Stephen Fraidin & Jon D. Hanson, Toward Unlocking Lockups, 103 Yale L.J. (1994).
Abstract: According to conventional wisdom, target boards face a powerful and unavoidable conflict of interest when deciding how to respond to a hostile bid. Because takeovers threaten the jobs of target directors and officers, target boards are thought to have an incentive either to defeat all bidders or to conspire with a particular bidder. If the target board pursues either of those strategies, target shareholders stand to lose all or some portion of a substantial takeover premium for their shares. As Professor Gilson explains, "it is impossible to identify ... any path management might take which would eliminate the inherent conflict of interest, and action, whether criticism or approval, reflects the potential for diversion of benefit to management and away from shareholders." Delaware courts have responded asymmetrically to this inherent conflict of interest. On one hand, they have shown near limitless deference to target boards (and thus little concern for the conflict of interest), provided the boards reject all bidders. As corporate commentators sometimes quip, target boards are permitted to "just say no.' On the other hand, once a board decides to sell its firm, courts often intervene to prevent the board from giving any one bidder undue advantage over other actual or potential bidders. The goal is to simply to sell to the highest valuing bidder on the best possible terms." For those reasons, Delaware courts do not permit a corporate board that has decided to sell the corporation to favor one potential buyer over another. Put differently, corporate boards cannot "just say yes." Pertinent Delaware takeover laws can thus be summarized with two simple rules: (1) a target board can just say no to any bidder so long as it says no to all potential bidders; (2) if, however, the target board does not reject all bidders, it cannot say yes to just one bidder. Efficiency-minded corporate law scholars have responded more symmetrically to the inherent conflict of interest. Most agree that target boards should be prohibited from seriously obstructing any tender offer, either by rejecting all potential bidders-through, say, a poison pill--or by rejecting all but one potential bidder through a lockup. According to this widely held view, target managements will, if permitted, use those defensive tactics to protect their jobs, and thus will obstruct the transfer of corporate assets to their highest valued use (that is, obstruct the goal of allocative efficiency). Consistent with that viewpoint, most corporate law scholars call for the abolition of virtually all takeover defenses (lockups included), criticizing Delaware's first rule regarding takeovers, but endorsing its second. It seems fair to say, therefore, that most corporate law scholars and courts agree that some lockups should be invalidated as contrary to the interests of target shareholders and/or the goal of allocational efficiency. In contrast, this Article defends the extreme position that all lockups should be enforced, subject only to the business judgment rule. The body of this Article is broken into two broad sections. Part II accepts as true the heretofore uncontested premise that some lockups should be invalidated, and argues that no sound practical method exists for distinguishing undesirable from desirable lockups. Part Ill rejects that premise and makes a case for enforcing virtually all lockups. More specifically, Part II describes and criticizes both the approach that courts have generally taken and an alternative approach that scholars have advanced for evaluating the net effect of lockups. Part II.B explains that Delaware courts purport to examine lockups from the perspective of target shareholders, asking whether the shareholders were better off immediately before or immediately after the lockup was granted. We argue that the openended "proportionality standard" that courts apply to make that assessment is without content and that courts have-perhaps because of the insuperable obstacles confronting them-adopted a clear-cut de facto rule which is equivalent in its effect to a rule that would invalidate all lockups.Part ll.C examines two recent proposals for replacing judicial substantive analysis with a kind of market-based test of lockups. Instead of weighing the benefits and costs of a lockup from the shareholders' perspective, courts should, according to these proposals, take an "ex post" or "bidder" perspective and enforce only those lockups that do not unduly deter or "foreclose" potential bidders from competing. The courts' only task would be to distinguish foreclosing from nonforeclosing lockups. Stephen Bainbridge proposes a "bright-line" version of this approach, recommending that courts enjoin any lockup that guarantees the recipient more than ten percent of the value of its bid. Ian Ayres endorses a more sophisticated version of the ex post approach, explaining that even some sizeable lockups can be nonforeclosing if they do not change the relative valuations of bidders. Both proposals are subject to numerous related criticisms, not least of which is that neither can deliver on its promise to provide courts a new means of identifying undesirable lockups. In short, Part II argues that courts are simply not capable of identifying and validating only those lockups that should be validated. In Part III, we critically examine the animating assumption of courts and scholars-that lockups can have undesirable consequences-and make a case for enforcing all lockups. Part III.A argues that lockups are unlikely to foreclose the highest valuing bidder from acquiring the target corporation because target boards are neither eager nor able to foreclose higher valuing bidders. Our analysis replicates the basic lesson of the Coase theorem, pointing out that if transactions costs are not prohibitively high, corporate assets will wind up in their highest valued use, lockups notwithstanding. Part III.A.2 then argues that this is one context in which the Coase theorem's zero-transaction-cost assumption is not intolerably heroic. While Part llI.A suggests that lockups pose little or no threat to the goal of allocative efficiency, Part llI.B argues that lockups do not imperil the judicial aim of maximizing target shareholder returns. Thus, Parts llI.A and llI.B are intended to rebut the conventional view that lockups pose a powerful threat to the (potentially conflicting) goals of efficiency and revenue maximization. Part HlI.C then shifts the emphasis of analysis and makes an affirmative case for lockups. Although the conventional justifications for lockups are more or less underdeveloped and unpersuasive, there are a variety of ways in which lockups can increase target shareholder revenues, either by enlarging the overall size of the gains to trade between the target and the lockup recipient or by increasing the target's share of those gains. The Article concludes by arguing that because lockups, like chicken soup,'5 can't hurt but may well help, courts should move toward unlocking lockups.