Omnicare: coercion and the new Unocal standard.

• Author: Quinn, Brian J.M.
• Position: Delaware

1. INTRODUCTION II. LEARNING TO LOVE OMNICARE III. THE GO-SHOP PUZZLE IV. LIVING WITH--OR WORKING AROUND--OMNICARE V. THE NEW DEAL PROTECTION JURISPRUDENCE VI. OMNICARE'S FUTURE AND DEAL PROTECTIONS I. INTRODUCTION

   When Omnicare, Inc. v. NCS Healthcare, Inc. (1) was decided ten years ago, it was widely derided as one of the worst corporate law opinions since Smith v. Van Gorkom. (2) In fact, chief Justice Myron steele of the Delaware supreme court remarked at a conference not long after that the opinion would likely have the life span of a "fruit fly." (3) I subsequently offered up a modest, and perhaps lonely, defense of the Omnicare decision published in the pages of this Journal (4) In that defense, I argued that when sellers grant buyers deal certainty there should be no expectation that such an act provides sellers any value, notwithstanding nominal payments buyers might make in exchange for that incremental certainty. (5) In fact, deal certainty should be expected to lead to low-ball offers. (6) I argued that Omnicare, for all its faults, was helpful because it placed fiduciary limits on sellers in situations in which sellers are not able to credibly resist buyer demands for additional transactional certainty. (7) These fiduciary limits, by precommitting sellers to a process that ensures a minimal degree of competition, or at least the threat of it, force buyers to reveal private information about their valuations of the sellers. (8) Buyers, for their part, need not be denied deal certainty by Omnicare's controversial rule. They can still get the transactional certainty they wish, but they have to pay for it.

   Like other modest defenses, my defense of Omnicare was hardly sufficient to protect the opinion's integrity. Now, all these years later, although it is still in my notebook, Omnicare is slightly the worse for wear. Practitioners have learned to live with--or more correctly--work around the decision. Deal protections are perhaps as formidable as they have ever been. While the Supreme Court has not had an opportunity to directly revisit the issue, the chancery court has taken the opportunities that have been regularly presented to it to peel back the ruling's effect and distinguish the facts before it from Omnicare's holding. Following the opinion, the courts could have taken Omnicare as a cue to move the needle on a long-standing debate about the proper limits on board action, but they collectively decided against that course of action. In recent years, as practitioners have introduced transactional innovations in response to Omnicare, the courts have regularly blessed them.

   Notwithstanding the fruit fly rhetoric, Omnicare may have a much longer life than many of its critics predict. In part, that is because of a second, now less controversial, aspect of the opinion. In Omnicare, the Delaware Supreme Court made it clear that it would apply Unocal (9) to the analysis of board decisions to adopt deal protection measures in friendly transactions not involving a change of control. (10) Looking back now, subjecting deal protection measures to intermediate scrutiny was undoubtedly correct, but, at the time, there were many in practice who believed that Paramount v. Time (11) provided a green light to dealmakers to negotiate almost any deal protections subject to business judgment deference. The clarification of the proper standard of review for deal protections in the context of a friendly merger is an important and enduring contribution of Omnicare.

   Of course, in the years since Omnicare, there have been a series of subtle doctrinal changes that now call into serious question the efficacy of Unocal's intermediate standard. The development of the Unocal doctrine in recent years has tended to reduce its plasticity and scope. In part, it appears, having given itself the power to review deal protections in negotiated transactions, the court has since backed away from an aggressive application of that oversight. The result is that Unocal has been largely supplanted by what one might understand as a preliminary inquiry into the competitive posture of a transaction, and then a more constricted view of Unocal's reach. Where transactions do not benefit from alternative bids, courts will be highly deferential to board decisions to grant buyers defensive measures. This approach to deal protections generates a troublesome incentive for dealmakers to innovate and deploy deal protection measures that fall just short of Omnicare's bright line rule, but are still powerful enough to deter second bids.

   Just as the courts have declined the opportunity Omnicare afforded them, the courts have also narrowed the reach of Unocal's intermediate standard. When the Delaware Supreme Court first announced the intermediate standard, Unocal's proportionality prong suggested a role for the courts in substantive review of deal protection measures. (12) However, the courts have, over the years, increasingly narrowed the scope of a court's review under the guise of proportionality. By now, preclusivity and "range of reasonableness" analyses are dead letters. Because of the narrowing of Unocal's application, the courts have been largely left to focus only on Unocal's coercion standard. Coercive deal protections that implicate statutory obligations of the board and shareholders are, by now, the only measures likely to run afoul of Unocal.

   In Part II of this Article, I review my previous defense of the majority opinion in Omnicare. The essence of that defense is that a prohibition against completely bulletproofing transactions against subsequent bids is beneficial for selling shareholders and helps boards overcome structural biases in negotiation. Such a rule does not dissuade potential bidders who have alternate ways of generating some degree of certainty. Not with standing the direction of the court and dealmakers in recent years, I believe this defense of Omnicare's controversial holding remains largely correct. In Part III, I raise the challenge that go-shop provisions present the most common criticism of the Omnicare decision--that dealmakers value transaction certainty. In particular, it is difficult for a proponent of deal certainty to reconcile a stated desire for transaction certainty with the proliferation of a deal structure that purports to generate a post-signing auction. In Part IV, I observe that in the years since Omnicare, dealmakers have proven themselves to be perfectly competent to structure transactions around the opinion's fiduciary requirement. In many ways, these new deal protection measures are just as effective as the protections struck down in Omnicare, but the courts have decided to let them stand. In Part V, I review what I call the new deal protection jurisprudence. The court's own inherent conservatism has resulted in increasingly narrow room to maneuver within Unocal's once flexible standard and Omnicare's mandate. By now, only coercion remains of Unocal's proportionality prong. In Part VI, I provide some thoughts about the future of Omnicare and conclude.

2. LEARNING TO LOVE OMNICARE

   In Omnicare, (13) the Delaware Supreme Court made two contributions of real import. First, Omnicare established conclusively that the Unocal intermediate standard was to be applied in all circumstances in which a board adopts a measure to defend a corporate policy. The application of the Unocal standard was not dependent on the presence of so-called Revlon duties. (14) In reaching this conclusion, the court observed:

   There are inherent conflicts between a board's interest in protecting a merger transaction it has approved, the stockholders' statutory right to make the final decision to either approve or not approve a merger, and the board's continuing responsibility to effectively exercise its fiduciary duties at all times after the merger agreement is executed. These competing considerations require a threshold determination that board-approved defensive devices protecting a merger transaction are within the limitations of its statutory authority and consistent with the directors' fiduciary duties. Accordingly, in Paramount v. Time, we held that the business judgment rule applied to the Time board's original decision to merge with Warner. We further held, however, that defensive devices adopted by the board to protect the original merger transaction must withstand enhanced judicial scrutiny under the Unocal standard of review, even when that merger transaction does not result in a change of control. (15) Although this result should have been clear to any reader of the case law, before Omnicare, there was a wide-spread feeling amongst practitioners that, following Time, (16) when negotiated or friendly transactions did not involve a change in control, board decisions about how much and in what manner to protect a transaction from a subsequent bid should receive the benefit of the business judgment presumption when challenged. (17) In Omnicare, the majority made it clear that the problem of cognitive biases in the board decision-making process is not constrained to boards resisting unwanted hostile offers. Indeed, even boards motivated to sell the corporation may face subtle conflicts when deciding whether, how, and with whom to pursue a corporate transaction. Before providing the decision to grant deal protections with the benefit of the business judgment rule in the context of a friendly transaction, the court must make a preliminary inquiry into the reasonableness of the board's decision-making process. (18) The decision to apply the intermediate standard to transactions not involving a change of control on its face appears to be an appropriate development of Unocal's flexible standard of review that takes into account the drastic change in circumstance between the mid-1980s when the standard was first developed and the turn of the last century when boards were more likely to be willing sellers, perhaps sometimes...