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Full Opinion
OMNICARE, INC., Plaintiff Below, Appellant,
v.
NCS HEALTHCARE, INC., Jon H. Outcalt, Kevin B. Shaw, Boake A. Sells, Richard L. Osborne, Genesis Health Ventures, Inc., and Geneva Sub, Inc., Defendants Below, Appellee.
Robert M. Miles, Guillerma Marti, Anthony Noble, Jeffrey Treadway, Tillie Saltzman, Dolphin Limited Partnership I, L.P., Ramesh Mehan, Renee Mehan, Renee Mehan Ira, Saroj Mehan, Maneesh Mehan, Rahul Mehan, Joel Mehan, Lajia Mehan, Darshan Mehan Ira, Danshal Mehan (Rollover Ira), Arsh N. Mehan, Arsh N. Mehan (Roth Ira), Ashok K. Mehan, and Ashok K. Mehan Ira, Ira, Plaintiffs Below, Appellants,
v.
Jon H. Outcalt, Kevin E. Shaw, Boake A. Sells, Richard L. Osborne, Genesis Health Ventures, Inc., Genesis Sub, Inc., and NCS Healthcare, Inc., Defendants Below, Appellees.
Supreme Court of Delaware.
Donald J. Wolfe, Jr. (argued), Kevin R. Shannon, Michael A. Pittenger, John M. Seaman, Richard L. Renck, of Potter, Anderson & Corroon, LLP, Wilmington, Robert C. Myers, Seth C. Farber, James P. Smith III, David F. Owens, Melanie R. Moss, of Dewey Ballantine, LLP, New York City, for appellant.
Edward P. Welch (argued), Edward B. Micheletti, Katherine J. Neikirk, James A. Whitney, of Skadden, Arps, Slate, Meagher & Flom, Wilmington, Mark A. Phillips, of Benesch, Friedlander, Coplan & Aronoff, Cleveland, OH, for appellees, NCS HealthCare, Inc., Boake A. Sells and Richard L. Osborne.
David C. McBride (argued), Bruce L. Silverstein, Christian Douglas Wright, Adam W. Poff, of Young, Conaway, Stargatt & Taylor, Wilmington, Paul Vizcarrondo, Jr., Theodore N. Mirvis (argued), Mark Gordon, John F. Lynch, Lauryn P. Gouldin, of Wachtell, Lipton, Rosen & Katz, New York City, for Genesis Health Ventures, Inc. and Geneva Sub, Inc.
Edward M. McNally, Michael A. Weidinger, Elizabeth A. Brown, of Morris, James, Hitchens & Williams, Wilmington, Timothy G. Warner, and James R. Bright, of Spieth, Bell, McCurdy & Newell Co., Cleveland, OH, for defendant, Kevin B. Shaw.
Jon E. Abramczyk, Brian J. McTear, of Morris, Nichols, Arsht & Tunnell, Wilmington, Frances Floriano Goins, and Thomas G. Kovach, of Squire, Sanders & Dempsey, Cleveland, OH, for defendant, Jon H. Outcalt.
Joseph A. Rosenthal (argued), Carmella P. Keener, of Rosenthal, Monhait, Gross & Goddess, P.A., Wilmington, Daniel A. Osborn of Beatie and Osborn, LLP, New York City and Richard B. Bemporad, Lowey, Dannenberg, Bemporad & Selinger, LLP, White Plains, NY, for plaintiffs.
Robert J. Kriner, Jr., of Chimicles & Tikellis, LLP, Wilmington, liaison counsel for plaintiffs.
Before VEASEY, Chief Justice, WALSH, HOLLAND, BERGER and STEELE, Justices, constituting the Court en Banc.
*917 HOLLAND, Justice, for the majority:
NCS Healthcare, Inc. ("NCS"), a Delaware corporation, was the object of competing acquisition bids, one by Genesis Health Ventures, Inc. ("Genesis"), a Pennsylvania corporation, and the other by Omnicare, Inc. ("Omnicare"), a Delaware corporation. The proceedings before this Court were expedited due to exigent circumstances, including the pendency of the stockholders' meeting to consider the NCS/Genesis merger agreement. The determinations of this Court were set forth in a summary manner following oral argument to provide clarity and certainty to the parties going forward. Those determinations are explicated in this opinion.
*918 Overview of Opinion
The board of directors of NCS, an insolvent publicly traded Delaware corporation, agreed to the terms of a merger with Genesis. Pursuant to that agreement, all of the NCS creditors would be paid in full and the corporation's stockholders would exchange their shares for the shares of Genesis, a publicly traded Pennsylvania corporation. Several months after approving the merger agreement, but before the stockholder vote was scheduled, the NCS board of directors withdrew its prior recommendation in favor of the Genesis merger.
In fact, the NCS board recommended that the stockholders reject the Genesis transaction after deciding that a competing proposal from Omnicare was a superior transaction. The competing Omnicare bid offered the NCS stockholders an amount of cash equal to more than twice the then current market value of the shares to be received in the Genesis merger. The transaction offered by Omnicare also treated the NCS corporation's other stakeholders on equal terms with the Genesis agreement.
The merger agreement between Genesis and NCS contained a provision authorized by Section 251(c) of Delaware's corporation law. It required that the Genesis agreement be placed before the corporation's stockholders for a vote, even if the NCS board of directors no longer recommended it.[1] At the insistence of Genesis, the NCS board also agreed to omit any effective fiduciary clause from the merger agreement. In connection with the Genesis merger agreement, two stockholders of NCS, who held a majority of the voting power, agreed unconditionally to vote all of their shares in favor of the Genesis merger. Thus, the combined terms of the voting agreements and merger agreement guaranteed, ab initio, that the transaction proposed by Genesis would obtain NCS stockholder's approval.
The Court of Chancery ruled that the voting agreements, when coupled with the provision in the Genesis merger agreement requiring that it be presented to the stockholders for a vote pursuant to 8 Del. C. § 251(c), constituted defensive measures within the meaning of Unocal Corp. v. Mesa Petroleum Co.[2] After applying the Unocal standard of enhanced judicial scrutiny, the Court of Chancery held that those defensive measures were reasonable. We have concluded that, in the absence of an effective fiduciary out clause, those defensive measures are both preclusive and coercive. Therefore, we hold that those defensive measures are invalid and unenforceable.
The Parties
The defendant, NCS, is a Delaware corporation headquartered in Beachwood, Ohio. NCS is a leading independent provider of pharmacy services to long-term care institutions including skilled nursing facilities, assisted living facilities and other institutional healthcare facilities. NCS common stock consists of Class A shares and Class B shares. The Class B shares are entitled to ten votes per share and the Class A shares are entitled to one vote per share. The shares are virtually identical in every other respect.
The defendant Jon H. Outcalt is Chairman of the NCS board of directors. Outcalt owns 202,063 shares of NCS Class A common stock and 3,476,086 shares of Class B common stock. The defendant *919 Kevin B. Shaw is President, CEO and a director of NCS. At the time the merger agreement at issue in this dispute was executed with Genesis, Shaw owned 28,905 shares of NCS Class A common stock and 1,141,134 shares of Class B common stock.
The NCS board has two other members, defendants Boake A. Sells and Richard L. Osborne. Sells is a graduate of the Harvard Business School. He was Chairman and CEO at Revco Drugstores in Cleveland, Ohio from 1987 to 1992, when he was replaced by new owners. Sells currently sits on the boards of both public and private companies. Osborne is a full-time professor at the Weatherhead School of Management at Case Western Reserve University. He has been at the university for over thirty years. Osborne currently sits on at least seven corporate boards other than NCS.
The defendant Genesis is a Pennsylvania corporation with its principal place of business in Kennett Square, Pennsylvania. It is a leading provider of healthcare and support services to the elderly. The defendant Geneva Sub, Inc., a wholly owned subsidiary of Genesis, is a Delaware corporation formed by Genesis to acquire NCS.
The plaintiffs in the class action own an unspecified number of shares of NCS Class A common stock. They represent a class consisting of all holders of Class A common stock. As of July 28, 2002, NCS had 18,461,599 Class A shares and 5,255,210 Class B shares outstanding.
Omnicare is a Delaware corporation with its principal place of business in Covington, Kentucky. Omnicare is in the institutional pharmacy business, with annual sales in excess of $2.1 billion during its last fiscal year. Omnicare purchased 1000 shares of NCS Class A common stock on July 30, 2002.
PROCEDURAL BACKGROUND
This is a consolidated appeal from orders of the Court of Chancery in two separate proceedings. One proceeding is brought by Omnicare seeking to invalidate a merger agreement between NCS and Genesis on fiduciary duty grounds. In that proceeding, Omnicare also challenges Voting Agreements between Genesis and Jon H. Outcalt and Kevin B. Shaw, two major NCS stockholders, who collectively own over 65% of the voting power of NCS stock. The Voting Agreements irrevocably commit these stockholders to vote for the merger. The Omnicare action was C.A. No. 19800 in the Court of Chancery and is No. 605, 2002, in this Court.
The other proceeding is a class action brought by NCS stockholders. That action seeks to invalidate the merger primarily on the ground that the directors of NCS violated their fiduciary duty of care in failing to establish an effective process designed to achieve the transaction that would produce the highest value for the NCS stockholders. The stockholder action was C.A. No. 19786 in the Court of Chancery and is No. 649, 2002 in this Court.
Standing Decision
In Appeal No. 605, 2002 (the "Omnicare appeal") the Court of Chancery entered two orders. The first decision and order (the "Standing Decision"), dated October 25, 2002, dismissed Omnicare's fiduciary duty claims because it lacked standing to assert those claims. The Court of Chancery refused to dismiss Omnicare's declaratory judgment claim, holding that Omnicare had standing, notwithstanding the timing of its purchase of NCS stock to assert its claim, as a bona fide bidder for control, that the NCS charter should be interpreted to cause an automatic conversion of Outcalt's and Shaw's Class B stock *920 (with ten votes per share) to Class A stock (with one vote per share).
Voting Agreements Decision
The second decision and order of the Court of Chancery that is before this Court in the Omnicare appeal is the Court of Chancery's order of October 29, 2002 (the "Voting Agreements Decision") adjudicating the merits of the Voting Agreements. With regard to that issue, the Court of Chancery held Omnicare had standing, as set forth in the preceding paragraph. In the Voting Agreements decision on summary judgment, the Court of Chancery interpreted the applicable NCS charter provisions adversely to Omnicare's contention that the irrevocable proxies granted in those agreements by Outcalt and Shaw to vote for the Genesis merger resulted in an automatic conversion of all of Outcalt's and Shaw's Class B stock into Class A stock. Omnicare's claim with respect to the Voting Agreements was, therefore, dismissed by the Court of Chancery.
Fiduciary Duty Decision
A class action to enjoin the merger was brought by certain stockholders of NCS in the Court of chancery in C.A. No. 19786. The Court of Chancery denied a preliminary injunction in a decision and order dated November 22, 2002, and revised November 25, 2002 (the "Fiduciary Duty Decision"). That decision is now before this Court upon interlocutory review in Appeal No. 649, 2002. The standing of these stockholders to seek injunctive relief based on alleged violations of fiduciary duties by the NCS directors in approving the proposed merger is apparently not challenged by the defendants. Accordingly, the fiduciary duty claims, including those claims Omnicare sought to assert are being asserted by the class action plaintiffs.
FACTUAL BACKGROUND
The parties are in substantial agreement regarding the operative facts. They disagree, however, about the legal implications. This recitation of facts is taken primarily from the opinion by the Court of Chancery.
NCS Seeks Restructuring Alternatives
Beginning in late 1999, changes in the timing and level of reimbursements by government and third-party providers adversely affected market conditions in the health care industry. As a result, NCS began to experience greater difficulty in collecting accounts receivables, which led to a precipitous decline in the market value of its stock. NCS common shares that traded above $20 in January 1999 were worth as little as $5 at the end of that year. By early 2001, NCS was in default on approximately $350 million in debt, including $206 million in senior bank debt and $102 million of its 5¾% Convertible Subordinated Debentures (the "Notes"). After these defaults, NCS common stock traded in a range of $0.09 to $0.50 per share until days before the announcement of the transaction at issue in this case.
NCS began to explore strategic alternatives that might address the problems it was confronting. As part of this effort, in February 2000, NCS retained UBS Warburg, L.L.C. to identify potential acquirers and possible equity investors. UBS Warburg contacted over fifty different entities to solicit their interest in a variety of transactions with NCS. UBS Warburg had marginal success in its efforts. By October 2000, NCS had only received one nonbinding indication of interest valued at $190 million, substantially less than the face value of NCS's senior debt. This proposal was reduced by 20% after the offeror conducted its due diligence review.
*921 NCS Financial Deterioration
In December 2000, NCS terminated its relationship with UBS Warburg and retained Brown, Gibbons, Lang & Company as its exclusive financial advisor. During this period, NCS's financial condition continued to deteriorate. In April 2001, NCS received a formal notice of default and acceleration from the trustee for holders of the Notes. As NCS's financial condition worsened, the Noteholders formed a committee to represent their financial interests (the "Ad Hoc Committee"). At about that time, NCS began discussions with various investor groups regarding a restructuring in a "pre-packaged" bankruptcy. NCS did not receive any proposal that it believed provided adequate consideration for its stakeholders. At that time, full recovery for NCS's creditors was a remote prospect, and any recovery for NCS stockholders seemed impossible.
Omnicare's Initial Negotiations
In the summer of 2001, NCS invited Omnicare, Inc. to begin discussions with Brown Gibbons regarding a possible transaction. On July 20, Joel Gemunder, Omnicare's President and CEO, sent Shaw a written proposal to acquire NCS in a bankruptcy sale under Section 363 of the Bankruptcy Code. This proposal was for $225 million subject to satisfactory completion of due diligence. NCS asked Omnicare to execute a confidentiality agreement so that more detailed discussions could take place.[3]
In August 2001, Omnicare increased its bid to $270 million, but still proposed to structure the deal as an asset sale in bankruptcy. Even at $270 million, Omnicare's proposal was substantially lower than the face value of NCS's outstanding debt. It would have provided only a small recovery for Omnicare's Noteholders and no recovery for its stockholders. In October 2001, NCS sent Glen Pollack of Brown Gibbons to meet with Omnicare's financial advisor, Merrill Lynch, to discuss Omnicare's interest in NCS. Omnicare responded that it was not interested in any transaction other than an asset sale in bankruptcy.
There was no further contact between Omnicare and NCS between November 2001 and January 2002. Instead, Omnicare began secret discussions with Judy K. Mencher, a representative of the Ad Hoc Committee. In these discussions, Omnicare continued to pursue a transaction structured as a sale of assets in bankruptcy. In February 2002, the Ad Hoc Committee notified the NCS board that Omnicare had proposed an asset sale in bankruptcy for $313,750,000.
NCS Independent Board Committee
In January 2002, Genesis was contacted by members of the Ad Hoc Committee concerning a possible transaction with NCS. Genesis executed NCS's standard confidentiality agreement and began a due diligence review. Genesis had recently emerged from bankruptcy because, like NCS, it was suffering from dwindling government reimbursements.
Genesis previously lost a bidding war to Omnicare in a different transaction. This led to bitter feelings between the principals of both companies. More importantly, this bitter experience for Genesis led to its insistence on exclusivity agreements and lock-ups in any potential transaction with NCS.
*922 NCS Financial Improvement
NCS's operating performance was improving by early 2002. As NCS's performance improved, the NCS directors began to believe that it might be possible for NCS to enter into a transaction that would provide some recovery for NCS stockholders' equity. In March 2002, NCS decided to form an independent committee of board members who were neither NCS employees nor major NCS stockholders (the "Independent Committee"). The NCS board thought this was necessary because, due to NCS's precarious financial condition, it felt that fiduciary duties were owed to the enterprise as a whole rather than solely to NCS stockholders.
Sells and Osborne were selected as the members of the committee, and given authority to consider and negotiate possible transactions for NCS. The entire four member NCS board, however, retained authority to approve any transaction. The Independent Committee retained the same legal and financial counsel as the NCS board.
The Independent Committee met for the first time on May 14, 2002. At that meeting Pollack suggested that NCS seek a "stalking-horse merger partner" to obtain the highest possible value in any transaction. The Independent Committee agreed with the suggestion.
Genesis Initial Proposal
Two days later, on May 16, 2002, Scott Berlin of Brown Gibbons, Glen Pollack and Boake Sells met with George Hager, CFO of Genesis, and Michael Walker, who was Genesis's CEO. At that meeting, Genesis made it clear that if it were going to engage in any negotiations with NCS, it would not do so as a "stalking horse." As one of its advisors testified, "We didn't want to be someone who set forth a valuation for NCS which would only result in that valuation ... being publicly disclosed, and thereby creating an environment where Omnicare felt to maintain its competitive monopolistic positions, that they had to match and exceed that level." Thus, Genesis "wanted a degree of certainty that to the extent [it] w[as] willing to pursue a negotiated merger agreement..., [it] would be able to consummate the transaction [it] negotiated and executed."
In June 2002, Genesis proposed a transaction that would take place outside the bankruptcy context. Although it did not provide full recovery for NCS's Noteholders, it provided the possibility that NCS stockholders would be able to recover something for their investment. As discussions continued, the terms proposed by Genesis continued to improve. On June 25, the economic terms of the Genesis proposal included repayment of the NCS senior debt in full, full assumption of trade credit obligations, an exchange offer or direct purchase of the NCS Notes providing NCS Noteholders with a combination of cash and Genesis common stock equal to the par value of the NCS Notes (not including accrued interest), and $20 million in value for the NCS common stock. Structurally, the Genesis proposal continued to include consents from a significant majority of the Noteholders as well as support agreements from stockholders owning a majority of the NCS voting power.
Genesis Exclusivity Agreement
NCS's financial advisors and legal counsel met again with Genesis and its legal counsel on June 26, 2002, to discuss a number of transaction-related issues. At this meeting, Pollack asked Genesis to increase its offer to NCS stockholders. Genesis agreed to consider this request. Thereafter, Pollack and Hager had further conversations. Genesis agreed to offer a total of $24 million in consideration for the *923 NCS common stock, or an additional $4 million, in the form of Genesis common stock.
At the June 26 meeting, Genesis's representatives demanded that, before any further negotiations take place, NCS agree to enter into an exclusivity agreement with it. As Hager from Genesis explained it: "[I]f they wished us to continue to try to move this process to a definitive agreement, that they would need to do it on an exclusive basis with us. We were going to, and already had incurred significant expense, but we would incur additional expenses..., both internal and external, to bring this transaction to a definitive signing. We wanted them to work with us on an exclusive basis for a short period of time to see if we could reach agreement." On June 27, 2002, Genesis's legal counsel delivered a draft form of exclusivity agreement for review and consideration by NCS's legal counsel.
The Independent Committee met on July 3, 2002, to consider the proposed exclusivity agreement. Pollack presented a summary of the terms of a possible Genesis merger, which had continued to improve. The then-current Genesis proposal included (1) repayment of the NCS senior debt in full, (2) payment of par value for the Notes (without accrued interest) in the form of a combination of cash and Genesis stock, (3) payment to NCS stockholders in the form of $24 million in Genesis stock, plus (4) the assumption, because the transaction was to be structured as a merger, of additional liabilities to trade and other unsecured creditors.
NCS director Sells testified, Pollack told the Independent Committee at a July 3, 2002 meeting that Genesis wanted the Exclusivity Agreement to be the first step towards a completely locked up transaction that would preclude a higher bid from Omnicare:
A. [Pollack] explained that Genesis felt that they had suffered at the hands of Omnicare and others. I guess maybe just Omnicare. I don't know much about Genesis [sic] acquisition history. But they had suffered before at the 11:59:59 and that they wanted to have a pretty much bulletproof deal or they were not going to go forward.
Q. When you say they suffered at the hands of Omnicare, what do you mean?
A. Well, my expression is that that was related to a deal that was related to me or explained to me that they, Genesis, had tried to acquire, I suppose, an institutional pharmacy, I don't remember the name of it. Thought they had a deal and then at the last minute, Omnicare outbid them for the company in a like 11:59 kind of thing, and that they were unhappy about that. And once burned, twice shy.
After NCS executed the exclusivity agreement, Genesis provided NCS with a draft merger agreement, a draft Noteholders' support agreement, and draft voting agreements for Outcalt and Shaw, who together held a majority of the voting power of the NCS common stock. Genesis and NCS negotiated the terms of the merger agreement over the next three weeks. During those negotiations, the Independent Committee and the Ad Hoc Committee persuaded Genesis to improve the terms of its merger.
The parties were still negotiating by July 19, and the exclusivity period was automatically extended to July 26. At that point, NCS and Genesis were close to executing a merger agreement and related voting agreements. Genesis proposed a short extension of the exclusivity agreement so a deal could be finalized. On the morning of July 26, 2002, the Independent Committee authorized an extension of the exclusivity period through July 31.
*924 Omnicare Proposes Negotiations
By late July 2002, Omnicare came to believe that NCS was negotiating a transaction, possibly with Genesis or another of Omnicare's competitors, that would potentially present a competitive threat to Omnicare. Omnicare also came to believe, in light of a run-up in the price of NCS common stock, that whatever transaction NCS was negotiating probably included a payment for its stock. Thus, the Omnicare board of directors met on the morning of July 26 and, on the recommendation of its management, authorized a proposal to acquire NCS that did not involve a sale of assets in bankruptcy.
On the afternoon of July 26, 2002, Omnicare faxed to NCS a letter outlining a proposed acquisition. The letter suggested a transaction in which Omnicare would retire NCS's senior and subordinated debt at par plus accrued interest, and pay the NCS stockholders $3 cash for their shares. Omnicare's proposal, however, was expressly conditioned on negotiating a merger agreement, obtaining certain third party consents, and completing its due diligence.
Mencher saw the July 26 Omnicare letter and realized that, while its economic terms were attractive, the "due diligence" condition substantially undercut its strength. In an effort to get a better proposal from Omnicare, Mencher telephoned Gemunder and told him that Omnicare was unlikely to succeed in its bid unless it dropped the "due diligence outs." She explained this was the only way a bid at the last minute would be able to succeed. Gemunder considered Mencher's warning "very real," and followed up with his advisors. They, however, insisted that he retain the due diligence condition "to protect [him] from doing something foolish." Taking this advice to heart, Gemunder decided not to drop the due diligence condition.
Late in the afternoon of July 26, 2002, NCS representatives received voicemail messages from Omnicare asking to discuss the letter. The exclusivity agreement prevented NCS from returning those calls. In relevant part, that agreement precluded NCS from "engag[ing] or particpat[ing] in any discussions or negotiations with respect to a Competing Transaction or a proposal for one." The July 26 letter from Omnicare met the definition of a "Competing Transaction."
Despite the exclusivity agreement, the Independent Committee met to consider a response to Omnicare. It concluded that discussions with Omnicare about its July 26 letter presented an unacceptable risk that Genesis would abandon merger discussions. The Independent Committee believed that, given Omnicare's past bankruptcy proposals and unwillingness to consider a merger, as well as its decision to negotiate exclusively with the Ad Hoc Committee, the risk of losing the Genesis proposal was too substantial. Nevertheless, the Independent Committee instructed Pollack to use Omnicare's letter to negotiate for improved terms with Genesis.
Genesis Merger Agreement And Voting Agreements
Genesis responded to the NCS request to improve its offer as a result of the Omnicare fax the next day. On July 27, Genesis proposed substantially improved terms. First, it proposed to retire the Notes in accordance with the terms of the indenture, thus eliminating the need for Noteholders to consent to the transaction. This change involved paying all accrued interest plus a small redemption premium. Second, Genesis increased the exchange ratio for NCS common stock to one-tenth of a Genesis common share for each NCS common share, an 80% increase. Third, it agreed to lower the proposed termination *925 fee in the merger agreement from $10 million to $6 million. In return for these concessions, Genesis stipulated that the transaction had to be approved by midnight the next day, July 28, or else Genesis would terminate discussions and withdraw its offer.
The Independent Committee and the NCS board both scheduled meetings for July 28. The committee met first. Although that meeting lasted less than an hour, the Court of Chancery determined the minutes reflect that the directors were fully informed of all material facts relating to the proposed transaction. After concluding that Genesis was sincere in establishing the midnight deadline, the committee voted unanimously to recommend the transaction to the full board.
The full board met thereafter. After receiving similar reports and advice from its legal and financial advisors, the board concluded that "balancing the potential loss of the Genesis deal against the uncertainty of Omnicare's letter, results in the conclusion that the only reasonable alternative for the Board of Directors is to approve the Genesis transaction." The board first voted to authorize the voting agreements with Outcalt and Shaw, for purposes of Section 203 of the Delaware General Corporation Law ("DGCL"). The board was advised by its legal counsel that "under the terms of the merger agreement and because NCS shareholders representing in excess of 50% of the outstanding voting power would be required by Genesis to enter into stockholder voting agreements contemporaneously with the signing of the merger agreement, and would agree to vote their shares in favor of the merger agreement, shareholder approval of the merger would be assured even if the NCS Board were to withdraw or change its recommendation. These facts would prevent NCS from engaging in any alternative or superior transaction in the future." (emphasis added).
After listening to a summary of the merger terms, the board then resolved that the merger agreement and the transactions contemplated thereby were advisable and fair and in the best interests of all the NCS stakeholders. The NCS board further resolved to recommend the transactions to the stockholders for their approval and adoption. A definitive merger agreement between NCS and Genesis and the stockholder voting agreements were executed later that day. The Court of Chancery held that it was not a per se breach of fiduciary duty that the NCS board never read the NCS/Genesis merger agreement word for word.[4]
NCS/Genesis Merger Agreement
Among other things, the NCS/Genesis merger agreement provided the following:
NCS stockholders would receive 1 share of Genesis common stock in exchange for every 10 shares of NCS common stock held;
NCS stockholders could exercise appraisal rights under 8 Del. C. § 262;
NCS would redeem NCS's Notes in accordance with their terms;
NCS would submit the merger agreement to NCS stockholders regardless of whether the NCS board continued to recommend the merger;
NCS would not enter into discussions with third parties concerning an alternative acquisition of NCS, or provide nonpublic information to such parties, unless (1) the third party provided an unsolicited, bona fide written proposal documenting the terms of the acquisition; (2) the NCS board believed in good faith that the proposal was or was likely to result in an acquisition on terms superior *926 or to those contemplated by the NCS/Genesis merger agreement; and (3) before providing non-public information to that third party, the third party would execute a confidentiality agreement at least as restrictive as the one in place between NCS and Genesis; and
If the merger agreement were to be terminated, under certain circumstances NCS would be required to pay Genesis a $6 million termination fee and/or Genesis's documented expenses, up to $5 million.
Voting Agreements
Outcalt and Shaw, in their capacity as NCS stockholders, entered into voting agreements with Genesis. NCS was also required to be a party to the voting agreements by Genesis. Those agreements provided, among other things, that:
Outcalt and Shaw were acting in their capacity as NCS stockholders in executing the agreements, not in their capacity as NCS directors or officers;
Neither Outcalt nor Shaw would transfer their shares prior to the stockholder vote on the merger agreement;
Outcalt and Shaw agreed to vote all of their shares in favor of the merger agreement; and
Outcalt and Shaw granted to Genesis an irrevocable proxy to vote their shares in favor of the merger agreement.
The voting agreement was specifically enforceable by Genesis.
The merger agreement further provided that if either Outcalt or Shaw breached the terms of the voting agreements, Genesis would be entitled to terminate the merger agreement and potentially receive a $6 million termination fee from NCS. Such a breach was impossible since Section 6 provided that the voting agreements were specifically enforceable by Genesis.
Omnicare's Superior Proposal
On July 29, 2002, hours after the NCS/Genesis transaction was executed, Omnicare faxed a letter to NCS restating its conditional proposal and attaching a draft merger agreement. Later that morning, Omnicare issued a press release publicly disclosing the proposal.
On August 1, 2002, Omnicare filed a lawsuit attempting to enjoin the NCS/Genesis merger, and announced that it intended to launch a tender offer for NCS's shares at a price of $3.50 per share. On August 8, 2002, Omnicare began its tender offer. By letter dated that same day, Omnicare expressed a desire to discuss the terms of the offer with NCS. Omnicare's letter continued to condition its proposal on satisfactory completion of a due diligence investigation of NCS.
On August 8, 2002, and again on August 19, 2002, the NCS Independent Committee and full board of directors met separately to consider the Omnicare tender offer in light of the Genesis merger agreement. NCS's outside legal counsel and NCS's financial advisor attended both meetings. The board was unable to determine that Omnicare's expressions of interest were likely to lead to a "Superior Proposal," as the term was defined in the NCS/Genesis merger agreement. On September 10, 2002, NCS requested and received a waiver from Genesis allowing NCS to enter into discussions with Omnicare without first having to determine that Omnicare's proposal was a "Superior Proposal."
On October 6, 2002, Omnicare irrevocably committed itself to a transaction with NCS. Pursuant to the terms of its proposal, Omnicare agreed to acquire all the outstanding NCS Class A and Class B shares at a price of $3.50 per share in cash. As a result of this irrevocable offer, on October 21, 2002, the NCS board withdrew its recommendation that the stockholders vote in favor of the NCS/Genesis merger agreement. *927 NCS's financial advisor withdrew its fairness opinion of the NCS/Genesis merger agreement as well.
Genesis Rejection Impossible
The Genesis merger agreement permits the NCS directors to furnish non-public information to, or enter into discussions with, "any Person in connection with an unsolicited bona fide written Acquisition Proposal by such person" that the board deems likely to constitute a "Superior Proposal." That provision has absolutely no effect on the Genesis merger agreement. Even if the NCS board "changes, withdraws or modifies" its recommendation, as it did, it must still submit the merger to a stockholder vote.
A subsequent filing with the Securities and Exchange Commission ("SEC") states: "the NCS independent committee and the NCS board of directors have determined to withdraw their recommendations of the Genesis merger agreement and recommend that the NCS stockholders vote against the approval and adoption of the Genesis merger." In that same SEC filing, however, the NCS board explained why the success of the Genesis merger had already been predetermined. "Notwithstanding the foregoing, the NCS independent committee and the NCS board of directors recognize that (1) the existing contractual obligations to Genesis currently prevent NCS from accepting the Omnicare irrevocable merger proposal; and (2) the existence of the voting agreements entered into by Messrs. Outcalt and Shaw, whereby Messrs. Outcalt and Shaw agreed to vote their shares of NCS Class A common stock and NCS Class B common stock in favor of the Genesis merger, ensure NCS stockholder approval of the Genesis merger." This litigation was commenced to prevent the consummation of the inferior Genesis transaction.
LEGAL ANALYSIS
Business Judgment or Enhanced Scrutiny
The "defining tension" in corporate governance today has been characterized as "the tension between deference to directors' decisions and the scope of judicial review."[5] The appropriate standard of judicial review is dispositive of which party has the burden of proof as any litigation proceeds from stage to stage until there is a substantive determination on the merits.[6] Accordingly, identification of the correct analytical framework is essential to a proper judicial review of challenges to the decision-making process of a corporation's board of directors.[7]
"The business judgment rule, as a standard of judicial review, is a commonlaw recognition of the statutory authority to manage a corporation that is vested in the board of directors."[8] 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."[9] "An application of the *928 traditional business judgment rule places the burden on the `party challenging the [board's] decision to establish facts rebutting the presumption.'"[10] The effect of a proper invocation of the business judgment rule, as a standard of judicial review, is powerful because it operates deferentially. Unless the procedural presumption of the business judgment rule is 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.'"[11]
The business judgment rule embodies the deference that is accorded to managerial decisions of a board of directors. "Under normal circumstances, neither the courts nor the stockholders should interfere with the managerial decision of the directors."[12] There are certain circumstances, however, "which mandate that a court take a more direct and active role in overseeing the decisions made and actions taken by directors. In these situations, a court subjects the directors' conduct to enhanced scrutiny to ensure that it is reasonable,"[13] "before the protections of the business judgment rule may be conferred."[14]
The prior decisions of this Court have identified the circumstances where board action must be subjected to enhanced judicial scrutiny before the presumptive protection of the business judgment rule can be invoked. One of those circumstances was described in Unocal: when a board adopts defensive measures in response to a hostile takeover proposal that the board reasonably determines is a threat to corporate policy and effectiveness.[15] In Moran v. Household, we explained why a Unocal analysis also was applied to the adoption of a stockholder's rights plan, even in the absence of an immediate threat.[16] Other circumstances requiring enhanced judicial scrutiny give rise to what are known as Revlon duties, such as when the board enters into a merger transaction that will cause a change in corporate control, initiates an active bidding process seeking to sell the corporation, or makes a break up of the corporate entity inevitable.[17]
Merger Decision Review Standard
The first issue decided by the Court of Chancery addressed the standard of judicial review that should be applied to the decision by the NCS board to merge with Genesis. This Court has held that a board's decision to enter into a merger transaction that does not involve a change in control is entitled to judicial deference pursuant to the procedural and substantive operation of the business judgment rule.[18] When a board decides to enter into a merger transaction that will result in a change of control, however, enhanced judicial scrutiny under Revlon is the standard of review.[19]
*929 The Court of Chancery concluded that, because the stock-for-stock merger between Genesis and NCS did not result in a change of control, the NCS directors' duties under Revlon were not triggered by the decision to merge with Genesis.[20] The Court of Chancery also recognized, however, that Revlon duties are imposed "when a corporation initiates an active bidding process seeking to sell itself."[21] The Court of Chancery then concluded, alternatively, that Revlon duties had not been triggered because NCS did not start an active bidding process, and the NCS board "abandoned" its efforts to sell the company when it entered into an exclusivity agreement with Genesis.
After concluding that the Revlon standard of enhanced judicial review was completely inapplicable, the Court of Chancery then held that it would examine the decision of the NCS board of directors to approve the Genesis merger pursuant to the business judgment rule standard. After completing its business judgment rule review, the Court of Chancery held that the NCS board of directors had not breached their duty of care by entering into the exclusivity and merger agreements with Genesis. The Court of Chancery also held, however, that "even applying the more exacting Revlon standard, the directors acted in conformity with their fiduciary duties in seeking to achieve the highest and best transaction that was reasonably available to [the stockholders]."[22]
The appellants argue that the Court of Chancery's Revlon conclusions are without factual support in the record and contrary to Delaware law for at least two reasons. First, they submit that NCS did initiate an active bidding process. Second, they submit that NCS did not "abandon" its efforts to sell itself by entering into the exclusivity agreement with Genesis. The appellants contend that once NCS decided "to initiate a bidding process seeking to maximize short-term stockholder value, it cannot avoid enhanced judicial scrutiny under Revlon simply because the bidder it selected [Genesis] happens to have proposed a merger transaction that does not involve a change of control."
The Court of Chancery's decision to review the NCS board's decision to merge with Genesis under the business judgment rule rather than the enhanced scrutiny standard of Revlon is not outcome determinative for the purposes of deciding this appeal. We have assumed arguendo that the business judgment rule applied to the decision by the NCS board to merge with Genesis.[23] We have also assumed arguendo that the NCS board exercised due care when it: abandoned the Independent Committee's recommendation to pursue a stalking horse strategy, without even trying to implement it; executed an exclusivity agreement with Genesis; acceded to Genesis' twenty-four hour ultimatum for making a final merger decision; and executed a merger agreement that was summarized but never completely read by the NCS board of directors.[24]
*930 Deal Protection Devices Require Enhanced Scrutiny
The dispositive issues in this appeal involve the defensive devices that protected the Genesis merger agreement. The Delaware corporation statute provides that the board's management decision to enter into and recommend a merger transaction can become final only when ownership action is taken by a vote of the stockholders. Thus, the Delaware corporation law expressly provides for a balance of power between boards and stockholders which makes merger transactions a shared enterprise and ownership decision. Consequently, a board of directors' decision to adopt defensive devices to protect a merger agreement may implicate the stockholders' right to effectively vote contrary to the initial recommendation of the board in favor of the transaction.[25]
It is well established that conflicts of interest arise when a board of directors acts to prevent stockholders from effectively exercising their right to vote contrary to the will of the board.[26] The "omnipresent specter" of such conflict may be present whenever a board adopts defensive devices to protect a merger agreement.[27] The stockholders' ability to effectively reject a merger agreement is likely to bear an inversely proportionate relationship to the structural and economic devices that the board has approved to protect the transaction.
In Paramount v. Time, the original merger agreement between Time and Warner did not constitute a "change of control."[28] The plaintiffs in Paramount v. Time argued that, although the original Time and Warner merger agreement did not involve a change of control, the use of a lock-up, no-shop clause, and "dry-up" provisions violated the Time board's Revlon duties. This Court held that "[t]he adoption of structural safety devices alone does not trigger Revlon. Rather, as the Chancellor stated, such devices are properly subject to a Unocal analysis."[29]
In footnote 15 of Paramount v. Time, we stated that legality of the structural safety devices adopted to protect the original merger agreement between Time and Warner were not a central issue on appeal.[30] That is because the issue on appeal involved the "Time's board [decision] to recast its consolidation with Warner into an outright cash and securities acquisition of Warner by Time."[31] Nevertheless, we determined that there was substantial evidence on the record to support the conclusions reached by the Chancellor in applying a Unocal analysis to each of the structural devices contained in the original merger agreement between Time and Warner.[32]
There are inherent conflicts between a board's interest in protecting a merger transaction it has approved, the stockholders' statutory right to make the final decision to either approve or not approve a merger, and the board's continuing responsibility to effectively exercise its fiduciary duties at all times after the merger agreement is executed. These competing considerations require a threshold determination *931 that board-approved defensive devices protecting a merger transaction are within the limitations of its statutory authority and consistent with the directors' fiduciary duties. Accordingly, in Paramount v. Time, we held that the business judgment rule applied to the Time board's original decision to merge with Warner.[33] We further held, however, that defensive devices adopted by the board to protect the original merger transaction must withstand enhanced judicial scrutiny under the Unocal standard of review, even when that merger transaction does not result in a change of control.[34]
Enhanced Scrutiny Generally
In Paramount v. QVC, this Court identified the key features of an enhanced judicial scrutiny test. The first feature is a "judicial determination regarding the adequacy of the decisionmaking process employed by the directors, including the information on which the directors based their decision."[35] The second feature is "a judicial examination of the reasonableness of the directors' action in light of the circumstances then existing."[36] We also held that "the directors have the burden of proving that they were adequately informed and acted reasonably."[37]
In QVC, we explained that the application of an enhanced judicial scrutiny test involves a judicial "review of the reasonableness of the substantive merits of the board's actions."[38]