March 19, 2008
What Standard Would Apply to the Bear Stearns Case in Delaware?
Posted by Gordon Smith

Earlier today, Ashby Jones of the WSJ Law Blog called to talk about the Bear Stearns transaction, and we discussed the possibility of a challenge by shareholders (or a new bidder, as yet unknown) under Delaware law. You can see the results of our conversation here. The interview was pretty hasty, as I was on my way to class, but this post should clarify any lingering ambiguities.

When I first saw the news of this deal on Sunday night, I assumed Bear was being sold for cash. After all, it was only two bucks a share. So I made a snarky remark about how the directors of Bear Stearns should have been trying to get the "best value reasonably available to the stockholders." (Revlon)

The only problem is that Revlon doesn't apply to stock-for-stock transactions unless they result in a change of control. Under QVC, the challenged transaction would have resulted in a shift of control to Sumner Redstone, so that deal was subject to Revlon. In the Bear Stearns-JP Morgan transaction, on the other hand, shareholders would be part of a “fluid aggregation of unaffiliated shareholders” both before and after the deal. No change of control. So it would not be a Revlon case.

Does this line make sense? The usual justification for the line is that the target company shareholders have not been deprived of their ability to receive a control premium. As a result, the market still has the chance to compensate them adequately for their shares, even if the current compensation is not adequate.

The opposing view is that the sale of the company is so important that it should be subject to enhanced scrutiny, not the deferential business judgment rule. Leo Strine seems to endorse this view in a 2001 article, where he remarked on the different treatment of cash and stock sales: "What is striking is how trivial this economic difference is compared to the great difference in the nature of the judicial standard that some practitioners would contend applies to each."

So would the Bear Stearns-JP Morgan merger be subject to business judgment review? Probably not. The key here is whether the Delaware courts would treat the now-famous Section 6.10 as a deal protection device. (The provision is quoted here.) It sure looks like one, though I believe this provision would be new to Delaware. If Section 6.10 (and perhaps 6.11 -- Morgan's option to buy the Bear Stearns building) were treated as deal protection devices, the Delaware litigation would invoke the Unocal-Unitrin standard, as developed in Quickturn, Omnicare, and other cases. I offered some thoughts on those cases in yesterday's post.

Corporate Governance, Corporate Law, Delaware | Bookmark

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