The Revlon Rule, Simplified
The Revlon Rule is a complex legal doctrine which emerged from Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). The Revlon Rule, also known as the Revlon Doctrine or Revlon Duties, applies a fiduciary duty of care to corporate boards of directors when facing hostile takeovers and mergers.
Revlon Rule in Brief
In the event a corporate takeover or break up is imminent, the board of directors owes a fiduciary duty of care to the shareholders to sell for the highest price possible. In exceedingly simple terms, this is the Revlon Doctrine.
When Revlon Duties apply, the standard for judicial review of board action becomes “enhanced scrutiny” of the fiduciary duty of care owed to shareholders. This rule ensures the board of directors maximizes shareholder value in the event of M&A.
Revlon Duties effectively preserve the rights of the shareholders through circumstances in which the directors may have both means and motive to participate in self-dealing. Prior to Revlon, directors were scrutinized based upon the business judgment rule which offered a low bar by which the actions of a board would be upheld.
Business Judgment Rule
The business judgment rule is the judicial standard of review by which courts determine whether or not a director breached the duty of care to shareholders. The business judgment rule establishes a presumption that the director acted in good faith, was reasonable, and acted in the best interest of the corporation—placing the burden of proof on the plaintiff bringing suit.
From a policy standpoint, the business judgment rule relies upon the principle that the board of directors and the interests of the shareholders are aligned. The business judgment rule assumes board members benefit most from the long-term success of the corporation and shareholders are best served by long-term, corporate success. In such cases, it would be unreasonable for the judiciary to interfere with the methods by which these goals are realized.
Business As Usual
Under business as usual circumstances, the directors are expected to act in good faith and for the benefit of the corporation. Unless the shareholders (or controlling shareholder), demonstrate that the board acted in bad faith, was grossly negligent, or a conflict exists, the presumption of good faith will be attributed to the directors.
This presumption allows the board of directors to make decisions based upon expertise and experience—without fear of retribution from shareholders who may prefer a different approach. While making a quick turnaround on profits may be in a shareholder’s immediate interest, it is the duty of the board to maintain the best interest for corporate sustainability.
In the event a hostile takeover or corporate merger becomes imminent, a schism often occurs between the board of directors and the shareholders. The shareholders have an interest in accepting the highest bid. Conversely, the directors may be motivated to seek alternative offers that provide benefits for the directors at the expense of the shareholders.
To that end, directors may employ tactics such as a “poison pill”, “white knight”, or “golden parachute” to secure their interests. While these methods are not a breach of duty necessarily, Revlonmakes it clear that use of such tactics to undermine an auction subjects the directors to “enhanced scrutiny” and the business judgment presumption will not apply.
The Revlon Rule requires judicial review to use “enhanced scrutiny” when evaluating board action. This method of review shifts the burden from the plaintiff—as with the business judgment rule—to the board.
Enhanced scrutiny requires an independent director to establish two things regarding the action(s) of the board: 1) that the process through which a decision was reached was executed with proper care and 2) that the action(s) itself was reasonable with then-existing circumstances.
When Revlon Duties Attach (and when they don’t)
Succinctly, Revlon Duties attach at the point a sale or break up of a corporation is imminent. In Revlon, the court held that defensive tactics meant to ward off a hostile takeover did not (initially) constitute a breach of the duty of care by the directors—nor was it necessary to abandon the business judgment rule as the standard for review. But after it became clear that a takeover was inevitable, the board’s sole duty became to garner the best sale price for its shareholders.
While these duties apply in the case of sale or takeover, the case law is clear that the Revlon Rule does not attach to: rejections of unsolicited offers for tactical reasons, evaluations of acceptance for acquisition proposals, or transactions which do not result in transfer of ownership or control.
The Revlon Rule is a complex legal issue and sorting through the subsequent cases often involves flowcharts. (Most notably, the Revlon Duties Flowchart and the Unocal Revlon Flowchart.) Despite the nuanced nature of its application, Revlon Rule can be summarized as a shift in fiduciary duties of the board of directors from that of long-term corporate interest to short-term shareholder interest.
In the event Revlon Duties attach, a board must secure the highest value for shareholders in order to meet the fiduciary duty of care. If a board fails to sell for the best offer, shareholders or the controlling shareholder may bring a suit against the board. At which point, the business judgment rule will be set aside and replaced with the “enhanced scrutiny” standard for judicial review.
Or in the most simplistic terms, the duty of care owed to the shareholders by the board of directors is precisely that, a duty of care to shareholders. The board is to act in accordance with the best interest of its shareholders (not itself), regardless of whether the interest considered is long term or short term.
The board may use a plethora of tactics to combat against a hostile takeover or merger, but at the point dissolution or change in ownership becomes imminent the interests of the board and the shareholders diverge.
Hostile takeovers were not invented in Revlon but they found certain limits which are carried forward–frequently referred to as the Revlon Duties. These duties shift the role of board during a takeover to that of short-sighted vs long term goals. At the point a company is going to be sold or dissolves, the board’s sole responsibility becomes to sell for as much as is possible, ensuring the highest return for stockholders.