Equitable Limits On Acquisitions And Defensive Maneuvers

• Author: James D. Cox/Thomas Lee Hazen
• Profession: Professor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
• Pages: 538-561

§ 23.1 Fiduciary Obligations in

Acquisit ion Transactions

Acquisitions where the acquiring company owns a majority of the tar-

get prior to the merger agreement create the potential of self-dealing

by favoring the majority over the mi nority. The essence of the major-

ity’s fiduciary obligations in such acquisit ions is the Delaware Supreme

Court’s “entire fairness” standard.1 The court embraced the give-get

formula for measuring fairness, reasoning that “the test of fairness

which we think [is] the correct one [is] that upon a merger the minor-

ity stockholder shall receive the substantial equivalent in value of what

he had before.”2 The Delaware Supreme Court, and other courts,3 now

recognize that the minority should also participate proportionally in

any nonspeculative gai ns generated by the acquisition.4

The procedural context in wh ich the transact ion is formulated,

proposed, and approved has assumed increasing importance. For

example, the Delaware Supreme Court has distinguished between

“fair dealing ” and “fair price” such that it more readily concludes the

appraisal remedy is exclusive as to the latter but not necessarily as to

the former.5 “Fair dealing” is defined to i nclude questions regardi ng the

acquisition’s timing, how it was initiated, struct ured, and negotiated,

and the approvals of the directors and stockholders obtained.6 In

essence, fair dealing examines whet her the transaction is the product of

overreaching misbehav ior by which those in a fiducia ry relationship to

the target corporation use their power to deprive the target corp oration

of fair and independent representation in the acquisition.7

These problems are circumvented by interjecting an independent

negotiating committee b etween the parent and the target corporat ion.8 A

furt her means to clothe the controlled corp oration with an i ndependent

voice is by conditioning the tra nsaction’s consummat ion on the approval

of a majority of the disinterested shares. However, the burden of proving

the acquisition’s entire fairness does not shift if the procedures followed

are not truly independent.9

§ 23.2 Equitable Limitations on the

Power of Sale or Merger

A controlling shareholder or parent corporation that dominates and

controls another corporation is not as a matter of law precluded from

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purchasing the enti re property and assets of the controlled corporation,

either when the assets of a going concern are sold or when the corpora-

tion is being wound up. However, such a purchase by a controlling per-

son or the company’s managers implicates the same concerns exa mined

in Chapter 10 regarding self-dealing such that close or rigorous judicial

scrutiny occurs.10

When the appraisal remedy is not exclusive, the reviewing court

should “carefully scrutinize the board’s actions to ascertain whether

the board instituted measures to ensure a fair process, and whether the

board achieved a fair price for the disinterested stockholder minority.”11

This formula is more frequently stated as the “entire fairness” inquiry

with fairness thus having two distinct components: fair dealings and

fair price.12 The court undertakes a unif ied assessment that involves

balancing the process followed and the price received by the minorit y.13

In assessing t he fairness of the process, the court will consider “the

board’s composition and independence, the timing, structure and

negotiation of the transact ion; how the board and shareholder approval

were obtained; and the extent to which the board and the shareholders

were accurately informed about the transaction.”14

Delaware has qualified the scope of the entire fair ness review stan-

dard. In Glassman v. Unocal Exploration Corporation, the court held that

the parent company that exercises its right under t he short-form merger

provision to rid itself of the minorit y shareholders in the subsidiary

does not have to establish the entire fairness for its actions.15 In such

a case, the exclusive remedy to the minority, absent fraud or illegality,

is the appraisal remedy.16 Simila rly, in Solomon v. Pathe,17 the Delaware

Supreme Court held that the entire fairness standard does not apply

to tender offers initiated by a controlling stockholder. However, fidu-

ciary limits do apply when the controlling shareholder combines the

tender offer and short-form merger with the objective of eliminating

the minority shareholders.18

§ 23.3 Merger Freeze-Outs of

Minority Shareholders

Abuses that may accompany a controlled merger or other conflict-of-

interest transact ion are magnified when the minority shareholder is

cashed out and thus is not able to share in the profits of the surviv-

ing corporation. These cash-outs, a lso known as “squeeze-outs” or

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