MM Cos. v. Liquid Audio, Inc. - 813 A.2d 1118 (Del. 2003)

Rule:

The Blasius and Unocal standards of enhanced judicial review under Delaware case law are not mutually exclusive. In certain circumstances, a court must recognize the special import of protecting the shareholders' franchise within Unocal's requirement that any defensive measure be proportionate and reasonable in relation to the threat posed. A board's unilateral decision to adopt a defensive measure touching upon issues of control that purposefully disenfranchises its shareholders is strongly suspect under Unocal, and cannot be sustained without a compelling justification. Thus, the same circumstances must be extant before the Blasius compelling justification enhanced standard of judicial review is required to sustain a board's action either independently, in the absence of a hostile contest for control, or within the Unocal standard of review when the board's action is taken as a defensive measure. The compelling justification standard set forth in Blasius is applied independently or within the Unocal standard only where the primary purpose of the board's action is to interfere with or impede exercise of the shareholder franchise and the shareholders are not given a full and fair opportunity to vote effectively.

Facts:

On August 26, 2002, MM Companies, Inc. ("MM") filed its original complaint in this action in the Court of Chancery against Liquid Audio, Inc. ("Liquid Audio"), as well as Raymond A. Doig, Gerald W. Kearby, Robert G. Flynn, Stephen V. Imbler and Ann Winblad (the "Director Defendants"). The original complaint sought injunctive relief against the August 22, 2002 action taken by the board of directors of Liquid Audio ("Board") to expand from five to seven members, and the purported effects that expansion might have on Liquid Audio's 2002 annual meeting that was scheduled for September 26, 2002. MM alleged that the Director Defendants' decision to expand the Board violated the principles established by the decision of the Court of Chancery in Blasius and the decision of this Court in Unocal. At a scheduling conference on August 29, 2002, the Court of Chancery set October 21, 2002 as the date for trial. On September 26, 2002, Liquid Audio held its 2002 annual meeting at which MM's two nominees were elected as Class III directors replacing incumbent directors Doig and Kearby. On October 1, 2002, MM filed an amended complaint, once again seeking to invalidate the August 22, 2002 action by Liquid Audio's board of directors to expand the size of the Board from five to seven members and to appoint two new directors to those recently created vacancies. The amended complaint also alleged that the Director Defendants' decision to expand the Board violated the principles established by Blasius and Unocal. The Court of Chancery denied the injunctive relief holding that the Board expansion did not violate Delaware law under either Blasius or Unocal. The Court of Chancery rejected the plaintiff's independent Blasius claim on the basis that the addition of two new directors "did not impact the shareholder vote or the shareholder choices in any significant way." The Court of Chancery rejected the plaintiff's Unocal claim, on the basis that: plaintiff did "not contend that the board expansion was coercive," the expansion was not "preclusive," because the "choices that the shareholders had before the board action was taken were the same as they had after," and the plaintiff failed to make a showing that "the action that the board took falls outside a range of reasonable responses."

Issue:

Did the Court of Chancery err in ruling that the "compelling justification" standard, as enunciated in Blasius, was not applicable to the Board's action?

Answer:

Yes.

Conclusion:

The high court held that while, under the Unocal standard of Delaware corporate case law, a board's defensive actions were normally reviewed only for reasonableness and proportionality, where those defensive actions interfered with shareholders' voting rights, the applicable standard, under Delaware's Blasius rule, was that the board had to show a compelling justification. Since the trial court had not applied that stricter standard, further proceedings were required.