Unitrin, Inc. v. American General Corp.

This is an appeal from the Court of Chancery’s entry of a preliminary injunction on October 13, 1994, upon plaintiffs’ motions in two actions: American General Corporation’s (“American General”) suit against Unitrin, Inc. (“Unitrin”) and its directors; and a parallel class action brought by Unitrin stock- ■ holders. 1 An interlocutory appeal was certified by the Court of Chancery on October 24, 1994. This Court accepted the appeal on October 27, 1994.

American General, which had publicly announced a proposal to merge with Unitrin for $2.6 billion at $50 — % per share, and certain Unitrin shareholder plaintiffs, filed suit in the Court of Chancery, inter alia, to enjoin Unitrin from repurchasing up to 10 million shares of its own stock (the “Repurchase *1367 Program”). 2 On August 26, 1994, the Court of Chancery temporarily restrained Unitrin from making any further repurchases. After expedited discovery, briefing and argument, the Court of Chancery preliminarily enjoined Unitrin from making further repurchases on the ground that the Repurchase Program was a disproportionate response to the threat posed by American General’s inadequate all cash for all shares offer, under the standard of this Court’s holding in Unocal Corp. v. Mesa Petroleum Co., Del.Supr., 493 A.2d 946 (1985) (“Unocal”).

Unitrin’s Contentions

Unitrin has raised several issues in this appeal. First, it contends that the Court of Chancery erred in assuming that the outside directors would subconsciously act contrary to their substantial financial interests as stockholders and, instead, vote in favor of a subjective desire to protect the “prestige and perquisites” of membership on Unitrin’s Board of Directors. Second, it contends that the Court of Chancery erred in holding that the adoption of the Repurchase Program would materially affect the ability of an insurgent stockholder to win a proxy contest. According to Unitrin, that holding is unsupported by the evidence, is based upon a faulty mathematical analysis, and disregards the holding of Moran v. Household Int’l, Inc., Del.Supr., 500 A.2d 1346, 1355 (1985). Furthermore, Unitrin argues that the Court of Chancery erroneously substituted its own judgment for that of Unitrin’s Board, contrary to this Court’s subsequent interpretations of Unocal in Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34, 45-46 (1994), and Paramount Communications, Inc. v. Time, Inc., Del.Supr., 571 A.2d 1140 (1990). Third, Unitrin submits that the Court of Chancery erred in finding that the plaintiffs would be irreparably harmed absent an injunction (a) because the Court of Chancery disregarded Unitrin’s proffered alternative remedy of sterilizing the increased voting power of the stockholder directors and (b) because there was no basis for finding that stockholders who sold into the market during the pendency of the Repurchase Program would be irreparably harmed.

This Court

Ultimate Disposition

This Court has concluded that the Court of Chancery erred in applying the proportionality review Unocal requires by focusing upon whether the Repurchase Program was an “unnecessary” defensive response. See Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d at 45-46. The Court of Chancery should have directed its enhanced scrutiny: first, upon whether the Repurchase Program the Unitrin Board implemented was draconian, by being either preclusive or coercive and; second, if it was not draconian, upon whether it was within a range of reasonable responses to the threat American General’s Offer posed. Consequently, the interlocutory preliminary injunc-tive judgment of the Court of Chancery is reversed. This matter is remanded for further proceedings in accordance with this opinion.

The Parties

American General is the largest provider of home service insurance. On July 12,1994, it made a merger proposal to acquire Unitrin for $2.6 billion at $50-% per share. Following a public announcement of this proposal, Unitrin shareholders filed suit seeking to compel a sale of the company. American General filed suit to enjoin Unitrin’s Repurchase Program.

Unitrin is also in the insurance business. It is the third largest provider of home service insurance. The other defendants-appellants are the members of Unitrin’s seven person Board of Directors (the “Unitrin Board” or “Board”). Two directors are em *1368 ployees, Richard C. Vie (“Vie”), the Chief Executive Officer, and Jerrold V. Jerome (“Jerome”), Chairman of the Board. The five remaining directors are not and have never been employed by Unitrin. These directors are:

(1) Dr. Henry E. Singleton (“Singleton”), who co-founded Teledyne, Inc. (from which Unitrin is a spin-off) in 1961, and served as its Chairman and Chief Executive Officer until 1988. He is Unitrin’s largest shareholder, owning 7,242,260 shares, in excess of 14% of the outstanding stock;

(2) Fayez S. Sarofim (“Sarofim”), the Chief Executive Officer and 70% owner of Fayez Sarofim & Co., which manages over $23 billion in investments for its clients. Sarofim personally owns 1,062,335 shares of Unitrin common stock, 2.26% of the outstanding stock;

(3) Dr. George A. Roberts (“Roberts”), retired Chairman and former President of Teledyne, Inc. He owns more than 400,-000 shares of Unitrin stock. Dr. Roberts managed Teledyne’s operations for more than 25 years and was apparently responsible for acquiring the companies that make up Unitrin’s core businesses;

(4) James E. Annable (“Annable”), Chief Economist for First National Bank of Chicago and a former professor of economics at the Massachusetts Institute of Technology; and

(5) Reuben L. Hedlund (“Hedlund”), a trial lawyer in Chicago, with experience in antitrust law.

The record reflects that the non-employee directors each receive a fixed annual fee of $30,000. They receive no other significant financial benefit from serving as directors. At the offering price proposed by American General, the value of Unitrin’s non-employee directors’ stock exceeded $450 million.

American General’s Offer

In January 1994, James Tuerff (“Tuerff’), the President of American General, met with Richard Vie, Unitrin’s Chief Executive Officer. Tuerff advised Vie that American General was considering acquiring other companies. Unitrin was apparently at or near the top of its list. Tuerff did not mention any terms for a potential acquisition of Unitrin. Vie replied that Unitrin had excellent prospects as an independent company and had never considered a merger. Vie indicated to Tuerff that Unitrin was not for sale.

According to Vie, he reported his conversation with Tuerff at the next meeting of the Unitrin Board in February 1994. The minutes of the full Board meeting do not reflect a discussion of Tuerff s proposition. Nevertheless, the parties agree that the Board’s position in February was that Unitrin was not for sale. It was unnecessary to respond to American General because no offer had been made.

On July 12, 1994, American General sent a letter to Vie proposing a consensual merger transaction in which it would “purchase all of Unitrin’s 51.8 million outstanding shares of common stock for $50-% per share, in cash” (the “Offer”). The Offer was conditioned on the development of a merger agreement and regulatory approval. The Offer price represented a 30% premium over the market price of Unitrin’s shares. In the Offer, American General stated that it “would consider offering a higher price” if “Unitrin could demonstrate additional value.” American General also offered' to consider tax-free “[alternatives to an all cash transaction.”

Unitrin’s Rejection

Upon receiving the American General Offer, the Unitrin Board’s Executive Committee (Singleton, Vie, and Jerome) engaged legal counsel and scheduled a telephonic Board meeting for July 18. At the July 18 special meeting, the Board reviewed the terms of the Offer. The Board was advised that the existing charter and bylaw provisions might not effectively deter all types of takeover strategies. It was suggested that the Board consider adopting a shareholder rights plan and an advance notice provision for shareholder proposals.

*1369 The Unitrin Board met next on July 25, 1994 in Los Angeles for seven hours. 3 All directors attended the meeting. The principal purpose of the meeting was to discuss American General’s Offer.

Vie reviewed Unitrin’s financial condition and its ongoing business strategies. The Board also received a presentation from its investment advisor, Morgan Stanley & Co. (“Morgan Stanley”), regarding the financial adequacy of American General’s proposal. Morgan Stanley expressed its opinion that the Offer was financially inadequate. 4 Legal counsel expressed concern that the combination of Unitrin and American General would raise antitrust complications due to the resultant decrease in competition in the home service insurance markets.

The Unitrin Board unanimously concluded that the American General merger proposal was not in the best interests of Unitrin’s shareholders and voted to reject the Offer. 5 The Board then received advice from its legal and financial advisors about a number of possible defensive measures it might adopt, including a shareholder rights plan (“poison pill”) 6 and an advance notice bylaw provision for shareholder proposals. Because the Board apparently thought that American General intended to keep its Offer private, the Board did not implement any defensive measures at that time.

On July 26, 1994, Vie faxed a letter to Tuerff, rejecting American General’s Offer. That correspondence stated:

As I told you back in January, when you first proposed acquiring our company, we are not for sale. The Board believed then, and believes even more strongly today, that the company’s future as an independent enterprise is excellent and will provide greater long-term benefits to the company, our stockholders and our other constituencies than pursuing a sale transaction.

Accordingly, we don’t view a combination with you as part of our future and our Board is unanimous and unequivocal that we should not pursue it.

The Board has specifically directed me to say that we assume you do not want to create an adversarial situation and that you agree with us it would be counterproductive to do so. But our Board is very firm in its conclusion about your offer and if our assumption about your intentions proves to be incorrect, Unitrin has, as you know, the financial capacity to pursue all avenues the Board considers appropriate.

Vie acknowledged during discovery that the latter portion of his letter referred, in part, to the Repurchase Program.

*1370 American General’s Publicity

Unitrin’s Initial Responses

On August 2, 1994, American General issued a press release announcing its Offer to Unitrin’s Board to purchase all of Unitrin’s stock for $50-% per share. The press release also noted that the Board had rejected American General’s Offer. After that public announcement, the trading volume and market price of Unitrin’s stock increased.

At its regularly scheduled meeting on August 3, the Unitrin Board discussed the effects of American General’s press release. The Board noted that the market reaction to the announcement suggested that speculative traders or arbitrageurs were acquiring Unit-rin stock. The Board determined that American General’s public announcement constituted a hostile act designed to coerce the sale of Unitrin at an inadequate price. The Board unanimously approved'the poison pill and the proposed advance notice bylaw that it had considered previously.

Beginning on August 2 and continuing through August 12, 1994, Unitrin issued a series of press releases to inform its shareholders and the public market: first, that the Unitrin Board believed Unitrin’s stock was worth more than the $50-% American General offered; second, that the Board felt that the price of American General’s Offer did not reflect Unitrin’s long term business prospects as an independent company; third, that “the true value of Unitrin [was] not reflected in the [then] current market price of its common stock,” and that because of its strong financial position, Unitrin was well positioned “to pursue strategic and financial opportunities;” fourth, that the Board believed a merger with American General would have anticompetitive effects and might violate antitrust laws and various state regulatory statutes; and fifth, that the Board had adopted a shareholder rights plan (poison pill) to guard against undesirable takeover efforts.

Unitrin’s Repurchase Program

The Unitrin Board met again on August 11, 1994. The minutes of that meeting indicate that its principal purpose was to consider the Repurchase Program. At the Board’s request, Morgan Stanley had prepared written materials to distribute to each of the directors. Morgan Stanley gave a presentation in which alternative means of implementing the Repurchase Program were explained. Morgan Stanley recommended that the Board implement an open market stock repurchase. The Board voted to authorize the Repurchase Program for up to ten million shares of its outstanding stock.

On August 12, Unitrin publicly announced the Repurchase Program. The Unitrin Board expressed its belief that “Unitrin’s stock is undervalued in the market and that the expanded program will tend to increase the value of the shares that remain outstanding.” The announcement also stated that the director stockholders were not participating in the Repurchase Program, and that the repurchases “will increase the percentage ownership of those stockholders who choose not to sell.”

Unitrin’s August 12 press release also stated that the directors owned 23% of Unitrin’s stock, that the Repurchase Program would cause that percentage to increase, and that Unitrin’s certificate of incorporation included a supermajority voting provision. The following language from a July 22 draft press release revealing the antitakeover effects of the Repurchase Program was omitted from the final press release.

Under the [supermajority provision], the consummation of the expanded repurchase program would enhance the ability of non-selling stockholders, including the directors, to prevent a merger with a greater-than-15% stockholder if they did not favor the transaction.

Unitrin sent a letter to its stockholders on August 17 regarding the Repurchase Program which stated:

Your Board of Directors has authorized the Company to repurchase, in the open market or in private transactions, up to 10 million of Unitrin’s 51.8 million outstanding *1371 common shares. This authorization is intended to provide an additional measure of liquidity to the Company’s shareholders in light of the unsettled market conditions resulting from American General’s unsolicited acquisition proposal. The Board believes that the Company’s stock is undervalued and that this program will tend to increase the value of the shares that remain outstanding.

Between August 12 and noon on August 24, Morgan Stanley purchased nearly 5 million of Unitrin’s shares on Unitrin’s behalf. The average price paid was slightly above American General’s Offer price.

Procedural Posture

It is important to begin our review by recognizing and emphasizing the procedural posture of this case in the Court of Chancery as well as in this Court. The Court of Chancery granted the plaintiffs’ request for a preliminary injunction. After the Court of Chancery entered the preliminary injunction, it certified an appeal from that interlocutory ruling. Supr.Ct.R. 42. This Court accepted the interlocutory appeal and has expedited its review.

The legal paradigm which guides the Court of Chancery before entering a preliminary injunction is well established. First, the plaintiff must demonstrate a reasonable probability of success on the merits at trial. Mills Acquisition Co. v. Macmillan, Inc., Del.Supr., 559 A.2d 1261, 1278 (1989). Second, the plaintiff must prove a reasonable probability of irreparable harm in the absence of such preliminary injunctive relief. Id. Finally, the plaintiff must convince the Court of. Chancery that, after balancing the relative hardships to the parties involved, the harm to the plaintiff if injunctive relief is denied outweighs the harm to the defendant if the relief is granted. Id. at 1278-79; Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Del.Supr., 506 A.2d 173, 179 (1986).

Nature of Proceeding

Determines Judicial Review

In this case, before the Court of Chancery could evaluate the reasonable probability of the plaintiffs’ success on the merits, it had to determine the nature of the proceeding. When shareholders challenge directors’ actions, usually one of three levels of judicial review is applied: the traditional business judgment rule, the Unocal standard of enhanced judicial scrutiny, or the entire fairness analysis. 7 “Because the effect of the proper invocation of the business judgment rule is so powerful and the standard of entire fairness so exacting, the determination of the appropriate standard of judicial review frequently is determinative of the outcome of [the] litigation.” Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d at 1279 (citing AC Acquisitions Corp. v. Anderson, Clayton & Co., Del.Ch., 519 A.2d 103, 111 (1986)).

The plaintiffs initially argued that Unit-rin’s Board put the corporation up for sale by implementing the Repurchase Program. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d at 182. The Court of Chancery ruled, however, that the plaintiffs had not established with reasonable probability that the Repurchase Program constituted a change of control from Unitrin’s public stockholders to the stockholder directors. See Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34 (1994). The ruling is not at issue in this interlocutory appeal.

*1372 The plaintiffs alternatively argued that the conduct of the Unitrin Board should be examined under the entire fairness standard. The Court of Chancery concluded that the Board’s implementation of the poison pill and the Repurchase Program, in response to American General’s Offer, did not constitute self-dealing that would require the Unitrin Board to demonstrate entire fairness. See Nixon v. Blackwell, Del.Supr., 626 A.2d 1366, 1376 (1993); Weinberger v. UOP, Inc., Del.Supr., 457 A.2d 701, 710 (1983). Consequently, the Court of Chancery addressed the plaintiffs’ third alternative argument, that the Unitrin Board’s actions should be examined under the standard of enhanced judicial scrutiny this Court set forth in Unocal.

Unitrin Board’s Actions Defensive

Unocal is Proper Review Standard

Before a board of directors’ action is subject to the Unocal standard of enhanced judicial scrutiny, the court must determine whether the particular conduct was defensive. 8 The stockholder-plaintiffs asked the Court of Chancery to review both the poison pill and the Repurchase Program pursuant to the Unocal standard. American General requested the Court of Chancery to apply Unocal and enjoin the Repurchase Program only. Unitrin acknowledged that the poison pill was subject to the enhanced scrutiny Unocal requires but argued that the Court of Chancery should evaluate the Repurchase Program under the business judgment rule.

According to the Unitrin Board, the Repurchase Program was enacted for a valid business purpose and, therefore, should not be evaluated as a defensive measure under Unocal. The Court of Chancery agreed that, had the Board enacted the Repurchase Program independent of a takeover proposal, its decision would be reviewed under the traditional business judgment rule. The Court of Chancery concluded, however, that the Unit-rin Board perceived American General’s Offer as a threat and, from the timing of the consideration and implementation of the Repurchase Program, adopted the Repurchase Program as one of several defensive measures in response to that threat. Unitrin does not dispute that conclusion for the purpose of this interlocutory appeal.

The Court of Chancery held that all of the Unitrin Board’s defensive actions merited judicial scrutiny according to Unocal, 9 The record supports the Court of Chancery’s determination that the Board perceived American General’s Offer as a threat and adopted the Repurchase Program, along with the poison pill and advance notice bylaw, as defensive measures in response to that threat. Therefore, the Court of Chancery properly concluded the facts before it required an application of Unocal and its progeny. See Stroud v. Grace, Del.Supr., 606 A.2d 75, 82 (1992). The evolution of that jurisprudence is didactic.

Unocal’s Standard

Business Judgment Rule

Enhanced Judicial Scrutiny

The business judgment rule applies to the conduct of directors in the context of a takeover. See Pogostin v. Rice, Del.Supr., 480 A.2d 619 (1984); Aronson v. Leivis, Del. *1373 Supr., 473 A.2d 805, 812 (1984). 10 Accord Paramount Communications, Inc. v. QVC Network, Inc., Del.Supr., 637 A.2d 34, 41-42 (1994). The business judgment rule is a “presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” Aronson v. Lewis, 473 A.2d at 812. 11 An application of the traditional business judgment rule places the burden on the “party challenging the [board’s] decision to establish facts rebutting the presumption.” Id. If the business judgment rule is not rebutted, a “court will not substitute its judgment for that of the board if the [board’s] decision can be ‘attributed to any rational business purpose.’ ” Unocal, 493 A.2d at 954 (citation omitted).

In Unocal, this Court reaffirmed “the application of the business judgment rule in the context of a hostile battle for control of a Delaware corporation where board action is taken to the exclusion of, or in limitation upon, a valid stockholder vote.” Stroud v. Grace, 606 A.2d at 82. This Court has recognized that directors are often confronted with an “ ‘inherent conflict of interest’ during contests for corporate control ‘[b]ecause of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders.’ ” Id. (quoting Unocal, 493 A.2d at 954). Consequently, in such situations, before the board is accorded the protection of the business judgment rule, and that rule’s concomitant placement of the burden to rebut its presumption on the plaintiff, the board must carry its own initial two-part burden:

First, a reasonableness test, which is satisfied by a demonstration that the board of directors had reasonable grounds for believing that a danger to corporate policy and effectiveness existed, and

Second, a proportionality test, which is satisfied by a demonstration that the board of directors’ defensive response was reasonable in relation to the threat posed.

Unocal, 493 A.2d at 955. See also Moran v. Household Int’l, Inc., Del.Supr., 500 A.2d 1346, 1356 (1985). The common law pronouncement in Unocal of enhanced judicial scrutiny, as a threshold or condition precedent to an application of the traditional business judgment rule, is now well known. 12

The enhanced judicial scrutiny mandated by Unocal is not intended to lead to a structured, mechanistic, mathematical exercise. 13 Paramount Communications, Inc. v. Time, Inc., Del.Supr., 571 A.2d 1140, 1153 *1374 (1990). Conversely, it is not intended to be an abstract theory. Id. The Unocal standard is a flexible paradigm that jurists can apply to the myriad of “fact scenarios” that confront corporate boards. Id.

Parties’ Burdens Shift

Judicial Review Standards Differ

Business Judgment Rule and Unocal

The correct analytical framework is essential to a proper review of challenges to the decision-making process of a corporate Board. Nixon v. Blackwell, Del.Supr., 626 A.2d 1366, 1375 (1993). The ultimate question in applying the Unocal standard is: what deference should the reviewing court give “to the decisions of directors in defending against a takeover?” E. Norman Veasey, The New Incarnation of the Business Judgment Rule in Takeover Defenses, 11 Del.J.Corp.L. 503, 504-05 (1986). The question is usually presented to the Court of Chancery, as in the present case, in an injunction proceeding, a posture which is known as “transactional justification.” Id. To answer the question, the enhanced judicial scrutiny Unocal requires implicates both the substantive and procedural nature of the business judgment rule. 14

The business judgment rule has traditionally operated to shield directors from personal liability arising out of completed actions involving operational issues. Id. When the business judgment rule is applied to defend directors against personal liability, as in a derivative suit, the plaintiff has the initial burden of proof and the ultimate burden of persuasion. See Spiegel v. Buntrock, Del.Supr., 571 A.2d 767, 774 (1990). In such cases, the business judgment rule shields directors from personal liability if, upon review, the court concludes the directors’ decision can be attributed to any rational business purpose. See Sinclair Oil Corp. v. Levien, Del .Supr., 280 A.2d 717, 720 (1971).

Conversely, in transactional justification cases involving the adoption of defenses to takeovers, the director’s actions invariably implicate issues affecting stockholder rights. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Del.Supr., 506 A.2d 173, 180 n. 10 (1986). In transactional justification cases, the directors’ decision is reviewed judicially and the burden of going forward is placed on the directors. See Joseph Hinsey, IV, Business Judgment and the American Law Institute’s Corporate Governance Project: the Rule, the Doctrine and the Reality, 52 Geo.Wash.L.Rev., 609, 611-13 (1984). If the directors’ actions withstand Unocal’s reasonableness and proportionality review, the traditional business judgment rule is applied to shield the directors’ defensive decision rather than the directors themselves. Id.

The litigation between Unitrin, American General, and the Unitrin shareholders in the Court of Chancery is a classic example of a transactional justification case. The Court of Chancery’s determination that the conduct of Unitrin’s Board was subject to Unocal’s enhanced judicial scrutiny required it to evaluate each party’s ability to sustain its unique burden in the procedural context of a preliminary injunction proceeding. The plaintiffs burden in such a proceeding is to demonstrate a reasonable probability of success after trial.

*1375 In general, to effectively defeat the plaintiffs ability to discharge that burden, a board must sustain its burden of demonstrating that, even under Unocal’s standard of enhanced judicial scrutiny, its actions deserved the protection of the traditional business judgment rule. Thus, the plaintiffs likelihood of success in obtaining a preliminary injunction was initially dependent upon the inability of the Unitrin Board to discharge the burden placed upon it first by Unocal. Accordingly, having concluded that the Board’s actions were defensive, the Court of Chancery logically began with an evaluation of the Unitrin Board’s evidence.

American General Threat

Reasonableness Burden Sustained

The first aspect of the Unocal burden, the reasonableness test, required the Unitrin Board to demonstrate that, after a reasonable investigation, it determined in good faith, that American General’s Offer presented a threat to Unitrin that warranted a defensive response. This Court has held that the presence of a majority of outside independent directors will materially enhance such evidence. Unocal, 493 A.2d at 955. Accord Paramount Communications, Inc. v. Time, Inc., Del.Supr., 571 A.2d 1140, 1154 (1990); Polk v. Good, Del.Supr., 507 A.2d 531, 537 (1986); Moran v. Household Int’l, Inc., Del.Supr., 500 A.2d 1346, 1356 (1985). An “outside” director has been defined as a non-employee and non-management director, (e.g., Unitrin argues, five members of its seven-person Board). See Grobow v. Perot, DeLSupr., 539 A.2d 180, 184 n. 1 (1988). Independence “means that a director’s decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences.” Aronson v. Lewis, Del.Supr., 473 A.2d 805, 816 (1984). 15

The Unitrin Board identified two dangers it perceived the American General Offer posed: inadequate price and antitrust complications. The Court of Chancery characterized the Board’s concern that American General’s proposed transaction could never be consummated because it may violate antitrust laws and state insurance regulations as a “makeweight excuse” for the defensive measure. It determined, however, that the Board reasonably believed that the American General Offer was inadequate and also reasonably concluded that the Offer was a threat to Unitrin’s uninformed stockholders.

The Court of Chancery held that the Board’s evidence satisfied the first aspect or reasonableness test under Unocal. The Court of Chancery then noted, however, that the threat to the Unitrin stockholders from American General’s inadequate opening bid was “mild,” because the Offer was negotiable both in price and structure. 16 The court then properly turned its attention to Unocal’s second aspect, the proportionality test because “[i]t is not until both parts of the Unocal inquiry have been satisfied that the business judgment rule attaches to defensive actions of a board of directors.” Paramount Com *1376 munications, Inc. v. Time, Inc., 571 A.2d at 1154. 17 See Unocal, 493 A.2d at 955.

Proportionality Burden

Chancery Approves Poison Pill

The second aspect or proportionality test of the initial Unocal burden required the Unitrin Board to demonstrate the proportionality of its response to the threat American General’s Offer posed. The record reflects that the Unitrin Board considered three options as defensive measures: the poison pill, the advance notice bylaw, and the Repurchase Program. The Unitrin Board did not act on any of these options on July 25.

On August 2, American General made a public announcement of its offer to buy all the shares of Unitrin for $2.6 billion at $50-% per share. The Unitrin Board had already concluded that the American General offer was inadequate. It also apparently feared that its stockholders did not realize that the long term value of Unitrin was not reflected in the market price of its stock.

On August 3, the Board met to decide whether any defensive action was necessary. The Unitrin Board decided to adopt defensive measures to protect Unitrin’s stockholders from the inadequate American General Offer in two stages: first, it passed the poison pill and the advance notice bylaw; and, a week later, it implemented the Repurchase Program.

With regard to the second aspect or proportionality test of the initial Unocal burden, the Court of Chancery analyzed each stage of the Unitrin Board’s defensive responses separately. Although the Court of Chancery characterized Unitrin’s antitrust concerns as “makeweight,” it acknowledged that the directors of a Delaware corporation have the prerogative to determine that the market undervalues its stock and to protect its stockholders from offers that do not reflect the long term value of the corporation under its present management plan. Parar mount Communications, Inc. v. Time, Inc., 571 A.2d at 1153. The Court of Chancery concluded that Unitrin’s Board believed in good faith that the American General Offer was inadequate and properly employed a poison pill as a proportionate defensive response to protect its stockholders from a “low ball” bid.

No cross-appeal was filed in this expedited interlocutory proceeding. Therefore, the Court of Chancery’s ruling that the Unitrin Board’s adoption of a poison pill was a proportionate response to American General’s Offer is not now directly at issue. Nevertheless, to the extent the Unitrin Board’s prior adoption of the poison pill influenced the Court of Chancery’s proportionality review of the Repurchase Program, the Board’s adoption of the poison pill is also a factor to be considered on appeal by this Court.

Proportionality Burden

Chancery Enjoins Repurchase Program

The Court of Chancery did not view either its conclusion that American General’s Offer constituted a threat, or its conclusion that the poison pill was a reasonable response to that threat, as requiring it, a fortiori, to conclude that the Repurchase Program was also an appropriate response. The Court of Chancery then made two factual findings: first, the Repurchase Program went beyond what was “necessary” to protect the Unitrin stockholders from a “low ball” negotiating strategy; and second, it was designed to keep the decision to combine with American General within the control of the members of the Unitrin Board, as stockholders, under virtually all circumstances. Consequently, the Court of Chancery held that the Unitrin Board failed to demonstrate that the Repurchase Program met the second aspect or *1377 proportionality requirement of the initial burden Unocal ascribes to a board of directors.

The Court of Chancery framed the ultimate question before it as follows:

This case comes down to one final question: Is placing the decision to sell the company in the hands of stockholders who are also directors a disproportionate response to a low price offer to buy all the shares of the company for cash?

The Court of Chancery then answered that question:

I conclude that because the only threat to the corporation is the inadequacy of an opening bid made directly to the board, and the board has already taken actions that will protect the stockholders from mistakenly falling for a low ball negotiating strategy, a repurchase program that intentionally provides members of the board with a veto of any merger proposal is not reasonably related to the threat posed by American General’s negotiable all shares, all cash offer.

In explaining its conclusion, the Court of Chancery reasoned that:

I have no doubt that a hostile acquiror can make an offer high enough to entice at least some of the directors that own stock to break ranks and sell their shares. Yet, these directors undoubtedly place a value, probably a substantial one, on their management of Unitrin, and will, at least subconsciously, reject an offer that does not compensate them for that value.... The prestige and perquisites that accompany managing Unitrin as a member of its Board of directors, even for the non-officer directors that do not draw a salary, may cause these stockholder directors to reject an excellent offer unless it includes this value in its “price parameter.”

The Court of Chancery concluded that, although the Unitrin Board had properly perceived American General’s inadequate Offer as a threat and had properly responded to that threat by adopting a “poison pill,” the additional defensive response of adopting the Repurchase Program was unnecessary and disproportionate to the threat the Offer posed. Accord