In late June, the Delaware Supreme Court issued in its decision in the second appeal of Coster v. UIP Companies, 2023 WL 4239581 (Del. June 28, 2023). As with their prior decision (255 A.3d 952 (Del. 2021)), the Court was reviewing a judgment in favor of the defendants on a challenge to the decision by an incumbent board of a 50/50 deadlocked corporation to sell shares to a longtime employee. In the first round, the Court of Chancery held that the challenged transaction satisfied the ‘entire fairness’ test, and so upheld it. On the first appeal, the Supreme Court found that analysis incomplete, reasoning that fiduciary conduct in Delaware is “‘twice-tested,’ first for legal authorization, and second for equity.” Entire fairness meant the transaction was legally authorized, but because additional considerations of equity were implicated the Court remanded for the Chancellor to conduct further “Schnell/Blasius” analysis in the first instance. On remand, the Chancellor found the transaction was equitable under the circumstances, and this time the Supreme Court upheld it in an extensive opinion discussing the interplay of three long-standing, landmark Delaware decisions — Schnell v. Chris Craft Industries, Inc., 285 A.2d 437 (Del. 1971), Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651 (Del. 1988), and Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 955 (Del. 1985).
Unocal is the hornbook case for anti-takeover measures. It is constantly cited in cases addressing challenges to board action when the directors have sought to prevent a hostile takeover. In what is sure to be an oft-quoted passage from Coster, the Supreme Court reasoned:
Unocal can also be applied with the sensitivity Blasius review brings to protect the fundamental interests at stake – the free exercise of the stockholder vote as an essential element of corporate democracy.
The recent decision Berger v. Adkins, 2023 WL 5162408 (Del. Ch. Aug. 8, 2023) gives some color to how the Court of Chancery understands Coster to operate. In Berger, a company received a capital infusion by selling a new series of preferred stock to a group of investors. The preferred stock could not vote, but was convertible to common stock, and could vote on an as-converted basis for change-of-control transactions. If converted, the preferred stock was 48% of the overall voting power of the corporation. As part of the infusion transaction, the investors agreed to standstill agreements which barred them from certain kinds of stockholder activism, such as soliciting proxies, for a specified time. A stockholder sued, reasoning that the board members’ own stock ownership combined with the preferred as-converted vote to constitute an outright majority, which in combination with the standstill agreements put the board in control of the corporation and effectively made the capital infusion a takeover that stripped the existing stockholders of their voting rights. After litigation began, the board waived the standstill agreements and the plaintiff dismissed the complaint and filed a mootness fee petition, which the Berger decision addressed.
In the Court’s evaluation of the merits of the original complaint for purposes of determining the appropriateness of a mootness fee, Chancellor McCormick summarized the Coster rule in a single sentence:
Following Coster, this decision treats Blasius as a context-specific variant of Unocal.
Delaware permits the directors of a corporation broad authority to manage a corporation, while cordoning off stockholder authority to a few areas. Though the province of authority reserved to the stockholders is small, it is mighty — numerous Delaware cases have disallowed intrusions upon it while rhetorically extolling stockholder supremacy within it as the normative foundation of “corporate democracy.”
Per Berger, the Court of Chancery reads Coster for the proposition that Unocal is the single framework for evaluating the board’s action when they seek to use their powers to intrude on the stockholders’ domain. In traditional Unocal analysis, the intrusion anticipates a new contender acquiring stock and exercising its powers in a way contrary to the incumbent board’s plans. The Coster situation is implicated when the putative interferer is already a stockholder whose interference consists of exercising their rights as stockholders. The fiduciary duty to treat stockholders equitably therefore requires greater ‘sensitivity.’ In other words, Coster makes Unocal analysis more searching when the call is coming from inside the house.
This framework brings an elegant simplicity to an area of analysis that, because it lies at the intersection of several key doctrines of Delaware corporate jurisprudence, has previously been difficult to analyze. Going forward, corporate boards have clear guidance on how their actions will be evaluated. From a practical standpoint, if the board is worried that the actions of existing stockholders might interfere with the board’s business plans for the company, they need to reckon with that possibility head-on. Stockholder authority is not something to be lightly sidestepped. If the Board decides to proceed in a manner designed or intended to neutralize stockholder opposition or power in order to achieve a corporate objective, they must deliberate on why such action is necessary, weigh possible alternatives, and choose a means of securing the corporate objective that interferes as minimally as possible with the stockholders’ voice. Proceeding in that way best-positions the directors to withstand the scrutiny the Court articulated in Coster:
First, the court should review whether the board faced a threat to an important corporate interest or to the achievement of a significant corporate benefit. The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interests of the stockholders.
Second, the court should review whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise. To guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control, a board that is properly motivated and has identified a legitimate threat must tailor its response to only what is necessary to counter the threat. The board’s response to the threat cannot deprive the stockholders of a vote or coerce the stockholders to vote a particular way.