The Hon J Travis Laster (Delaware Court of Chancery) has published a short blog post and made available a full chapter: Changing Attitudes: The Stark Results of Thirty Years of Evolution in Delaware M&A Litigation. The blogpost and the chapter on which it is based trace the evolution of mergers and acquisitions litigation in Delaware after the 1985 'creation' of the 'enhanced scrutiny' standard.
The enhanced scrutiny standard
- In 1985 the Delaware Supreme Court issued four landmark decisions: Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) (overruled on other grounds by Gantler v. Stephens, 965 A.2d 695 (Del. 2009)); Unocal Corp v Mesa Petroleum Co, 493 A.2d 946 (Del. 1985); Moran v Household Int’l Inc, 500 A.2d 1346 (Del. 1985) and Revlon Inc v MacAndrews & Forbes Hldgs, Inc., 506 A.2d 173 (Del. 1986) which established a new framework for reviewing third-party mergers and acquisitions
- Since then, the author notes, Delaware courts have reviewed third-party merger and acquisition events (hostile and friendly) using an intermediate standard known as 'enhanced scrutiny' under which the defendant directors bear the burden of proving that they sought to serve a legitimate corporate purpose and that their actions fell within a range of reasonableness.
- Although the concept of a range of reasonableness implies an objective test, 'there is no Platonic form of reasonableness'. Attitudes and perceptions necessarily influence what a court regards as reasonable.
Changes in the application of the enhanced scrutiny standard
The chapter traces the changes in the Delaware Supreme Court's 'perceptions of recurring third party M&A scenarios' in four areas:
- the level of comfort with management-led, single bidder processes
- the legitimacy of defensive measures that appear designed to deter the emergence of alternative bids
- the relative priority of fiduciary duties and third-party contract rights
- deference to stockholder voting
According to the author's analysis, early decisions were coloured by the court's view of stockholders as 'financially unsophisticated' and unknowledgeable which meant that fiduciary duties were consistently prioritized over contract rights.
This approach, the author notes has changed markedly from the approach taken in the 1980s: 'No longer can courts, practitioners, or scholars treat the old learning as it still applies, simply because the decisions have not been formally overruled'.
According to his analysis the Delaware court now have signalled:
- 'presumptive validity of a single bidder process combined with a passive market check;
- presumptive deference to the stockholder vote absent a competing bid;
- and prioritisation of the bidders contract rights and hostility towards targeted injunctions'.
The author argues that each of these steps is a deregulatory move that makes it less likely that a Delaware court will issue an injunction in a deal case ('for enhanced scrutiny, the mode of application has become significantly more deferential to sell-side boards') and as such, is a positive development as markets not courts will decide the outcome. He adds that the change in approach also signals recognition of the rise of sophisticated institutional investors who can influence the direction of the corporations in which they invest and determine the outcome of M&A events, and acknowledges the 'system-wide failure of stockholder-led M&A litigation to generate meaningful benefits for investors'. 'When a market-driven protection is available and the litigant-driven mechanism has failed, it makes sense to favor the former over the latter'.