MM Companies, Inc. v. Liquid Audio, Inc., 813 A.2d 1118 (Del. 2003)
MM Companies v. Liquid Audio is a cornerstone Delaware Supreme Court decision that safeguards the shareholder franchise while clarifying how courts scrutinize director conduct taken during election contests.
When directors act during a proxy contest to expand the board and appoint new directors, thereby diluting the effectiveness of an imminent shareholder vote, what standard of review applies, and does such action violate the directors' fiduciary duties?
Director defensive measures are reviewed under Unocal enhanced scrutiny: the board must show (1) reasonable grounds for believing a threat to corporate policy and effectiveness exists, based on good faith and reasonable investigation, and (2) that the response is reasonable and proportionate to the threat (i.e., not coercive or preclusive and falling within a range of reasonableness). Where board action has the primary purpose of interfering with or impeding the exercise of the shareholder franchise, Blasius applies as a specific, more exacting application of enhanced scrutiny, requiring the board to demonstrate a compelling justification for its action. Schnell's principle also applies: inequitable action does not become permissible simply because it is legally possible under the DGCL or corporate instruments.
Actions taken in the midst of a proxy contest that primarily interfere with the shareholder franchise must satisfy Blasius's compelling justification requirement in addition to Unocal. Liquid Audio's mid-contest expansion of the board and appointment of two directors lacked a compelling justification and therefore violated fiduciary duties. Other challenged measures that did not primarily impede the vote were properly analyzed under Unocal and sustained.
Liquid Audio is a leading modern articulation of how Unocal and Blasius interact. It cautions boards that while they retain broad statutory powers, those powers cannot be wielded to undermine the stockholder vote. The case protects the franchise by requiring a compelling justification when actions primarily impede an election, yet leaves room for reasonable, proportionate defensive measures. For law students, it is essential for understanding enhanced scrutiny, the limits of board authority during proxy contests, and the doctrinal synthesis that guides judicial review of entrenchment-related conduct.