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What Are Directors’ Fiduciary Duties When Selling Control of a Corporation?

In Delaware, courts impose the so-called Revlon duty, which can be described as the fiduciary duty to make reasonable efforts to obtain the highest sales price reasonably possible in view of the market for the company. This may even involve conducting a public auction for the company or at least a check of the market, depending on the circumstances, and agreements must include a so-called “fiduciary out” to allow the directors to accept a higher bid after the agreement has been signed by a would-be buyer. See Revlon Inc. v MacAndrews & Forbes Holdings, Inc. (Del 1985) 506 A2d 173; Omnicare, Inc. v NCS Healthcare, Inc. (Del 2003) 818 A2d 914. But, as Keith Paul Bishop notes in his recent blog post on California Corporate and Securities Law, “[d]espite its notoriety in Delaware, Revlon is nearly unknown in California jurisprudence.”

Although California case law is scarce, the California General Corporation Law (CGCL) has many provisions that expressly set out the rights and obligations of directors and shareholders in change-of-control contexts. As Andrew T. Orr explained in his article Applying Revlon in California in CEB’s California Business Law Practitioner, the CGCL establishes a robust, cohesive statutory foundation that gives shareholders greater protection and a louder voice in change-of-control transactions than do statutory schemes in other states, including Delaware. See, e.g., Corp C §152 (class-vote requirement), §§407, 1101, 1110 (restrictions on freeze-out transactions), §1203 (fairness opinion requirement), §§1502, 1502.1 (access to information), §§1300–1313 (dissenter’s rights). Moreover, the many bright-line restrictions and statutory safe harbors in the CGCL arguably provide clearer and more reliable guidelines around which directors may orient their conduct. Orr, Applying Revlon in California, 22 CEB Cal Bus L Prac 97, 99 (Fall 2007). See also Hernand & Miller, California Law Issues for the M&A Lawyer, 27 CEB Cal Bus L Prac 33 (Spring 2012).

In Jewel Cos. v Pay Less Drug Stores Northwest, Inc. (9th Cir 1984) 741 F2d 1555, the Ninth Circuit rejected the notion that the defendant corporation had an obligation to auction the company, stating that the California Corporations Code “does not adopt the auction model in regulating negotiated transactions.” 741 F2d at 1562. Although the Ninth Circuit in Jewel did conclude that a board could enter into an “exclusive” merger agreement, it acknowledged that the board could not, consistent with its fiduciary obligations, withhold from the shareholders information about a potentially more attractive competing offer. See 741 F2d at 1564. Jewel was followed in Monty v Leis (2011) 193 CA4th 1367, 1374, in which the California court of appeal confirmed that a board of directors may lawfully agree in a merger agreement to forbear from negotiating or accepting competing offers. The court of appeal refused to follow Omnicare, Inc. v NCS Healthcare, Inc. (Del 2003) 818 A2d 914, holding that the board of directors had no duty to include a “fiduciary out” provision in the relevant agreement.

This doesn’t mean that directors in California can satisfy their fiduciary duties without gathering market data on the value of the company or considering other opportunities that might provide greater shareholder returns. Common sense suggests that the consideration of alternative transactions is an important element of the duty of care for any board considering a sale of control. Orr, Applying Revlon in California, 22 CEB Cal Bus L Prac 97, 101 (Fall 2007).

The Revlon holding fits within the Delaware model because Delaware’s statutory regime gives directors greater authority and discretion in negotiating transactions for shareholders. But Revlon wouldn’t enhance California’s corporate governance ideals because the California model entrusts the shareholders with greater authority and responsibility to decide for themselves whether or not to support a transaction. 22 CEB Cal Bus L Prac at 105.

Although written ten years ago, Mr. Orr’s conclusion is still appropriate (and was reiterated by Mr. Bishop):

California has more extensive statutory treatment of fiduciary duties of directors and shareholder rights in connection with change-of-control transactions than Delaware. The Revlon duty that Delaware courts have established ad hoc through a series of decisions would undermine California’s existing legal scheme and would create internal inconsistencies within an arguably elegant “shareholder democracy” model of corporate governance. California courts should therefore avoid importing a Revlon duty into the California law of mergers and acquisitions.

22 CEB Cal Bus L Prac at 107.

For extensive discussion of the fiduciary duties of directors of for-profit corporations, turn to CEB’s Understanding Fiduciary Duties in Business Entities, chap 4 and Sales and Mergers of California Businesses, chap 2A. Subscribe to CEB’s California Business Law Practitioner so that you don’t miss articles on important issues for business lawyers. 

Other CEBblog™ posts you may find interesting:

© The Regents of the University of California, 2017. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

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