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conscious disregard of the interests of the corporation and the rights of its stockholders."
Reclassification, of course, can be accomplished by a merger or consolidation. Mergers, like charter amendments, are subject to safeguards which protect the interests of minority shareholders.
Where there is a thin market, a stockholder dissenting from a merger has a right to an appraisal of his stock." The stockholder must object in writing to the merger and demand payment for the value of his shares. If he and the surviving corporation do not reach agreement, he or the corporation may begin an appraisal proceeding.
The Delaware courts have identified various factors which are to be considered and weighed in arriving at a valuation for stock in an appraisal proceeding.
... [T]he actual or true value of the stock is to be determined by considering the various factors of value including earnings, dividends, market price, assets, and the other factors deemed relevant in a stock evaluation problem arising under the Delaware Corporation Merger Statute, 8 Del. C.
$ 262," Furthermore, the over-riding consideration is that all factors relevant to a determination of fair price in a particular situation are to be examined and weighed as appropriate to the circumstances of the particular corporation and merger. The courts recognize that the determination of fair price necessitates much balancing and judgment.
Thus, for example, in Sterling v. Mayflower Hotel Corp.," the Supreme Court accorded less weight to net assets value than market value.
... But the requirement that consideration be given to all relevant factors entering into the determination of value does not mean that any one factor is in every case important or that it must be given a definite weight in the evaluation. ... The relevant importance of several tests of value depends on the circumstances. Thus, in some cases net asset value may be quite important. . . . But in the case at bar it is of much less importance than the factors analysed in the [investment banker's] report. We are dealing here with corporations engaged in the hotel business, whose capital is invested largely in fixed assets. The shares of such corporations are worth, from the viewpoint of an investor, what they can earn and pay. A comparison of net asset values may have some weight, but it is of much less importance than demonstrated capacity of the corporation to earn money and pay dividends." In appraisal proceedings, as elsewhere, the courts of Delaware look to the circumstances of the particular case in applying statutory and common law as the equities require.
Much of the recent criticism of appraisal had to do with its complexity and cost."* Two recent developments show that such criticism is baseless or outdated. The Delaware Supreme Court in Raab v. Villager 7 recently reaffirmed that: "The requirements of 262 (6) are to be liberally construed for the protection of objecting stockholders, within the boundaries of orderly corporate procedure and the purpose of the requirement." [Emphasis supplied) Perhaps, more importantly, Chief Justice Herrman on that occasion announced a prospective policy-make sure that their stockholders were fully informed of their rights under Section 262:
A Delaware corporation, engaged in 8 262 proceedings, henceforth shall have an obligation to issue specific instructions to its stockholders as to the correct manner of executing and filing a valid objection or demand for payment under the Statute, as construed by Delaware courts, including: (1) the general rule that all such papers should be executed by or for the stock
* Bodell v. General Gas & Electric Corp., 140 A. 264 (Supr. Ct. 1927). 70 8 Del. C. $ 262.
71 Poole v. N. V. Deli Maatschappij, 243 A. 20 67, 69 (Del. Supr. 1968). (These factors are customarlly grouped under the three principal headings of market value, earnings value and net asset value.)
72 Supra note 61.
78 93 A. 2d at 115, 116. See also Universal City Studios, Inc. v. Francis I. duPont d Co., 334 A. 20 216, 218 (Del. Supr. 1975); Gibbon8 v. Schenley Industries, Inc., 339 A. 28 460 (Del. Ch. 1975). A. 20
(Del. Supr. 1976), C.A. Nos. 5, 56, 73, and 99, 1975 (Del. Supr., filed April 12, 1976).
76 Compare salt Dome Oil Corp. v. Schenck, 41 A. 20 583 (Del. Supr. 1945) and Carl M. Loeb, Rhoades & Co. v. Hilton Hotels Corp., 222 A. 2d 789 (Del. Supr. 1966).
holder of record, fully and correctly, as named in the notice to the stockholder; and (2) the manner in which one may purport to act for a stockholder of record, such as a joint owner, a partnership, a corporation, a trustee, or a guardian.
Fairness to stockholders require such reasonably specific instructions in § 262 proceedings. As a general rule in the future, failure by the corporation to furnish such instructions will result in the resolution in favor of the stockholder of all doubt as to the sufficiency, for corporate purposes, of the
objection or demand." Second, effective July 1, 1976, the General Corporation Law has been amended by the Delaware General Assembly to permit reimbursement of attorney's fees and simplification of procedures. The official commentary sets out the purposes sought to be attained :
The present statute contains circuitous and arbitrary provisions governing the time limits for an appraisal so that an appraisal action may be filed up to four months and 50 days following the effective date of the merger. Under the proposal to 8 262(c), this period would be changed to 120 days and provision made for the filing of an appraisal action immediately following the effective date of the merger. However, the stockholder has been afforded the opportunity to change his mind and withdraw the appraisal action during the first 60 days of the 120 day period.
The proposed revisions to 8 262(h) are intended to provide a more equi. table means of sharing the cost of an appraisal. Under the present practice, each stockholder bears his own expenses in the appraisal so that if one stockholder hires an attorney and expert witnesses, he must bear all of the expenses while all of the other stockholders receive the benefit of the attorney's representation and the testimony of the expert witnesses. This has resulted in unfairness to the stockholder who has neither the money nor a sufficient stock interest in the corporation to hire attorneys and experts. Also, the stockholder who does hire attorneys and experts is unfairly taxed with all of the cost. Under the proposed revisions of 8 262(h), all of the stockholders would share the expenses of the attorneys and ex
perts who have achieved a benefit for them." There, of course, are well recognized circumstances under which a stockholder need not choose between appraisal and accepting the merger."" Where unfairness amounts to fraud, actual or constructive, the stockholder may enjoin the merger. If a constituent corporation is "on both sides" of the transaction, the burden of proving the intrinsic fairness of the transaction, under the careful scrutiny of the court, is shifted to the defendant.
Indemnification of directors against losses suffered from good faith performance of duty seems desirable, if not necessary, to enable corporations to attract qualified independent directors. Some have faulted the indemnification provisions of the General Corporation Law for allowing corporations to pay insurance premiums for directors' and officers' liability insurance policies. This analysis is faulty.
No responsible insurer will make coverage available to protect directors against liability for defalcations or breaches of trust. Even a tentative inquiry into the subject of available coverage makes this plain. As does lawyers' and doctors' malpractice insurance, director and officer liability insurance serves both to protect the insured against consequences of negligent behavior and to benefit the victims of that behavior by providing a fund to compensate them.
A. 2d at
(Del. Supr. 1976), supra note 75. 78 Official Commentary to $$ 253 and 262 (Appraisal Rights) ; House Bill #906, 128th General Assembly, Second Session 1976.
70 As an additional problem with reclassifications, Professor Cary has said that the Delaware courts have avoided looking through form to substance. Federalism Article, at 677. In support of this, he cited, alternatively, Keller v. Wilson & Co., supra note 65 and Federal United Corporation v. Havender, infra note 80. Since, 8 Del. o. $ 242(a) (4) now permits elimination of dividend accruals by charter amendment, Cary is wrestling with a dead issue.
50 Porges v. Vadsco Sales Corporation, supra note 68. See also Federal United Corporation v. Havender, 11 A. 20 331 (Del. Supr. 1940).
81 Sterling v. Mayflower Hotel Corp., supra note 61; David J. Greene d Co. v. Dunhin International, Inc., supra note 61 ; and pages 22-25, supra.
* 8 Del. C. $ $ 145 (f) and 145(g) ; Cary, Federalism Article at 669, 670.
IV. COMPETITION FOR CONTROL
A. AVAILABLE TOOLS
When an outsider or a group of stockholders seeks to replace incumbent management, the structure of the corporation law receives a severe test. Perlaps it is in the corporation's best interest for the outsiders to succeed. As Professor Cary has written; "The raider may sometimes be a better manager than the 'raidee'".&
IIowever, as the word "sometimes” would suggest, the matter is not black and white. "Raiders" and others frequently use surprise and market forces, such as stampede and arbitrage ; and foul play is not unknown. Financing for a takeover may make real or thinly veiled use of the target's own credit, Certain stockholders of well managed and conservatively financed businesses may be offered a quick profit to the disadvantage of other stockholders at a time of depressed market price." A good corporation law must deal in the context of its more permanent structure, with the abuses on all sides that arise in competitions for control, and strike a fair balance between the competing considerations.
In order to perform their duties properly when faced with a raid or attack believed contrary to the interests of the stockholders, the directors must have available to them as many legitimate tools as possible to defend those interests. The field is well developed. Capital structure may be flexible with power to buy or sell securities, whether common stock, preferred stock, convertible securities or warrants, together and the statutory and charter authorization to use them. To act promptly, a large board must be able to delegate decision-making to a smaller committee of its members."
Continuity of board membership can provide the stability that is particularly, but not exclusively, desirable when a company is engaged in a financial recovery or undergoing otherwise difficult times. Such a board prevents the wholesale replacement of all the knowledgeable members. Prohibition, in certain cases, of the removal without cause of board members by shareholders is as important an adjunct to the procedure as the ability to effect that removal may be in other circumstances. Mergers and other major corporate changes for many years required votes of substantially more than 51% of the stockholders. Normal business flexibility may require the lower majority vote, which is the general rule. Nevertheless, a higher vote, if adopted by the stockholders, may retard or inhibit takeover."
A corporation whose shares are selling at a depressed price may desperately need, but not attract, the best managers because of the hazards of short tenure. These hazards may also require the payment of undesirably high salaries. What the shareholders of such a corporation may need is not corporate war, but a corporate peace in which to develop or recover resources. In such cases, management's needs may not be “entrenchment” so much as "peace of mind". If such is the will of the stockholders, a proper statute should make the tools available; and the Delaware statute does.
On the other hand, the available tools are subject to abuse. Delaware courts have time and again condemned and proscribed that abuse. It was the context of a corporate takeover fight, that gave rise to that touchstone of Delaware corporate common law:
83 Cary. A Proposed Federal Corporate Minimum Standards Act, 29 Bus. Law. 1101, 1105 (1974).
84 See Casey, Introduction to Aranov & Einhorn Tender Offers for Corporate Control, Columbia University Press, p. xvi-il (1973), p. xvi-11.
$58 Del 0. $ $ 122(4); 123 : 160.
868 Del. o. 141 (c)'; but see Folk, Corporation Law Development:—1969, 56 Va. L. Rev. 755, 790 (1970).
57 $ Del. c. 141(d): cf. Essential Enterprises Corp. v. Automatic Steel Prod., 159 A. 20 288, 291 (Del. Ch. 1960).
88 Del. c. 141(k); cf. Dillon v. Berg, 326 F. Supp. 1214, 1224 (D. Del.), afa, 453 F. 20 876 (3rd Cir. 1971); Campbell v. Loero's Inc., 134 A. 2d 852, 857-58 (Del. Ch. 1957).
Arsht and Stapleton, Analysis of the 1969 Amendments to the Delaware Corporation Law, Prentice-Hall, Inc., 1969.
90 8 Del. C. $ $ 102(4) ; 242 (c) (4).
Inequitable action does not become permissible simply because legally possible." Experience bas shown that, by merger with another company, or through a competing offer, a "target" can often obtain, for its stockholders, a higher price, or price equivalent, per share than the first offeror is willing to provide. To make the alternative transaction in the face of a raid, management needs capital flexibility and time to act.
A potential target must have sufficient securities available to provide for splits in common or issuance of securities in connection with acquisitions. The statute provides for the initial capitalizations and permits amendment of the certificate of incorporation to increase or reclassify authorized common stock. Preferred may be authorized subject to the board's authority to fix the rights and preferences without amendment of the charter. Convertible securities may be created for later use. This is not to say that the manipulation of shares to perpetuate management is encouraged. Only a failure to read the Delaware cases would lead to such a conclusion.
B. ABUSE OF CAPITAL FLEXIBILITY i. Sale of stock to insiders and increasing authorized shares
Delaware courts have long applied strict fiduciary rules to the purchase and disposition by the corporation of its own securities. More than a half century ago, Chancellor Josiah 0. Wolcott wrote:
Directors of a corporation are frequently spoken of as its trustees. Their acts are scanned in the light of those principles which define the relationships existing between trustee and cestui que trust. Tested by these familiar company enough stock to fix themselves in undisputed control of its affairs,
is reprehensible. As recently as March 10, 1976, Vice Chancellor Marvel enjoined a corporation from increasing its authorized shares to eliminate a 50% stockholder from his position." The basis for these rulings are time honored fiduciary principles governing the relationship between directors and stockholders.
Many Delaware cases have declared that efforts to "freeze out” a minority interest are actionable without regard to the fairness of price, and, similarly, an effort to eliminate majority voting control by the issuance of stock without first offering the majority holder the right to buy has been enjoined."
In Condeo v. Lunkenheimer,100 Vice Chancellor Marvel stated these principles flatly :
... [S]hares may not be issued for 'an improper purpose such as a takeover of voting control from others...
The converse of the above rule is also established, namely that corporate machinery may not be manipulated so as to injure minority stockholders. In Condec, the target company (Lunkenheimer), in fighting off a takeover, had sought to increase the float of common stock to abort an apparently successful tender offer by "purchasing" an asset from the merger partner whom management wished to "marry". This, the court wrote, “is a case of a stockholder [the offeror] with a contractual right to assert voting control being deprived of such control by what is virtually a corporate legerdemain. Manipulation of this type is not permissible." 101
a Schnell v. Chris-Craft, 285 A. 2d 437, 439 (Del. Supr. 1971).
07 Chinetti v. Chinetti-Garthwaite Imports, Inc., C. A. 5025, (Del. Ch., filed March 10, 1976).
58 Állaun v. Consolidated Oil, 147 A. 257, 260 (Del. Ch. 1929); Bodell v. General Gas de Elec. Corp., 140 A, 264 (Del, Supr. 1927); Bennett v. Bruil Petroleum Corp., 99 A. 20 236 (Del. Ch. 1953).
19 Canada Southern Oils, Ltd. v. Manabi Exploration Co., 96 A. 20 810, 813–14 (Del. Ch. 1953).
100 230 A. 20 769, 775 (Del. Ch. 1967). 101 230 A. 20 at 777. At page 775, the Vice Chancellor said : It is a breach of [fiduciary) duty, wholly apart from any consideration of preemptive rights. for directors to make use of the issuance of chares to accomplish an improper purpose, such as to enable a particular person or group to maintain or obtain voting control, against the objection of shareholders from whom control is thereby wrested.
ii. Purchase and redemption of shares
Quite recently on similar principles, Vice Chancellor Brown dealt with the use of corporate funds by management, not to issue more shares, but to redeem on a selective basis certain shares of voting preferred stock held by a member of management in a voting trust." The voting trustee and his associates on the board had voting control of the corporation without the use of the trust shares and the trust was to expire in about six months. Upon the expiration of the trust, control would effectively shift away from the trustee and his associates in management and devolve on the beneficial owners of the trusteed shares. To make matters worse, the redemption was selective; that is, the remaining preferred, all of which was held outright by the trustee and another director, was not scheduled for redemption. The Vice Chancellor restrained the redemption :
In addition, it is unquestionably Delaware law that the use of corporate funds to purchase corporate shares primarily to maintain management in control is improper. [Citations omitted] Here it appears that redemption of all preferred shares other than those owned by Leslie and Nadeau will assure their continued control of Penntech (even though they may not be under open assault at present) and particularly if it does away with such shares prior to the expiration of the voting trust which present management now controls. Under such circumstances, a selective redemption of a large amount of voting stock which thereby guarantees control in those determining to make the redemption would initially seem no different in result than a purchase of shares with corporate funds to remove a threat to incumbent management policy and control, in which latter case the burden is on the directors to justify the purchase as one primarily in the corporate interest and not their own. [Citation omitted.]
At this juncture, to redeem all other preferred stock, but none of their own, so as to continue their own business incentive and to avoid a possible, but yet unsubstantiated, tax consequence to the other preferred shareholders, does not appear sufficient to carry the day for the present defendants when
the various other factors alleged by the plaintiff are considered.2009 The Petty court cited Bennett v. Propp as controlling. In Bennett, the target corporation bought its own shares in an effort to thwart a tender offer. Delaware Supreme Court had affirmed a derivative plaintiffs' judgment on behalf of the corporation against two of the directly responsible officers and directors. The Supreme Court stated the proposition in clear terms:
Sadacca's purchases were made to preserve the control of the corporation in himself and his fellow directors ... The use of corporate funds for such a purchase is improper. In the face of the overwhelming authority in the Delaware courts, a manage ment that seeks to abuse the capital flexibility made available by the statute and manipulate its capital, or indeed perform any act in order to stay in office, runs a grave risk not only of having its actions restrained or annulled, but also of paying dearly for the effort.
c. GRANTING TIME TO STOCKHOLDERS AND MANAGEMENT
Many state legislatures have felt that the timing set out in the Williams Act,197 which permits a tender offer to be made and closed over a ten day period, did not give management time to exercise its fiduciary duty, the stockholders time to consider the worth of the offer, or competitors the time to raise the price.
Between 1968 and 1976, eleven states enacted laws to deal with the problem.108 It was widely recognized as a legitimate legislative goal to protect a target's stockholders by giving them sufficient time and information to make a considered
102 Petty v. Pennetch Papers, Inc., 347 A. 2d 140 (Del. Ch. 1975).
105 In the trial court, the Bennett case had been decided by the same Vice Chancellor who had two years before decided Kors v. Carey, 158 A. 2d 135 (Del. Ch. 1960). The Kors case had recognized an exception to the rule, recited also in Cheff y. Mathes, 199 A. 2d 548 (Del. Supr. 1964), in cases where directors reasonably believe that the takeover would be injurious to the company.
108 187 A. 2d at 408.
108 Colorado, Hawaii, Idaho, Indiana, Kansas, Minnesota, Nevada, Ohio, South Dakota, Virginia, and Wisconsin.