Dilutive Stock Issuances, Deadlocks, and Delaware Law: Blasius Lives

The Delaware Supreme Court recently invoked the Blasius test to invalidate a dilutive stock issuance intended to eliminate a deadlock between a corporation’s two stockholders.  Under Blasius, a board must have a compelling purpose when it acts with the primary purpose of interfering with a stockholder’s voting rights.  Illustrating the consequences of a Blasius review, the Delaware Supreme Court remanded the case for further proceedings even though the Court of Chancery had ruled in a post-trial decision that the stock issuance was “entirely fair.”  While Blasius has been questioned by commentators and invoked sparingly by courts, this decision shows that Blasius still has life.

Background

Coster v. UIP Companies, Inc. involved a deadlock between the two stockholders of a corporation.¹ Before the Court of Chancery could appoint a custodian to resolve the deadlock, the board of directors granted newly issued shares to a director.  The share issuance effectively ended the deadlock by diluting the plaintiff’s ownership below 50%.  After a trial, the Court of Chancery found that a majority of the board of directors was interested in the transaction, but it also found that the share issuance was “entirely fair” and ruled in favor of the defendants.  The plaintiff appealed.

On appeal, the Delaware Supreme Court held that the transaction was subject to equitable review under Schnell v. Chris-Craft and Blasius.  The Supreme Court further suggested that the board of directors had approved the stock issuance for “inequitable reasons” because, among other things, (i) the stock issuance occurred after buyout negotiations between the two stockholders had stalled, (ii) the stockholders had been unable to elect new directors due to the deadlock, and (iii) the issuance was intended to break the deadlock, preserve the incumbent directors’ positions on the board, and avoid the appointment of a custodian.  The Supreme Court remanded the case for further review.

Take-Aways

Under Blasius, a board must demonstrate a “compelling justification” when it acts with the primary purpose of interfering with a stockholder franchise.²  As recognized by the Delaware Supreme Court, Blasius is a “quite onerous” standard and “is therefore applied rarely.”³ While Coster is based on unique circumstances involving a 50/50 stockholder deadlock, the Delaware Supreme Court’s ruling is noteworthy in several regards. 

Blasius can invalidate board action even if it is “entirely fair”

Blasius creates a substantial burden for directors to justify their actions, which may go beyond “entire fairness.”  Entire fairness is often referred to as Delaware’s most stringent standard of review and, in Coster, the Court of Chancery found the stock issuance was “entirely fair.”  As a result, the Court of Chancery did not engage in a Blasius analysis, finding the directors’ motives were “beside the point.” 

The Delaware Supreme Court, however, said that further analysis was required under Blasius where “an interested board issues stock to interfere with corporate democracy and that stock issuance entrenches the existing board.”  It explained that “under Blasius, even if the court finds that the board acted in good faith… if [the board] approved the sale for the primary purpose of interfering with [the plaintiff’s] statutory or voting rights, the Stock Sale will survive judicial scrutiny only if the board can demonstrate a compelling justification for the sale.”⁴  Moreover, the Supreme Court indicated that, even though it was not disturbing the finding of entire fairness, the Court of Chancery, on remand, would likely find that the stock issuance was approved for “inequitable reasons.”  The Supreme Court said the lower court’s finding that “the Stock Sale was at an entirely fair price did not substitute for further equitable review when [the plaintiff] alleged that an interested board approved the Stock Sale to interfere with her voting rights and leverage as an equal stockholder.”⁵

Rumors of Blasius’s death have been exaggerated

The decision shows that the dormant Blasius test still has life.  The Delaware Supreme Court has not applied Blasius for quite some time, and commentators have questioned whether it is necessary.  In an influential article published 20 years ago, three former Delaware jurists discussed the difficulty courts have in determining the “primary purpose” of a board’s decision.⁶ They also argued that the concerns driving Blasius – i.e., protecting the stockholder franchise – can be addressed via other Delaware doctrines (e.g., Unocal) in a more streamlined manner.⁷

Subsequent Delaware decisions have thus limited the application of Blasius because the “compelling justification” requirement can give little deference to well-intentioned, independent directors once the court determines that they acted to interfere with stockholder voting rights.⁸ Blasius has generally been limited to director actions that directly interfere with director elections or corporate control, with Delaware courts resisting a broad interpretation of what constitutes “interference” with the stockholder franchise.⁹ Coster gave the Delaware Supreme Court the opportunity to streamline Delaware’s standards of judicial review, but the Supreme Court declined to do so on its own initiative.¹⁰

Breaking deadlock at closely-held corporations

Lastly, Coster has direct implications for closely-held corporations.  In contrast to the governance arrangements at many corporations with two “50/50” stockholders, the Coster plaintiff did not have a contractual right to approve share issuances and thus faced the risk of dilution.  In addition, as noted above, the lower court held that the share issuance was entirely fair.  The Delaware Supreme Court nevertheless remanded the case and intimated that the directors acted with inequitable purpose.  While every case is unique, practitioners will have to consider the extent to which corporations can break deadlocks with dilutive stock issuances under Delaware law.

 

¹ Coster v. UIP Companies, Inc., No. 49, 2020, mem. op. (June 28, 2021).

² Blasius Indus. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988).

³ Williams v. Geier, 671 A.2d 1368, 1376 (Del. 1996). 

⁴ Coster, mem. op. at 24 (emphasis added).

⁵ Id.

⁶ William T. Allen, Jack B. Jacobs & Leo E. Strine, Jr., Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. Law. 1287 (2001).

⁷ See Mercier v. Inter-Tel (Delaware), Inc., 929 A.2d 786, 809-10 (Del. Ch. 2007) (“One can read Liquid Audio as suggesting that the heightened scrutiny that Unocal’s fit test employs to assess defensive actions by directors, was to be ratcheted up to a form of strict scrutiny when the directors’ actions affected the corporate franchise. Although it does not use those precise words, Liquid Audio can be viewed as requiring the directors to show that their actions were reasonably necessary to advance a compelling corporate interest.”).

⁸ See Mercier, 929 A.2d at 805-10; In re MONY Grp., Inc. S’holder Litig., 853 A.2d 661, 674-76 (Del. Ch. 2004), as revised (Apr. 14, 2004).  

⁹ See, e.g., Yucaipa Am. All. Fund II, L.P. v. Riggio, 1 A.3d 310, 331 (Del. Ch. 2010), aff’d, 15 A.3d 218 (Del. 2011) (holding that the adoption of a “poison pill” in response to a threatened proxy contest did not trigger Blasius); Apple Computer, Inc. v. Exponential Tech., Inc., 1999 WL 39547, at *5 (Del. Ch. Jan. 21, 1999) (holding that the failure to submit a sale of substantially all assets to a statutorily required stockholder vote did not trigger Blasius); see also Mercier, 929 A.2d at 809 (“Post-Blasius cases . . . display understandable discomfort about using such a stringent standard of review in circumstances when a stockholder vote has no bearing on issues of corporate control.”).

¹⁰ Coster, mem. op. at 24 n.66 (“Although Coster relied on this Court’s decision in Liquid Audio, she did not argue that a Unocal analysis should follow after review under Blasius.  Thus, we will not consider the impact of Unocal review on this case….  Further, the parties have not asked us to revisit how Schnell/Blasius and Unocal should fit together in future cases.”).