Appeal from the United States District Court for the Northern District of Illinois, Eastern Division, No. 86 C 1624, Susan Getzendanner, Judge.
Before BAUER, Chief Judge, and CUDAHY and POSNER, Circuit Judges.
This case involves a challenge under the corporate law of Indiana to a "poison pill," which is a device used by corporate managers to fend off hostile tender offers. The case is a sequel to Dynamics Corp. of America v. CTS Corp., 794 F.2d 250 (7th Cir. 1986). Although the Supreme Court has noted probable jurisdiction of the appeals by CTS and the State of Indiana from the part of the decision that invalidated on federal constitutional grounds an Indiana statute regulating takeovers, 479 U.S. 811, 107 S. Ct. 58, 93 L. Ed. 2d 17, 55 U.S.L.W. 3231 (Oct. 7, 1986), that part is not pertinent to this sequel.
On March 10 of this year Dynamics Corporation of America, which already owned 9.6 percent of the common stock of CTS Corporation, made a tender offer that if accepted would bring its stock holdings up to 27.5 percent. CTS's stock was trading at $36 a share (all dollar figures are rounded to the nearest dollar). The price in the tender offer was $43. On March 22, after very hurried consideration, CTS adopted a shareholders' rights plan of the kind known as a "poison pill." Under the plan, if and when one shareholder (namely Dynamics) obtained 15 percent of more of the company's common stock, every other shareholder would be entitled to buy a package of stock and debentures for 25 percent of the market price of the package. In April the district court issued a preliminary injunction against the poison pill. 637 F. Supp. 406 (N.D. Ill. 1986). We affirmed. The tender offer then went through, and Dynamics used its newly obtained 27.5 percent position in CTS to begin a proxy fight to oust CTS's existing board of directors.
Meanwhile CTS had responded to the district court's injunction by referring the question of further defensive measures to a committee of outside directors. After several days of intensive deliberation the committee returned to the full board with a recommendation that the company be sold and that pending sale a new poison pill be adopted under which, if any shareholder obtained 28 percent of the company's common stock, all the other shareholders would be entitled to turn in their shares and receive in exchange for each share a $50 debenture (bond), payable after one year, with interest at 10 percent per annum. The plan would remain in effect for one year but could be cancelled by the board of directors at any time. It would be cancelled automatically if anyone made a cash tender offer for all outstanding shares at a price of $50 or more.
The board adopted the plan on the same day we upheld the district court's preliminary injunction (April 23). At the time, CTS's stock was selling at $38 a share, but it rose to $45 the next day, when CTS announced that it had adopted the plan as part of a strategy for selling the company - through this was also the first day after we affirmed the district court's preliminary injunction. Dynamics moved immediately to enjoin this second "poison pill," but on May 3 the district judge denied the motion, 635 F. Supp. 1174 (N.D. Ill. 1986), and she adhered to this decision on reconsideration following issuance of our opinion affirming the preliminary injunction against the first poison pill, 638 F. Supp. 802 (N.D. Ill 1986). Dynamics has appealed.
The election for the board of directors was held on May 16. CTS's board, which had campaigned on a platform of selling the company and had represented that the second poison pill was designed to maximize the price at which the company would be sold, won reelection by a narrow margin.
As noted in our previous opinion, citing earlier decisions of this court, "the task for a district judge asked to grant a preliminary injunction is to compare the irreparable harm to the plaintiff if the injunction is denied, weighted by the likelihood that the denial would be erroneous because the plaintiff will prevail in the plenary trial, with the irreparable harm to the defendant if the injunction is granted, weighted by the likelihood that the grant would be erroneous because the defendant, not the plaintiff, will prevail in the trial." 794 F.2d at 252. This "sliding scale" approach implies that if, so far as it is possible to determine, the irreparable harm that the plaintiff is likely to suffer from denial of the preliminary injunction is equal to that which the defendant is likely to suffer if the injunction is granted, likelihood of success on the merits becomes decisive, and the question is simply: who is likelier to win the case when and if it is tried on the merits - the plaintiff or the defendant? Id.
Our previous opinion noted that the irreparable harms from granting or denying the preliminary injunction appeared to be in equipoise in this case, so that analysis would have to focus on the likelihood that Dynamics would prevail on the merits if its suit to invalidate the poison pill was tried. After pointing out that the controlling law was that of Indiana and that in matters of corporation law the Indiana courts normally take their cue from the Delaware courts, which are more experienced in such matters, we observed that while the board of directors of a corporation that is a target or potential target of hostile tender offers has the power to adopt a poison pill, the particular poison pill it adopts must be reasonably related to the goal of shareholder wealth maximization. Since, moreover, there is a potential conflict of interest between the managers and shareholders of the target, courts are not simply to rubber stamp the board's judgment but must review it carefully to make sure that in adopting the poison pill the board really was acting in the best interests of the corporation. See, e.g., Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954-55 (Del. 1985); AC Acquisitions Corp. v. Anderson, Clayton & Co., 519 A.2d 103, LEXIS pp. 10-11 (Del. Ch. 1986). In making this determination the court must consider the procedures leading up to the adoption of the poison pill and the terms of the poison pill. CTS's counsel acknowledged at the argument of the present appeal that the action of a board of directors in adopting a poison pill is subject to "enhanced scrutiny" by the courts, because of the potential conflict of interest between the board and the shareholders. In nevertheless and inconsistently insisting that the standard of judicial review is whether the board acted with gross negligence, counsel was misstating the test set forth in the Delaware decisions and in our previous opinion to govern review of poison pills.
The first poison pill that CTS adopted clearly flunked the test. The circumstances of its adoption indicated that the board's objective was to block Dynamics' tender offer regardless of the consequences for the welfare of CTS's shareholders. So did the terms of that poison pill. If Dynamics completed its tender offer the pill would be administered and Dynamics would find that its 27.5 percent ownership position had shrunk to 20.7 percent, the dilution being caused by the stock component of the pill. I would also find that it had incurred a capital loss in excess of $20 million, for the value of the company would be no greater as a result of the exercise of the rights conferred by the poison pill but Dynamics' share of the company would be smaller. And CTS would be saddled with a heavy ($80 million) new long-term debt, for no value received.
This summary of our previous decision establishes the basic principles that guide our consideration of the present appeal. As we interpret the two opinions that the district judge wrote in explanation of her refusal to enjoin the second poison pill, the irreparable harms are again in equipoise, so that decision again must turn on an evaluation of the merits. In what appears to be the key passage in the opinions, the judge said that "while [Dynamics] has shown fair ground for litigation, its probability of success . . . is decidedly lower than was true in connection with the earlier rights plan, and . . . the balance of hardships does not weight sufficiently in [Dynamics'] favor to justify injunctive relief." 635 F. Supp. at 1177-78. Implicit in the "sliding scale" approach to deciding whether to grant a preliminary injunction is the proposition that even if the movant has a relatively small chance of prevailing at trial, he may still be entitled to the injunction if the irreparable harm to him from a denial would greatly exceed the irreparable harm to the defendant from a grant. The quoted language makes clear that the district judge did not think this such a case, and implies that she thought it a case where the irreparable harms were (as before) approximately equal. It is true that elsewhere she describes the irreparable harm to Dynamics as "slight." Id. at 1182. But she never says the irreparable harm to CTS would be great. And her statement that the harm to Dynamics would be slight appears to have been based on her expectation that Dynamics would win the proxy fight (then two weeks away) - in which event, controlling the board as it would, it could waive the poison pill at will. In fact Dynamics lost the proxy fight, and the balance of harms is therefore as before. In any event, the ground on which the district judge denied the preliminary injunction had nothing to do with the balance of harms; it was simply that she thought Dynamics unlikely to prevail at trial - unlikely, that is, to succeed in invalidating the second poison pill.
The scope of appellate review of a decision granting or denying a preliminary injunction depends on the ground of that decision. If it is based on a purely factual determination, we can reverse only if the determination is clearly erroneous; if on a purely legal determination, we can reverse if our view of the law is different from the district court's, for review of legal determinations is plenary. But if the decision is based on the balance of harms, or on that balance together with the likelihood of success on the merits (the likelihood operating to weight the balance in favor of plaintiff or defendant in accordance with the sliding scale approach), we can reverse only if persuaded that the district court abused its discretion, that is, was not merely incorrect but unreasonable. See e.g., Lawson Products, Inc. v. Avnet, Inc., 782 F.2d 1429, 1436-39 (7th Cir. 1986); Roland Machinery Co. v. Dresser Industries, Inc., 749 F.2d 380, 388-92 (7th Cir. 1984).
Where the balance of harms is equal and therefore drops out of the analysis - where the only issue is the plaintiff's likelihood of winning when the case is tried - the scope of appellate review is similar to that of final judgments. The two opinions the district judge wrote in connection with Dynamics' request for a preliminary injunction against the second poison pill contain a mixture of factual and legal determinations all feeding into her ultimate determination regarding the lawfulness of the pill. That determination is more tentative than if the case had been tried, because it is based on a less complete development of evidence than possible in a regular trial, but its ingredients are the same and - with issues of irreparable harm cancelled out - is a matter of finding facts and applying law, not of exercising discretion. In reviewing the decision, therefore, we must examine the procedures leading up to the adoption of the second poison pill and the terms of the pill, and, accepting all of the district judge's findings of fact that are not clearly erroneous, we must determine whether she was justified in concluding that the infirmities that had led her and us to invalidate the ...