# FIRST UNION CORP. v. SUNTRUST BANKS, INC., 2001 NCBC 09 (Amended 08/10/01)

> North Carolina Business Court · August 10, 2001

URL: https://www.frixlaw.com/law-library/cases/11057402

## Case

- **Court:** North Carolina Business Court
- **Decided:** August 10, 2001
- **Precedential status:** Published
- **Opinion:** Opinion
- **Cited by:** 0 later opinions in the Frix Law Library

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## Opinion text

STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
MECKLENBURG COUNTY

FIRST UNION CORPORATION, )
WACHOVIA CORPORATION, )
and FIRST UNION NATIONAL BANK, )
)
Plaintiffs )
)
v. )
)
SUNTRUST BANKS, INC., )
)
Defendant. )
)
v. )
)
FIRST UNION CORPORATION, ET AL., )
)
Counterclaim Defendants, )
) 01-CVS-10075
LESLIE M. BAKER, JAMES S. BALLOUN, )
PETER C. BROWNING, JOHN T. CASTEEN, III, )
THOMAS K. HEARN, JR., GEORGE W. )
HENDERSON, III, W. HAYNE HIPP, LLOYD )
U. NOLAND, III, JOHN C. WHITAKER, JR., )
and DONA DAVIS YOUNG, )
)
Additional Counterclaim Defendants. )

STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
FORSYTH COUNTY

IN RE WACHOVIA SHAREHOLDERS ) Consolidated
LITIGATION ) Civil Action No. 01-CVS-4486
)
STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
COUNTY OF GUILFORD

HARBOR FINANCE PARTNERS, )
derivatively on behalf of Wachovia Corporation, )
)
Plaintiff, )
)
v. )
)
JAMES S. BALLOUN, PETER C. ) 01-CVS-8036
BROWNING, W. HAYNE HIPP, )
LLOYD U. NOLAND, III, DONA DAVIS )
YOUNG, LESLIE M. BAKER, )
JR., THOMAS K. HEARN, JR., )
ELIZABETH VALK LONG, )
MORRIS W. OFFIT, JOHN C. WHITAKER, )
JR., F. DUANE ACKERMAN, JOHN T. )
CASTEEN, III, )
GEORGE W. HENDERSON, III, ROBERT A. )
INGRAM, GEORGE R. )
LEWIS and FIRST UNION CORPORATION, )
)
Defendants, )
)
and WACHOVIA CORPORATION, )
)
Nominal Defendant. )

This Order and Opinion was amended on August 10, 2001 in response to a motion made by
Morris W. Offit asking this Court to strike comments in the opinion attributed to him that are not
reflected in the evidence before the Court. Additionally, grammatical corrections and factual
clarifications were made to this Order.

AMENDED ORDER AND OPINION

I.
{1} THIS MATTER comes to the Court as a result of the proposed merger between First Union

Corporation (“First Union”) and Wachovia Corporation (“Wachovia”), and SunTrust Banks,

Inc.’s (“SunTrust”) resulting unsolicited bid for Wachovia. SunTrust and the shareholder

plaintiffs in the consolidated cases (hereinafter collectively referred to as “SunTrust”) request that
this Court invalidate a non-termination provision in the merger agreement and enjoin

consummation of the merger pending determination of the validity of provisions in an Option

Agreement entered into in connection with the merger. All parties request declaratory judgment

with respect to validity of the Option Agreement. For the reasons set forth below, the Court finds

the non-termination provision invalid and unenforceable and declines to enter the injunctive relief

requested.
Robinson, Bradshaw & Hinson, P.A., by Russell M. Robinson, II, Martin L. Brackett, Jr.,
Robert W. Fuller, Louis A. Bledsoe, III, and Lawrence C. Moore; Sullivan & Cromwell
by John L. Hardiman, Stephanie G. Wheeler and Kevin Puvalowski; First Union
Corporation, by Francis Charles Clark; for plaintiffs and counterclaim defendants First
Union Corporation and First Union National Bank.

Bell, Davis & Pitt, P.A., by William K. Davis, Kevin G. Williams and Troy D. Cahill;
Brooks, Pierce, McLendon, Humphrey & Leonard, L.L.P., by James T. Williams, Jr. and
Mack Sperling; Simpson Thacher & Bartlett, by George M. Newcombe, Michael J.
Chepiga, Bruce D. Angiolillo, David E. Massengill, Edward D. Hassi, and
Catherine Morris; for plaintiff, counterclaim defendant and nominal defendant Wachovia
Corporation .

Ellis & Winters, L.L.P., by Richard W. Ellis, Paul K. Sun, Jr., and Thomas D. Blue, Jr.;
Skadden, Arps, Slate, Meagher & Flom, LLP, by Jay B. Kasner and Timothy A. Nelson;
for defendant and counterclaim plaintiff Suntrust Banks, Inc.

Wilson & Iseman, L.L.P., by Gray Wilson and Linda L. Helms; Abbey Gardy, LLP, by
Arthur N. Abbey, Stephen T. Rodd, James N. Notis and Curt P. Beck; for Wachovia
shareholder plaintiffs.

Kilpatrick Stockton, L.L.P., by J. Robert Elster and Richard S. Gottlieb, for defendant
Morris W. Offit.

Donaldson & Black, P.A., by Arthur J. Donaldson; The Brualdi Law Firm, by Richard B.
Brualdi; for plaintiff Harbor Finance Partners.

{2} This case requires the Court to determine the judicial tools North Carolina courts will apply in

maintaining the appropriate balance between shareholder power and board authority in corporate

mergers. The issues are both current and difficult. The appellate courts in North Carolina have

not had the opportunity to address the issues directly. The approach to these issues adopted by

the Delaware courts since 1985 is now under rigorous reexamination1 and the Delaware Supreme

Court may have signaled a shift away from reliance on fiduciary duty standards in Quickturn
Design Sys., Inc. v. Shapiro, 721 A.2d 1281 (Del. 1998) and other recent decisions.2 The

required determination is further complicated by the North Carolina Legislature’s 1993

amendment to N.C.G.S. § 55-8-30.3 For those reasons and because the Supreme Court will have

a short period of time in which to review this order and determine these complex and significant

issues, the Court will (a) place the issues in the context of our corporate structure, (b) highlight

the critical function of standards of conduct and processes of review, (c) briefly survey the key

Delaware decisions dealing with the issues and look at the current reexamination underway there

and (e) offer a North Carolina-centered alternative. The Court will then apply that review

process to the facts in this case and determine if injunctive relief is warranted.

{3} In the context of this case the issues are presented as follows:

(1) What review process will be used by North Carolina courts to determine the validity

of deal protection measures in stock-for-stock mergers?

(2) Did the directors of Wachovia breach their fiduciary duty when they approved the

merger agreement with First Union which contained:

(a) a non-termination provision which will keep the merger agreement in place

until January 2002, even if it is rejected by the Wachovia shareholders at the

scheduled August 3, 2001 shareholder meeting, and

(b) an option agreement which has effectively resulted in a $780 million breakup

fee?

II.

A.
{4} At the outset, it is important to put the issues in this case in their larger context. Corporations

exist to create value. In purely economic terms, if they do not do that, they cease to exist.4
Corporations can create different kinds of value. Value can come in the form of an increase in the

price per share of the owner’s stock. It may be derived from the creation of jobs in or the
contributions a company makes to a community. It may result from cheaper and better products

and services. Value may be derived from the individual employee or entrepreneur’s fulfillment of

some personal goal through association with the corporation. The enhancement of one value may

adversely affect another value. The value we expect corporations to create thus determines in

some measure what we think corporations are and how we want them to be governed. William T.

Allen, former Chancellor of the Delaware Chancery Court, identified and described this conflict

in Our Schizophrenic Conception of the Business Corporation, 14 Cardozo L. Rev. 261, 2643-65

(1992).5 He said:
Two inconsistent conceptions have dominated our thinking about
corporations since the evolution of the large integrated business
corporation in the late nineteenth century. Each conception could claim
dominance for a particular period, or among one group or another, but
neither has so commanded agreement as to exclude the other from the
discourses of law or the thinking of business people.
In the first conception, the corporation is seen as the private property of its
stockholder-owners. The corporation’s purpose is to advance the purposes
of these owners (predominantly to increase their wealth) and the function
of directors, as agents of the owners, is faithfully to advance the financial
interests of the owners. I call this the property conception of the
corporation, because it sees the corporation as the property of its
stockholders. This model might almost as easily be called a contract
model, because in its most radical form, the corporation tends to
disappear, transformed from a substantial institution into just a relatively
stable corner of the market in which autonomous property owners freely
contract.
The second conception sees the corporation not as the private property of
stockholders, but as a social institution. According to this view, the
corporation is not strictly private; it is tinged with a public purpose. The
corporation comes into being and continues as a legal entity only with
governmental concurrence. The legal institutions of government grant a
corporation its judicial personality, its characteristic limited liability, and
its perpetual life. This conception sees this public facilitation as justified
by the state’s interest in promoting the general welfare. Thus, corporate
purpose can be seen as including the advancement of the general welfare.
The board of directors’ duties extend beyond insuring investors a fair
return, to include a duty of loyalty, in some sense, to all those interested in
or affected by the corporation. This view could be labeled in a variety of
ways: the managerialist conception, the institutionalist conception, or the
social entity conception. All would be descriptive, since the corporation is
seen as distinct from each of the individuals that happens to fill the social
roles that its internal rules and culture define. The corporation itself is, in
this view, capable of bearing legal and moral obligations. To law and
economics scholars, who have been so influential in academic corporate
law, this model is barely coherent and dangerously wrong.

{5} New value, however we define it, is created by change. Risk is the shadow of change, ever

present wherever change occurs. The presence of risk creates tensions within the structure where

that change is occurring. How those risks and the tensions they create are managed in the

corporate system is the work of corporate governance. Corporate law should help promote or

enhance the creation of corporate value.

{6} Essentially three competing systems for creating corporate value have emerged in today’s

world economy. Each approaches four key tasks differently. The first task is to decide what

values corporations should create and how those values are ranked.6 The second task is to

determine how available financial capital will be combined and used. The third task is to

determine how human capital will be combined and used.7 Finally, the proper combination or

relationship of financial capital and human capital must be found. All four must be harmonized

for the corporate system to function smoothly.

{7} How those tasks are accomplished and how the resulting governance systems are structured

depend on certain basic characteristics or fundamental beliefs of the societies in which they

operate. There are at least six basic American characteristics that find reflection in our corporate

system. First, we are leery of concentrations of power. We like power, ownership and wealth
dispersed or distributed.8 Second, we are firmly committed to individual liberty and the worth of
the individual. Third, we are a nation of risk takers; we encourage and reward them. Fourth, we

love competition and believe that the real value of anything, be it a product, idea or action, is best

determined in the marketplace. Fifth, we value fairness and try to keep the playing field for that

competition level. Sixth, we prefer a system of checks and balances to protect the other five

values.

{8} The three competing global systems are exemplified by: (1) the Japanese system based upon

its kieretsu, (2) the European system based upon its strong ownership and direction by financial

institutions and state-controlled companies and (3) the American system based upon accumulation
of capital from a diverse ownership base, including individual investors. This dispersed

ownership base has little direct control over those who manage their property.9 The managers are

encouraged to be risk takers. To date, the American system has arguably outperformed the other

two.10

{9} Each of these three systems must constantly adapt to change. That change is usually generated

from one of three sources11 — technology, politics, or capital market structure. The clearest

example of the variable pressure created by capital market structures is the rise and fall of junk

bond financing in the 1980’s and the resulting problems created for corporate governance, which

will be more fully discussed below. The mid to latter part of the 1990’s saw a technological

revolution and the creation of a new currency in the form of extraordinary share prices creating

different problems and pressures on the governance system. It is not surprising that the number

of hostile takeover attempts, which diminished after the collapse of the junk bond market,

returned to 1980’s levels in the late 1990’s. An example of political change relevant to this case

would be the amendments to the Glass-Stegall Act, which opened the door to significant changes

in the ownership of financial institutions. Technology is also having a dramatic impact on the

operation of banks today. The landscape of the banking industry is thus being buffeted by all

three winds of change at the same time.

{10} Each system of corporate governance has its own method of absorbing the pressures created

by these changes. Those methods are dictated by the structure of the corporate system.

B.
{11} The structure of the American system dictates that two competing requirements be

harmonized when change occurs: fundamental shareholder rights and director independence.12
Each is discussed below. Harmonization is sometimes difficult because of the wide gulf between

our diverse base of ownership and the directors from whom we demand high levels of risk-taking.

Our corporate law provides the means to accomplish that harmonization or balance.

1.
{12} Within the corporate structure, shareholder/owners require certain basic rights without which

they will not contribute their capital to the enterprise. The shareholder must have the rights to

vote, sell and sue.13 The most famous defense of shareholder rights is found in Blasius Indus. v.

Atlas Corp., 564 A.2d 651 (Del. Ch. 1988), in which Chancellor Allen stated: “The shareholder

franchise is the ideological underpinning upon which the legitimacy of directorial power rests. . . .

It has, for a long time, been conventional to dismiss the shareholder vote as a vestige or ritual of

little practical importance. . . . [W]hether the vote is seen functionally as an unimportant

formalism, or as an important tool of discipline, it is clear that it is critical to the theory that

legitimates the exercise of power by some (directors and officers) over vast aggregations of

property that they do not own.”14 Vice Chancellor Strine has noted that the Delaware courts have

traditionally been willing to more closely scrutinize board decisions dealing with ownership

issues, citing Loudon v. Archer-Daniels-Midland Co., 700 A.2d 135 (Del. 1997).15 “U.S.

corporation law affords to stockholders three principal sources of protection of their interests: the

stockholder’s right to vote his or her stock, to sell stock, and the fiduciary duty of corporate

officers and directors, all of which are principally enforced judicially through shareholder-

initiated lawsuits.”16

{13} In corporate governance, as in our system of government, the courts are uniquely positioned

to preserve the rights to vote, sell and sue for those our system determines should possess those

rights.17

2.
{14} Coexisting with shareholder requirements are certain requirements directors have if they are to

function in the manner which fosters or promotes the best interests of the corporation and all of its

constituents.18 Directors must have the freedom to take risks and the power to manage the
business without undue interference from shareholders or the courts. That freedom is achieved

by protection from liability for good faith errors in judgment and deference from the courts in

business decisions. In today’s environment where outside directors must serve on audit,

compensation and other committees requiring substantial time commitments and legal exposure,
potential directors must carefully weigh the decision to serve.19 If corporate value is to be

enhanced, the courts must not discourage qualified and capable people from serving as directors

and taking risks.

{15} The variable sources of change described above often create conflict between shareholder

requirements and director requirements. The tensions created by the conflicts between director

and shareholder requirements are elastic.

{16} Thus, the context in which balance of power issues must be determined looks something like

the drawing below.20

Shareholder Rights Director Requirements

{17} If the requirements of both shareholders and directors are not being met, i.e., the right tension

maintained, our corporate governance system has failed. The success of the American legal

system is due in some measure to the ability of the American court system to flexibly balance the

rights of generally passive shareholders with the power allocated to directors to manage the

business affairs of the corporation through all the changes that occur.

{18} Not coincidentally, the tension between shareholders and the interests of society described by

Chancellor Allen in paragraph 4 above closely follows this same model.

{19} Often, the two become confused or intertwined. The clearest examples of that entwinement

can be found in both the reaction of several states to the hostile takeover frenzy in the 1980’s and

the Delaware Supreme Court’s decision in Revlon v. McAndrews & Forbes requiring directors in

change of control situations to obtain the highest value reasonably available for shareholders.21
For the shareholders, that holding could be interpreted as defining “corporate value” solely in

terms of enhanced share value. Those who viewed the corporation as a social institution took

action. Illinois, for example, adopted a statute that specifically authorized directors to consider the

interests of corporate constituents other than shareholders when responding to a hostile

takeover.22 In doing so, Illinois statutorily adjusted the balance of power between shareholders
and other corporate constituents by giving additional power to directors that Revlon had arguably

taken away. It did so not to advance the power of directors, but to permit directors to assert the

interests of other corporate constituents in the heat of the takeover battle. It did not eliminate

shareholder rights; it arguably put a little more tension in the elasticity on the side of the directors

so that they could consider “corporate value” as including values important to society. A fuller

discussion of the action of the North Carolina Legislature in reaction to the developments in

Delaware appears below.23

{20} The American economic system has benefited greatly from the American corporate

governance system’s ability to maintain the balance and tensions between shareholders and

directors, and shareholders and the other corporate constituents. Maintaining that balance has

required flexibility because of the variable pressures that change with the economy, the creativity

of entrepreneurs, innovations in technology, and capital markets and the predilections of

politicians. The primary responsibility for designing and maintaining the American corporate

governance system has been left to the states.24 Most states, including North Carolina, have

adopted very broad enabling statutes that provide corporations with the flexibility they need to

operate. Those flexible statutes cannot provide guidelines ex ante for all the problems that can

arise in the business context.25 Accordingly, the primary tools to maintain the balance of power

described above have been ex post decisions of courts applying either fiduciary duty concepts or

statutory interpretations.26 It has been the singular and outstanding contribution of the Delaware
courts to thoughtfully craft the decisions and tools by which the state courts provide the necessary

guidance and flexibility to keep the corporate governance system operating smoothly and in a

way that promotes corporate value.

{21} It is necessary to understand the structure that underlies the complexities of corporate

governance because the issues in this case revolve around the tools or levers that are available to

maintain the correct balance between two principal requirements of the structure: shareholder

rights and director power. It is equally important to understand that there must be flexibility in

the corporate governance system to maintain that balance when changes pressure the corporate
structure. In this case, the tools that help maintain that balance are standards of conduct and

standards of review. Together with the allocation of the burden of proof, they guide the review

process by which the ex post court decisions are formulated. An understanding of each is

important to the decision in this case.

C.
{22} Professor Eisenberg has succinctly described the difference between standards of conduct and

standards of review and their divergence in corporate governance:
A standard of conduct states how an actor should conduct a given activity
or play a given role. A standard of review states the test a court should
apply when it reviews an actor’s conduct to determine whether to impose
liability or grant injunctive relief.
In many or most areas of the law, these two kinds of standards tend to be
conflated.
The conflation of standards of conduct and standards of review is so
common that it is easy to overlook the fact that whether the two kinds of
standards are or should be identical in any given area is a matter of
prudential judgment. Perhaps standards of conduct and standards of
review in corporate law would always be identical in a world in which
information was perfect, the risk of liability for assuming a given
corporate role was always commensurate with the incentives for assuming
the role, and institutional considerations never required deference to a
corporate organ. In the real world, however, these conditions seldom
hold, and the standards of review in corporate law pervasively diverge
from the standards of conduct. A byproduct of this divergence has been
the development of a great number of standards of review in this area. In
the past, the major standards of review have included good faith, business
judgment, prudence, negligence, gross negligence, waste, and
fairness. An important new development has been the emergence of
intermediate standards of review.27

{23} There are two main reasons why standards of review and standards of conduct have diverged

in corporate law: fairness and efficiency.28 Both are related to needs of the corporate structure.

The corporate structure requires competent directors willing to serve. In order to attract competent

directors it is only fair that we judge their conduct according to the circumstances in which they

must make decisions. Those circumstances include the fact that they often have to act without

full information. They do not have control over the business environment that can affect the
decisions they make. The business environment is constantly changing and courts, not as

knowledgeable as businesswomen when it comes to operational business decisions, thus should

defer to their business judgment. While we want to set high aspirational goals (standards of

conduct) for directors, it is fundamentally fair to review their conduct on a less demanding level

because of the circumstances in which they are called upon to act.

{24} The efficiency argument relates to creation of corporate value or wealth. In order for the

corporation to increase in value and thereby increase the wealth of its owners, it must take risks. If

we discourage the directors who must make those risk decisions from being bold and creative by

imposing a standard of review that is too onerous and creates too great a possibility of

unacceptable liability, we defeat one of the very purposes for which corporations exist. Just as we

limit the liability of those who contribute their financial capital to the enterprise, we must limit the

liability of those who contribute their human capital (knowledge and judgment) in order to

promote creation of value or wealth.29 Accordingly, where fairness and structural requirements

dictate, standards of review have diverged from standards of conduct in corporate law.

Significantly, when that divergence is permitted, the law recognizes that some legal duties may go

unenforced.

{25} Former Chancellor Allen has described the business judgment rule this way: “Closer to a

description of the ‘rule’ that courts enforce, in the absence of a director conflict of interest, would

be as follows: in the absence of a conflicting financial interest, a director will be liable for

corporate losses caused by board action he authorizes, only if he has authorized such action

without at that time having a good faith belief that, in the circumstances present, he has satisfied

his obligation to be reasonably informed.”30
{26} Where fairness and structural requirements have not supported the need for standards of

review to diverge from standards of conduct in corporate law, the two have tended to conflate.

For example, where courts have applied a duty of loyalty as opposed to a duty of care, the

standard of review has been more closely aligned with the duty standard. Directors in self-

interested transactions are required to establish that the transaction was entirely fair to the
corporation. The reasons are clear. In cases in which a director engages in a transaction with the

corporation in which she has a personal interest, it is fair to apply a stricter standard of review.

The director has more complete information since she is a party to the transaction and she has

some control over it. It is fair to ask the director to simply prove that the manner in which the

transaction in question is conducted is no different from the manner in which the same transaction

would be conducted between the corporation and a third party on the open market. The question is

not whether the decision was good or bad, only if it was the same as an open market transaction.

That does not require the same kind of judicial expertise and does not call for the institutional

deference that duty of care questions require. There is no structural incentive to reduce the

director’s potential liability, and there exists an incentive to require directors to be particularly

careful when they engage in self-interested transactions with the corporation. In a self-interested

transaction, the director is acting both on her own behalf and as the economic agent of the

owner/shareholder.

{27} In summary then, standards of review in corporate law diverge from standards of conduct

when fairness and structural requirements dictate that such a divergence will promote corporate

value or wealth creation. Where fairness and structural requirements do not support a divergence

between the standard of review and the standard of conduct and thus do not promote corporate

value, the two standards are more closely aligned or conflated. When conflation is present, legal

duties are less likely to go unenforced.

{28} Prior to the 1980’s, when courts decided whether to apply a duty of loyalty to a particular

fiduciary action, they were actually selecting a situation-specific process for reviewing that

fiduciary action. If the duty of loyalty was applied, the review process included placing the

burden on the fiduciary to justify the action on a market-specific basis. The fiduciary had to

prove her action did not diminish corporate value. Application of the loyalty standard of conduct

with its entire fairness standard of review protected corporate value by prohibiting fiduciaries

from taking unfair advantage of their position to transact business with the corporation at less than

fair market value.
{29} If the duty of loyalty standard of conduct was not applied or a duty of care standard of

conduct was applied,31 the review process placed the burden of proof on the party challenging the

fiduciary action. The fiduciary received the benefit of the business judgment rule with its

divergent and less demanding standard of review. The less demanding standard of review process

was selected because under the circumstances it best promoted corporate value by preventing

judicial review under circumstances where that judicial review would deter director risk-taking. It

reduced director risk of liability. A combination of the standard of review and placement of

burden of proof can have a significant impact on final determination of an issue.

{30} Standards of review serve other functions. They can serve as guideposts to alert businessmen

to conduct that would trigger judicial intervention. They also serve as self-imposed restraints,

limiting judicial intervention in the corporate process to those situations in which intervention can

promote corporate value.

{31} As will be more fully discussed herein, the corporate landscape was dramatically altered in the

1980’s, resulting in the search for new judicial review processes that would best promote

corporate value under the circumstances then existing. The Delaware courts and the legislatures

of other states did not always agree on their definition of “corporate value” or their concept of the

corporation. That disagreement can lead to a difference in approach to the review process.

D.
{32} The Court next turns to the application of these tools by the Delaware courts in hostile

takeover cases, not because Delaware law applies in this case, but because much can be learned

from the Delaware experience and the reevaluation being conducted there. It is also true that the

North Carolina courts have frequently looked to Delaware for guidance because of the special

expertise and body of case law developed in the Delaware Chancery Court and the Delaware

Supreme Court.

{33} Prior to the 1980’s, the corporate landscape was fairly tame, and ownership disputes generally

resulted from internal disagreements. For example, in Schnell v. Chris-Craft Industries, Inc., 285

A.2d 437 (Del. 1971), the court acted to enjoin the conduct of corporate management that
attempted to perpetuate themselves in office and obstruct shareholder rights to engage in a proxy

contest.

{34} The advent of the hostile takeover era and its pressures on the structure of corporate

governance required a new approach to the judicial review process because the situation in which

owners and directors were placed had been dramatically altered.32 Often the identity of owners

would change rapidly. If not the identity, certainly the interests of older owners shifted when the

prospect arose of getting more for their property than it was worth. Directors’ duties could shift

overnight from (a) enhancing shareholder value to either (b) protecting shareholder value or (c)

obtaining payment of maximum value for the shareholders. Even more difficult, directors could

face all three challenges at once.

{35} In the 1980’s the creation of junk bonds and the deregulation of the savings and loan industry

combined to change the capital market. The new currency of junk bonds financed corporate

raiders and white knights and fueled the use of arbitrage in takeover situations. The growth of

institutional investors served to consolidate the ownership base. The circumstances in which

directors were required to exercise their fiduciary duties changed dramatically and almost

overnight. The prospect of fast short-term profits caused shareholders to become increasingly

attentive to their rights to vote and sell their shares. Owners changed from passive investors to

aggressive short-term profit maximizers. Owners are always more willing to sell when purchasers

are willing to pay more for their property than owners think it is worth. While the inherent value

of companies had not changed, the prices purchasers were willing to pay for them had. In short,

the market for companies changed dramatically and caused shareholders to become less passive.

{36} Managers were threatened and had every incentive to adopt measures that would entrench

them in their positions. The long-term view of shareholder value and long-term management

policies seemed to lose importance. Well-conceived corporate strategy was threatened by the debt

load and sale of assets required to sustain junk bond financing. Whole communities were

threatened with plant closures and corporate relocations. Directors who were nominated by

management and were often prominent members of the communities where their corporations
were located were torn in many different directions. They faced the prospect of the loss of their

positions as well as the possibility of irreparable damage to the companies they helped govern and

the loyal employees to whom they felt an allegiance. They also faced suits from shareholders.

{37} Thus, this rapid and significant change in circumstances caused pressure to intensify from

both shareholders and directors.33 It fell to the Delaware courts to maintain the proper balance in

corporate governance in the midst of this turmoil. It was not an easy job given the short time

constraints in which many decisions were made.

E.
{38} The Delaware decisions reviewing director decisions in the new world of hostile takeovers are

best analyzed from several perspectives. First, the task that the court was performing is important.

Whether it was ruling on injunctive relief or determining liability damages is significant. These

cases should also be viewed in time in relation to amendments to the Delaware statutes further

limiting the monetary liability of directors charged with breach of the duty of care.34 Second, the

task that the directors were performing is important. These tasks can be separated into four

general categories: (A) self-interested transactions, (B) non-ownership or enterprise transactions35

not involving self-interest, (C) cases in which the directors were choosing between alternatives

which involved determinations of corporate value or ownership but not payment for sale of

control, and (D) cases in which the directors were obtaining payment for the premium associated

with the sale of control. Third, consideration should be given to the circumstances under which

the directors were acting: were they in a proactive or reactive mode? Fourth, was there a fair

market test of corporate value conducted in connection with the action or a fair shareholder vote

involved? Finally, each decision might be viewed in terms of the hypothesis offered by former

Chancellor Allen:
In those cases [takeover cases], too, I would offer – but not explore here –
the hypothesis that the gist of the motivation for the decision is a judicial
interpretation of the motivation of the directors. That is, where the court
interprets the facts as indicating that the board is trying to favor one deal
over the other for reasons that are inexplicable except on the ground of
personal interest or favor (e.g., QVC), it will be inclined to intervene, but
where discrimination appears to be a good faith business judgment the
court will respect it.36

{39} Before beginning the analysis, it would be helpful to set a baseline of the standards of review

and standards of conduct employed by the Delaware courts prior to the takeover era.

{40} In category A cases involving self-interest, the courts employed the loyalty standard of

conduct and the entire fairness standard of review and placed the burden of persuasion on the

fiduciary engaging in the self-interested transaction.

{41} In category B cases, the court applied the business judgment rule to decisions of directors.

That meant that the standard of conduct was negligence, and the standard of review was gross

negligence. The complaining shareholder had the burden of persuasion on gross negligence and

had to prove causation and actual damages to recover in a liability case. If the director was

attentive to her duties (informed) and the action taken was rational, the courts did not intervene.

F.

1.
{42} The first departure from this base line occurred in Smith v. Van Gorkom.37 It was the

beginning of an effort to find a new review process for the problems created by hostile takeovers.

It was also the first time that the language of the old cases was used in a confusing way to achieve

a new result.

{43} In Smith v. Van Gorkom, the court was asked to rescind a cash-out merger approved by

outside directors that offered shareholders a 50 percent premium over the market price. The

Chancery Court found that the board did not act “recklessly or improvidently” because the board

appeared to review the proposal three times, the market premium in the bid price seemed

adequate, and the business acumen of the collective board members was high.38 The Delaware

Supreme Court reversed finding that the directors relied too heavily on the advice of the CEO,

failed to conduct a “market test” to ascertain the value of the company, did not adequately

negotiate the “no shop” provision in a way that would allow the board a means to terminate the

agreement, and failed to adequately inform the shareholders.39 While the higher court evoked a
gross negligence standard in its opinion, the standard under which the board was actually judged
appeared to be ordinary negligence. In response to the negative reaction in the directors and

officers insurance industry to the Van Gorkom opinion and Van Gorkom’s perceived detrimental

impact on director risk taking, in 1986 Delaware amended its corporate laws to add Del. Code

Ann. Tit. 8, § 102(b)(7). That Delaware statute allows shareholders to adopt certificate of

incorporation or charter provisions limiting the monetary liability of directors for certain breaches

of fiduciary duties.40

{44} The first seminal case to follow Smith v. Van Gorkom was Unocal Corp. v. Mesa Petroleum

Co., 493 A.2d 946 (Del. 1985). Unocal involved the reasonableness of a target company board’s

defensive measures. Under the Unocal standard, later added to by Unitrin,41 where a target board

adopts defensive measures in an effort to thwart a perceived threat, the target board has the

burden of proving 1) that the board reasonably perceived a threat to corporate effectiveness and

policy and 2) that the defensive measure was reasonable in response to the threat.42 Unitrin

expanded on this two-step process by adding the condition that a defensive measure that is outside

the normal range of defensive measures or that is “draconian” will not be considered

proportionate to the perceived threat and will fail the second prong of the Unocal test.43 A

draconian measure was one that was preclusive or coercive.

{45} If the court finds that the board was reasonable in its perception of a threat and that the

defensive measure taken was proportionate to the threat, the court will then subject the board

actions to the traditional business judgment rule.44 Thus, the Unocal/Unitrin standard added
another layer to, but did not preempt application of, the standard business judgment rule. It also

created the situation where directors were, in effect, obligated to show that the shareholder

plaintiff could not prevail on the merits, a reversal of the normal rule.

{46} Following Unocal, the Delaware Supreme Court premiered yet another standard with which to

judge the duty of care owed to shareholders. This standard applied when a company engaged in a

transaction that involved a sale of control, the break-up of the company, or a response to an offer

with a break-up of the company.45 In Revlon v. MacAndrews & Forbes, in response to a hostile

offer from Pantry Pride, the Revlon directors adopted a number of defensive measures.46
Undeterred, Pantry Pride continued its pursuit of the company.47 Subsequently, the Revlon

directors entered into an agreement with another potential buyer that included a number of deal

protection devices prohibiting Pantry Pride from acquiring the company.48 The court rejected

application of the Unocal/Unitrin doctrine because “the duty of the board . . . changed from the

preservation of Revlon as a corporate entity to the maximization of the company’s value at a sale

for the stockholders’ benefit . . . . The whole question of defensive measures was moot. The

directors’ role changed from defenders of the corporate bastion to auctioneers charged with

getting the best price from the stockholders at a sale of the company.”49 Thus, Revlon became the

standard under which to evaluate transactions that changed the control of a corporation.

{47} Following Revlon, another standard in relation to fiduciary duties emerged that is triggered

when a board acts “for the primary purpose of thwarting a shareholder vote.”50 In Blasius Indus.

v. Atlas Corp., the directors, in an attempt to prevent a majority shareholder from instituting an

unwise business strategy, amended the by-laws to expand the size of the board.51 The majority

shareholder intended to implement his plan by taking control of the board.52 As a result of the by-

law amendment, even if the shareholders voted to refill the vacancies on the board, the

replacements would not have control of the board; the shareholder vote would be ineffectual.53

The court found that the directors acted in good faith and in the best interests of the company.54

However, the court struck down the board’s actions and refused to apply the business judgment

rule because the board’s amendment interfered with one of the “two [shareholder] protections

against perceived inadequate business performance”: shareholders may sell their stock or replace

an incumbent board.55 Thus, director actions that impeded a shareholder’s right to vote

impermissibly shifted the allocation of authority between directors and shareholders.56 The court

ruled that if a board acts for the “sole purpose of thwarting a shareholder vote,” the business

judgment rule does not apply, and the board must prove it had a “compelling justification for such

action.”57

{48} Thus, from 1985 to 1988 the Delaware courts had added bite to the fiduciary duty of care;

they imposed a de facto negligence standard on director business decisions, applied a
reasonableness/proportionality standard for board-taken defensive actions, imposed a

maximization of shareholder wealth standard to transactions involving changes in control, and

applied a compelling justification test to director actions that usurped shareholder votes.

{49} Another seminal case, Paramount Communications, Inc. v. Time, Inc., provided an

opportunity for the Delaware courts to differentiate between a board transaction that contemplated

a sale of control and a transaction that perpetuated the interests of the corporation in a merger

transaction.58 In Time, the board of directors entered into a merger agreement with Warner

Communications.59 Following this announcement Paramount made a bid for Time.60 In response

to Paramount’s bid, Time and Warner amended the merger agreement to remove the optional

requirement of a shareholder vote so as not to be required to entertain the Paramount bid.61 The

merger agreement also included a number of deal protection devices.62 The Chancery Court

denied the preliminary injunction and refused to apply Revlon. The Delaware Supreme Court

characterized the question posed to the Chancery Court as deciding “under what circumstances

must a board of directors abandon an in-place plan of corporate development in order to provide

its shareholders with the option to elect and realize an immediate control premium.”63 The

Delaware Supreme Court answered the question as follows:
Under Delaware law there are, generally speaking and without excluding
other possibilities, two circumstances which may implicate Revlon duties.
The first, and clearer one, is when a corporation initiates an active bidding
process seeking to sell itself or to effect a business reorganization
involving a clear break-up of the company . . . . However, Revlon duties
may also be triggered where, in response to a bidder’s offer, a target
abandons its long-term strategy and seeks an alternative transaction also
involving the breakup of the company. Thus, in Revlon, when the board
responded to Pantry Pride’s offer by contemplating a “bust-up” sale of
assets in a leveraged acquisition, we imposed upon the board a duty to
maximize immediate shareholder value and an obligation to auction the
company fairly. If, however, the board’s reaction to a hostile tender offer
is found to constitute only a defensive response and not an abandonment
of the corporation’s continued existence, Revlon duties are not triggered,
though Unocal duties attach.64 [citations omitted]

Thus, the court in Paramount v. Time gave business judgment deference to the board’s decision

placing the continuing interest of the corporation over the interest of the shareholders in voting
for receipt of an immediate premium, and placed deal protection measures, like defensive

measures, under the Unitrin/Unocal doctrine.

{50} Eight years after Smith v. Van Gorkom, in Cede & Co. v. Technicolor, Inc., 634 A.2d 345

(Del. 1993), the Delaware Supreme Court reasserted its negligence standard under the gross

negligence rubric but added yet another twist to the business judgment rule. In Cede, dissenting

shareholders challenged a second stage merger and requested share appraisal.65 Plaintiffs alleged

both a breach of loyalty and care. The lower Chancery Court found no breach of loyalty but did

find breach of care.66 However, no liability was imposed on the directors because plaintiffs

failed to allege injury.67

{51} The Supreme Court reversed the Chancery Court’s ruling that plaintiff was required to

“establish injury from a proven claim of board lack of due care to rebut the rule for breach of the

duty of care.”68 Then, citing Weinberger v. UOP, 457 A.2d 701, 710 (Del. Supr. 1983), the court,

after finding the directors breached their duty of care, applied the “entire fairness test” to the

directors’ actions. The “entire fairness test” had only previously been applied in breach of the

duty of loyalty cases.69 Thus, the “gross negligence” standard of the business judgment rule

evolved into a standard wherein the directors, if found in breach of their duty of care, must prove

that the proposed transaction was entirely fair as to both process and price. Thus, directors in

interested (duty of loyalty) and non-interested (duty of care) transactions were subject to the same

enhanced judicial scrutiny.

{52} In 1994, the Delaware Supreme Court purported to clarify Revlon and Time with Paramount

Communications v. QVC Network.70 In QVC the directors entered into a stock-for-stock merger
transaction with Viacom that would result in a change in control since Viacom was controlled by

a majority shareholder.71 The merger agreement contained a no-shop provision, a termination fee

and a stock option agreement.72 Citing Time, Paramount and Viacom argued that this stock-for-

stock merger did not implicate Revlon duties. The QVC court distinguished Time by emphasizing

that Time’s merger agreement, unlike the Paramount-Viacom merger, would not result in placing

the stock in the hands of a majority shareholder.73 Thus, this situation required the directors to
inform “themselves of all material information reasonably available . . . and decide which

alternative is most likely to offer the best value reasonably available to the stockholders.”74 In

pursuit of this goal, “the directors were not limited to considering only the amount of cash

involved,” nor were the directors “required to ignore totally its view of the future value of a

strategic alliance.”75 The court applied the “enhanced scrutiny” of Revlon, which consisted of:
(a) a judicial determination regarding the adequacy of the decision making
process employed by the directors, including the information on which the
directors based their decision; and (b) a judicial examination of the
reasonableness of the directors’ action in light of the circumstances then
existing. The directors have the burden of proving that they were
adequately informed and acted reasonably.76

The court stated that, despite Paramount’s arguments otherwise, a “break-up” of the company

was not required by the court’s ruling in Paramount Communications, Inc. v. Time.77

{53} The Paramount court also considered the contractual rights and obligations of the merger

partners. In evaluating the board’s fiduciary duty, the court struck down the argument by the

merger partners that Paramount was precluded by the contractual provisions of the merger

agreement from negotiating with QVC.78 The court stated,
[s]uch provisions, whether or not they are presumptively valid in the
abstract, may not validly define or limit the directors’ fiduciary duties
under Delaware law or prevent the Paramount directors from carrying out
their fiduciary duties under Delaware law. . . . The Paramount directors
could not contract away their fiduciary obligations. Since the No-Shop
Provision was invalid, Viacom never had any vested contract rights in the
provision.79

Thus, the court made clear that a board’s fiduciary obligations supercede their right to enter into

contracts on behalf of the corporation.

{54} The Chancery Court looked at contract rights from a different perspective in Ace Ltd v.

Capital Re Corp., 747 A.2d 95 (1999). In Ace, the merger agreement contained a “no-shop” and

“fiduciary out” provision that prevented Capital Re from considering other offers unless it

received written advice from counsel. That written advice must indicate that the other offer was

of such superiority that to not consider it would be a breach of fiduciary duties.80 Subsequently,

Capital Re did receive a superior offer and rescinded the merger agreement.81 However, it had
not received the written advice from counsel as ostensibly required by the agreement.82 Ace

requested that the court enjoin Capital Re from terminating the merger agreement.83 The court

refused, stating:
Though the Board must ‘base’ its judgment on the ‘written advice’ of
outside counsel, the language of the contract does not preclude the board
from concluding, even if outside counsel equivocates . . . as to whether
such negotiations are fiduciarily mandated.84

{55} The court went further by stating that Ace’s interpretation of the provision would likely be

found invalid since it interfered with the board’s exercise of its fiduciary duties.85 The court

applied a four-part test to determine if Ace’s contractual rights should outweigh the board’s

obligations to the shareholders. The test is:
(1) whether the acquiror knew, or should have known, of the target
board’s breach of fiduciary duty; (2) whether the . . . transaction remains
pending or is already consummated at the time judicial intervention is
sought; (3) whether the board’s violation of fiduciary duty relates to policy
concerns that are especially significant; and (4) whether the acquiror’s
reliance interest under the challenged agreement merits protection in the
event the court were to declare the agreement unenforceable.86

In this situation the court found that protecting the shareholders from the board’s breach of

fiduciary duties outweighed or invalidated the contractual rights of Ace.87

{56} Despite the abundance of standards with which to evaluate fiduciary duties available in

Delaware law in 1997, the Delaware Supreme Court completely dodged the business judgment

rule and its offshoots in Brazen v. Bell Atlantic Corp., 695 A.2d 43 (1997). In Brazen, the merger

agreement contained a termination fee provision that would be triggered by an acquisition

proposal of Bell Atlantic during a specified period of time.88 The agreement stated that the 550

million dollar fee would “constitute liquidated damages and not a penalty.”89 Plaintiff requested

a preliminary injunction alleging that the termination fee was “an unconsciously high termination

or ‘lockup’ fee employed ‘to restrict and impair the exercise of the fiduciary duty. . . and coerce

the shareholders’ to approve the merger.”90 The Chancery Court evaluated the termination
provision under the business judgment rule.91 However, the Delaware Supreme Court stated that
the provision should have been analyzed under the “test accepted by Delaware courts for

analyzing the validity of liquidated damages provisions.”92 The sole basis for the court’s

treatment of the provision as liquidated damages was based on the express “liquidated damages”

language in the merger agreement.

{57} Two years later, the Delaware Chancery Court case, Phelps Dodge Corp. v. Cyprus Amax

Minerals Co., raised the question of the appropriateness of a preliminary injunction in the context

of a pending shareholder vote.93 In Phelps Dodge a merger agreement between Cyprus and

ASARCO contained a no-talk provision and a 6.3% termination fee.94 The court said the “no-

talk” provision “was the legal equivalent of legal blindness, a blindness that may constitute a

breach of the board’s duty of care; that is, the duty to be informed of all material information

reasonably available.”95 Despite finding that the board likely breached its fiduciary duties and

that plaintiffs would likely prevail at trial, the court refused to enjoin the merger because it could

not find irreparable harm. The court stated:
Phelps’ contention that it will walk away after a merger is consummated
between Cyprus and Asarco is a self-inflicted harm. This Court cannot
and, in my judgment, should not save one from oneself.
I also need not rescue the shareholders from losing out on a premium bid,
as they can simply vote down the Cyprus/Asacro transaction which is
scheduled to be voted on this Thursday. When such self-help measures
are clearly available and when the arsenals of all parties have been
unleashed so as to fully and completely educate the shareholders of their
choices, it is not for this Court to ride to their rescue.
And even if the Court were to invalidate the challenged provisions, it is
not clear that such relief will benefit the shareholders voting on Thursday.
Plenty of information, from all that I can tell, is already available in the
marketplace.96

The Phelps Dodge opinion suggests that judicial interference may be unnecessary when relevant

information is readily available and an unhindered shareholder vote would provide the

appropriate remedy.

{58} Again, despite the abundance of standards available, in In re IXC Communications, Inc.

Shareholders Litig., the court simply applied the business judgment rule to deal protection

measures.97 The merger agreement between the parties contained no-talk and stock option
provisions and a $105 million termination fee.98 The shareholders requested that the court enjoin

the shareholder vote based, among other things, on the preclusive provisions of the agreement.

After finding that the plaintiffs were unable to satisfy the burden of proof under the business

judgment rule, the court stated that:
I do not find it necessary to reach the question of whether this fee is unfair
and unenforceable, since enhanced judicial scrutiny does not apply and
entire fairness is not the standard of review. Neither the termination fee,
the stock option agreements, nor the no-solicitation provisions are
defensive mechanism instituted to respond to a perceived threat to a
potential acquiror. In the absence of a showing of disloyalty or lack of
care in agreeing to the termination fee, these provisions are reviewable as
business judgments and are, thus, granted deference.99

Further, the court stated that:
[w]here the plaintiffs fail to show that the IXC shareholders are either
inadequately informed or are misinformed about either the terms of the
merger or the process by which it came about and the vote will be a valid
and independent exercise of the shareholders’ franchise, without any
specific preordained result which precludes them from rationally
determining the fate of the proposed merger the Court of Chancery has no
basis to intervene to frustrate the exercise of the shareholder franchise in
law or equity.100

Thus, in IXC, deal protection devices in a merger agreement not followed by a hostile offer did

not merit Unocal/Unitrin analysis.

{59} These cases demonstrate the difficulty faced by the Delaware courts during a period of rapid

change and enormous pressure on the corporate governance system. Despite the inconsistencies

and conflicts, the Delaware courts guided corporate law through a tremendous upheaval. While

reevaluation out of the heat of battle is called for, it should be not with a critical, but rather a

constructive, eye.
{60} Finally, the Court looks at the reevaluation of the use of standards of review underway in

Delaware. If it had not begun before, that critical analysis was forecast by Chancellor Chandler

in a presentation to the Tulane Corporate Law Institute in March of 2000. In that presentation he

asked fellow panelists to consider
the recent series of Delaware Chancery decisions in Phelps-Dodge, Ace
and IXC, all of which involve challenges to so called no-talk and no-shop
provisions in stock-for-stock merger deals. Can these decisions, and
others we might consider, be understood as suggesting for the first time
that the Revlon-Time dichotomy is not as credible a distinction as
practitioners may have believed in recent years? Instead, might one posit
the existence of a continuum that would perhaps more accurately describe
the framework of judicial review than the Revlon-Time analytical
dichotomy? Would this continuum reflect that fundamental or
transformative business transactions, sometimes referred to as
“ownership” issue transactions, receive more rigorous and skeptical
judicial review than non-ownership or enterprise types of cases?
Under this slightly different analytical paradigm, what if a court
examined some business transactions with greater skepticism than others
because of the importance of the transaction to the corporation’s
stockholders?

{61} A number of academics and judges have taken up the challenge thrown out by Chancellor

Chandler.101 The Delaware Supreme Court has not yet been presented with the right opportunity.

{62} The results of the ongoing reevaluation are not complete, but some conclusions can be

drawn. First, the number of standards of review has become confusing and contributes to an

inability of practitioners to advise their clients appropriately. Second, the use of categories of

transactions to which standards of review are applied has been perceived as outcome

determinative. As a result, practitioners have focused too heavily on making their transactions fit

within a category. 102 Third, the Delaware Supreme Court has erroneously blended the duty of

care standard and the test of entire fairness creating confusion in the bar.103 As a result, the

original benefits of the circumstance specific application of the business judgment rule in duty of
care cases and the application of the entire fairness test in duty of loyalty cases have been

lost. Those standards of review need to be reevaluated and reapplied in a way that serves their

original purpose, which was to acknowledge certain institutional requirements under particular

circumstances. Fourth, the straight application of either the business judgment rule or the entire

fairness test does not work to resolve the tensions between the conflicting requirements of

shareholders and directors in transactions or board actions affecting the shareholders’ right to sell

or vote. The use of some other review process is required. Failure to provide a meaningful

review process will remove a critical tool and much needed flexibility in resolving the inherent

conflict between the internal requirements of our corporate system. Fifth, the intermediate
standards adopted in Delaware are confusing and perhaps not internally consistent.104 The focus

on “entrenchment” may be part of the problem. The necessity for courts to evaluate “threats” and

“proportional responses” starts to sound a lot like nondeferential judicial review of business

decisions. A refocus on the relationship between shareholder rights and directors duties to make

informed decisions in good faith would be more helpful. The current language in Delaware may

not be reflective of what is actually happening there.105 Circumstance-specific review procedures

should not be abandoned. They provide needed flexibility.106

{63} Ten lessons can be learned from the Delaware experience in designing review processes in

corporate law.
1. The review process should enhance corporate value and appropriately balance
the competing interests in the corporate structure.

2. Review processes should be circumstance- and task-specific.

3. Clarity in language is important. Confusion can result from appropriating
language from standards of review and conduct from other circumstances and
situations.

4. Simpler is better; fewer is preferable.

5. Director attention to process should be encouraged.

6. Fairness and efficiency must be considered.

7. The nature of the legal duties at issue is important. As the importance of the
legal duty increases, the narrower should be the gap between the standard of
review and the standard of conduct.

8. To the extent possible, the review process should extricate the courts from
substituting their judgment for the business decisions of those with superior
business knowledge.

9. The process should discourage frivolous lawsuits.

10. Review processes should provide guideposts from which businesses and their
advisors can discern when judicial intervention might occur.107
{64} The Court has devoted an extensive portion of this opinion to the development of review

procedures because they are so important. Like corporate legislation, judicial review procedures

require thoughtful study. Chief Justice Veasey of the Delaware Supreme Court has said the

relationship between courts and directors is the defining tension in our corporate governance

system. 108

III.
{65} The Court now turns to a determination of the review process that should be applied in North

Carolina. Our courts can benefit from the prudent policy analysis in the Delaware decisions that

supports application of circumstance-specific review procedures while avoiding the categorical

and linguistic quagmire which resulted there. The guidelines set forth above should be applied to

the extent possible. The structural requirements of our corporate system must be met.

{66} Our system requires: (a) that directors have the power and authority to plan, develop, design,

negotiate and contract for mergers and other acquisitions fundamental to the corporation’s

business strategy, (b) that shareholders have the right to vote on any such fundamental changes in

corporate structure and (c) that their vote results in a free, uncoerced and informed valuation of

the proposed corporate action. Exposing a transaction to valuation in the marketplace is the best

test of its worth. When corporate law adopts a review process that insures that these structural

requirements are met, it promotes corporate value.

{67} Trapped in the linguistic box of Delaware law, counsel for all the parties suggest resolution of

the issues in this case in terms of standards of review employed in Delaware. First Union and

Wachovia urge the court to adopt a business judgment approach while SunTrust and counsel for

the shareholders promote the Unocal review process. Each side can point to decisions of the

Chancery Court that support its position, and strong policy arguments can be made for each. Vice

Chancellor Strine has set those arguments out in great detail and more effectively than this court

could in his article Categorical Confusion: Deal Protection Measures in Stock-for-Stock Merger

Agreements.109 He concludes his article with a suggestion that a judicial emphasis on uncoerced
shareholder choice makes sense in trying to balance the competing pressures from shareholders

and directors in the circumstance of stock-for-stock mergers:
Although one can press the point too far, an approach that focuses on
uncoerced stockholder choice does much to reconcile these values. How?
For starters, this emphasis is faithful to a key theme of Time-Warner.
Well-motivated directors ought to have the right to present a strategic
merger to their stockholders and to give their merger partner substantial
contractual protections to induce them to contract. Unlike in the Revlon
context, the court will defer to director decisions to give a preferred
merger partner bidding and timing advantages over later emerging rivals.
This deference to directors, as a practical matter, may mean that the courts
will give scant weight to whether deal protection measures are preclusive
of other bids as a short-term matter. That is, if all the board is asking for
is to go first and to require other bidders to await the outcome of an
unfettered stockholder vote, it seems likely to get that opportunity.
At the same time, this emphasis on stockholder choice recognizes that a
stock-for-stock merger agreement is not an ordinary contract within the
sole power of the directors to consummate. Stockholders have the right to
vote yes or no without being, in essence, compelled or coerced.
Stockholder can legitimately expect that their directors will bring a merger
proposal to a reasonably prompt vote so that the mere passage of time
does not leave the board’s preferred deal as the only viable corporate
strategy. Stockholders also have a right to a genuine, current
recommendation from their directors regarding the advisability of the
transaction.
This judicial emphasis on stockholder choice makes sense. It gives boards
the first bite at the apple and contractual tools to use to accomplish their
preferred strategy. It enables the merger partners to receive contractual
protections that limit their injuries if transactions do not go through. But it
also ensures integrity by limiting the boards’ ability to intrude on the
stockholders’ co-equal right to approve mergers.
Of course, the judicial task of determining whether deal protection
measures have deprived the stockholders of a fair chance to vote freely on
a transaction has its own difficulties. Nonetheless, channeling the judicial
inquiry in this way has the virtue of reinforcing the primacy of director
and stockholder decision-making. It also provides a relatively elegant way
of acknowledging the greater scope of director discretion that exists in the
non-Revlon context, while also recognizing that the stockholder
“ownership” interests that take primacy in the Revlon context also loom
large when a corporate board presents a stock-for-stock merger
agreement.110
{68} The policy considerations supporting Vice Chancellor Strine’s approach are compelling. That

approach serves to balance the competing interests in a fair and efficient manner. It recognizes the

importance of the legal duty to protect the shareholder right to vote and thus does not employ a

standard of review that diverges from the standard of conduct. It narrows the gap where the legal

rights are most important.

{69} It also dovetails into what this court believes the North Carolina Legislature intended to do

when it amended N.C.G.S. § 55-8-30(d). That amendment provided: “[t]he duties of a director

weighing a change of control situation shall not be any different, nor the standard of care any

higher, than otherwise provided in this section.” [emphasis added].111 The amendment did not

refer to a standard of review, and the legislature did not make any change in the shareholders’

right to vote on a merger. The most reasonable interpretation of the Legislature’s intent was that it

intended to eliminate by statute the unidimensional requirement imposed on directors by Revlon.

The impetus for the change is unclear. It is clear that the amendment evidenced a policy that

obtaining the highest dollar value for the shareholders was not the sole criteria by which the

courts could or should judge the conduct of directors in change of control situations. To the extent

Revlon could be read to require a higher level of attentiveness from directors in change of control

situations than in other situations, the amendment eliminated that requirement as well. It

effectively eliminated the Category D cases referred to above and collapsed those cases into

Category C. Like Illinois and other states, it rejected the pure property concept of corporate value

so firmly held in Delaware and aligned itself with states which adopted the social entity concept

of corporations.112
{70} The 1993 amendment was directed to Revlon and its implications. At the time it was enacted,

Unocal and its progeny had long been decided. Nothing in the amendment appears to be directed

specifically to the Unocal standard of review. There is certainly nothing in the amendment which

indicates that the legislature intended to diminish shareholders’ voting rights. Thus, a review

process that provides some deference to the directors’ strategic decisions while vigorously
preserving the shareholders’ voting rights in connection with the transaction would fit neatly into

North Carolina’s policy position. What would such a review process look like?

In reviewing deal protection measures in a stock-for-stock merger subject to

shareholder approval, the court will first review the transaction, including the

adoption of deal protection measures, to determine if the directors have complied

with their statutory duty of care under N.C.G.S. § 55-8-30. The burden is upon the

shareholder challenging their actions to prove that a breach of duty has occurred.

If no breach of duty is proven, the action of the directors is entitled to a strong

presumption of reasonableness and validity, including noncoercion, and the court

should not intervene unless the shareholder can rebut that presumption by clear

and convincing evidence that the deal protection provisions were actionably

coercive, or that the deal protection provisions prevented the directors from

performing their statutory duties. If a breach of duty is established, the burden

shifts to the directors to prove that their actions were reasonable and that it is in

the best interests of the shareholders that they be permitted to vote on the

transaction, and, if at issue, that the deal protection measures were not actionably

coercive and did not prevent the directors from performing their statutory duties.

Where the court finds that the deal protection measures are coercive or require

directors to breach their statutory duties, the court must then weigh the harm to

the shareholders in enjoining either the deal protection measures, the vote on the

transaction or the merger, if the transaction is approved, against the harm resulting

from not entering injunctive relief. That is a very case- and fact-specific

determination.
{71} This review process applies to requests for injunctive relief invoking the equitable powers of

the court. It is not intended to apply to liability determinations that are subject to other statutory

provisions. As indicated elsewhere in this opinion, there are compelling reasons to apply

different standards of review to liability determinations.

1. THE STATUTORY DUTY OF CARE
{72} This prong of the review process recognizes the intent of the Legislature in amending the

statute in 1993. Directors receive the benefit of court deference to business decisions that are

made in good faith and on an informed basis. As long as the decision to include the deal

protection measures in the merger transaction was informed and in good faith, it will not be

disturbed by the courts absent proof by clear and convincing evidence of interference with

shareholder voting rights or statutory duties. The directors’ duties and standard of care applied to

them are no different from any other situation.

{73} This standard of review defers to the board’s business expertise and strategic decision

prerogative. It provides the board with the opportunity to get its proposal before the shareholders

in advance of any other offeror. It recognizes that a board may give significant and enforceable

bidding advantages to its preferred merger partner and recognizes the contractual rights of that

partner. The courts are not making ex post decisions, but reviewing the ex ante actions of

directors. If those ex ante actions demonstrate that the board was attentive and negotiated the deal

protections carefully, the court will not intervene in the voting process absent clear and

convincing evidence of interference with shareholder rights.113 Under this procedure the courts
do no more than they normally do.
But it is natural that the court will look for a record of deliberations
commensurate with what is at stake. If lock-ups are extraordinary, did the
board know about that? What was the reason for agreeing to them? Was
the deal that good? How confident was the board that another more
favorable transaction would not arise, including a substantial topping bid
or a better strategic merger? Did the board negotiate as hard as possible to
minimize the restrictions on its own flexibility?114

{74} In asking such questions, the court is only seeing that the directors did their job, not

questioning their decision. The review is fair because this is not the usual situation where
directors may not have full information. There are few corporate transactions as heavily advised

as merger transactions. Directors get an abnormal dose of advice and advisors.

{75} The process permits the court to act in those situations where important shareholder rights are

implicated. Where the directors have complied with their statutory duties, it requires clear and

convincing evidence of interference with shareholder rights or abrogation of director duties. It is

a high burden, but one which, when met, should not then be diminished by a standard of review

which diverges from the standard of care or, in this case, the obligation of the board not to

interfere with the shareholder franchise. It ensures the integrity and the maintenance of the proper

balance in the system by limiting the board’s ability to intrude on the stockholder’s co-equal right

to approve mergers. The focus is not the directors’ performance as much as the shareholder’s

rights. It is a necessary means to protect against those situations where the directors acted in good

faith, were informed, but perhaps got bad advice or were just mistaken. It recognizes the reality

that some deal advisors might feel it their duty to their client to test the edges of the envelope.

The requirement of clear and convincing evidence removes more of the opportunity for judicial

error as does the strong presumption of noncoercion earned by compliance with the statutory duty

of care. It rewards good process in board actions.

{76} The court has specifically omitted a preclusive prong of this test. Where a board has adopted

a specific strategy and selected a merger partner, it has every incentive to see its business

judgment in that regard carried out and to protect it from attack. Therefore, there may well exist

situations where defensive measures adopted with statutory care are preclusive of interference by

other parties, or have some preclusive effect, without necessarily being coercive of the

shareholder vote. This is particularly true of short-term preclusive measures. The shareholder is

voting on whether or not to approve the proposed merger. He is not electing between alternative

transactions, and the board is not required to structure its merger to permit alternative

transactions. This is not to say that there might not be situations in which the court could find

that preclusive actions had an impermissible coercive effect. The focus on coercion rather than
preclusion recognizes the board’s authority to make strategic decisions while preserving the

shareholder’s free uncoerced vote on the proposal.

{77} The focus on coercion and the burden of clear and convincing evidence should help diminish

the incidence of frivolous lawsuits and limit judicial interference in the process.

2. COERCIVE MEASURES
{78} The Court next turns to a consideration of the definitions of coercive. As Vice Chancellor

Strine indicated, this endeavor is not without difficulty.115 A review of the Delaware decisions

provides some linguistic help, but few specific answers. Like so many issues in corporate law,

the rapidity with which circumstances change and the myriad of possibilities makes a precise

definition impossible and undesirable. It is undeniable that deal protection devices are valid and

legitimate tools.
The accepted rationale for deal protection measures is to protect a
beneficial business transaction from attack by an interloper and, where the
primary purpose is unsuccessful, to compensate the unsuccessful party for
lost economic and opportunity costs. There are several reasons why
potential merger partners would desire the inclusion of deal protection
measures. As an initial matter, no company wants to be a stalking horse.
There is simply no benefit or utility to an acquiror simply to become the
initial bidder, incur significant costs in terms of money and time, and then
not be able to consummate the contemplated transaction. In addition to
direct costs incurred in this process, there also may be indirect costs. Such
indirect costs could include opportunity costs arising from focusing on the
potential merger at hand and the costs and risks associated with the public
announcement of the proposed merger. A public announcement of an
extraordinary transaction could lead to a perception that the company has
departed from its long-term corporate strategy and has put itself "in play."
Such a perception obviously could significantly erode the leverage that the
company may have in any future negotiations for an extraordinary
transaction.

Deal protection measures can aid the consummation of the negotiated
transaction in several ways. First, the existence of such measures could
discourage other potential business partners from coming forward with a
proposal of their own. Second, assuming another party did come forward,
such protective measures could make it more difficult procedurally for
such bidder to pursue its alternative proposal. Third, these protective
measures could also make it more difficult economically for a subsequent
offer to succeed.116
Deal protection devices are more like chameleons than ducks: they change appearance depending

upon the background against which they are viewed. They are particularly important since deal

jumping is a common occurrence.117

{79} Some guidelines are necessary. First, this is an ex post review. At issue is the validity of the

market test represented by the shareholder vote. That determination must be made at the time the

voting rights are to be exercised. The Court is not reviewing the decision of the board so much as

the impact of the deal protection measures on the shareholder vote.

{80} Second, the Court must look at coercion from the viewpoint of the shareholder. The

shareholders will make their decisions based upon their own economic interests.

{81} Third, some guidance can be gained from the language of prior decisions, but as Vice

Chancellor Jacobs noted in Lieb v. Clark, 1987 Del. Ch. Lexis 442 at *12 (1987), labeling a

measure as “coercive” is only the starting point for legal analysis.
The relevant question is whether the transaction is wrongfully, i.e.,
actionably, coercive. As a general matter a tender offer is not actionably
coercive unless the shareholders are being wrongfully induced to accept
the offer unrelated to its merits.” [citations omitted]

Other cases use similar language. Justice Steele phrased the issue this way in IXC: Will the vote

“be a valid and independent exercise of the shareholders’ franchise, without any specific

preordained result which precludes them from rationally determining the fate of the proposed

merger?”118
{82} Vice Chancellor Strine used this test: “A defensive measure is preclusive when its operation

precludes an acquisition of the company. A defensive measure is coercive when it operates to

force management’s preferred alternative upon the stockholders.”119

{83} He also stated: “Initially, it seems to me clear that the primary thrust of the coercion prong of

Unocal is to enable the court to vitiate measures that foist an alternative strategic transaction (e.g.,

a repurchase program or merger) on stockholders that prevents them from taking advantage of

another acquisition offer.”120
{84} In Brazen, the court spoke of “structurally or situationally coercive factors.”121 In Williams v.

Geier, 671 A.2d 1368, 1382-1383 (Del. 1994), the court held that coercion existed where “the

board or some other party takes actions which have the effect of causing the stockholders to vote

in favor of the transaction for some reason other than the merits of that transaction.”

{85} Fourth, the Court may also resort to prior decisions and marketplace statistics to provide help

in its legal analysis of coercion.122 The decisions in prior cases can be of some help but each is

fact-specific.123 Cross checks such as liquidated damages claims may also be useful.124

{86} In the merger context, the court is looking to determine if the deal protection measures

impermissibly penalize shareholders for voting against the deal. The courts also look to see what

the bidder gave or the shareholders of the acquired company received for the deal protection

measure.125

3. ABROGATION OF STATUTORY AND FIDUCIARY DUTY
{87} The third basis for challenge to deal protection measures in the review process set forth above

is a simple recognition of long held principles of corporate law. Under North Carolina law as

under Delaware law, the authority to manage the business and affairs of the corporation is vested

in the board of directors and that authority carries with it the statutory obligation to exercise the

authority.126

{88} A long line of Delaware cases dealing with various “rights plans” or “poison pills” has

consistently held that the adoption of such defensive devices, while permissible as a general rule,

could not relieve the directors of their fundamental duties to the corporation and its shareholders.

Other jurisdictions agree.127 In Moran v. Household International, Inc., 500 A.2d 1346 (Del.
1985) the court upheld the adoption of a rights plan but cautioned “ultimate response to an actual

takeover bid must be judged by the Directors’ actions at the time and nothing we say relieves

them of their fundamental duties to the corporation and its shareholders.”128 Ever inventive

corporate advisors searched for defensive measures which would slow down hostile bidders. At

each turn, the Delaware Courts have invalidated plans that purport to restrict a board’s duty to

fully protect the interests of the corporation and its shareholders.129
{89} In Quickturn, both the Chancery Court and the Supreme Court invalidated a “no hand” or

“delayed redemption” provision in a rights plan which placed restrictions on a newly elected

board’s ability to redeem the existing rights plan for six months after taking office.130 The

Supreme Court elected to do so on the grounds that the delayed redemption provision violated

fundamental Delaware law. It found that the provision impermissibly deprived any newly elected

board of its statutory authority to manage the corporation and its concomitant fiduciary duty

pursuant to that mandate.131 The Supreme Court held:
The Delayed Redemption Provision, however, would prevent a newly
elected board of directors from completely discharging its fundamental
management duties to the corporation and its stockholders for six months.
While the Delayed Redemption Provision limits the board of directors’
authority in only one respect, the suspension of the Rights Plan, it
nonetheless restricts the board’s power in an area of fundamental
importance to the shareholders -- negotiating a possible sale of the
corporation.” [emphasis added]132

Quoting from Malone v. Brincat, 722 A.2d 5 (Del. 1998), the court stated: “This Court has held

‘to the extent that a contract, or a provision thereof, purports to require a board to act or not act in

such a fashion as to limit the exercise of fiduciary duties, it is invalid and unenforceable.”133

IV.
{90} Having determined the review procedure that this court believes will be applied in North

Carolina in stock-for-stock merger transactions subject to shareholder vote, the Court next turns
to a review of the facts and the deal protection measures in the merger agreement.

{91} Wachovia’s board of directors consists of two inside and thirteen outside directors. The

outside directors include the presidents of two universities and top level executives of the

following corporations: BellSouth, National Services Industries, Nucor Corp., Burlington

Industries, Liberty Corporation, GlaxoSmithKline, Philip Morris Capital Corp., Time, Inc. Noland

Company, Phoenix Home Life Mutual Insurance Co., and Inmar Enterprises.

{92} On a number of occasions prior to December 2000, SunTrust and Wachovia explored the

possibility of entering into a business combination. In the fall of 1997, SunTrust and Wachovia
conducted due diligence on each other in an effort to ascertain long-term benefits to their

shareholders of a merger. A merger agreement did not result at that time. The rumors of a “coke

and smoke” merger were fairly common and a Wachovia-SunTrust merger would not have

surprised the industry.

{93} In the fall of 2000, Wachovia retained the consulting firm of McKinsey & Co. to develop a

strategic plan for the corporation. In October 2000 McKinsey & Co. presented its recommended

strategy to the board, which strategy the board adopted on October 26, 2000. Part of the strategy

called for Wachovia to become a “regional ruler” as opposed to a nationwide bank. However the

board also considered strategic combinations with other financial institutions: two of the

institutions identified as potential merger partners included First Union and SunTrust. Essentially

the Wachovia strategy was to grow independently unless the right merger presented itself.

{94} Since it was considering mergers with both First Union and SunTrust, Wachovia asked its

financial advisor Credit Suisse First Boston (“CSFB”) to prepare an analysis of those potential

mergers. The analysis was presented to an executive committee, consisting of three independent

directors and the CEO. There were pros and cons regarding both potential merger partners.

During the fall, L.M. Baker, Jr., Wachovia's Chairman, President and Chief Executive Officer,

began talks with both SunTrust and First Union. Neither potential merger partner knew that

Wachovia was in talks with the other.

{95} Beginning in September and continuing in the fall of 2000, Mr. Baker and G.

Kennedy Thompson, First Union's Chairman, President and Chief Executive Officer,

held preliminary meetings and conversations to discuss generally the concept and structure of a

possible combination of Wachovia and First Union. On October 14, 2000, officials at Wachovia

and First Union met and engaged in further discussions regarding steps that would be involved in

pursuing a merger-of-equals transaction. In December, Mr. Baker told Mr. Kennedy that he

wanted to postpone any further discussions.

{96} In October-November, 2000, Mr. Baker received a telephone call from L. Phillip

Humann, Chairman, President and Chief Executive Officer of SunTrust. Mr. Humann requested
that Mr. Baker meet with him to discuss the possibility of a merger between SunTrust and

Wachovia. Mr. Baker agreed to meet with Mr. Humann on November 6, 2000.

{97} On December 1, 2000, Messrs. Baker and Humann met again to discuss the structure of a

possible merger and a process for proceeding to negotiate a transaction. The transaction

contemplated at that point was a merger-of-equals transaction in which the combined company

would retain the Wachovia name and Mr. Baker would act as Chief Executive Officer of that

company for two years. On December 2, 2000, Mr. Truslow and Mr. Robinett, senior

management officials at Wachovia, met with John Speigel, SunTrust's Executive Vice President

and Chief Financial Officer, to formulate a schedule for the parties' due diligence reviews and a

general timeline for the contemplated transaction, to discuss the engagement of financial advisors

and to outline substantive business issues to be discussed at future meetings.

{98} On December 9, 2000, Wachovia and SunTrust signed a confidentiality agreement. In

addition, on that date various senior executives of Wachovia and SunTrust, including Messrs.

McCoy, Truslow and Speigel and Mr. Theodore Hoepner, Vice Chairman of SunTrust, together

with representatives from Wachovia's financial advisor, Credit Suisse First Boston, and

SunTrust's financial advisor, Morgan Stanley, met to discuss credit and financial due diligence

issues, to engage in preliminary discussions relating to material terms of the transaction, including

the basis for arriving at an exchange ratio, and to further discuss a potential timeline for arriving

at a definitive agreement.

{99} The draft merger agreement provided that Mr. Baker would be Chairman, CEO and President

of the combined entity. The parties also reached tentative agreement on the exchange ratio (1.03),

the name of the merged entity (Wachovia), the composition of the new board (50/50

Wachovia/SunTrust), and the location of the headquarters (Atlanta) among other factors. The

proposed merger agreement had “deal protection” devices, including reciprocal options allowing

SunTrust or Wachovia to purchase 19.9% of the other’s stock in the event of a merger with a third

party. There was no cap on that option at that time. The option could be triggered during the 18

months after the merger agreement was terminated. Negotiations were far enough along that both
boards scheduled meetings for December 15, 2000, at which time a merger would have been

approved.

{100} Simply stated, Wachovia management got cold feet about the merger. It is fair to say that

they thought there were going to be integration problems and that the merger might not turn out to

be a true merger of equals. The articulated concerns included a difference in approach to the

wealth management business and general structure. Wachovia had a centralized line of business

approach. SunTrust had a decentralized, geographic approach. Other problems surfaced in the

area of technology. Wachovia said it was not able to investigate SunTrust’s technology and thus

could not judge its quality. Some Wachovia directors considered a strong technology program

crucial. Wachovia’s management also expressed concern about emerging negative trends in

SunTrust’s core earnings, limited potential for future growth and the effect of SunTrust’s

investment in Coca-Cola stock, among other factors. SunTrust management believed the

problems had been addressed.

{101} On December 13, Wachovia’s management team met with the Executive Committee, and

recommended against the merger for structural issues. Management did not believe further

negotiations would solve the issues. The Executive Committee agreed to end discussions. Mr.

Baker called Mr. Humann on the morning of December 14 and cancelled further due diligence.

{102} In a telephone call with Wachovia's directors following that termination, Mr. Baker and other

members of Wachovia's executive management briefed the directors on the results of these

discussions with SunTrust (including the major structural transaction terms that had been

under discussion) and the reasons for the termination of those discussions. There were no minutes

taken of this conference call. Mr. Baker cancelled the board meeting scheduled to take place the

next day. The Wachovia directors were not shown the merger materials prepared by CSFB.

SunTrust was not informed that it was no longer considered a potential merger partner.

{103} The Wachovia Board held a board meeting on January 26, 2001. On January 25 there was a

“working dinner” devoted to the progress on the strategic plan. This included further talks about
the failed SunTrust discussions. Materials were presented to the directors. Management further

elaborated on what had happened.

{104} During late 2000 and early 2001, Messrs. Baker and Thompson had further discussions

regarding the concept and structure of a possible merger between First Union and Wachovia. On

several occasions during March 2001, Messrs. Baker and Thompson held meetings and

conversations to discuss a possible business combination.

{105} On April 8, preliminary credit due diligence began between Wachovia and First Union. On

April 9, 2001, Messrs. Thompson and Baker authorized senior management and the heads of

their major business lines to engage in more extensive due diligence and authorized their legal

counsel and financial advisors to begin to negotiate the specific terms of a merger-of-equals

transaction between the parties. On April 9, First Union and Wachovia signed a reciprocal

confidentiality agreement and on April 10, the companies commenced extensive due diligence

reviews of each other's operations. Representatives of First Union and Wachovia's financial

advisors and legal counsel also began meetings and discussions on April 10. Negotiations of the

specific terms of the transactions, including the exchange ratio, and the merger agreement, stock

option agreements and other documents, occurred throughout the period from April 10 through

April 15.

{106} First Union’s board met on April 12 to consider the proposal giving preliminary support for

the proposed merger. Among the key terms in their proposal was an exchange rate of 1.9 First

Union shares for each Wachovia share. For deal protection, they proposed several terms,

including a termination fee of $375 million; a “no talk/no shop” covenant and a joint venture to

which First Union and Wachovia would each contribute their “crown jewel” wealth and asset

management businesses. If the deal was broken up by a successful competing bidder for

Wachovia, First Union would gain control of these assets, which would then include the

competing bidder’s wealth and asset management businesses. When Wachovia’s management

and advisors told First Union that Wachovia’s Board was unlikely to accept these terms, First

Union proposed a form of blocking preferred stock as an alternative to the crown jewel joint
venture. The deal protection measures also contained a non-termination provision. Wachovia

objected to its inclusion.

{107} The Wachovia Board held a meeting on April 13 to begin deliberating the proposed business

combination. Messrs. Baker and McCoy discussed the structure and terms of the merger as

proposed to date, as well as the status of negotiations, the strategic reasons, potential benefits,

possible risks and other matters relating to the proposed merger. A review of due

diligence matters regarding First Union was presented to the board, which included presentations

by Messrs. McCoy, Robinett and Truslow, as well as the heads of Wachovia's technology, retail

banking, corporate banking, asset management, legal and human resources departments. The

individuals presenting the due diligence matters also responded to questions from the board.

CSFB discussed with the board its financial analyses relating to the proposed First Union merger.

Wachovia's general counsel, Kenneth McAllister, and lawyers from the firm of Simpson Thatcher

& Bartlett discussed with the Wachovia Board its fiduciary duties and the terms of the proposed

merger agreement as well as various proposed related agreements. Wachovia's legal and financial

advisors also responded to questions from directors. Following these presentations, the board

discussed the proposed terms at length. Some board members believed the exchange rate was too

low. Other directors said that they wanted more protection for Wachovia’s shareholders on their

dividends. And the directors objected to the deal protection provisions proposed by First Union.

{108} At the conclusion of this meeting, Wachovia's board authorized its senior management to

continue negotiating the terms of the definitive merger agreement and related agreements,

including reciprocal stock option agreements or similar deal protection measures proposed by

First Union, for presentation to the board for further consideration on April 15, 2001. On

Saturday, April 14, 2001, F. Duane Akerman, one of Wachovia’s outside directors, called Mr.

Baker and told him he could not support the merger unless the exchange ratio was improved.

{109} On April 14 and 15, the parties and their legal and financial advisors continued negotiating the

terms of the merger agreement and related agreements, including the exchange ratio and various

deal protection measures proposed by First Union. During this period Messrs. Thompson and
Baker responded to questions and comments from individual members of their respective boards

and advised them on the status and progress of discussions between the representatives of the two

companies. The negotiations were at arms-length and, at times tense.

{110} In response to Wachovia’s rejection of First Union’s deal protection measures, First Union

proposed the possibility of a capless option. Wachovia insisted on a cap to the option and a

fiduciary exception to the “no shop” covenant. Wachovia wanted the non-termination provision

eliminated. First Union increased its proposed exchange ratio to 2 to 1 and agreed to issue a

special $ 0.48 per share dividend. In addition, First Union agreed to provide Wachovia with its

requested “fiduciary exception” to the no-shop covenant. These concessions, however, were

contingent upon First Union receiving satisfactory deal protection. The parties agreed on

reciprocal stock options. Each of the options is exercisable if the deal is broken up by a

competing bidder and a merger with a third party occurs. The option is triggered by a takeover of

the option issuer within 18 months after the merger agreement was terminated. The option has a

double, not single, trigger.

{111} First Union also insisted that the options contain two provisions not found in prior deals: (1) a

doubling provision in the standard substitute option provision, allowing the option holder to buy

shares of the company that acquired the option issuer representing twice the value that otherwise

could be purchased—but subject to the option profit cap, and (2) a provision permitting the

options to be exercised for property with a fair market value equal to the exercise price. First

Union also insisted on retaining the non-termination provision.

{112} Also on April 14, Mr. Baker and Mr. McCoy each received calls from their counterparts at

SunTrust, Messrs. Humann and Spiegel, reporting that SunTrust had become aware of rumors that

Wachovia was considering a merger with First Union. Messrs. Baker and McCoy were prohibited

by the terms of the confidentiality agreement between First Union and Wachovia from

disclosing, among other things, the existence of the First Union merger discussions to SunTrust

and accordingly did not confirm the rumors. Messrs. Humann and Spiegel each indicated that
SunTrust remained interested in discussing a potential business combination with Wachovia. Mr.

Baker did not invite an offer.

{113} At First Union's board meeting on April 15, the board received a description of the final

proposed terms of the merger agreement and related agreements. The board unanimously adopted

the merger agreement and the plan of merger, the stock option agreements, Mr.

Baker's employment agreement and the amendments to First Union's articles of incorporation and

by-laws and resolved to recommend that its shareholders vote to approve the plan of merger

contained in the merger agreement.

{114} On April 15, the Wachovia Board reconvened by telephone. Management presented the new

merger proposal, including the higher exchange ratio and the special dividend. The overall

benefit to Wachovia’s shareholders of these changes was over $750 million. CSFB advised the

board that in its opinion the exchange ratio was fair from a financial viewpoint to Wachovia’s

shareholders.

{115} The proposed deal protection measures were discussed. The legal and financial advisors

described the options. The advisors then said it was not possible to tell exactly how much each

option would cost if exercised, because that would fluctuate based upon share prices. But they

could state categorically that the maximum profit could not exceed the $780 million cap.

{116} In exchange for the options First Union had agreed to give up on the crown jewel joint venture

or the blocking preferred stock. First Union also had agreed to include a “fiduciary exception”

provision allowing Wachovia’s directors to negotiate with an offeror who made a superior offer

before the shareholder vote. The non-termination clause remained.

{117} Mr. Baker and Mr. McCoy reported on their telephone calls from Mr. Humann and Mr.

Spiegel. After the proposed merger discussions Morris Offit, an inside Wachovia director, moved

that the merger be approved. His motion was seconded. It passed unanimously. The board, by

the same unanimous vote resolved to recommend that its shareholders vote to approve the plan of

merger contained in the merger agreement. The one Wachovia director who was absent from this
meeting later indicated his concurrence with the board's actions and, at the May 22 meeting

discussed below, voted to reaffirm the First Union merger agreement.

{118} First Union and Wachovia executed the merger agreement and stock option agreements in the

evening of April 15 following completion of the meetings of the boards of directors. Early the

following morning, First Union and Wachovia issued a joint press release announcing the

proposed First Union/Wachovia merger. The agreement is non terminable until January 16, 2002

whether or not the Wachovia shareholders vote in favor of the merger. The stock option

agreement provides that if two triggering events occur, including a Wachovia merger with another

partner, First Union has the right to buy Wachovia stock at a set price.

{119} On May 14, 2001, SunTrust publicly announced its unsolicited proposal to acquire Wachovia.

At the same time, SunTrust sent a letter to the Wachovia Board concerning its proposal and

announced that it would be soliciting proxies in opposition to the merger between First Union and

Wachovia. SunTrust’s hostile bid is subject to a number of conditions, including its satisfactory

completion of due diligence. SunTrust has conceded that as part of its proposal, it is willing to

pay the “in the money” value of the option, up to $780 million.

{120} On May 21, 2001, First Union's board approved, and First Union subsequently proposed

to Wachovia, an amendment to the merger agreement that would provide Wachovia shareholders

with an option to receive, in addition to the First Union common stock: (1) a one-time cash

payment of $0.48 per share of Wachovia common stock as had been previously agreed or (2) two

DEPs for each share of Wachovia common stock.

{121} On May 22, 2001, the Wachovia Board met with its advisors to discuss and consider

SunTrust's unsolicited proposal and the proposed change to the merger agreement. At that

meeting Morris Offit criticized Wachovia’s management and Mr. Baker in particular. He

questioned whether Mr. Baker had told the directors all the facts about the discussions with

SunTrust in December 2000. He also questioned whether proper procedures of corporate

governance had been followed. The week before, Mr. Offit had been communicating with

SunTrust. He called William Weiant, a managing director at Morgan Stanley and the most senior
member of the SunTrust advisory team. Thereafter, he spoke with Mr. Weiant and his colleague,

Jonathan Pruzan.

{122} Other directors did not agree with Mr. Offit.134 The board voted to affirm the First Union

merger and to reject the SunTrust offer with only Mr. Offit dissenting.

{123} First Union sued SunTrust in North Carolina state court for an order upholding the validity of

the stock option agreements, among other things. On May 23, 2001, SunTrust filed a lawsuit in

Georgia state court alleging that the stock option agreements between First Union and Wachovia

contained certain excessive provisions, particularly in relation to the cap on the total profit that

may be obtained upon exercise of the option. On that same day, Wachovia joined in the lawsuit

brought by First Union.

{124} On May 29, 2001, First Union and Wachovia modified the option agreements in three ways.

First, they explicitly reaffirmed that the option profit was capped at $780 million under all

conditions. Second, they changed the payment provision to allow only cash or debt securities or

preferred stock with a market value agreed upon by both parties’ investment bankers. In doing

so, they eliminated a substantial degree of uncertainty for the shareholders. Third, they made a

technical correction to the formula for calculating the exercise price of a “substitute option.”

Because of changes in Wachovia’s stock price, these provisions of the “substitute option” are now

irrelevant.

{125} The executive committee of Wachovia’s board approved these changes on behalf of

Wachovia. First Union’s board approved the changes on behalf of First Union.

{126} The First Union shareholders meeting will be held on July 31, 2001. Wachovia’s

shareholders will vote on August 3, 2001. A majority of the outstanding voting shares is required

to approve the merger on behalf of Wachovia and First Union.

{127} On June 4, 2001, SunTrust proposed an amendment to Wachovia's by-laws that would permit

holders of 10% or more of Wachovia's outstanding shares to require Wachovia to call a special

shareholder meeting. SunTrust stated that if Wachovia shareholders approve the by-law

amendment and do not approve the merger with First Union at Wachovia's shareholders meeting
on August 3, 2001, and subsequently the Wachovia Board does not enter into merger discussions

with SunTrust, SunTrust would seek to call a special meeting to increase the size of Wachovia's

board and elect directors whom we expect would pursue a merger with SunTrust.

{128} First Union and Wachovia advocated with the North Carolina Legislature for an amendment

to the North Carolina Business Corporation Act that requires provisions relating to special

meetings called by shareholders to be in a corporation's articles of incorporation and not the by-

laws. Without the board’s prior approval, the shareholders cannot adopt amendments to a

corporation’s articles of incorporation. The amendment was approved by the North Carolina

Legislature and was signed into law on June 14. On June 15, Wachovia informed SunTrust that

its proposed by-law amendment would be invalid.

{129} The SEC approved the proxy statements of Wachovia, First Union and SunTrust in the last

week of June. They were mailed out to shareholders by the beginning of July. There is a

vigorous and hotly contested proxy fight and public relations war ongoing, which insures that the

shareholders will have full and complete information when they vote.

V.

A.
{130} Having reviewed the facts, the Court must apply the review process to them. The non-

termination provision and option agreement will be analyzed separately. The review process

begins with a determination of the Wachovia directors’ compliance with their statutory duties

under N.C.G.S. § 55-8-30. In summary, the statute requires the directors to make decisions in

good faith and with the care an ordinarily prudent person would exercise under like

circumstances. Subsection (d) makes it clear that the standard of care does not differ in change of

control transactions, and by clear implication, mergers. The director must also act in a manner

which she reasonably believes is in the best interests of the corporation. The statute expressly

provides that directors may rely on advice from management, legal counsel, accountants,

investment bankers and other professionals in exercising their statutory powers to manage the

business of the corporation.
{131} Neither SunTrust nor the shareholder plaintiffs assert that the Wachovia directors were not

acting in good faith or in the best interests of the corporation. Indeed, there is absolutely no

evidence of that on the record. The attack is directed to the due care requirement, specifically the

duty to be informed.

{132} Thus, as an initial review, the actions of the Wachovia Board pass Chancellor Allen’s footnote

56 test.135 There is no evidence in this record that any of the thirteen outside independent directors

had any personal interests or bias in favor of First Union or against SunTrust. Their selection of

First Union as a merger partner was consistent with a thoroughly studied and well-conceived

business strategy which had been approved by the directors well in advance of the merger

decision. It was not reactive to any perceived threat and not intended to block SunTrust or any

other suitor; rather, it was a proactive measure intended by the directors to enhance Wachovia’s

long-term value.

{133} The SunTrust attack on the duty of care exercised by the Wachovia Board is aimed at two

levels. On a broader view, SunTrust attempts to portray the Wachovia directors as mere lackeys

of Mr. Baker: uniformed, subservient, dysfunctional, consistent in their ignorance, complacent,

apathetic and of limited knowledge. In support of its position, SunTrust cites the deposition

testimony of Mr. Offit who said that he believed the board was inadequately informed by Mr.

Baker, and that the board had limited knowledge of the operations of financial institutions. On the

other hand, the record in this case establishes that this was an informed, independent, fully

functional, intelligent, engaged and knowledgeable board. Thirteen of the fifteen directors are

independent. They include ten current or retired chief executive officers or presidents of major

corporations, an executive vice president of Time, Inc. and two university presidents, one of

whom had experience on other bank boards. They brought a wide range of experience and depth

of knowledge to their positions. Several had extensive experience with mergers and acquisitions.

They met regularly and insured that Wachovia had developed a long-term strategy for its

business. The members of the Executive Committee were knowledgeable businessmen and fully

competent to fulfill the duties assigned to them. The fact that an executive committee functioned
as a liaison between management and the full board is not unusual or demonstrative of any lack of

care on the part of the directors. It is in many respects standard operating procedure, given the

burdensome duties currently imposed on directors of major corporations. Most of these directors

held demanding fulltime positions of their own. From this record it is clear that SunTrust

executives operated with just as much independence as Wachovia’s management. Mr. Baker’s

discussions with SunTrust and First Union were not his independent decision. They were direct

results of the strategic plan approved by the Wachovia Board in October of 2000. SunTrust’s

broadside attack on the functionality of the Wachovia Board is not supported by the record.

{134} On a narrower plane, SunTrust asserts that the directors were not sufficiently informed with

respect to the deal protection measures in this transaction. This determination is governed by the

statutory direction that directors act as an ordinarily prudent person under like circumstances. It

does not require the directors to have professional expertise in law and accounting. In fact, the

statute specifically authorizes directors to rely on other professionals for advice on those matters.

{135} The record in this case establishes that the Wachovia Board met on April 13, 2001 to consider

the First Union merger proposal. Prior to this meeting two significant actions had occurred. First,

the concept of a merger with First Union had been explored as a part of the board’s overall

strategic planning and had been identified as a transaction that might enhance shareholder value.

Thus it came as no surprise that the board would be asked to consider a merger and the board

started out with a knowledge base gained from its strategic planning. Second, the board had also

considered a merger with SunTrust in connection with its strategic planning. It knew from its

meetings in January 2001 that the management of Wachovia had held extensive negotiations with

SunTrust in December and that management had concluded that there were integration problems

associated with a SunTrust transaction. While SunTrust does and has vigorously disagreed with

Wachovia management’s assessment of those fit and integration questions, the Wachovia Board

could and naturally would rely on the assessment of its own management on those issues unless

they knew of some reason that reliance would be unreasonable. There is no evidence of any such

reason in this record. There is no question that SunTrust was still interested in a merger and the
Wachovia Board was aware of that. There was no indication that SunTrust would make any

hostile move toward Wachovia. All previous discussions had been on the basis of a friendly

merger. Hostile takeovers are not common in the banking industry. Wachovia’s deliberately

adopted strategy called for it to remain independent unless an attractive merger with First Union

or SunTrust presented itself. SunTrust was out of the picture from the board’s perspective. Thus,

on April 13 when the First Union merger came to the board for review and approval for

submission to the shareholders, the board’s attention was properly focused on the merger with

First Union, not on putting the company up for bid, sale or auction. It was under no duty to

structure its merger proposal with First Union to permit an interloping bid from SunTrust. To do

so would have run directly counter to the business judgment it had made to merge with First

Union or remain independent. Its obligation was to complete its business strategy and submit a

proposal to its shareholders for a vote.

{136} It is clear that the Wachovia Board did not simply adopt the proposal presented to it. It

received full and complete reports and advice from investment bankers, lawyers, and

management. It rejected the deal protection measures counsel had labeled “toxic” and instructed

management to negotiate different and acceptable deal protection measures. It also required a

better financial deal for Wachovia shareholders even though the transaction was characterized as

a merger of equals. The Wachovia Board was fully attentive to its duties at the April 13 meeting

and each director present exercised the care of an ordinarily prudent person under like

circumstances.

{137} When the Wachovia Board reconvened on Sunday April 15 by telephone conference it was

presented with a revised agreement that provided $750 million more in benefits to the Wachovia

shareholders. Since it was Sunday, and it was a telephone conference, the directors did not have

the written merger documents in front of them. They were told that the previous toxic deal

protection devices had been replaced by a cross option agreement which contained a $780 million

cap on the benefit First Union or Wachovia could obtain in the event the terms of the option

agreement ever became operable. There is no doubt that each and every director understood that
there was a possibility that activation of the option agreement could result in a $780 million dollar

breakup fee being paid to one of the parties and that that breakup fee was an amount that a would-

be interloper could have to absorb in order to break up the Wachovia/First Union merger. They

were told it was a high number, but not preclusive or coercive. In addition, the directors were told

that all the deal protective measures were lawful and not coercive. The directors’ reliance on that

advice was reasonable.

{138} The directors were also told that Mr. Baker and Mr. McCoy had received phone calls from

SunTrust executives inquiring about the rumors that a First Union/Wachovia merger was being

negotiated. No doubt the directors understood that SunTrust was still interested in a merger. That

option had been explored. The directors were under no obligation to pursue a merger with

SunTrust at that time. They had made a business judgment to merge with First Union.

{139} How then could an issue arise over the directors’ duty of care? The controversy arises out of

the addition of the single word “twice” in one sentence of an obscure subparagraph in the option

agreement dealing not with the options, but with “substitute options.”

{140} Paragraph 8 of the Stock Option Agreement covers the “Substitute Option.” Subparagraph

8(d) provides: “The Substitute Option shall be exercisable for such number of shares of Substitute

Common Stock as is equal to the Assigned Value multiplied by twice the number of shares of

Common Stock for which the Option was exercisable immediately prior to the event described in

the first sentence of Section 8(a).” The Court will attempt to simplify the legal terminology by

example to demonstrate the impact of the insertion of the twice multiplier. Under the option

agreement, if SunTrust were to acquire Wachovia in a merger, First Union would have the right

(option) to buy a number of shares of Wachovia stock equal to 19.9 percent of Wachovia’s

outstanding common stock. The price is discounted so that First Union would make a profit when

it exercised its option and sold the Wachovia shares after the merger. The total profit would equal

the number of shares it purchased times the per share profit. The agreement caps that profit at

$780 million and the directors understood that cap. If the price SunTrust offered was not high

enough to reach the cap based upon the allowable number of option shares, First Union’s profit
(the breakup fee) would be less than $780 million. So far, the provisions are not novel. The option

agreement went on to provide that instead of buying Wachovia shares, First Union could buy

shares of the new merged company. That is not novel. The cap remains the same. The twist came

when the word “twice”

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/11057402. Public record. Not legal advice.