nevertheless, the parties agree that the Board's position in February was that Unitrin was not for sale. It was unnecessary to respond to American General because no offer had been made.
On July 12, 1994, American General sent a letter to Vie proposing a consensual merger transaction in which it would "purchase all of Unitrin's 51.8 million outstanding shares of common stock for $50-3/8 per share, in cash" (the "Offer"). The Offer was conditioned on the development of a merger agreement and regulatory approval. The Offer price represented a 30% premium over the market price of Unitrin's shares. In the Offer, American General stated that it "would consider offering a higher price" if "Unitrin could demonstrate additional value." American General also offered to consider tax-free "[a]lternatives to an all cash transaction."
Unitrin's Rejection Upon receiving the American General Offer, the Unitrin Board's Executive Committee (Singleton, Vie, and Jerome) engaged legal counsel and scheduled a telephonic Board meeting for July 18. At the July 18 special meeting, the Board reviewed the terms of the Offer. The Board was advised that the existing charter and bylaw provisions might not effectively deter all types of takeover strategies. It was suggested that the Board consider adopting a shareholder rights plan and an advance notice provision for shareholder proposals.
Vie reviewed Unitrin's financial condition and its ongoing business strategies. The Board also received a presentation from its investment advisor, Morgan Stanley & Co. ("Morgan Stanley"), regarding the financial adequacy of American General's proposal. Morgan Stanley expressed its opinion that the Offer was financially inadequate.
The Unitrin Board unanimously concluded that the American General merger proposal was not in the best interests of Unitrin's shareholders and voted to reject the Offer.
On July 26, 1994, Vie faxed a letter to Tuerff, rejecting American General's Offer. That correspondence stated:
Vie acknowledged during discovery that the latter portion of his letter referred, in part, to the Repurchase Program.
American General's Publicity
Unitrin's Initial Responses
On August 2, 1994, American General issued a press release announcing its Offer to Unitrin's Board to purchase all of Unitrin's stock for $50-3/8 per share. The press release also noted that the Board had rejected American General's Offer. After that public announcement, the trading volume and market price of Unitrin's stock increased.
At its regularly scheduled meeting on August 3, the Unitrin Board discussed the effects of American General's press release. The Board noted that the market reaction to the announcement suggested that speculative traders or arbitrageurs were acquiring Unitrin stock. The Board determined that American General's public announcement constituted a hostile act designed to coerce the sale of Unitrin at an inadequate price. The Board unanimously approved the poison pill and the proposed advance notice bylaw that it had considered previously.
Beginning on August 2 and continuing through August 12, 1994, Unitrin issued a series of press releases to inform its shareholders and the public market: first, that the Unitrin Board believed Unitrin's stock was worth more than the $50-3/8 American General offered; second, that the Board felt that the price of American General's Offer did not reflect Unitrin's long term business prospects as an independent company; third, that "the true value of Unitrin [was] not reflected in the [then] current market price of its common stock," and that because of its strong financial position, Unitrin was well positioned "to pursue strategic and financial opportunities;" fourth, that the Board believed a merger with American General would have anticompetitive effects and might violate antitrust laws and various state regulatory statutes; and fifth, that the Board had adopted a shareholder rights plan (poison pill) to guard against undesirable takeover efforts.
Unitrin's Repurchase Program
The Unitrin Board met again on August 11, 1994. The minutes of that meeting indicate that its principal purpose was to consider the Repurchase Program. At the Board's request, Morgan Stanley had prepared written materials to distribute to each of the directors. Morgan Stanley gave a presentation in which alternative means of implementing the Repurchase Program were explained. Morgan Stanley recommended that the Board implement an open market stock repurchase. The Board voted to authorize the Repurchase Program for up to ten million shares of its outstanding stock.
On August 12, Unitrin publicly announced the Repurchase Program. The Unitrin Board expressed its belief that "Unitrin's stock is undervalued in the market and that the expanded program will tend to increase the value of the shares that remain outstanding." The announcement also stated that the director stockholders were not participating in the Repurchase Program, and that the repurchases "will increase the percentage ownership of those stockholders who choose not to sell."
Unitrin's August 12 press release also stated that the directors owned 23% of Unitrin's stock, that the Repurchase Program would cause that percentage to increase, and that Unitrin's certificate of incorporation included a supermajority voting provision. The following language from a July 22 draft press release revealing the antitakeover effects of the Repurchase Program was omitted from the final press release.
Unitrin sent a letter to its stockholders on August 17 regarding the Repurchase Program which stated:
Between August 12 and noon on August 24, Morgan Stanley purchased nearly 5 million of Unitrin's shares on Unitrin's behalf. The average price paid was slightly above American General's Offer price.
Procedural Posture It is important to begin our review by recognizing and emphasizing the procedural posture of this case in the Court of Chancery as well as in this Court. The Court of Chancery granted the plaintiffs' request for a preliminary injunction. After the Court of Chancery entered the preliminary injunction, it certified an appeal from that interlocutory ruling. Supr.Ct.R. 42. This Court accepted the interlocutory appeal and has expedited its review.
The legal paradigm which guides the Court of Chancery before entering a preliminary injunction is well established. First, the plaintiff must demonstrate a reasonable probability of success on the merits at trial. Mills Acquisition Co. v. Macmillan, Inc., Del.Supr., 559 A.2d 1261, 1278 (1989). Second, the plaintiff must prove a reasonable probability of irreparable harm in the absence of such preliminary injunctive relief. Id. Finally, the plaintiff must convince the Court of Chancery that, after balancing the relative hardships to the parties involved, the harm to the plaintiff if injunctive relief is denied outweighs the harm to the defendant if the relief is granted. Id. at 1278-79; Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Del.Supr., 506 A.2d 173, 179 (1986).
Nature of Proceeding
Determines Judicial Review
In this case, before the Court of Chancery could evaluate the reasonable probability of the plaintiffs' success on the merits, it had to determine the nature of the proceeding. When shareholders challenge directors' actions, usually one of three levels of judicial review is applied: the traditional business judgment rule, the Unocal standard of enhanced judicial scrutiny, or the entire fairness analysis.
The plaintiffs initially argued that Unitrin's Board put the corporation up for sale by implementing the Repurchase Program. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d at 182. The Court of Chancery ruled, however, that the plaintiffs had not established with reasonable probability that the Repurchase Program constituted a change of control from Unitrin's public stockholders to the stockholder directors. See Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34 (1994). The ruling is not at issue in this interlocutory appeal.
Unitrin Board's Actions Defensive
Unocal is Proper Review Standard
Before a board of directors' action is subject to the Unocal standard of enhanced judicial scrutiny, the court must determine whether the particular conduct was defensive.
According to the Unitrin Board, the Repurchase Program was enacted for a valid business purpose and, therefore, should not be evaluated as a defensive measure under Unocal. The Court of Chancery agreed that, had the Board enacted the Repurchase Program independent of a takeover proposal, its decision would be reviewed under the traditional business judgment rule. The Court of Chancery concluded, however, that the Unitrin Board perceived American General's Offer as a threat and, from the timing of the consideration and implementation of the Repurchase Program, adopted the Repurchase Program as one of several defensive measures in response to that threat. Unitrin does not dispute that conclusion for the purpose of this interlocutory appeal.
The Court of Chancery held that all of the Unitrin Board's defensive actions merited judicial scrutiny according to Unocal.
Business Judgment Rule
Enhanced Judicial Scrutiny
The business judgment rule applies to the conduct of directors in the context of a takeover. See Pogostin v. Rice, Del.Supr., 480 A.2d 619 (1984); Aronson v. Lewis, Del.
In Unocal, this Court reaffirmed "the application of the business judgment rule in the context of a hostile battle for control of a Delaware corporation where board action is taken to the exclusion of, or in limitation upon, a valid stockholder vote." Stroud v. Grace, 606 A.2d at 82. This Court has recognized that directors are often confronted with an "`inherent conflict of interest' during contests for corporate control `[b]ecause of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders.'" Id. (quoting Unocal, 493 A.2d at 954). Consequently, in such situations, before the board is accorded the protection of the business judgment rule, and that rule's concomitant placement of the burden to rebut its presumption on the plaintiff, the board must carry its own initial two-part burden:
Unocal, 493 A.2d at 955. See also Moran v. Household Int'l, Inc., Del.Supr., 500 A.2d 1346, 1356 (1985). The common law pronouncement in Unocal of enhanced judicial scrutiny, as a threshold or condition precedent to an application of the traditional business judgment rule, is now well known.
The enhanced judicial scrutiny mandated by Unocal is not intended to lead to a structured, mechanistic, mathematical exercise.
Parties' Burdens Shift
Judicial Review Standards Differ
Business Judgment Rule and Unocal
The correct analytical framework is essential to a proper review of challenges to the decision-making process of a corporate Board. Nixon v. Blackwell, Del.Supr., 626 A.2d 1366, 1375 (1993). The ultimate question in applying the Unocal standard is: what deference should the reviewing court give "to the decisions of directors in defending against a takeover?" E. Norman Veasey, The New Incarnation of the Business Judgment Rule in Takeover Defenses, 11 Del. J.Corp.L. 503, 504-05 (1986). The question is usually presented to the Court of Chancery, as in the present case, in an injunction proceeding, a posture which is known as "transactional justification." Id. To answer the question, the enhanced judicial scrutiny Unocal requires implicates both the substantive and procedural nature of the business judgment rule.
The business judgment rule has traditionally operated to shield directors from personal liability arising out of completed actions involving operational issues. Id. When the business judgment rule is applied to defend directors against personal liability, as in a derivative suit, the plaintiff has the initial burden of proof and the ultimate burden of persuasion. See Spiegel v. Buntrock, Del.Supr., 571 A.2d 767, 774 (1990). In such cases, the business judgment rule shields directors from personal liability if, upon review, the court concludes the directors' decision can be attributed to any rational business purpose. See Sinclair Oil Corp. v. Levien, Del.Supr., 280 A.2d 717, 720 (1971).
Conversely, in transactional justification cases involving the adoption of defenses to takeovers, the director's actions invariably implicate issues affecting stockholder rights. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Del.Supr., 506 A.2d 173, 180 n. 10 (1986). In transactional justification cases, the directors' decision is reviewed judicially and the burden of going forward is placed on the directors. See Joseph Hinsey, IV, Business Judgment and the American Law Institute's Corporate Governance Project: the Rule, the Doctrine and the Reality, 52 Geo.Wash.L.Rev., 609, 611-13 (1984). If the directors' actions withstand Unocal's reasonableness and proportionality review, the traditional business judgment rule is applied to shield the directors' defensive decision rather than the directors themselves. Id.
The litigation between Unitrin, American General, and the Unitrin shareholders in the Court of Chancery is a classic example of a transactional justification case. The Court of Chancery's determination that the conduct of Unitrin's Board was subject to Unocal's enhanced judicial scrutiny required it to evaluate each party's ability to sustain its unique burden in the procedural context of a preliminary injunction proceeding. The plaintiff's burden in such a proceeding is to demonstrate a reasonable probability of success after trial.
American General Threat
Reasonableness Burden Sustained
The first aspect of the Unocal burden, the reasonableness test, required the Unitrin Board to demonstrate that, after a reasonable investigation, it determined in good faith, that American General's Offer presented a threat to Unitrin that warranted a defensive response. This Court has held that the presence of a majority of outside independent directors will materially enhance such evidence. Unocal, 493 A.2d at 955. Accord Paramount Communications, Inc. v. Time, Inc., Del.Supr., 571 A.2d 1140, 1154 (1990); Polk v. Good, Del.Supr., 507 A.2d 531, 537 (1986); Moran v. Household Int'l, Inc., Del.Supr., 500 A.2d 1346, 1356 (1985). An "outside" director has been defined as a non-employee and non-management director, (e.g., Unitrin argues, five members of its seven-person Board). See Grobow v. Perot, Del.Supr., 539 A.2d 180, 184 n. 1 (1988). Independence "means that a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences." Aronson v. Lewis, Del.Supr., 473 A.2d 805, 816 (1984).
The Unitrin Board identified two dangers it perceived the American General Offer posed: inadequate price and antitrust complications. The Court of Chancery characterized the Board's concern that American General's proposed transaction could never be consummated because it may violate antitrust laws and state insurance regulations as a "makeweight excuse" for the defensive measure. It determined, however, that the Board reasonably believed that the American General Offer was inadequate and also reasonably concluded that the offer was a threat to Unitrin's uninformed stockholders.
The Court of Chancery held that the Board's evidence satisfied the first aspect or reasonableness test under Unocal. The Court of Chancery then noted, however, that the threat to the Unitrin stockholders from American General's inadequate opening bid was "mild," because the Offer was negotiable both in price and structure.
Chancery Approves Poison Pill
The second aspect or proportionality test of the initial Unocal burden required the Unitrin Board to demonstrate the proportionality of its response to the threat American General's Offer posed. The record reflects that the Unitrin Board considered three options as defensive measures: the poison pill, the advance notice bylaw, and the Repurchase Program. The Unitrin Board did not act on any of these options on July 25.
On August 2, American General made a public announcement of its offer to buy all the shares of Unitrin for $2.6 billion at $50-3/8 per share. The Unitrin Board had already concluded that the American General offer was inadequate. It also apparently feared that its stockholders did not realize that the long term value of Unitrin was not reflected in the market price of its stock.
On August 3, the Board met to decide whether any defensive action was necessary. The Unitrin Board decided to adopt defensive measures to protect Unitrin's stockholders from the inadequate American General Offer in two stages: first, it passed the poison pill and the advance notice bylaw; and, a week later, it implemented the Repurchase Program.
With regard to the second aspect or proportionality test of the initial Unocal burden, the Court of Chancery analyzed each stage of the Unitrin Board's defensive responses separately. Although the Court of Chancery characterized Unitrin's antitrust concerns as "makeweight," it acknowledged that the directors of a Delaware corporation have the prerogative to determine that the market undervalues its stock and to protect its stockholders from offers that do not reflect the long term value of the corporation under its present management plan. Paramount Communications, Inc. v. Time, Inc., 571 A.2d at 1153. The Court of Chancery concluded that Unitrin's Board believed in good faith that the American General Offer was inadequate and properly employed a poison pill as a proportionate defensive response to protect its stockholders from a "low ball" bid.
No cross-appeal was filed in this expedited interlocutory proceeding. Therefore, the Court of Chancery's ruling that the Unitrin Board's adoption of a poison pill was a proportionate response to American General's Offer is not now directly at issue. Nevertheless, to the extent the Unitrin Board's prior adoption of the poison pill influenced the Court of Chancery's proportionality review of the Repurchase Program, the Board's adoption of the poison pill is also a factor to be considered on appeal by this Court.
Chancery Enjoins Repurchase Program
The Court of Chancery did not view either its conclusion that American General's Offer constituted a threat, or its conclusion that the poison pill was a reasonable response to that threat, as requiring it, a fortiori, to conclude that the Repurchase Program was also an appropriate response. The Court of Chancery then made two factual findings: first, the Repurchase Program went beyond what was "necessary" to protect the Unitrin stockholders from a "low ball" negotiating strategy; and second, it was designed to keep the decision to combine with American General within the control of the members of the Unitrin Board, as stockholders, under virtually all circumstances. Consequently, the Court of Chancery held that the Unitrin Board failed to demonstrate that the Repurchase Program met the second aspect or
The Court of Chancery framed the ultimate question before it as follows:
The Court of Chancery then answered that question:
In explaining its conclusion, the Court of Chancery reasoned that:
The Court of Chancery concluded that, although the Unitrin Board had properly perceived American General's inadequate Offer as a threat and had properly responded to that threat by adopting a "poison pill," the additional defensive response of adopting the Repurchase Program was unnecessary and disproportionate to the threat the Offer posed. Accordingly, it concluded that the plaintiffs had "established with reasonable probability that the [Unitrin Board] violated its duties under Unocal [by authorizing the Repurchase Program]" because the Board had not sustained its burden of demonstrating that the Repurchase Program was a proportionate response to American General's Offer. Therefore, the Court of Chancery held that the plaintiffs proved a likelihood of success on that issue and granted the motion to preliminarily enjoin the Repurchase Program.
Before the Repurchase Program began, Unitrin's directors collectively held approximately 23% of Unitrin's outstanding shares. Unitrin's certificate of incorporation already included a "shark-repellent"
The Court of Chancery found that by not participating in the Repurchase Program, the Board "expected to create a 28% voting block to support the Board's decision to reject [a future] offer by American General."
The parties are in substantial disagreement with respect to the Court of Chancery's ultimate factual finding that the Repurchase Program was a disproportionate response under Unocal. Unitrin argues that American General or another potential acquiror can theoretically prevail in an effort to obtain control of Unitrin through a proxy contest. American General argues that the record supports the Court of Chancery's factual determination that the adoption of the Repurchase Program violated the principles of Unocal, even though American General acknowledges that the option of a proxy contest for obtaining control of Unitrin remained theoretically available. The stockholder-plaintiffs argue that even if it can be said, as a matter of law, that it is acceptable under certain circumstances to leave potential bidders with a proxy battle as the sole avenue for acquiring an entity, the Court of Chancery correctly determined, as a factual matter, that the Repurchase Program was disproportionate to the threat American General's Offer posed.
This Court has been and remains assiduous in its concern about defensive actions designed to thwart the essence of corporate democracy by disenfranchising shareholders. Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34, 42 n. 11 (1994). See also Stroud v. Grace, Del. Supr., 606 A.2d 75 (1992). For example, when this Court concluded that rescheduling an annual meeting date directly manifested an entrenchment motive on the part of a board, we stated:
Schnell v. Chris-Craft Indus., Inc., Del. Supr., 285 A.2d 437, 439 (1971). See also Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d at 42 n. 11.
Nevertheless, this Court has upheld the propriety of adopting poison pills in given defensive circumstances. Keeping a poison pill in place may be inappropriate, however, when those circumstances change dramatically. See Moran v. Household Int'l, Inc., Del. Supr., 500 A.2d 1346, 1355 (1985). Cf. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Del.Supr., 506 A.2d 173, 179 (1986). Similarly, this Court has recognized the propriety of implementing certain repurchase programs (as in Unocal itself), as well as the unreasonableness and non-proportionality of responding defensively to a takeover bid with a coercive and preclusive partial self-tender offer. See Paramount Communications, Inc. v. Time, Inc., Del.Supr., 571 A.2d 1140, 1154 (1990) (citing AC Acquisitions Corp. v. Anderson, Clayton & Co., Del.Ch., 519 A.2d 103 (1986)).
More recently, this Court stated: "we accept the basic legal tenets," set forth in
This Court also specifically noted that boards of directors often interfere with the exercise of shareholder voting when an acquiror launches both a proxy fight and a tender offer. Id. at 92 n. 3.
Tender Offer/Proxy Contest
We begin our examination of Unitrin's Repurchase Program mindful of the special import of protecting the shareholder's franchise within Unocal's requirement that a defensive response be reasonable and proportionate. Stroud v. Grace, 606 A.2d at 92. For many years the "favored attack of a [corporate] raider was stock acquisition followed by a proxy contest." Unocal, 493 A.2d at 957. Some commentators have noted that the recent trend toward tender offers as the preferable alternative to proxy contests appears to be reversing because of the proliferation of sophisticated takeover defenses. Lucian A. Bebchuk & Marcel Kahan, A Framework for Analyzing Legal Policy Towards Proxy Contests, 78 Cal.L.Rev. 1071, 1134 (1990). In fact, the same commentators have characterized a return to proxy contests as "the only alternative to hostile takeovers to gain control against the will of the incumbent directors." Id.
The Court of Chancery, in the case sub judice, was obviously cognizant that the emergence of the "poison pill" as an effective takeover device has resulted in such a remarkable transformation in the market for corporate control that hostile bidders who proceed when such defenses are in place will usually "have to couple proxy contests with tender offers." Joseph A. Grundfest, Just Vote No: A Minimalist Strategy for Dealing with Barbarians Inside the Gates, 45 Stan. L.Rev. 857, 858 (1993).
The record reflects that the Court of Chancery's decision to enjoin the Repurchase Program is attributable to a continuing misunderstanding, i.e., that in conjunction with the longstanding Supermajority Vote provision in the Unitrin charter, the Repurchase Program would operate to provide the director shareholders with a "veto" to preclude a successful proxy contest by American General.
"Prestige and Perquisites"
The subjective premise was the Court of Chancery's sua sponte determination that Unitrin's outside directors, who are also substantial stockholders, would not vote like other stockholders in a proxy contest, i.e., in their own best economic interests. At American General's Offer price, the outside directors held Unitrin shares worth more than $450 million. Consequently, Unitrin argues the stockholder directors had the same interest as other Unitrin stockholders generally, when voting in a proxy contest, to wit: the maximization of the value of their investments.
In rejecting Unitrin's argument, the Court of Chancery stated that the stockholder directors would be "subconsciously" motivated in a proxy contest to vote against otherwise excellent offers which did not include a "price parameter" to compensate them for the loss of the "prestige and perquisites" of membership on Unitrin's Board. The Court of Chancery's subjective determination that the stockholder directors of Unitrin would reject an "excellent offer," unless it compensated them for giving up the "prestige and perquisites" of directorship, appears to be subjective and without record support. It cannot be presumed.
It must be the subject of proof that the Unitrin directors' objective in the Repurchase Program was to forego the opportunity to sell their stock at a premium. In particular, it cannot be presumed that the prestige and perquisites of holding a director's office or a motive to strengthen collective power prevails over a stockholder-director's economic interest. Even the shareholder-plaintiffs in this case agree with the legal proposition Unitrin advocates on appeal: stockholders
Without Repurchase Program
Actual Voting Power Exceeds 25%
The first objective premise relied upon by the Court of Chancery, unsupported by the record, is that the shareholder directors needed to implement the Repurchase Program to attain voting power in a proxy contest equal to 25%. The Court of Chancery properly calculated that if the Repurchase Program was completed, Unitrin's shareholder directors would increase their absolute voting power to 25%. It then calculated the odds of American General marshalling enough votes to defeat the Board and its supporters.
The Court of Chancery and all parties agree that proxy contests do not generate 100% shareholder participation. The shareholder plaintiffs argue that 80-85% may be a usual turnout. Therefore, without the Repurchase Program, the director shareholders' absolute voting power of 23% would already constitute actual voting power greater than 25% in a proxy contest with normal shareholder participation below 100%. See Berlin v. Emerald Partners, Del.Supr., 552 A.2d 482 (1989).
No Realistic Deterrent
The second objective premise relied upon by the Court of Chancery, unsupported by the record, is that American General's ability to succeed in a proxy contest depended on the Repurchase Program being enjoined because of the Supermajority Vote provision in Unitrin's charter.
As American General acknowledges, a less than 15% stockholder bidder need not proceed with acquiring shares to the extent that it would ever implicate the Supermajority
The record reflects that institutional investors own 42% of Unitrin's shares. Twenty institutions own 33% of Unitrin's shares. It is generally accepted that proxy contests have re-emerged with renewed significance as a method of acquiring corporate control because "the growth in institutional investment has reduced the dispersion of share ownership." Lucian A. Bebchuk & Marcel Kahan, A Framework for Analyzing Legal Policy Towards Proxy Contests, 78 Cal. L.Rev. 1071, 1134 (1990).
With Supermajority Vote
After Repurchase Program
Proxy Contest Appears Viable
The assumptions and conclusions American General sets forth in this appeal for a different purpose are particularly probative with regard to the effect of the institutional holdings in Unitrin's stock. American General's two predicate assumptions are a 90% stockholder turnout in a proxy contest and a bidder with 14.9% holdings, i.e., the maximum the bidder could own to avoid triggering the poison pill and the Supermajority Vote provision. American General also calculated the votes available to the Board or the bidder with and without the Repurchase Program:
American General then applied these assumptions to reach conclusions regarding the votes needed for the 14.9% stockholder bidder to prevail: first, in an election of directors; and second, in the subsequent vote on a merger. With regard to the election of directors, American General made the following calculations:
Consequently, to prevail in a proxy contest with a 90% turnout, the percentage of additional shareholder votes a 14.9% shareholder bidder needs to prevail is 30.2% for directors and 35.2% in a subsequent merger. The record reflects that institutional investors held 42% of Unitrin's stock and 20 institutions held 33% of the stock. Thus, American General's own assumptions and calculations in the record support the Unitrin Board's argument that "it is hard to imagine a company more readily susceptible to a proxy contest concerning a pure issue of dollars."
The conclusion of the Court of Chancery that the Repurchase Program would make a proxy contest for Unitrin a "theoretical" possibility that American General could not realistically pursue may be erroneous and appears to be inconsistent with its own earlier determination that the "repurchase program strengthens the position of the Board of Directors to defend against a hostile bidder, but will not deprive the public stockholders of the `power to influence corporate direction through the ballot.'" Even a complete implementation of the Repurchase Program, in combination with the pre-existing Supermajority Vote provision, would not appear to have a preclusive effect upon American General's ability successfully to marshall enough shareholder votes to win a proxy contest. Accord Shamrock Holdings, Inc. v. Polaroid Corp., Del.Ch., 559 A.2d 278 (1989). A proper understanding of the record reflects that American General or any other 14.9% shareholder bidder could apparently win a proxy contest with a 90% turnout.
The key variable in a proxy contest would be the merit of American General's issues, not the size of its stockholdings. Moran v. Household Int'l, Inc., Del.Supr., 500 A.2d 1346, 1355 (1985). If American General presented an attractive price as the cornerstone of a proxy contest, it could prevail, irrespective of whether the shareholder directors' absolute voting power was 23% or 28%. In that regard, the following passage from the Court of Chancery's Opinion is poignant:
Consequently, a proxy contest apparently remained a viable alternative for American General to pursue notwithstanding Unitrin's poison pill, Supermajority Vote provision, and a fully implemented Repurchase Program.
American General's Threat
This Court has recognized "the prerogative of a board of directors to resist a third party's unsolicited acquisition proposal or offer." Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34, 43 n. 13 (1994). The Unitrin Board did not have unlimited discretion to defeat the threat it perceived from the American General Offer by any draconian
"The obvious requisite to determining the reasonableness of a defensive action is a clear identification of the nature of the threat." Paramount Communications, Inc. v. Time, Inc., Del.Supr., 571 A.2d 1140, 1154 (1990). Courts, commentators and litigators have attempted to catalogue the threats posed by hostile tender offers. Id. at 1153. Commentators have categorized three types of threats:
Id. at 1153 n. 17 (quoting Ronald J. Gilson & Reinier Kraakman, Delaware's Intermediate Standard for Defensive Tactics: Is There Substance to Proportionality Review?, 44 Bus.Law. 247, 267 (1989)).
This Court has held that the "inadequate value" of an all cash for all shares offer is a "legally cognizable threat." Paramount Communications, Inc. v. Time, Inc., 571 A.2d at 1153. In addition, this Court has specifically concluded that inadequacy of value is not the only legally cognizable threat from "an all-shares, all-cash offer at a price below what a target board in good faith deems to be the present value of its shares." Id. at 1152-53. In making that determination, this Court held that the Time board of directors had reasonably determined that inadequate value was not the only threat that Paramount's all cash for all shares offer presented, but was also reasonably concerned that the Time stockholders might tender to Paramount in ignorance or based upon a mistaken belief, i.e., yield to substantive coercion.
The record reflects that the Unitrin Board perceived the threat from American General's Offer to be a form of substantive coercion. The Board noted that Unitrin's stock price had moved up, on higher than normal trading volume, to a level slightly below the price in American General's Offer. The Board also noted that some Unitrin shareholders had publicly expressed interest in selling at or near the price in the Offer. The Board determined that Unitrin's stock was undervalued by the market at current levels and that the Board considered Unitrin's stock to be a good long-term investment. The Board also discussed the speculative and unsettled market conditions for Unitrin stock caused by American General's public disclosure. The Board concluded that a Repurchase Program would provide additional liquidity to those stockholders who wished to realize short-term gain, and would provide enhanced value to those stockholders who wished to maintain a long-term investment. Accordingly, the Board voted to authorize the Repurchase Program for up to ten million shares of its outstanding stock on the open market.
In Unocal, this Court noted that, pursuant to Delaware corporate law, a board of directors' duty of care required it to respond actively to protect the corporation and its shareholders from perceived harm. Unocal, 493 A.2d at 955. In Unocal, when describing the proportionality test, this Court listed several examples of concerns that boards of
The record appears to support Unitrin's argument that the Board's justification for adopting the Repurchase Program was its reasonably perceived risk of substantive coercion, i.e., that Unitrin's shareholders might accept American General's inadequate Offer because of "ignorance or mistaken belief" regarding the Board's assessment of the long-term value of Unitrin's stock. See Shamrock Holdings, Inc. v. Polaroid Corp., Del.Ch., 559 A.2d 278, 290 (1989). In this case, the Unitrin Board's letter to its shareholders specifically reflected those concerns in describing its perception of the threat from American General's Offer. The adoption of the Repurchase Program also appears to be consistent with this Court's holding that economic inadequacy is not the only threat presented by an all cash for all shares hostile bid, because the threat of such a hostile bid could be exacerbated by shareholder "ignorance or ... mistaken belief." Paramount Communications, Inc. v. Time, Inc., 571 A.2d at 1153.
Range of Reasonableness
Proper Proportionality Burden
The Court of Chancery's legal conclusions are subject to de novo review by this Court. Merrill v. Crothall-American, Inc., Del.Supr., 606 A.2d 96, 99 (1992). The Court of Chancery's factual findings will be accepted if "they are sufficiently supported by the record and are the product of an orderly and logical deductive process." Levitt v. Bouvier, Del.Supr., 287 A.2d 671, 673 (1972).
We have already noted that the Court of Chancery made a factual finding unsupported by the record, i.e., that the increase in the percentage of ownership by the stockholder directors from 23% to 28%, resulting from the completed Repurchase Program, would make it merely theoretically possible for an insurgent to win a proxy contest. That finding was based upon a hypothetical risk which originated from the Court of Chancery's attribution of subjective "prestige and perquisite" voting motives to Unitrin's outside shareholder directors. See Stroud v. Grace, Del.Supr., 606 A.2d 75, 82 (1992). In addition, that factual finding was based upon two objective mathematically erroneous calculations regarding the relative voting strength of American General and the stockholder directors.
The Court of Chancery applied an incorrect legal standard when it ruled that the Unitrin decision to authorize the Repurchase Program was disproportionate because it was "unnecessary." The Court of Chancery stated:
In QVC, this Court recently elaborated upon the judicial function in applying enhanced scrutiny, citing Unocal as authority, albeit in the context of a sale of control and the target board's consideration of one of several reasonable alternatives. That teaching is nevertheless applicable here:
Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34, 45-46 (1994) (emphasis in original). The Court of Chancery did not determine whether the Unitrin Board's decision to implement the Repurchase Program fell within a "range of reasonableness."
The record reflects that the Unitrin Board's adoption of the Repurchase Program was an apparent recognition on its part that all shareholders are not alike.
The Court of Chancery's determination that the Unitrin Board's adoption of the Repurchase Program was unnecessary constituted a substitution of its business judgment for that of the Board, contrary to this Court's "range of reasonableness" holding in Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d at 45-46. Its decision to enjoin the Repurchase Program as an "unnecessary" addition to other complementary defensive mechanisms is also inconsistent with a similar analysis in Shamrock Holdings, Inc. v. Polaroid Corp., Del.Ch., 559 A.2d 278 (1989). In Shamrock, the Court of Chancery refused to enjoin any one of a series of transactions which included a repurchase plan. With respect to a repurchase program, the Court of Chancery held that a self-tender offer and buy-back plan constituted a reasonable proportionate response to the perceived threat to Polaroid shareholders by offering "some immediate value to those holders interested in cash while increasing the equity interest held by the remaining stockholders." Shamrock Holdings, Inc. v. Polaroid Corp., 559 A.2d at 290.
Coercive or Preclusive
Range of Reasonableness
In assessing a challenge to defensive actions by a target corporation's board of directors in a takeover context, this Court has held that the Court of Chancery should
In Unocal, the progenitor of the proportionality test, this Court stated that the board of directors' "duty of care extends to protecting the corporation and its [stockholders] from perceived harm whether a threat originates from third parties or other shareholders." Unocal, 493 A.2d at 955. We then noted that "such powers are not absolute." Id. Specifically, this Court held that the board "does not have unbridled discretion to defeat any perceived threat by any Draconian means available." Id. Immediately following those observations in Unocal, when exemplifying the parameters of a board's authority in adopting a restrictive stock repurchase, this Court held that "the directors may not have acted solely or primarily out of a desire to perpetuate themselves in office" (preclusion of the stockholders' corporate franchise right to vote) and, further, that the stock repurchase plan must not be inequitable. Unocal, 493 A.2d at 955 (emphasis added).
An examination of the cases applying Unocal reveals a direct correlation between findings of proportionality or disproportionality and the judicial determination of whether a defensive response was draconian because it was either coercive or preclusive in character. In Time, for example, this Court concluded that the Time board's defensive response was reasonable and proportionate since it was not aimed at "cramming down" on its shareholders a management-sponsored alternative, i.e., was not coercive, and because it did not preclude Paramount from making an offer for the combined Time-Warner company, i.e., was not preclusive. See Paramount Communications, Inc. v. Time, Inc., Del.Supr., 571 A.2d 1140, 1154-55 (1990) (citing for comparison as coercive or preclusive disproportionate responses Mills Acquisition Co. v. Macmillan, Inc., Del. Supr., 559 A.2d 1261 (1989), and AC Acquisitions Corp. v. Anderson, Clayton & Co., Del. Ch., 519 A.2d 103 (1986)).
This Court also applied Unocal's proportionality test to the board's adoption of a "poison pill" shareholders' rights plan in Moran v. Household Int'l, Inc., Del.Supr., 500 A.2d 1346 (1985). After acknowledging that the adoption of the rights plan was within the directors' statutory authority, this Court determined that the implementation of the rights plan was a proportionate response to the theoretical threat of a hostile takeover, in part, because it did not "strip" the stockholders of their right to receive tender offers and did not fundamentally restrict proxy contests, i.e., was not preclusive. Id. at 1357.
More than a century before Unocal was decided, Justice Holmes observed that the common law must be developed through its application and "cannot be dealt with as if it contained only the axioms and corollaries of a book of mathematics." Oliver Wendell Holmes, Jr., The Common Law 1 (1881). As common law applications of Unocal's proportionality standard have evolved, at least two characteristics of draconian defensive measures taken by a board of directors in responding to a threat have been brought into focus through enhanced judicial scrutiny. In the modern takeover lexicon, it is now clear that since Unocal, this Court has consistently recognized that defensive measures which are either preclusive or coercive are included within the common law definition of draconian.
If a defensive measure is not draconian, however, because it is not either coercive
The ratio decidendi for the "range of reasonableness" standard is a need of the board of directors for latitude in discharging its fiduciary duties to the corporation and its shareholders when defending against perceived threats. The concomitant requirement is for judicial restraint. Consequently, if the board of directors' defensive response is not draconian (preclusive or coercive) and is within a "range of reasonableness," a court must not substitute its judgment for the board's. Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d at 45-46.
Proportionate With Poison Pill
In this case, the initial focus of enhanced judicial scrutiny for proportionality requires a determination regarding the defensive responses by the Unitrin Board to American General's offer. We begin, therefore, by ascertaining whether the Repurchase Program, as an addition to the poison pill, was draconian by being either coercive or preclusive.
A limited nondiscriminatory self-tender, like some other defensive measures, may thwart a current hostile bid, but is not inherently coercive. Moreover, it does not necessarily preclude future bids or proxy contests by stockholders who decline to participate in the repurchase. Cf. AC Acquisitions Corp. v. Anderson, Clayton & Co., Del. Ch., 519 A.2d 103 (1986) (enjoining a coercive self-tender and restructuring plan). A selective repurchase of shares in a public corporation on the market, such as Unitrin's Repurchase Program, generally does not discriminate because all shareholders can voluntarily realize the same benefit by selling. See Larry E. Ribstein, Takeover Defenses and the Corporate Contract, 78 Geo.L.J. 71, 129-31 (1989). See also Michael Bradley & Michael Rosenzweig, Defensive Stock Repurchases, 99 Harv.L.Rev. 1377 (1986). Here, there is no showing on this record that the Repurchase Program was coercive.
We have already determined that the record in this case appears to reflect that a proxy contest remained a viable (if more problematic) alternative for American General even if the Repurchase Program were to be completed in its entirety. Nevertheless, the Court of Chancery must determine whether Unitrin's Repurchase Program would only inhibit American General's ability to wage a proxy fight and institute a merger or whether it was, in fact, preclusive
The Court of Chancery found that the Unitrin Board reasonably believed that American General's Offer was inadequate and that the adoption of a poison pill was a proportionate defensive response. Upon remand, in applying the correct legal standard to the factual circumstances of this case, the Court of Chancery may conclude that the implementation of the limited Repurchase Program was also within a range of reasonable additional defensive responses available to the Unitrin Board. In considering whether the Repurchase Program was within a range of reasonableness the Court of Chancery should take into consideration whether: (1) it is a statutorily authorized form of business decision which a board of directors may routinely make in a non-takeover context;
The Court of Chancery's holding in Shamrock, cited with approval by this Court in Time,
American General argues that the all cash for all shares offer in Shamrock is distinguishable because Shamrock involved a hostile tender offer, whereas this case involves a fully negotiable Offer to enter into a consensual merger transaction. Nevertheless, American General acknowledges that a determinative factor in Shamrock was a finding that the defensive responses had only an incidental effect on the stockholder profile for the purpose of a proxy contest, i.e., was not preclusive. See id. at 286-288. In Shamrock, the Court of Chancery's proportionality holding was also an implicit determination that the series of multiple defensive responses were within a "range of reasonableness."
Remand to Chancery
In this case, the Court of Chancery erred by substituting its judgment, that the Repurchase Program was unnecessary, for that of the Board. The Unitrin Board had the power and the duty, upon reasonable investigation, to protect Unitrin's shareholders from what it perceived to be the threat
If the Court of Chancery concludes that individually and collectively the poison pill and the Repurchase Program were proportionate to the threat the Board believed American General posed, the Unitrin Board's adoption of the Repurchase Program and the poison pill is entitled to review under the traditional business judgment rule. The burden will then shift "back to the plaintiffs who have the ultimate burden of persuasion [in a preliminary injunction proceeding] to show a breach of the directors' fiduciary duties." Moran v. Household Int'l, Inc., Del.Supr., 500 A.2d 1346, 1356 (1985) (citing Unocal, 493 A.2d at 958). In order to rebut the protection of the business judgment rule, the burden on the plaintiffs will be to demonstrate, "by a preponderance of the evidence that the directors' decisions were primarily based on [(1)] perpetuating themselves in office or [(2)] some other breach of fiduciary duty such as fraud, overreaching, lack of good faith, or [(3)] being uninformed." Unocal, 493 A.2d at 958 (emphasis added).
American General's alternative argument on appeal is that the preliminary injunction should be affirmed, notwithstanding the reversible error that has been identified in the Court of Chancery's Unocal analysis, based upon breaches by the Unitrin Board of its duties of care, loyalty and disclosure. See A.I.D. v. P.M.D., Del.Supr., 408 A.2d 940, 942 (1979). We recognize that this Court may affirm on the basis of a different rationale than that which was articulated by the trial court. We also recognize that this Court may rule on an issue fairly presented to the trial court, even if it was not addressed by the trial court. Standard Distrib. Co. v. Nally, Del.Supr., 630 A.2d 640, 647 (1993).
Because of its erroneous determination under Unocal, the Court of Chancery did not reach American General's claims that the Unitrin defendants breached their duties of due care, disclosure and loyalty in connection with the adoption of the Repurchase Program. We have concluded that it would be inequitable to take the alternative course of action American General advocates in this expedited interlocutory appeal. The Court of Chancery should have the opportunity to address those alternative breach of duty arguments in the first instance.
Unitrin's alternative argument is that the Court of Chancery should not have enjoined the Repurchase Program, even if it was not entirely persuaded that the Program's enactment was within a range of reasonableness. According to Unitrin, under such circumstances in the context of a preliminary injunction proceeding, the appropriate equitable remedy would have been to enjoin the defendants from exercising any increase in their voting power as shareholders that resulted from the Repurchase Program. Upon remand, it may be necessary for the Court of Chancery to address Unitrin's alternative argument.
After applying Unocal's proportionality test, the Court of Chancery may conclude that Unitrin's Repurchase Program was within the range of reasonableness. Nevertheless, this Court recognizes that in all preliminary injunction proceedings, after an application of Unocal's proportionality test, a bright line might not appear to delineate
We hold that the Court of Chancery correctly determined that the Unocal standard of enhanced judicial scrutiny applied to the defensive actions of the Unitrin defendants in establishing the poison pill and implementing the Repurchase Program. The Court of Chancery's finding, that the Repurchase Program was a disproportionate defensive response, was based on faulty factual predicates, unsupported by the record. This error was exacerbated by its application of an erroneous legal standard of "necessity" to the Repurchase Program as a defensive response.
The interlocutory judgment of the Court of Chancery, in favor of American General, is REVERSED. This matter is REMANDED for further proceedings in accordance with this opinion. The mandate shall issue at 4:30 p.m. on January 16, 1995. Supr.Ct.R. 19(a).
Robert J. Klein, The Case for Heightened Scrutiny in Defense of the Shareholders' Franchise Right, 44 Stan.L.Rev. 129, 129 n. 6 (1991). For a discussion of poison pills and their possible "flip over" or "flip in" features, see Jeffrey N. Gordon, Corporations, Markets and Courts, 91 Colum.L.Rev. 1931, 1937-38 n. 21 (1991).
Unocal, 493 A.2d at 954 (footnote omitted).
(FV - TP)(pFV) - (TP -SV)(pSV) > 0
George H. Kanter, Comment, Judicial Review of Antitakeover Devices Employed in the Noncoercive Tender Offer Context: Making Sense of the Unocal Test, 138 U.Pa.L.Rev., 225, 254-55 (1989) (footnote omitted).
The day after the original opinion was issued, American General's counsel wrote to the Court of Chancery to inform it of a factual error. According to American General's counsel, the original opinion was:
The Court of Chancery acknowledged its mistake by sending out two corrected pages. Even with the two revised pages, the Court of Chancery's decision continues to reflect its initial misunderstanding of the Supermajority Vote provision.
Randall S. Thomas, Judicial Review of Defensive Tactics in Proxy Contests: When is Using a Rights Plan Rights?, 46 Vand.L.Rev. 503, 512 (1993).
Id. at 619.