When a Delaware company board pursues a transaction that would result in a change in corporate control, Delaware law subjects the board to an enhanced duty to maximize short-term value for the corporation’s shareholders. This duty is called a Revlon duty because it emerged from a series of cases beginning with Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.1×1. 506 A.2d 173 (Del. 1986). What constitutes a change in corporate control — a crucial question for courts deciding whether to apply Revlon — is contested. E.g., In re Smurfit-Stone Container Corp. S’holder Litig., No. 6164-VCP, 2011 WL 2028076, at *12 (Del. Ch. May 24, 2011) (observing “when . . . a corporation enter[s] Revlon mode” is “a question of much ongoing debate”); Marcel Kahan, Paramount or Paradox: The Delaware Supreme Court’s Takeover Jurisprudence, 19 J. Corp. L. 583, 585 (1994) (asking “under what circumstances does the court apply the Revlon test[?]”). Clear cases include cash-out mergers, where all shareholders are paid cash for their shares, and transactions where one majority owner sells its entire stake to a new majority owner. See Smurfit-Stone, 2011 WL 2028076, at *12–13. In contrast, mergers where shareholders receive new shares in exchange for old shares might not constitute a change even though the resulting ownership group will not be the same as it was before the transaction. See id. at *13. A board that fails to fulfill this duty faces remedies ranging from court-ordered conflict disclosure to an injunction against the proposed transaction. Despite the disruptive potential of imposing Revlon duties, the Delaware Supreme Court has not exhaustively categorized transactions triggering Revlon. Recently, in C&J Energy Services, Inc. v. City of Miami General Employees’ & Sanitation Employees’ Retirement Trust,2×2. 107 A.3d 1049 (Del. 2014). the Delaware Supreme Court determined that a corporate board had met its duties under Revlon. The C&J court reached its decision assuming, without deciding, that Revlon applied. However, the Delaware Supreme Court could have looked to the ample protections afforded C&J shareholders and determined that the transaction did not trigger Revlon duties.
C&J is a publicly listed, Delaware-incorporated oilfield services provider.3×3. Id. at 1055. Oilfield services providers supply the equipment and expertise to remove oil and natural gas from the ground once other companies have identified deposits. See Alison Sider, Weak Drilling Curbs Oil-Field Services Firms, Wall St. J., Oct. 14, 2012, http://www.wsj.com/articles/SB10000872396390444799904578050881312672400 [http://perma.cc/HK7E-3NPQ]. In 2013, C&J began looking for acquisitions; by early 2014, Nabors, a company with oilfield services business, appeared to be a viable target.4×4. C&J Energy Servs., 107 A.3d at 1056. C&J’s management perceived strategic value in a combination since C&J could put Nabors’s services assets to work more effectively than Nabors.5×5. Id. The transaction6×6. The shareholders seeking to enjoin the transaction termed it an “[a]cquisition” of C&J, see Verified Class Action Complaint at 2, City of Miami Gen. Emps.’ & Sanitation Emps.’ Ret. Trust v. C&J Energy Servs., Inc., No. 9980-VCN (Del. Ch. Nov. 25, 2014), 2014 WL 3753190 [hereinafter Complaint]; C&J called the transaction a “merger,” see The C&J Defendants’ Answering Brief in Opposition to Plaintiff’s Motion for Expedited Proceedings at 1, C&J Energy Servs., No. 9980-VCN. Financial press referred to the transaction as a “merger.” E.g., Jef Feeley, C&J Energy Can Proceed with $2.86 Billion Nabors Merger, Bloomberg (Dec. 19, 2014, 1:51 PM), http://www.bloomberg.com/news/articles/2014-12-19/c-j-energy-can-proceed-with-2-86-billion-nabors-merger [http://perma.cc/8DRR-XQ9G]. could create additional value through a lower corporate tax rate if structured so that Nabors would become the parent company.7×7. C&J Energy Servs., 107 A.3d at 1057. Nabors is headquartered in Bermuda. Id. C&J would merge with a new Nabors subsidiary, aptly named “C&J,” and trade under C&J’s previous stock ticker.8×8. See id. at 1061–62. The new subsidiary began with another name and was renamed “C&J” as part of the transaction. Id. Old C&J shares would be exchanged for new ones such that the Nabors corporation would own 53% of the resulting company and prior C&J shareholders the remaining 47%.9×9. See id. at 1061.
The transaction agreement contained several provisions that kept certain kinds of control in the hands of C&J’s old shareholders.10×10. See id. at 1062–63. These features balanced tax-driven ownership requirements against the understanding that the transaction’s goal was to have C&J run Nabors’s services business. See id. at 1057 (“Nabors would need to own a majority of the new company [for tax purposes].”). First, old C&J stockholders could choose four of the seven initial board members.11×11. Id. at 1055, 1062. Second, corporate action normally requiring a majority shareholder vote would require a two-thirds vote for five years after the transaction.12×12. See id. at 1062. Examples of such actions include selling the company or issuing stock. Third, for the same five-year period, Nabors would be prohibited from increasing its stake in C&J.13×13. Id. at 1062–63. Nabors was also restricted in how it could sell its stake. See id. Finally, if significant assets or the whole company were sold, all shareholders would be entitled to receive the same pro rata consideration.14×14. Id. at 1062. In other words, all shareholders would be paid with the same currency, in direct proportion to their holdings in C&J. C&J’s board unanimously approved the transaction on June 24, 2014.15×15. Id. at 1064.
After the transaction’s announcement, C&J shareholders sued the C&J corporation, its board, and Nabors in the Delaware Court of Chancery alleging breaches of fiduciary duty and seeking an injunction halting the completion of the proposed transaction.16×16. See Complaint, supra note 6, at 1–2, 33–34. In a bench opinion, Vice Chancellor Noble enjoined the merger for thirty days.17×17. Preliminary Injunction Hearing and Ruling of the Court at 154, City of Miami Gen. Emps.’ & Sanitation Emps.’ Ret. Trust v. C&J Energy Servs., Inc., No. 9980-VCN (Del. Ch. Nov. 25, 2014), 2014 WL 7328818 [hereinafter Chancery Opinion]. The Vice Chancellor also disposed of disclosure claims that had not been adequately presented. Id. at 142. While the Vice Chancellor made no factual findings, he determined that the plaintiffs had a reasonable probability of success on their claim that C&J’s board breached its fiduciary duty of care by arranging the transaction without fulfilling its Revlon duties.18×18. C&J Energy Servs., 107 A.3d at 1071. The preliminary injunction standard is that the plaintiff must demonstrate “a reasonable probability of success on the merits, the threat of imminent irreparable harm, and that a balancing of the equities favors injunctive relief.” Chancery Opinion, supra note 17, at 147. The opinion identified as “the major problem” the fact that C&J’s board did not approach the transaction as a sale of the whole company.19×19. Chancery Opinion, supra note 17, at 149. Having determined, albeit without providing explicit reasoning, that the transaction triggered Revlon, the Vice Chancellor explained that the board’s process was insufficient under Revlon’s heightened requirements.20×20. See id. at 148, 152. The Vice Chancellor faulted the board for taking “no steps to sell or shop” C&J beyond its negotiation with Nabors.21×21. Id. at 150. The Vice Chancellor held that the C&J board’s knowledge of C&J’s value was not an adequate substitute for an auction because what really mattered in this transaction was the value of Nabors’s assets as managed by C&J. Id. He also found that the arrangement by which members of the old C&J board would hold guaranteed five-year terms on the new C&J board “raise[d] concern.”22×22. Id. at 151. Based on these considerations, the Vice Chancellor found a sufficient likelihood of a breach of the duty of care.23×23. Id. at 152. The court issued a thirty-day injunction ordering the C&J directors to “solicit [buyers] interest[ed]” in C&J.24×24. Id. at 154.
The Delaware Supreme Court reversed. Chief Justice Strine, writing for a unanimous court, held that even if Revlon duties applied, C&J’s board acted sufficiently in line with those duties to defeat a preliminary injunction.25×25. C&J Energy Servs., 107 A.3d at 1053. The opinion declined to determine if protections for C&J shareholders in the merger agreement were sufficient to avoid triggering Revlon duties because of the minimally developed record.26×26. Id. at 1053, 1069 n.98. However, the opinion also refers to the transaction as a purchase by C&J of Nabors’s assets. See, e.g., id. at 1070 (referring to C&J as a “buyer of assets”). The C&J court found that the Chancery Court had incorrectly applied Revlon to the board’s decisionmaking process. After reiterating that Revlon stands for a board’s duty, when it “engages in a change of control transaction,” to “not take actions inconsistent with achieving the highest immediate value reasonably attainable,”27×27. Id. at 1067. the Chief Justice characterized the Chancery opinion as mandating “a pre-signing active solicitation process”28×28. Id. at 1068. whenever the board lacked “impeccable knowledge.”29×29. Id. (quoting Chancery Opinion, supra note 17, at 150). The Supreme Court noted that no single checklist exists to fulfill Revlon duties30×30. See id. at 1068 n.87, 1069 n.95 (collecting cases). and, specifically, that the Chancery erred in requiring “impeccable knowledge,” and in considering an active sale process to be the only method of obtaining such knowledge.31×31. Id. at 1069. The opinion observed that Revlon requires reasonable, not perfect, decisionmaking, and that the Chancery Court’s other findings suggested that the board acted reasonably.32×32. Id. Further, the Supreme Court characterized the board as having worked to mitigate the transaction’s potential negative consequences for shareholders.33×33. Id. Beyond the protection for shareholders once the transaction was completed, the opinion also looked favorably on the merger agreement’s minimal deal protections.34×34. Id. at 1070. These included a “fiduciary out” providing C&J’s board with broad powers to back out of the proposed transaction if a better one appeared, and a minimal termination fee. Id. Finally, the Supreme Court noted that C&J’s stockholders would have the opportunity to vote to accept or reject the transaction.35×35. Id. In sum, the Supreme Court found that even if the transaction had triggered Revlon duties, the C&J board had fulfilled them. In addition to determining that the Chancery Court’s substantive findings were incorrect, the C&J court criticized the Chancery’s procedural basis for issuing the injunction.36×36. First, the injunction was incorrectly based on disputed, untried facts. Id. at 1071. Second, Chancery should not have ordered C&J to solicit other bids without finding liability because doing so compromised Nabors’s rights. Id. at 1071–72. Third, this was an atypical use of injunctions in takeover litigation. Id. Fourth, the “harmed” parties — the shareholders — retained the ability to redress the harm by voting against the transaction. Id. at 1072. The Delaware Supreme Court reversed the Chancery Court’s decision based on those procedural faults in addition to its finding that C&J’s board met the duties required of it if Revlon had applied.37×37. Id. at 1054.
While the C&J court reached its conclusion by assuming that the transaction triggered Revlon duties, it could have reached the same result by analyzing whether Revlon applied at all. Had the court done so, it would have found that the transaction’s protections for minority shareholders distinguished it from a Revlon-triggering change of control. While courts have generally invoked Revlon duties to protect shareholders who are about to become minority shareholders, they have emphasized that Revlon applies only when a transaction threatens shareholders’ valuable benefits of control.38×38. See, e.g., Kahan, supra note 1, at 595. Because the C&J-Nabors transaction specifically protected C&J shareholders from surrendering these benefits through supermajority voting and provision for pro rata payment in future sales, Revlon duties should not have applied. Thus, because the C&J transaction was not a Revlon-invoking change of control, the C&J board should not have been required to enter Revlon’s “radically altered state”39×39. Paramount Commc’ns Inc. v. Time Inc., Nos. 10866, 10670, and 10935, 1989 WL 79880, at *734 (Del. Ch. July 14, 1989). that requires boards to abandon their typical long-term focus to instead “act reasonably to maximize short-term value of the corporation for its stockholders.”40×40. In re Smurfit-Stone Container Corp. S’holder Litig., No. 6164-VCP, 2011 WL 2028076, at *12 (Del. Ch. May 24, 2011). Revlon has been described as a standard of review, in addition to or instead of a duty. See, e.g., William T. Allen et al., Function over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. Law. 1287, 1312 (2001) (describing Revlon as an “‘intermediate’ standard of review”). Conceptualizing Revlon as at least narrowing the permissible scope of board action by imposing a duty to seek short-term (as opposed to long-term) value and as providing courts with the tool of enhanced scrutiny to review the way the board attempted to achieve that goal is sufficient for a discussion of Revlon triggers. See In re Toys “R” Us, Inc. S’holder Litig., 877 A.2d 975, 999–1000 (Del. Ch. 2005) (describing the Revlon decision as making “two important determinations,” id. at 999: one regarding what directors should do and one regarding how courts should review board actions).
While the precise triggers for Revlon are contested,41×41. See supra note 1. case law indicates that Delaware courts should look at transactions holistically to determine whether soon-to-be minority shareholders are really giving up their benefits of control — that is, if Revlon is triggered — before examining the extent to which a corporate board complied with Revlon’s duties. Revlon itself involved a sale of the whole company; the board’s actions and attendant circumstances made a breakup of the enterprise “inevitable.”42×42. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 182 (Del. 1986). Later cases elucidated other circumstances triggering Revlon duties,43×43. See Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34, 45–48 (Del. 1994) (summarizing developments in Revlon case law to include triggers beyond “an inevitable dissolution,” id. at 46, and concluding that Revlon’s duties are invoked at least when a transaction will either cause “a change in corporate control” or “a break-up,” id. at 48). but there is no definitive and exhaustive list.
One Revlon-triggering change of control, identified in Paramount Communications Inc. v. QVC Network Inc.,44×44. 637 A.2d 34. is a transaction resulting in a company having a single controlling shareholder when the company was previously broadly held.45×45. See id. at 43. Prior to the transaction in that case, “public stockholders” owned the majority of the target’s stock, id.; after, Sumner Redstone, the controlling shareholder of Viacom, id. at 38, was to hold a majority stake, id. at 42–43. The QVC court’s reasoning identified the soon-to-be minority shareholders’ loss of control and premium for that control as valuable assets requiring protection.46×46. Id. at 43 (observing that after the transaction, a single shareholder would have the power to, among other things, “elect directors” and “alter materially the nature of the corporation”). The QVC court described control premia as the “price” of “majority status . . . recogniz[ing] not only the value of a control block of shares, but also compensat[ing] the minority shareholders for their resulting loss of voting power.” Id. Revlon duties applied because this was the minority shareholders’ “last chance.”47×47. Id. (“Once control has shifted, . . . stockholders will have no leverage in the future . . . .”). The C&J plaintiffs used this part of QVC to argue that Revlon applied.48×48. See, e.g., Chancery Opinion, supra note 17, at 9–10. The QVC court, however, did not create a per se rule. Instead, it emphasized that Delaware courts should look to the totality of the transaction — not just the appearance of a new majority shareholder — to determine if there is a Revlon-triggering change of control. Before turning to its analysis of what minority shareholders would lose, the QVC court observed that there were no “devices” to protect the minority’s voting power after the merger.49×49. QVC, 637 A.2d at 42 & n.12. Such devices included “supermajority voting provisions” and “majority of the minority requirements.” Id. at 42 n.12. The QVC court noted that it was passing no judgment on how the inclusion of such devices would have changed its analysis in the present case but that it had approved similar devices under different circumstances. Id. at 42. The opinion reiterated the analytical importance of the absence of such protections in concluding that Revlon applied.50×50. Id. at 43 (“There being no such protective provisions . . .[,] directors had an obligation to . . . realize for the stockholders the best value reasonably available.” (emphasis added)). Delaware courts are infrequently presented with the sorts of protective devices envisioned by QVC,51×51. Chief Justice Strine noted that the question of whether such contractual provisions could keep a transaction “out of Revlon’s reach” was a matter of first impression for the Delaware Supreme Court. C&J Energy Servs., 107 A.3d at 1069 n.98. so they tend to skip the QVC court’s preliminary inquiry. But when a court is called upon to address whether a transaction triggers Revlon, QVC’s holistic inquiry would provide a better framework than a formalistic inquiry that looks only for a nominal change in control. Such a holistic inquiry not only fits more comfortably with Delaware’s context-sensitive judicial decisionmaking,52×52. See, e.g., In re Toys “R” Us, Inc. S’holder Litig., 877 A.2d 975, 999–1000 (Del. Ch. 2005) (observing “there is ‘no single blue-print’ for fulfilling [Revlon duties],” id. at 1000 (quoting Barkan v. Amsted Indus., 567 A.2d 1279, 1286 (Del. 1989)), and engaging in a fact-intensive analysis). but also better protects shareholders than an overinclusive, formalistic inquiry would.53×53. Invoking Revlon forces boards to focus on the short term. If such a shift in focus is not actually required to adequately protect minority shareholders, those shareholders could be harmed if boards are not allowed to consider legitimate, long-term-value-creating transactions.
One recent Delaware decision indicates how a court can approach novel transactions, like C&J’s, with a holistic analysis, like QVC’s, to determine if Revlon duties apply. The precise facts of In re Smurfit-Stone Container Corporation Shareholder Litigation54×54. No. 6164-VCP, 2011 WL 2028076 (Del. Ch. May 24, 2011). are not comparable to C&J, but the opinion’s style of analysis provides a useful template for approaching first-impression Revlon-trigger questions.55×55. Vice Chancellor Parsons noted that the Smurfit transaction structure’s potential for triggering Revlon had “not yet been squarely addressed in Delaware law.” Id. at *1. The Smurfit court began by identifying two bases for evaluation: “relevant judicial precedent” and the transaction’s “economic implications.”56×56. Id. at *13. The court briefly discussed the “few occasions [in which] Delaware courts have provided guidance on this issue” before turning to the transaction’s economics. Id. In analyzing the economic implications, the court reviewed three issues. First, the “no tomorrow” problem: Smurfit’s shareholders had no future opportunities to participate in the company’s gains to the extent they were cashed out.57×57. Id. at *14. Second, the court considered whether the shareholders would be able to obtain a control premium in the future for all of their existing holdings.58×58. Id. at *15. Third, the Vice Chancellor assessed the effect of the transaction on the ability of shareholders to exert themselves in corporate governance.59×59. Id. at *16. By looking at these economic and governance considerations, the Smurfit court correctly reflected the shareholder-protective goals that Revlon serves: boards are compelled to maximize short-term value when some shareholders will give up their valuable benefits of control.60×60. See, e.g., Kahan, supra note 1, at 593–94. Smurfit demonstrates that Delaware courts can and do analyze possible Revlon transactions in a holistic fashion to serve these purposes.
If the C&J court had reviewed the C&J–Nabors transaction with a holistic analysis of change of control like that found in QVC and Smurfit, it would have concluded that the transaction did not trigger Revlon. The C&J–Nabors merger agreement contained features best understood as the protective devices to which the QVC court referred because they address that opinion’s governance and voting concerns. Other devices addressed the QVC and Smurfit courts’ economic concerns.
The C&J–Nabors merger agreement contained terms intended to protect old C&J shareholders’ voting power in a manner similar to QVC’s shareholder-protective measures. The devices affected corporate governance: bylaw amendments, stock issuance and repurchase, and the sale of the company would require a two-thirds shareholder vote.61×61. C&J Energy Servs., 107 A.3d at 1062–63. The devices also constrained Nabors’s ability to change the size of its stake in C&J.62×62. Id. The minority would be well protected from attempts by third parties to obtain control or significant influence over C&J. Thus, the devices protect an important component of the minority shareholders’ valuable asset: their ability to participate meaningfully in the high-level management of the company.63×63. E.g., Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34, 43 (Del. 1994). Accordingly, the provisions of the transaction itself prevent future loss of control at the hands of Nabors, making the key rationale for imposing Revlon duties inapplicable to the C&J transaction.
The C&J transaction’s future-consideration provision protects another aspect of the soon-to-be minority shareholders’ valuable asset: the control premium. This term prevents old C&J shareholders from losing their control premium by requiring that if the new C&J or “major assets” are sold, every shareholder will receive pro rata consideration of “the same type.”64×64. C&J Energy Servs., 107 A.3d at 1062. This term is inserted in the new company bylaws (or “bye-laws” as they are spelled in Bermuda, id. at 1052 n.2), and can only be changed with unanimous consent of the shareholders. Id. at 1062. Unlike the transaction in Smurfit (which provided no assurance that the soon-to-be minority would share fully in future corporate gains), C&J’s minority stockholders would share equally in the price a party acquiring the company would be willing to pay. This term addresses a primary concern of Revlon head-on: a self-interested board might approve a transaction that restricts current shareholder access to control premia in the future.65×65. See, e.g., Ronald J. Gilson & Reinier Kraakman, What Triggers Revlon?, 25 Wake Forest L. Rev. 37, 53–54 (1990). Requiring consideration of the same type removes some of the possible controversy over valuation that can exist when different shareholders receive different sorts of consideration (for example, all stock versus a mix of stock and bonds). More importantly, the pro rata element prevents Nabors from receiving extra consideration for providing its majority stake to another party.66×66. These provisions do not even reach the question of the conditions under which Nabors would be able to sell the share block given the standstill terms also embedded in the agreement. See C&J Energy Servs., 107 A.3d at 1062–63. The protective devices agreed to as part of the merger, taken together, mean that for five years the minority C&J shareholders would be in much the same position they occupied before this transaction.67×67. One reasonable objection to the efficacy of these protections is that five years is not forever. However, in the context of modern U.S. equity markets, it is the next best thing. The institutional investors who dominate U.S. equity markets hold stocks for a much shorter period: some research suggests their median weighted average holding period is as low as 1.37 years. See, e.g., Martijn Cremers et al., Stock Duration, Analysts’ Recommendations, and Misvaluation 31 tbl.1 (Dec. 24, 2014) (unpublished manuscript), http://ssrn.com/abstract=2190437 [http://perma.cc/PCG4-3ULN].
Revlon protections are not necessary in every change of control transaction. Had the C&J court determined that Revlon did not apply to the transaction at hand, it would have made clear that when boards engage in transactions in which their shareholders continue to enjoy the valuable benefits of control through protective devices, those boards are free to focus on creating long-term value otherwise constrained under Revlon scrutiny.