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Wading into the midst of a battle for control of a digital-music distribution company, the Delaware Supreme Court has killed a plan to pack the corporation’s board with directors friendly to the incumbent management. More than 50 percent of the nation’s publicly traded companies are incorporated under Delaware law. The decision sharpens some of the rules for fending off stockholder insurgencies in those corporations, experts in the field said. The board-packing plan would have diluted an attempt by a New York holding company to gain influence through election of its slate of directors. MM Cos. Inc. v. Liquid Audio Inc., C.A. No. 19869-NC. When it became apparent in August 2002 that MM’s two-director slate would likely be elected to Liquid Audio’s five-seat board, the five incumbent directors voted to expand the board to seven members by appointing two allies. All five incumbents, plus the allies, were named as defendants. The court said that the incumbent board’s decision to appoint the allies — while permissible under the company bylaws — was invalid in practice. Reversing a chancery court decision upholding the action, the high court said, “[t]hat defensive action by the director defendants compromised the essential role of corporate democracy in maintaining the proper allocation of power between the shareholders and the Board, because that action was taken in the context of a contested election for successor directors.” Key to the Delaware Supreme Court’s ruling were two prior state court decisions: its own 1985 ruling in Unocal Corp. v. Mesa Petroleum and the Chancery Court’s 1988 decision in Blasius Industries v. Atlas Corp. The Blasius court said that judicial review under the traditional, and deferential, business-judgment rule is inappropriate when a board acts for the primary purpose of interfering with a shareholder vote. Three years earlier, the high court in Unocal had said that in order to warrant business-judgment-rule deference, a defensive action had to be “reasonable in relation to the threat posed.” MM’s attorney, Michael J. Maimone of Wilmington, Del.’s Gordon Fornaris and Mammarella, said that before the Liquid Audio ruling, the Delaware Supreme Court had never applied Blasius where the control of a corporation was not immediately at stake. He added that in doing so, the court actually expanded the doctrines of both Blasius and Unocal. Attorney Scott A. Edelman, a partner in New York’s Milbank, Tweed, Hadley & McCloy, who argued the case for Liquid Audio, declined to comment. Wake Forest University law professor Alan Palmiter teaches Blasius to his corporate law students. He called the Liquid Audio decision “a clear and authoritative endorsement of the Blasius methodology.” Palmiter said that the ruling tips the balance of power in battles over the composition of a board of directors in favor of the insurgents and away from the defenders. He also said that he and his writing colleagues are rushing to add it to their corporation law textbook. Kevin R. Sweeney, a partner in Kansas City, Mo.’s Shook, Hardy & Bacon and an adjunct professor of corporate law, said that a troubled corporation is more likely to feel the effects of the Liquid Audio ruling than one that is well managed and does not suffer from shareholder unrest. “ Unocal is still the overriding standard,” he said. “Any action that affects election of directors during a takeover contest is going to be highly suspect,” Sweeney said. “Don’t do it … and if you do do it, you’d better come up with a really good reason so you can argue that your primary purpose was not to interfere with an election.”

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