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[1](1): Torts - Breach of Legal Duty

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[1](1): Torts - Breach of Legal Duty

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  1. [1](1): Torts - Breach of Legal Duty • State Common Law Judges Create Civil Duties • Decisions create tort duties NOT based on property or contract obligations • Breach of the duty by person with duty (defendant D) allows an injured person (plaintiff P) to recover damages from the defendant who caused the injuries • What is the duty? • Take care to avoid causing injuries to certain types of persons • Defendant must exercise some minimum level of care to prevent such injuries • What is a breach? What is the minimum standard of care? • Intentional: D intentionally causes harm to P • Recklessness (gross negligence): D recklessly disregards potential harm to the P • Negligence: D did not exercise “reasonable care”, and caused harm to the P • Strict Liability: D has an absolute duty to avoid harming the P irrespective of the level of care taken by the D

  2. [1](2): Torts - Background • Early English Torts • Crimes: first torts created for battery, theft, and trespass of land • Nuisance: early tort for damage to the property of others • Fraud: early tort for misrepresentations in contracts • Examples of Torts relevant for topics in this course • breach of fiduciary duties such as the board of directors of a corporation • product liability for manufacturers, beyond contractual warranties • fraud for misrepresentations by corporations • Many Common Law Torts have become Statutory • Statutes define civil liabilities for particular actions • Statutes have also created criminal liabilities for the same actions

  3. [1](3): Duty of Care for Directors/Officers • Fiduciary Duty of Care • Perform responsibilities in good faith and with reasonable care • Act in the best interests of the corporation • Exercise care not to harm the corporation • Make decisions based on adequate information and deliberation • Prevent the corporation from violating the laws • Business Judgment Rule: for business decisions • Courts will not second guess the substantive merits of business decisions • Delaware: Directors breach their duty of care only when they are grossly negligent in making decisions • Gross negligence surely means that the decision “process” was clearly flawed • inadequate information or deliberation • Gross negligence might mean that the “substance” of the decision was clearly harmful to the corporation

  4. [1](4): Duty of Care - To Whom? • To whom do directors and officers have a duty of care? • To the corporation itself, and thus to the shareholders? YES • To creditors? MAYBE, if bankrupt or insolvent • To employees? Generally NO To customers? NO • Some states (New York but NOT Delaware) allow directors to consider the interests of these other groups, besides shareholders • But no state allows these other groups to sue the directors or officers • Why is there no general duty of care to these other groups? • Creditors, employees, and customers can and should protect themselves by contractual provisions in their business relationships with the corporation • Problem with this view: Contractual protections have little value when the corporation declares bankruptcy

  5. [1](5): Duty of Loyalty for Directors/Officers • Fiduciary Duty of Loyalty • Directors and Officers must place the financial interests of the corporation above their own financial interests • Conflicts of Interest arise when • Directors or Officers engage in contracts with the corporation • Directors or Officers learn of profitable opportunities which could be undertaken by either the corporation or themselves • Directors or Officers can take actions to protect their jobs at the expense of shareholders • Business Judgment Rule does not apply if a Conflict of Interest exists • Shareholders can sue to void the contract or rescind the decision • Director/Officer can defend the contract or decision only if they can prove that the it was substantively “fair” to the corporation and the shareholders

  6. [1](6): Conflicts of Interest • Conflicts of interest can be resolved if the contract or decision is • Approved by a vote of the disinterested directors • Approved by a vote of the shareholders • If approved, then the contract or decision has the protection of the Business Judgment Rule • Contract becomes voidable or decision rescindable only if there is a breach of the duty of care in that the director/officer was grossly negligent • BUT Approval by the disinterested directors (or shareholders) must be fully informed as to the conflict • Director/Officer must fully disclose his/her conflict AND the material facts about the contract or decision • If so, then approval removes the need to prove that the contract or decision was substantively fair to the corporation

  7. [1](7): Shareholder Lawsuits • Shareholder Derivative Actions for Breach of Duties • Incorporation statutes permit shareholders to sue on behalf of the corporation • after they have made some effort to get the Board to remedy the problem • Harm to the corporation, and thus only indirectly to the shareholders • Remedies: rescind contracts, recover property or payments for the corporation • Shareholders benefit indirectly, but the plaintiffs will be paid attorney’s fees • To avoid collusive settlements in which the corporation purchases the shares of the plaintiffs, the statutes require that the court approve any settlement • Shareholder Class Actions for Breach of Duties • Harm is directly to the shareholders • Directors approve a merger which forces shareholders to sell their stock • Directors fraudulently induce shareholders to purchase or sell their stock • Remedies: shareholders can obtain damages

  8. [1](8): Indemnification and Insurance • Can corporations indemnify their directors, officers, and employees for their legal expenses from lawsuits arising out of actions and decisions in their jobs? • If the director prevails on the merits, incorporation statutes generally require indemnification • If the director does not prevail on the merits or settles the lawsuit without a trial, can the corporation still indemnify the director? • Civil: YES, if the director satisfied the duties of care and loyalty • Criminal: YES, if the director reasonably believed the action was not illegal • Suppose the director settles a criminal case by paying a fine? • Delaware statute would permit indemnification • Corporations may purchase insurance for the legal expenses of their directors and officers which cannot be indemnified

  9. [1](9): Triangular Mergers • Acquiring corporation creates a shell corporation as a subsidiary • Shell subsidiary receives cash, bonds, or stock from the parent corporation • Shell corporation is then merged into the target corporation • In a normal merger, the shareholders of the target corporation would retain their shares and the shareholders of the corporation merging into the target corporation would receive newly issued shares of the target corporation • But state incorporation statutes also allow shares of either merging corporation to be converted into “cash, property, rights or securities of any other corporation”, e.g. the parent corporation (See 8 Del Code 251(b)) • Shareholders of the target corporation are paid cash, bonds, or shares from the acquiring corporation for their shares • Parent corporation is then paid the shares of the target corporation for its shares of the shell corporation • Target corporation becomes a wholly-owned subsidiary

  10. [1](10): Triangular Merger Parent Corporation Shareholders Cash Bonds Stock Cash Bonds Stock Target Stock Target Stock Target Stock New Subsidiary Target Corporation Cash, Bonds, or Stock

  11. [1](11): Weinberger v. UOP (Del. 1983)Background Events • Signal acquires 50.5% of UOP in 1975 • $21 per share, when market price was $14 per share • Signal takes control of the UOP Board • Appoints Signal officers as UOP directors • Walkup, Shumway, Arledge, and Chitiea • Arledge was VP for Planning of Signal and Chitiea was CFO of Signal • Appoints Crawford as CEO of UOP, now also on UOP Board • Signal considers buying remaining 49.5% of UOP in 1978 • Walkup and Shumway commission a study by Arledge and Chitiea on the value to Signal of purchasing the minority UOP shares • Arledge and Chitiea study of UOP for Signal concludes that any price up to $24 would be a good investment for Signal (using UOP confidential information) • Crawford proposes and advocates an offer of $21 per share, while the market price is only $14.50 per share

  12. [1](12): Freeze-Out or Cash-Out Merger Signal Minority 50.5% 49.5% UOP stock Cash UOP stock New Subsidiary UOP $21 per share to minority shareholders

  13. [1](13): Weinberger v. UOP (1983) Board and Shareholder Meetings • Simultaneous Signal and UOP Board meetings on March 6, 1978 • UOP Board approves a freeze-out merger at $21 per share • Non-Signal directors separately discuss and vote for the merger • Approval of the merger is made contingent on approval by a • (1) majority of the minority UOP shares voted at the shareholder meeting • (2) two-thirds majority of all outstanding UOP shares • Neither is required by Delaware law, only a simple majority is required • UOP Shareholder Meeting on May 26, 1978 • Proxy statement from Board urges approval by the minority shareholders • (1) 92% of the voting minority shares voted for the merger • Only 56% of outstanding minority shares voted at the meeting • Despite this, 52% of the outstanding minority shares voted for the merger • (2) 76% of all outstanding shares voted for the merger (includes Signal shares)

  14. [1](14): Weinberger v. UOP (1983)Breach of Duty of Loyalty • What was the Conflict of Interest? • UOP Board contained Interested Directors and Officers • Arledge and Chitiea were officers and directors of Signal • Walkup and Shumway were officers and directors of Signal • Note that CEO Crawford was a former officer of a Signal subsidiary • Was the Conflict disclosed to the disinterested directors? • Effectively YES: Conflict was Obvious • Present and former relationships of the interested directors was known • Were all the Material Facts concerning the Conflict disclosed to the disinterested directors? • NO: A/C Study was not disclosed to the Disinterested Directors • Arledge and Chitiea used confidential UOP information for the study

  15. [1](15): Weinberger v. UOP (1983)Procedural Fairness • Did the approval (apparently unanimous) of the merger by the disinterested directors of UOP resolve the conflict of interest? • NO, because the disinterested directors were not informed about the A/C report and its estimated value of UOP shares for $24 per share • Did the UOP shareholder vote (overwhelming) in favor of the merger resolve the conflict of interest? • NO, because the shareholders were not informed of the A/C report • Thus, even though these are two of the three ways in which a conflict of interest can be resolved, neither was adequate because the interested directors did not inform the disinterested directors or shareholders of an important material fact

  16. [1](16): Weinberger v. UOP (1983)Substantive Fairness of the Price • Was it relevant that the price of $21 offered by Signal for the UOP minority shares was the same as the price that was paid for the majority shares purchased in 1975? • NO, not relevant • Was it relevant that the price of $21 offered by Signal was 50% higher than the price at which UOP shares were trading ($14.50)? • NO, not relevant • Was it relevant that Lehman Brothers provided a “fairness opinion” that $21 was a fair value for the UOP minority shares? • NOT in this case, because the Lehman partner Glanville (also a director of UOP) prepared the opinion with great haste and arrived at the UOP Board meeting with the price term in the letter left blank.

  17. [1](17): Weinberger v. UOP (1983)Court Ruling and Appraisal Remedy • Court holds that the freeze-out merger and price were unfair • Breach of fiduciary duty of loyalty to shareholders by the interested directors who were Signal officers • What is the remedy for Weinberger and members of the class? • Statutes imply that the transaction can be voided or rescinded • Is this a realistic remedy four years after the merger? Of course not! • What about the Appraisal Remedy? See 8 Del. Code 262 • (a) Shareholders who vote against a merger can demand an appraisal • Thus, an appraisal would not benefit the minority shareholders who voted for the merger, even though they were not informed of the A/C study • (h) Appraisal of the fair value cannot include “any element of value arising from the accomplishment or expectation of the merger” • Thus, an appraisal of the fair value could be as low as the price the shares were trading for before the announced merger, here $14.50

  18. [1](18): Weinberger v. UOP (1983)Rescission Remedy • Plaintiffs ask for $26 per share, instead of $21 per share • Lower Chancery Court rejected plaintiff’s analysis and required the use of the “Delaware block method” of calculating the value of shares • Weighted average of market price, asset value, and present value of earnings • Delaware Supreme Court overturns “Delaware block method” • “fair value” can be established by “any techniques or methods which are generally considered acceptable in the financial community” • Fair Value in cases of breach of the duty of loyalty must include the expectation of the value of the merger (e.g., rescissory damages) • Unlike the appraisal remedy, all minority shareholders can receive damages, not just those who voted against the merger • On Remand, the Chancery Court awards an additional $1 per share

  19. [1](19): Weinberger v. UOP (1983)Conjectural Questions • Would Signal have a duty to reveal a study on the value of the UOP shares if it was done solely by Signal employees who were not directors or officers of UOP? • Certainly NOT: Signal has no duty, only the interested UOP directors • Would Signal have a duty to reveal a study on the value of the UOP shares if it was done solely by Signal employees, but that used confidential information obtained from Crawford? • Probably NOT, if the disinterested directors approved the provision of the confidential UOP information to Signal • Maybe YES, if no such approval was obtained from the disinterested directors

  20. [1](20): Weinberger v. UOP (1983)How to Proceed - Soft Ball • How SHOULD Signal have handled this freeze-out merger? • (1) Obtained approval of UOP disinterested (outside) directors to use UOP confidential information for a study of the value of the shares • (2) Isolated the Signal officers on the Board of UOP from any study or information about the value of UOP shares • (3) Negotiated a price with a committee of UOP disinterested directors, and given them time and resources to obtain an adequate fairness opinion based on the same confidential information • (4) Permit the UOP disinterested directors to deliberate and vote on the merger without the presence of the Signal interested directors • (5) Make the approval of the merger contingent on a majority vote of the minority shareholders

  21. [1](21): Weinberger v. UOP (1983)How to Proceed - Hard Ball • How COULD Signal have handled this freeze-out merger? • (1) Make a “take-it-or-leave-it” offer for the minority shares to the disinterested directors • (2) Obtain an independent fairness opinion that the offer is a fair value for the minority shares, exclusive of the benefits of the merger • (3) Present the offer and fairness opinion to the disinterested directors • (4) At the Board meeting, vote the interested directors in favor of the merger, and disinterested directors will be out-voted • (5) For the shareholder meeting, provide the fairness opinion and accurately report the vote and views of the disinterested directors • (6) At the shareholder meeting, vote controlling shares for the merger • (7) Dissenting minority shareholders can seek an appraisal

  22. [1](22): Tender Offers • Williams Act (1968) Amended the Securities Exchange Act (1934) • Section 14(d) defines some rules and authorizes the SEC to promulgate other rules governing tender offers and proxy solicitations • Tender Offer is a public offer to the shareholders of a corporation • Tender Offer is designed to purchase a large block, typically a controlling block, of the outstanding shares in a corporation • Tender Offer will specify an offer price and the minimum and maximum number of shares that will be purchased at that price • The minimum can equal the maximum and be 51% in order to gain control • What about the Board of Directors of the target corporation? • Tender Offers often arise after the Board has refused to negotiate a friendly merger with the acquiring corporation • Tender Offers allow acquiring corporations to bypass the Board and acquire control of the target corporation directly from the shareholders.

  23. [1](23): Rules for Tender Offers • Tender Offers must be sent to all shareholders, and published • Tender Offers must also be filed with the SEC • Board of Directors of the corporation must also be notified of the tender offer • Tender Offers can be made for cash, bonds, or stock • Tender Offers must be open for 20 days, and 10 additional days if the offer price is increased during that period • All shares must be purchased at the highest price offered • Shareholders accept the offer by “tendering” their shares, but can withdraw their tender in order to accept a higher offer from another corporation • If the tender offer is under-subscribed (number of shares tendered is less than the minimum), there is no obligation to buy any shares • If the tender offer is over-subscribed (number of shares tendered is more than the maximum), the shares must be purchased on a pro rata basis

  24. [1](24): Unocal v. Mesa (1985)Mesa Two-Tiered Offer • Mesa Petroleum (Boone Pickens) purchased 13% of the outstanding shares of Unocal in the stock market, mostly secretly • Section 13(d) of the Securities Exchange Act requires anyone who purchases more than 5% of the stock in a corporation to notify the SEC, the stock exchanges, and the Board of Directors • Mesa then announces a two-tiered offer • Tender Offer of $54 per share for 37% of the outstanding shares (64 million) • If successful, Mesa would gain control (51%) of Unocal • Freeze-Out merger using subordinated debentures which Mesa claims would have a value of $54 per share • If all shareholders tendered, a shareholder with 100 shares of Unocal would receive cash for 42 shares (37/87) and bonds for 58 shares

  25. [1](25): Unocal v. Mesa (1985)Unocal Defense • Unocal Board adopted a resolution to make an “Exchange Offer” • What was the “Exchange Offer”? • (1) Self Tender Offer by Unocal for its own outstanding shares • Such shares repurchased by Unocal would become treasury stock • Price of $72 but in new bonds instead of cash • (2) Contingent on the Tender Offer of Mesa being successful • Exchange Offer is made only if Mesa first acquires 64 million shares • Mesa Purchase Condition • (3) Selective Offer in that the offer would not apply to shares owned by Mesa, whether purchased before or during Mesa’s tender offer • Self Tender Offer would only be made to the 49% minority shareholders • Mesa Exclusion

  26. [1](26): Unocal v. Mesa (1985)What is the Effect of the Exchange Offer? • Suppose Mesa’s Tender Offer and the Unocal’s Exchange Offer are both in place • If less than 37% of the shares are tendered to Mesa, then nothing happens • Mesa withdraws and the Mesa Condition is not triggered for the Exchange Offer • But if more than 37% of the shares are tendered to Mesa, and Mesa purchases exactly 37%, then what happens? • Mesa Condition would trigger the Exchange Offer and the shares not purchased by Mesa would surely be tendered to Unocal rather than Mesa • Shareholders would prefer bonds valued at $72 per share from Unocal rather than subordinated bonds valued at $54 per share from Mesa in the freeze-out merger • Mesa would then own 100% of the outstanding shares of Unocal • BUT Unocal would now have over $6 billion in new debt • Mesa would pay $72 per share, instead of $54, for the minority shares

  27. [1](27): Unocal v. Mesa (1985)Is the Exchange Offer a Breach of Duty? • Mesa immediate files a lawsuit against the Exchange Offer • Mesa cannot proceed with its tender offer while the Exchange Offer is in place • Mesa’s complaint alleges a Breach of the Duty of Care and/or Loyalty • What would be the Breach of Duty of Care? • Directors are forcing Mesa to withdraw its offer which has a higher effective price (cash and bonds) than the prevailing market price for Unocal stock • Directors are discriminating against Mesa as a Unocal shareholder because the Exchange Offer does not apply to shares owned by Mesa (Mesa Exclusion) • What would be the Breach of Duty of Loyalty? • Directors are ensuring that their shares will be repurchased at $72 per share? • Directors and Officers are protecting their positions because the Exchange Offer is solely designed to force Mesa to withdraw its tender offer • Are these conflicts of interest?

  28. [1](28): Unocal v. Mesa (1985)New Unocal Duty? • Does the Business Judgment Rule apply to this case? • NO, there is some heighten duty because takeover defenses can protect the existing management, at the expense of shareholders • Is there a Conflict of Interest requiring substantive fairness? • Not Really, the interest of directors in their positions and shares are not an inherent conflict of interest • The heighten duty does not require the directors to avoid takeover defenses or to submit them to a shareholder vote • What is the nature of this new heighten duty of care? • Negligence Standard: takeover defenses must be a “reasonable response to the threat posed” by the takeover attempt to the corporation and its shareholders - UNOCAL DUTY

  29. [1](29): Unocal v. Mesa (1985)What is the Threat of the Mesa Offer? • (1) Mesa’s Offer is INADEQUATE • $54 price offered by Mesa is less than the value of Unocal’s shares • If the junk bonds in the freeze-out offer are worth less than $54, the value received by the Unocal shareholders would be less than $54. • Goldman Sachs estimated the value of a Unocal liquidation in excess of $60 per share • (2) Mesa’s Offer is COERCIVE • The freeze-out price offered in junk bonds is not worth $54 • Mesa’s offer is “front-loaded” and will create a stampede or bandwagon of Unocal shareholders tendering their shares to Mesa • Without a takeover defense, Mesa might be able to acquire the Unocal shares even if Unocal shareholders agreed that the Mesa offer was inadequate

  30. [1](30): Unocal v. Mesa (1985)Was the Unocal Response Reasonable? • YES, the Exchange Offer was a reasonable response • The Exchange Offer was $72 per share in bonds • If all shareholders tendered their shares to Mesa, 42% of them would be purchased by Mesa (37%/87%) at $54 in cash and the remaining 58% would be purchased by Unocal at $72 in bonds. • Thus, Unocal shareholders would receive about $64 per share, within the range of value estimated by Goldman Sachs • The Unocal directors can protect the minority shareholders when a majority shareholder threatens the value of their shares • The Exchange Offer is just one example of the new takeover defenses designed to force acquiring corporations to make higher offers to the target’s shareholders

  31. [1](31): Unocal v. Mesa (1985)Ruling and Outcome • Delaware Supreme Court holds that the Unocal directors did NOT violate their new “Unocal Duty of Care” • The Unocal Exchange Offer is a reasonable response to the inadequate and coercive offer by Mesa • SEC then promulgated a new rule making selective self tender offers illegal • Unocal Duty is a higher standard than the Business Judgment Rule • Stronger judicial review under a negligence that under gross negligence • But not as high a standard as a conflict of interest • Unocal Duty defines the rules for takeover defenses (poison pills) • And what happened to Unocal? • Gulf Oil purchased Unocal for $13 billion, $75 per share

  32. [1](32): Unocal v. Mesa (1985)Conjectural Questions • Suppose Mesa modified its tender offer, offering to purchase ALL the outstanding shares at a price of $54 per share in cash • Would the Exchange Offer be a reasonable response? • Probably YES: the offer is no longer coercive, but it is still inadequate • What would happen if Mesa also raised the offer to $65 or $70? • At some price, Mesa’s offer could be adequate and the Exchange Offer would not be a reasonable response • What would happen if Mesa raised the offer to $75 per share? • The Exchange Offer would be irrelevant because the Unocal shareholders would not tender to Unocal under the Exchange Offer of $72 in bonds • Breach of the Unocal Duty of Care depends on the takeover offer • Takeover defenses in response to an adequate non-coercive offer would be a breach of the Unocal Duty

  33. [1](33): What is a Poison Pill? • Special Dividend to shareholders: one “right” for each share • Flip-In Provision of each right • If another corporation acquires 15% of the outstanding shares (without prior approval of the Board), then the “right” becomes an option to purchase a specific number of new shares in the target corporation (newly issued shares) at a exercise price substantially below the prevailing market price. • Flip-Over Provision of each right • If another corporation merges with the target corporation, then the “right” becomes an option to purchase a specific number of shares in the surviving corporation (the acquiring corporation) at a exercise price substantially below what the prevailing market price would be. • The rights can be redeemed by the Board prior to the triggering event • The redemption price is trivial so that the Board can redeem the rights in response to an attractive offer for shareholders

  34. [1](34): Revlon v. MacAndrews (1986)Pantry Pride Tender Offer • Pantry Pride (Ronald Perelman) approached Revlon about a friendly acquisition but Revlon rejected the offer • The Board of Pantry Pride authorized a hostile tender offer for all of the outstanding shares of Revlon • Pantry Pride makes a conditional tender offer for all the shares of Revlon at $47.50 in cash per share for the common stock • Note that this offer is not coercive, but it might be inadequate? • Conditional on obtaining financing (junk bond financing with Drexel-Burnham) • Conditional on the Board of Revlon redeeming the “Rights Plan” • Pantry Pride also files a lawsuit arguing that the Rights Plan is a breach of the duty of care of the directors, and thus illegal • So what is the Rights Plan of Revlon? Early Poison Pill

  35. [1](35): Revlon v. MacAndrews (1986)Revlon’s First Response • Investment bankers estimate the value of Revlon • Sell Revlon as a whole: “mid 50” dollar range • Breakup value: $60 - $70 per share • Investment bankers construct a two defensive tactics • (1) Tender offer to repurchase 10 million of the outstanding shares • with a $47.50 Note and convertible preferred stock, oversubscribed • New Notes contained covenants restricting new debt, sale of assets, or payment of dividends without approved of the disinterested directors • (2) Rights Plan: Special dividend of one “right” for each share • If any acquiring corporation acquires 20% of Revlon’s outstanding shares (unless they acquire all the outstanding shares for $65 per share or more), then each share can be exchanged for a Revlon one-year note having a principal of $65 and an interest rate of 12%.

  36. [1](36): Revlon v. MacAndrews (1986)Revlon’s Second Response • Pantry Pride first initiates a lawsuit to invalidate the Rights Plan • Pantry Pride then raises its conditional offer to $56.25 per share • And Pantry Pride announces that it will match offers by Forstmann • But the Board of Revlon negotiates with Forstmann to fund a management leveraged buyout (MLBO) • Revlon Management and Forstmann would set up a new corporation, borrow money, and merge into Revlon • The debt incurred would then be paid down by selling some Revlon subsidiaries • Management would have a larger equity interest in the new Revlon, but Revlon would have a very high debt/equity ratio • Revlon Management and Forstmann agree to make a tender offer for $57.25 per share in cash for all the shares of Revlon, but demand • “lock-up” option, a “no shop” provision, and a cancellation fee

  37. [1](37): Revlon v. MacAndrews (1986)What is a Lock-Up Option? • Lock-Up Options are contingent options to purchase an asset of the target corporation • Granted to the favored acquiring corporation (White Knight) when this corporation agrees to acquire the target corporation • Purchase price is a substantially below the true value of the asset • Contingent on a competing acquiring corporation acquiring control or a blocking fraction of the outstanding shares of the target corporation • Revlon lock-up option: If another acquirer (such as PantryPride) obtains 40% of the outstanding shares of Revlon, then Forstmann can purchase Vision Care and National Health Labs for $525 million • These two subsidiaries are worth between $625 - $700 million

  38. [1](38): Revlon v. MacAndrews (1986)What is the Effect of the Lock-Up Option? • If the offer by Pantry Pride is blocked by the Rights Plan, then the MLBO will be successful, and the lock-up option irrelevant • Forstmann will be a co-owner of Revlon and would not exercise the option • If the offer by Pantry Pride is not blocked by the Rights Plan, and is successful in obtaining over 40% of the outstanding shares, then Forstmann will exercise the option • Pantry Pride is planning on breaking up Revlon, but not by selling these two valuable subsidiaries at a discount to Forstmann • Thus, Pantry Pride must also condition its offer on the illegality and elimination of the lock-up option • Pantry Pride amends its existing complaint to challenge the lock-up option as a breach of the duty of loyalty of the directors

  39. [1](39): Revlon v. MacAndrews (1986)Ruling on Revlon’s First Response • Was the Stock Repurchase a breach of the duty of care? • No, reasonable response to an initial inadequate offer by Pantry Pride • Was the Rights Plan (Poison Pill) a breach of the duty of care? • No, reasonable response to an initial inadequate offer by Pantry Pride • Was the Rights Plan a breach of the duty of care after Pantry Pride finally raised its offer to $58 per share? • Maybe, but not an issue here because the Board of Revlon redeemed the Rights Plan for any offer above $57.25 • In general, Poison Pills must be redeemed by the Board of Directors in response to an adequate and non-coercive offer

  40. [1](40): Revlon v. MacAndrews (1986)Ruling on the Revlon’s Second Response • Was the Lock-Up Option a breach of the duty of care or loyalty? • YES, breach of the duty of care to the corporation and shareholders • At the last price offered by Pantry Pride, there was no “threat” to Revlon • Pantry Pride offer was adequate and non-coercive • Revlon will be broken up, irrespective of who acquires the corporation • YES, breach of the duty of loyalty to shareholders • Directors cannot consider the covenants in the new Notes issued to the shareholders in acquiring 10 million shares (one third of the outstanding shares) • Directors cannot favor their management in providing information and negotiating to sell the corporation on behalf of shareholders • Both offers from Pantry Pride and Forstmann will rely heavily on debt financing, but the current shareholders will receive cash

  41. [1](41): Revlon v. MacAndrews (1986)New Revlon Duty? • Does the Business Judgment Rule apply to this case? • NO, there is a new heighten duty when it becomes clear that the corporation will be sold • Is there a Conflict of Interest? • YES, if the Directors favor one acquiring corporation in their own interest and at the expense of the shareholders • What is the nature of this new heighten duty of care and loyalty? • Revlon Duty: When it becomes clear that a target corporation will be sold, the Board has a duty to run a fair auction for the corporation to maximize the price received by the shareholders • When is it clear that the target corporation will be sold? • Certainly if there are two outside bidders each offering an adequate price

  42. [1](42): Revlon v. MacAndrews (1986)What is the Nature of the Revlon Duty? • Board cannot disadvantage one bidder over the others bidders • Once a bidder is committed and participating in the auction, lock-up options and other similar options would be a breach of duty • Does the Board have a duty to provide confidential information to all potential bidders? • Presumably Yes, but there are special concerns in providing this information to competitors, to suppliers, or to distributors • Does the Board has a duty to seek other bidders? • The Court also upheld the preliminary injunction against the “no shop” provision in favor of Forstmann as a breach of duty in this case • Can the Board passively consider all bids? • Or must the Board actively seek new bidders? • Is a “no shop” provision an inherent breach of the duty of care?

  43. [1](43): Recent Developments • Suppose the Board of the target corporation refuses to redeem the poison pill in response to an arguably adequate offer? • How might the acquiring corporation proceed? • Accumulate the maximum number of shares below the triggering percentage • Initiate a proxy contest to elect a new slate of directors to the board • With new directors, the acquiring corporation can redeem the poison pill • Responses of target corporations to the threat of a proxy contest • Staggered Boards of Directors: Elect one-third of the directors each year • Hilton v. ITT (1999): Held that it was a breach of duty for ITT to create a staggered Board in the midst of the takeover attempt by Hilton • Dead-Hand Poison Pills: Only directors who adopted the pill can redeem the pill • Likely to be a breach of duty for infringing on the statutory powers of the Board • See Quickturn Design Systems v. Shapiro (1998)