Hanson Trust PLC v. ML SCM Acquisition Inc.

781 F.2d 264, 54 U.S.L.W. 2359, 1986 U.S. App. LEXIS 26714

• Court: Court of Appeals for the Second Circuit
• Decided: January 6, 1986
• Docket: Nos. 693, 726, Dockets 85-7951, 85-7953
• Status: Published

Opinions

PIERCE, Circuit Judge:

Hanson Trust PLC, HSCM Industries Inc., Hanson Holdings Netherlands B.V., and HMAC Investments Inc. (hereinafter sometimes referred to collectively as “Hanson”) appeal from an order, dated November 26, 1985, in the United States District Court for the Southern District of New York, Shirley Wohl Kram, Judge, denying their motion for a preliminary injunction restraining Merrill Lynch, Pierce, Fenner & Smith Incorporated and related entities, including ML SCM Acquisition Inc. (hereinafter “Merrill”), and SCM Corporation (hereinafter “SCM”), and their respective officers, agents and employees, and all persons acting in concert with them, from exercising or seeking to exercise an asset purchase option (hereinafter sometimes referred to as a “lock-up option”) pursuant to an Asset Option Agreement and a Merger Agreement between those corporate entities. Under those Agreements, in the event that by March 1, 1986, any third party acquires one third or more of SCM’s outstanding common stock or rights to acquire such stock, Merrill would have the right to purchase SCM’s Pigments and Consumer Foods Divisions for $350 million and $80 million, respectively. After an eight-day evidentiary hearing, the district court denied Hanson’s motion for a preliminary injunction, principally because it found that under New York law approval of the lockup option by the SCM directors (hereinafter sometimes referred to as the “Board”), and the lock-up option itself, were, in the exercise of business judgment, “part of a viable business strategy, as the law currently defines those terms,” and because “Hanson failed to adduce sufficient credible proof to the contrary.” Hanson Trust PLC v. SCM Corp., 623 F.Supp. 848, 859-60 (S.D.N.Y.1985) (hereinafter “Op.”). We reverse and remand.

BACKGROUND

This is the second suit arising out of an intense struggle for control of a large public corporation, SCM. In the first case, Hanson Trust PLC v. SCM Corp., 774 F.2d 47 (2d Cir.1985) (hereinafter referred to as “Hanson P), we held that Hanson’s termination of a $72 offer and nearly immediate purchases of several large blocks of stock amounting to approximately twenty-five per cent of the outstanding shares of SCM privately from five sophisticated institutional investors and in one open market transaction did not violate §§ 14(d)(1) and (6) of the Williams Act, 15 U.S.C. § 78n(d)(l) and (6) and rules promulgated by the Securities and Exchange Commission thereunder. In the present case, the issue presented is whether it was proper under New York law for SCM and Merrill to execute a lock-up option agreement as part of a $74 offer by Merrill for SCM common stock. In Hanson I, Judge Mansfield summarized the “fast-moving bidding contest” as follows: first, a $60 per share cash tender offer by Hanson, for any and all shares of SCM; next, a counter tender offer of $70, part cash and part debenture, by the SCM Board and their “white knight,” Merrill Lynch Capital Markets (with underwriting participation by Prudential Insurance Co.), for a “leveraged buyout” (hereinafter sometimes referred to as an “LBO”); then an increase by Hanson to $72 cash, conditioned on SCM not locking up corporate assets; then a revised $74 cash and debenture offer by SCM-Merrill, with “a ‘crown jewel’ irrevocable lock-up option to Merrill designed to discourage Hanson from seeking control by providing that if any other party (in this case Hanson) should acquire more than one-third of SCM’s outstanding shares (66% being needed under N.Y.Bus. Corp.L. § 903(a)(2) to effectuate a merger) Merrill would have the right to buy SCM’s two most profitable businesses” (Pigments and Consumer Foods) at $350 million and $80 million, respectively. Hanson I at 50-51. Hanson, evidently deterred by the option and faced with the $74 LBO offer, terminated its $72 offer, but made the September 11 purchases upheld in Hanson I, and later announced a $75 cash tender offer conditioned on the withdrawal or judicial invalidation of the subject lock-up options. A more detailed account of the rele-_v§nt background follows.

I SCM is a New York corporation with its 1 1 principal place of business in New York 1 City. It consists of several divisions, including Chemicals, Coatings and Resins, Paper Products, Foods, and Typewriters. Pigments, a subdivision of Chemicals, and Consumer Foods, a subdivision of Foods, referred to by Hanson as the “crown jewels” of the SCM Corporation, have generat-I ed approximately 50% of SCM’s net operating income in recent yearsT) SCM’s Board J oí Directors consists of twelve members. Three directors, Messrs. Elicker, Hall, and Harris, are also members of SCM’s management: Elicker is Chairman of the Board and Chief Executive Officer; Harris is SCM’s President and Chief Operating Officer; Hall is a Senior Vice President of SCM. The remaining nine members of the board are “outside” or “independent” directors. None of the nine holds a management position in SCM, owns significant amounts of SCM common stock, or receives any remuneration from SCM other than the standard directors’ fee. The district court also found that none is affiliated with any entity that does business with SCM and that all of the directors have considerable business experience and working knowledge of SCM and its operations. Op. at 853.

Hanson Trust PLC is a corporation organized under the laws of the United Kingdom. HSCM Industries Inc. is a Delaware corporation and an indirectly wholly owned subsidiary of Hanson Trust PLC. Hanson Holdings Netherlands B.Y. is a limited liability company incorporated under the laws of the Kingdom of the Netherlands, and is an indirectly wholly owned subsidiary of Hanson Trust PLC. HMAC Investments Inc. is also a Delaware corporation and is a wholly owned subsidiary of Hanson Trust PLC.

On August 21, 1985, Hanson announced its intention to make a $60 cash tender offer for any and all shares of SCM common stock. The evidence showed that SCM common stock traded below $50 per share in July 1985, and that between August 1 and August 19, Hanson had purchased over 87,000 shares for between approximately $54 and $56. See Offer to Purchase For Cash Any and All Outstanding Shares of Common Stock of SCM Corporation (Aug. 26,1985), PX 37 at II — l.¹ On August 22, 1985, the day after the Hanson offer was announced, the price of SCM stock closed on the New York Stock Exchange at 64V8.

It is not disputed that also on August 22 — three days prior to the SCM Board’s first meeting regarding Hanson’s offer— SCM management met with representatives of the investment banking firm of Goldman Sachs & Co. and the law firm of Wachtell, Lipton, Rosen & Katz to discuss a response to Hanson’s bid.² Tr. 27, 30; PX 1 at 31-33. Among the alternatives considered in response to Hanson’s offer was the possibility of a leveraged buyout that would include SCM management participation. Tr. 1119. By August 23 or 24, SCM management and Goldman Sachs had initiated discussions with the leveraged buyout firms of Kohlberg, Kravis, Roberts & Co. and Merrill Lynch. Tr. 30-33, 51, 1119-21, 1202-03. SCM’s Board met on August 25, and approved the retention of .Goldman Sachs and Wachtell Lipton on behalf of SCM and the SCM Board. PX 16 at 11.

The parties agree that the August 25 Board meeting was called to discuss alternatives to the Hanson offer; that discussions focused principally on finding either another public company to act as a “white knight” or one or more financial institutions to underwrite a leveraged buyout. Willard J. Overlock, Jr., SCM’s principal adviser at Goldman Sachs, advised that because SCM was a highly diversified conglomerate, finding another company to act as a “white knight” in time to defeat Hanson was unlikely. Martin Lipton of Wach-tell Lipton advised that a leveraged buyout might be the best approach, assuming SCM could find institutional or private investors. The minutes show that the Board delegated to management the responsibility of investigating both options with Goldman Sachs and Wachtell Lipton. During the next five days, Goldman Sachs and SCM management, pursuing the Board’s mandate, found that none of over forty companies contacted were willing to act as a “white knight,” and that of three LBO firms contacted, by August 80 only Merrill was interested in participating in a leveraged buyout. Meanwhile, Hanson’s $60 tender offer had become effective as of August 26, notwithstanding that the market price for SCM shares on that day was in the mid 60's. SCM did not respond to Hanson’s overtures for discussions.

Following five days of negotiations, SCM management and Goldman Sachs reached an LBO agreement with Merrill, pending approval of the SCM Board. Under the proposal, Merrill, through a corporate shell called ML SCM Acquisition Inc., would make a $70 cash tender offer for up to 10,500,000 SCM shares (approximately 85% of the outstanding shares), to be followed by a second step in which the remaining shareholders would either have to exchange their shares for “high risk, high yield” subordinated debentures (commonly called “junk bonds”) priced so as to be valued at $70 per share or resort to their appraisal rights under New York law. N.Y.Bus.Corp.L. § 623. Proportionately, the proposed buyout would be $59.50 per share in cash and $10.50 per share in to-be-newly-issued debentures. SCM management would have the right to purchase up to 15% of the resulting ML SCM Acquisition Inc.

Merrill, concerned that it be compensated for its work and that it not become a mere “stalking horse” in the looming battle between Hanson and SCM, insisted on some protective assurances that it would profit for its efforts whether or not they proved fruitful. Although SCM’s management would not accede to Merrill’s demand for stock options, it granted a $1.5 million engagement fee (the so-called “hello” fee), and a $9 million “break-up” fee (the so-called “goodbye” fee), the latter to be paid to Merrill in the event that any third party should acquire one third or more of the outstanding shares of SCM common stock for $62 or more per share prior to March 1, 1986. The obvious significance of a third party acquiring one third of the shares was that such acquisition would enable that party to “block” the planned merger of tendered shares into the new ML SCM Acquisition entity, since under New York law a merger requires the approval of “two thirds of the outstanding shares entitled to vote.” N.Y.Bus.Corp.L. § 903(a)(2).

On August 30, the SCM Management-Merrill LBO proposal was presented to the SCM Board via a telephonic conference call meeting. The terms of the proposal were reduced to a two-page Letter Agreement, which was described to the nine independent directors in detail, but which was not available for them to read until after they had unanimously voted to approve it and to authorize SCM management and Merrill to negotiate a definitive merger agreement. The three management directors did not vote. The meeting was conducted from SCM’s offices where SCM management, Goldman Sachs and Wachtell Lipton representatives, but not outside directors, were present.

The Merger Agreement was negotiated and drafted over Labor Day weekend, and presented to a special meeting of the Board of Directors on September 3. Overlock from Goldman Sachs explained to the Board that the proposal remained the only firm offer to counter Hanson’s still-outstanding $60 bid, and delivered Goldman Sach’s opinion that Merrill’s $70 bid was “fair” to SCM shareholders. Overlock further informed the Board that the $70 debentures would be priced by Goldman Sachs and Merrill (or, if they disagreed, by a third nationally recognized investment banker) to ensure that the debentures would have a market value of $70 per share at the time of their issuance. The SCM Board understood that some SCM officers, as yet unidentified, would participate in the LBO, and would obtain an equity position in the new entity of up to 15 percent. The three management directors, though present at the meeting, did not vote. Again, the nine outside directors unanimously approved the Agreement, which was subsequently publicly announced.

In response to this Agreement, on that same day, September 3, Hanson announced that it would raise the price of its tender offer to $72 all cash, for any and all shares of SCM’s common stock. Hanson conditioned this new offer on SCM’s refraining from “grant[ing] to a person or group proposing to acquire the Company ... any type of option, warrant or right which, in the sole judgment of [Hanson], constitutes a ‘lock-up’ device ... and ... makes it inadvisable to proceed with the Offer or with such acceptance for payment or payment.” Supplement Dated September 5, 1985 to Offer to Purchase Dated August 26, 1985, DX A A at 4. Upon making this offer, Hanson again made unsuccessful overtures to SCM to discuss a “friendly” takeover. Tr. 783-84.

On September 6, Merrill and SCM management announced termination of the $70 offer under the broad authority that the Board had given to management to take all “necessary and advisable” actions regarding the offer. Negotiations between Merrill and SCM management for a second LBO-Merger Agreement resumed, and on September 10, the parties prepared a new proposal for the SCM Board. Merrill proposed to make a $74 cash tender offer for a minimum of two-thirds on a fully diluted basis and up to 80 percent (as opposed to the earlier 85%) of SCM’s common stock. This would be followed by a second-step merger in which each of the remaining 20% of the shares of SCM common stock would be exchanged for a high risk, high yield debenture, subordinated to other corporate debt and not accruing interest for five years, valued at $74. Given the greater proportion of debenture financing in this offer as compared to Merrill’s earlier $70 offer, the effective cash component of the new offer on a proportionate basis was $59.20 per share, or thirty cents less per share than under the $70 offer, and the effective debenture component overall was $14.80 per share, or $4.30 more per share than under the $70 offer. The net result was that under the $74 offer Merrill was not putting up any more cash than it was under the $70 offer.

As consideration for this new offer, SCM agreed to place the $9 million break-up fee into an escrow account, payable should a third party acquire one third of SCM stock, paid Merrill an additional $6 million “hello again” fee, and, most importantly, proposed to grant Merrill an option to purchase SCM’s Pigments and Consumer Foods businesses.³ Tr. 1033, 1254. Merrill also sought stock options for 18V2% of SCM’s stock, but SCM refused that request.

Under the proposed asset option provision, Merrill would have the irrevocable right to purchase SCM’s Pigments business for $350,000,000, and SCM’s Durkee Famous Foods (sometimes referred to herein as “Consumer Foods”) for $80,000,000, in the event that a third party acquired more than one third of SCM’s common stock.⁴ The district court found that Merrill had made clear that it would not proceed without the asset options, and that the lock-up option prices were the product of “arm’s length negotiations” between Goldman Sachs and Merrill. Op. at 853. There is evidence that Merrill initially proposed $260 million for Pigments and $65 to 70 million for Consumer Foods; that Goldman Sachs, negotiating on behalf of SCM, counterof-fered $400 million for Pigments and $90-95 million for Consumer Foods; and that the parties ultimately settled at $350 million for Pigments and $80 million for Consumer Foods. Tr. 1039-40, 1260-62.

On September 10, 1985, at the special meeting of the Board, the nine independent directors for the first time were, informed of and considered the new LBO merger agreement and the proposed lock-up options. The meeting began at nine o’clock in the evening, and lasted approximately three hours. Goldman Sachs advised the Board that the $74 offer was the best available, and was fair to SCM shareholders. See Minutes of SCM Board of Directors Meeting (Sept. 10, 1985), PX 27 at 6. This opinion was later confirmed in a formal letter to the SCM Board. Tr. 1060-61. As to the Asset Option Agreement, Overlock advised the Board that the option prices were “within the range of fair value,” though he did not inform the Board as to what that range was.⁵ Overlock stated that he believed that SCM could obtain a higher price for each business if an orderly sale were conducted. PX 27 at 5-6. He also stated that “the current trading value” of Merrill’s $74 offer would be above $72 per share. Id. He testified that, giving effect just to the time value of money, the Merrill $74 LBO was in fact worth $1.25 to $1.50 more per share than the Hanson $72 cash offer, but it would trade at about $72.50 per share. Tr. 1179.

The testimony at the evidentiary hearing shows that Goldman Sachs never advised the Board, and the Board never asked, what the fair value of the two businesses was, or what the range of such value was. Tr. 922-25, 932, 1070-71. Further, Goldman Sachs had not calculated such values — and had not informed the Board that it had not made such calculations. Tr. 1071, 1169-70. Nor was there any discussion of the significance for SCM of selling these two businesses, which represent approximately one half of SCM’s present and projected operating income. No documents or pro forma financial statements were given out at the meeting, and none were requested. Tr. 910, 1177. None of the directors suggested postponing a decision on the lock-up option. Tr. 920. Nor did the Board suggest contacting Hanson to see if it might top the proposed $74 offer, including the lock-up option. Tr. 1065.

Martin Lipton advised the Board that in Wachtell Lipton’s opinion, the decision whether to approve the Asset Option Agreement was within the discretion of the Board’s business judgment. PX. 27 at 7-9. There was evidence that one director asked Merrill’s chief negotiator whether Merrill would proceed with its $74 proposal without the lock-up option. The negotiator responded that neither Merrill nor its partner, Prudential, would go forward without the asset option. After the three management directors left the room, SCM’s independent directors unanimously approved the Asset Option Agreement. The district court found that the directors “approved the lock-up options after concluding that they could not secure the $74 LBO offer without the options.” Op. at 854.

In response to Merrill’s new proposed tender offer, on September 11 Hanson announced the termination of its $72 all cash tender offer, which had been expressly conditioned upon SCM’s not granting a lock-up option. Within hours following this announcement, Hanson purchased approximately twenty-five percent of SCM’s common stock in transactions that this court upheld in Hanson I as not constituting a de facto tender offer in violation of the Williams Act. In the present action, the district court found that Hanson’s September 11 purchases triggered Merrill’s rights to exercise the lock-up option. Op. at 854. Following this court's decision in Hanson I on September 30, Hanson purchased an additional 545,000 shares of SCM stock between October 2 and October 4, bringing its aggregate holdings to some 37.4% on a primary basis and approximately 32.1% on a fully diluted basis.⁶

On October 8, after commencing the present suit in district court, Hanson announced its intention to make a $75 cash tender offer for any and all shares of SCM common stock, conditioned on the withdrawal or judicial invalidation of the lockup option,⁷ to commence on October 11. PX 200 at 15. On October 8, Merrill announced that it was exercising the lock-up option and on October 9 it announced that it had withdrawn the $9 million break-up fee from escrow for its own use. On October 10, the SCM Board approved an Exchange Offer whereby if both the Hanson and Merrill offers fail, all SCM shareholders could exchange each SCM share for $10 cash and $64 in a new series of SCM preferred stock. The offer was made for up to 8,254,000 shares, or two thirds of the outstanding shares on a fully diluted basis.

In the evidentiary hearings before the district court, the parties presented extensive evidence regarding not only the decision-making process of the SCM directors in approving the lock-up option but also the substantive fairness to SCM shareholders of the option and the option prices. This evidence included testimony by Overlock that, based on acceptable price-earnings ratios applied to Goldman Sachs’ own data, /the value of Pigments could be substantially higher than the option price agreed to by SCM for Pigments. There was also evidence that the Consumer Foods business was seriously undervalued in the Option Agreement. Notwithstanding the extensive evidence adduced from both sides as to the value of the optioned businesses, the district court declined to make findings regarding such evidence. Hanson appeals from the district court’s denial of the motion for a preliminary injunction.

DISCUSSION

In this second phase of litigation in this takeover dispute, we are asked to determine whether SCM’s Board of Directors’ approval of a lock-up option of substantial corporate assets is protected by the business judgment rule. More specifically, we are to consider whether the district court was correct in holding, as it did, that the appellants did not “make a strong showing that the directors somehow breached their fiduciary duties,” Op. at 857, such as to shift to the SCM directors the burden of justifying the fairness of the lock-up option. We believe that the district court erred in holding that Hanson has failed to make a prima facie showing of a breach of a fiduciary duty; we also believe that, once the burden shifted, the extensive evidence presented during the eight-day evidentiary hearing clearly shows that, for preliminary injunction purposes, the appellees did not sustain their burden of justifying the fairness of the lock-up option.

I

To obtain a preliminary injunction, Hanson faces the formidable task of showing:

(a) irreparable harm and (b) either (1) likelihood of success on the merits or (2) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly toward the party requesting the preliminary relief. See Norlin Corp. v. Rooney, Pace Inc., 744 F.2d 255, 260 (2d Cir.1984); Jack Kahn Music Co., Inc. v. Baldwin Piano & Organ Co., 604 F.2d 755, 758 (2d Cir.1979).

We note at the outset that the district court properly recognized that a preliminary injunction is an extraordinary measure, particularly in a takeover context. As we noted in Hanson I:

... the preliminary injunction, which is one of the most drastic tools in the arsenal of judicial remedies, Medical Soc. of State of N.Y. v. Toia, 560 F.2d 535, 537 (2d Cir.1977) (“an extraordinary and drastic remedy which should not be routinely granted”), must be used with great care, lest the forces of the free market, which in the end should determine the merits of takeover disputes, [be] nullified.

Hanson I, 774 F.2d at 60.

Our standard of review is whether 1 the district court abused its discretion in denying the preliminary injunction, Coca-Cola v. Tropicana Products, Inc., 690 F.2d 312, 315 (2d Cir.1982) (remanding for issuance of preliminary injunction), i.e., whether it “relie[d] on clearly erroneous findings of fact or on an error of law in [not] issuing the injunction,” Hanson I, 774 F.2d at 54.

SCM is a New York corporation^ and no party disputes that the acts of its directors are to be considered in light of New York law. Under New York corporation law, a director’s obligation to a corporation and its shareholders includes a duty of care in the execution of directorial responsibilities. Under the duty of care, a director, as a corporate fiduciary, in the discharge of his responsibilities must use' at least that degree of diligence that an “ordinarily prudent” person under similar circumstances would use. See N.Y.Bus. Corp.L. § 717. In evaluating this duty, New York courts adhere to the business judgment rule, which “bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes.” Auerbach v. Bennett, 47 N.Y.2d 619, 629, 419 N.Y.S.2d 920, 926, 393 N.E.2d 994, 1000 (1979); see also Pollitz v. Wabash R.R. Co., 207 N.Y. 113, 124, 100 N.E. 721, 724 (1912).

Thus, in duty of care analysis, a presumption of propriety inures to the benefit of directors; absent a prima facie showing to the contrary, directors enjoy “wide latitude in devising strategies to resist unfriendly [takeover] advances” under the business judgment rule. See Norlin, 744 F.2d at 264-65 (citing Treadway v. Care Corp., 638 F.2d 357, 380-84 (2d Cir.1980); Crouse-Hinds Co. v. Internorth, Inc., 634 F.2d 690, 701-04 (2d Cir.1980)). However, even if a board concludes that a takeover attempt is not in the best interests of the company, it does not hold a blank check to use all possible strategies to forestall the acquisition moves. Norlin, 744 F.2d at 265-66.

Although in other jurisdictions, directors may not enjoy the same presumptions per the business judgment rule, at least in a takeover context, see, e.g., Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954-55 (Del.Sup.1985) (initial burden on directors in takeover context to show reasonable grounds for believing that takeover would endanger corporate policy; satisfied by directors’ showing good faith and reasonable investigation), under New York law, the initial burden of proving directors’ breach of fiduciary duty rests with the plaintiff. See Crouse-Hinds, 634 F.2d at 702; see also Auerbach, 419 N.Y.S.2d at 926-27, 393 N.E.2d at 1000-01.

In the present case, the challenged acts of the directors concern the grant of the lock-up option. This takeover defensive tactic is not per se illegal. See, e.g., Buffalo Forge Co. v. Ogden Corp., 717 F.2d 757 (2d.Cir.), cert. denied, 464 U.S. 1018, 104 S.Ct. 550, 78 L.Ed.2d 724 (1983) (validating a stock lock-up under the business judgment rule), but it may nonetheless be illegal in particular cases, see e.g., Data Probe, Inc. v. C.R.C. Information Systems, No. 92138-1983 (Sup.Ct.N.Y. Co. Dec. 11, 1984), reprinted in N.Y.L.J. Dec. 28, 1984 at 7, Col. 2. See also MacAndrews & Forbes Holdings, Inc. v. Revlon, Inc., 501 A.2d 1239, 1250 (Del.Ch.1985) aff'd, Nos. 353 & 354 (Del.Sup. Nov. 1, 1985) (noting that lock-up options are not per se illegal, but preliminarily enjoining asset option agreement as likely misapplication of directorial authority.) Further, in evaluating the acts of SCM’s directors in the present case, we remain mindful of our overriding concern in Hanson I that the role of the court in an action to enjoin takeover measures is to allow the forces of the free market to determine the outcome to the greatest extent possible within the bounds of the law. See Hanson I, 774 F.2d at 60. In this regard, we are especially mindful that some lock-up options may be beneficial to the shareholders, such as those that induce a bidder to compete for control of a corporation, while others may be harmful, such as those that effectively preclude bidders from competing with the optionee bidder. See Thompson v. Enstar Corp., Nos. 7641, 7643 at 7-13 (Del.Ch. June 20, 1984), at 7-13 revised, Aug. 16, 1984 (distinguishing options that attract or foreclose competing bids); see also Note, Lock-Up Options: Towards a State Law Standard, 96 Harv.L.Rev. 1068, 1076-82 (1983).

II

Under the circumstances presented in this case, the business judgment doctrine is misapplied when it is extended to provide protection to corporate board members where there is an abundance of evidence strongly suggesting breach of fiduciary duty, as we develop below. See generally, Arsht, The Business Judgment Rule Revisited, 8 Hofstra L.Rev. 93 (1979) (noting-limits of business judgment rule).

The district court herein found no fraud, no bad faith and no self-dealing by SCM’s directors; we do not disagree with these findings. However, the exercise of fiduciary duties by a corporate board member includes more than avoiding fraud, bad faith and self-dealing. Directors must exercise their “honest judgment in the lawful and legitimate furtherance of corporate purposes,” Auerbach, 419 N.Y.S.2d at 926, 393 N.E.2d at 1000. It is not enough that directors merely be disinterested and thus not disposed to self-dealing or other indicia of a breach of the duty of loyalty. Directors are also held to a standard of due care. They must meet this standard with “conscientious fairness,” Alpert v. 28 Williams St. Corp., 63 N.Y.2d 554, 569, 483 N.Y.S.2d 667, 674, 473 N.E.2d 19, 26 (1984) (citing cases). For example, where their “methodologies and procedures” are “so restricted in scope, so shallow in execution, or otherwise so pro for-ma or halfhearted as to constitute a pretext or sham,” then inquiry into their acts is not shielded by the business judgment rule. Auerbach, 419 N.Y.S.2d at 929, 393 N.E.2d at 1002-03.

The law is settled that, particularly where directors make decisions likely to affect shareholder welfare, the duty of due care requires that a director’s decision be made on the basis of “reasonable diligence” in gathering and considering material information. In short, a director’s decision must be an informed one. See American Law Institute, Principles of Corporate Governance: Analysis and Recommendations § 4.01(c)(2) (Tent.Draft No. 4, April 12, 1985) (“informed with respect to the subject of his business judgment to the extent he reasonably believes to be appropriate under the circumstances”); H. Ballantine, Law of Corporations § 63a at 161 (rev. ed. 1946) (“presupposed that reasonable diligence and care have been - exercised”); Arsht, supra, at 111 (business judgment rule should not be available to directors who do “not exercise due care to ascertain the relevant and available facts before voting”). Directors may be liable to shareholders for failing reasonably to obtain material information dr to make a reasonable inquiry into material matters. See e.g., Manheim Dairy Co. v. Little Falls Nat. Bank, 54 N.Y.S.2d 345, 365-66 (Sup.Ct.1945), cited in Platt Corp. v. Platt, et al., 42 Misc.2d 640, 249 N.Y.S.2d 1, 6 (Sup.Ct.1964), aff'd, 23 A.D.2d 823, 258 N.Y.S.2d 629 (1st Dep’t.1965), rev’d on other grounds, 17 N.Y.2d 234, 270 N.Y.S.2d 408, 217 N.E.2d 134 (1966). Cf. Beveridge v. New York El. R. Co., 112 N.Y. 1, 22, 19 N.E. 489, 494 (1889) (directors owe to shareholders duties “of the most responsible kind”). Thus, while directors are protected to the extent that their actions evidence their business judgment, such protection assumes that courts must not reflexively decline to consider the content of their “judgment” and the extent of the information on which it is based.

The actions of the SCM Board do not rise to that level of gross negligence found in Smith v. Van Gorkom, 488 A.2d 858, 874-78 & n. 19 (Del.Sup.1985). There, in making its decision after only two hours of consideration, the board relied primarily on a twenty-minute presentation by the chief executive officer who had arranged the proposed merger- without informing other Board members or management and despite the advice of senior management that the merger price was inadequate. On the other hand, the SCM directors failed to take many of the affirmative directorial steps that underlie the finding of due care in Treadway, supra, on which the district court herein relied. In Treadway, the directors “armed” their bankers with financial questions to evaluate; they requested balance sheets; they adjourned deliberations for one week to consider the requisitioned advice; and they conditioned approval of the deal on the securing of a fairness opinion from their bankers. See Treadway, 638 F.2d at 384. By contrast, the SCM directors, in a three-hour late-night meeting, apparently contented themselves with their financial advisor’s conclusory opinion that the option prices were “within the range of fair value,” although had the directors inquired, they would have learned that Goldman Sachs had not calculated a | range of fairness. There was not even a I written opinion from Goldman Sachs as to ] the value of the two optioned businesses. Tr. 1070. Moreover, the Board never, asked what the top value was or why two businesses that generated half of SCM’s income were being sold for one third of the total purchase price of .the company under the second LBO merger agreement, or what the company would look like if the options were exercised. Tr. 131, 142-44. There was little or no discussion of how likely it was that the option “trigger” would be pulled, or who would make that decision — Merrill, the Board, or management. Also, as was noted in Van Gorkom, the directors can hardly substantiate their claim that Hanson’s efforts created an emergency need for a hasty decision, given that Hanson would not acquire shares under the tender offer until September 17. PX 37. The directors manifestly declined to use “time available for obtaining information” that might be critical, given “the importance of the business judgment to be made.” See ALI supra § 4.01 at 66. In short, the SCM directors’ paucity of information and their swiftness of decision-making strongly suggest a breach of the duty of due care.

Nor is SCM’s argument that it was entitled to rely on advice of Wachtell Lipton and Goldman Sachs dispositive of Hanson’s claim that the SCM directors failed adequately to inform themselves under the duty of care. In general, directors > have some oversight obligations to become reasonably familiar with an opinion, report, or other source of advice before becoming entitled to rely on it. In our view, the test j of reasonableness should suffice with respect to the area of expertise relied upon, whether that area be legal or financial. See ALI, supra § 4.02 at 76-79. Cf. Harris v. Pearsall, 116 Misc. 366, 384, 190 N.Y.S. 61, 71 (Sup.Ct.1921) (reliance unwarranted); Hawes & Sherrard, Reliance on Advice of Counsel as a Defense in Corporate and Securities Cases, 62 Va.L.Rev. 1, 48-49 (1976); Longstreth, Reliance on Advice of Counsel as a Defense to Securities Law Violations, 37 Bus.Law. 1185, 1190-93 (1982); Small, The Evolving Role of the Director in Corporate Governance, 30 Hastings L.J. 1353, 1359-62, 1382-83 (1979).

The district court in the present ease notes that the Board failed to read or review carefully the various offers and agreements and instead relied on the advisers’ descriptions. In particular, the district court found that at the September 10 Board meeting, the directors accepted Goldman Sachs’ conclusion that the prices of the optioned assets were fair, without ever inquiring about the range of fair value. Had the directors so inquired, and had Goldman Sachs revealed that they had not investigated the range of fair value as such, the directors might have then discovered that the prices represented lower valuations than their own experienced business judgment would allow them to approve. The directors did not seek any documents in support of Goldman Sachs’ conclusory opinion. Nor would the costs of obtaining documentation have outweighed any conceivable legitimate needs of the directors to conserve time and rely on Goldman Sachs’ “conclusion.” Cf ALI, supra § 4.01 at 66 (considering “the costs related to obtaining information”). After all, only one week earlier, Goldman Sachs had compiled an extensive set of financial data, which, while not stating a value or range of values for the Pigments and Consumer Foods businesses, at least offered some quantitative bases for assessing whether the option prices indeed were “within the range of fair value.” Given that Hanson would not acquire stock through its $72 tender offer until one week after the September 10 meeting, there was certainly time to consider these data. Moreover, the fact that Overlock opined at the September 10 board meeting that an “orderly sale” could achieve higher prices for Pigments and Consumer Foods should have led the directors to investigate, rather than rely baldly upon, the oral opinion as to fairness. Finally, Goldman Sachs offered no opinion as to what kind of company SCM would be without its “core” businesses. On this issue, of which there is no evidence of any inquiry by the directors, there is thus not even a conclusory opinion from its advisors on which the directors plausibly might have relied.

We find unpersuasive SCM’s defense that this “working board” was already familiar with SCM, and hence was capable of making the swift decisions that it made. Given this “working board’s” considerable familiarity with SCM, we must question why it did not find the option prices troublesome in light of the considerable evidence — from Overlock, its own investment banker, and others, and from valuations made by SCM’s management and Merrill— that the optioned assets were worth considerably more than their option prices. Indeed, given that the very purpose of an ,asset option in a takeover context is to give the optionee a bargain as an incentive to bid and an assured benefit should its bid fail, see Fraidin & Franco, Lock-Up Arrangements, 14 Rev.Sec.Reg. 821, 823, 827 (1981), one again might have expected under such circumstances a heightened duty of care. The price may be low enough to entice a reluctant potential bidder, but no lower than “reasonable pessimism will allow.” Cf Brudney & Chirelstein, Fair Shares in Corporate Mergers and Takeovers, 88 Harv.L.Rev. 297, 298 (1974). To ascertain that management's proposal has not crossed this critical line, the Board certainly should have subjected the proposal to some substantial analysis. Instead, we view the board as only minimally fulfilling, if not abdicating, its role.

The proper exercise of due care by a director in informing himself of material information and in overseeing the outside advice on which he might appropriately rely is, of necessity, a pre-condition to performing his ultimate duty of acting in good faith to protect the best interests of the corporation. See Auerbach, 419 N.Y.S.2d at 927, 393 N.E.2d at 1001. Although the SCM independent directors have not been shown to have acted out of self-interest or to have been fraudulent or self-dealing in breach of their duty of loyalty, they do not appear to have pursued adequately their obligation to ensure the shareholders’ fundamental right to make the “decisions affecting [the] corporation’s ultimate destiny,” Norlin, 744 F.2d at 258, as required by their duty of care.

In the context of a self-interested management proposing a defensive LBO, the independent directors have an important duty to protect shareholder interests, as it would be unreasonable to expect management, with financial expectancies in an LBO, fully to represent the shareholders. Cf Longstreth, Fairness of Management Buyouts Needs Evaluation, Legal Times, Oct. 10, 1983, at 15 (noting that independent directors, even without evidencing “wrongdoing, venality or antisocial behavior,” may improperly defer to management at the expense of shareholders). See also Cox & Munsinger, Bias in the Boardroom: Psychological Foundations and Legal Implications of Corporate Cohesion, 48 Law & Contemp.Probs. 83 (1985). We do not say that the independent directors of SCM were required to appoint an independent negotiating committee of outside directors to negotiate with Merrill, as the court suggested in Weinberger v. UOP, Inc., 457 A.2d 701, 709 n. 7 (Del.Sup.1983), though that certainly would have constituted one appropriate procedure under the circumstances. But in approving post hoc the LBO negotiated and proposed by management directors with a not insubstantial potential 15% equity interest in the arrangement, the independent directors should have taken at least some of the prophylactic steps that were identified as constituting due care in Treadway, 638 F.2d at 384.

SCM’s board delegated to management broad authority to work directly with Merrill to structure an LBO proposal, PX 21 at 11; PX 27 at 20-21, and then appears to have swiftly approved management’s proposals. Such broad delegations of authority are not uncommon and generally are quite proper as conforming to the way that a Board acts in generating proposals for its own consideration. However, when management has a self-interest in consummating an LBO, standard post hoc review procedures may be insufficient. See Long-streth, supra. Even before the Board first met on August 25, 1985, in reaction to Hanson’s offer, Goldman Sachs and Wach-tell Lipton, who were later to become the Board’s advisers, were already discussing an LBO with management. When Hanson raised its bid to $72, it was SCM’s management and these advisers who caucused to develop a response. Even after Wachtell Lipton was formally retained by the Board, there was sufficient confusion for one of Prudential’s participants in the negotiations to note in a confidential notebook: “Lipton rep[resentin]g m[ana]g[emen]t.” PX 103 at P-003044. It was SCM’s management that put the $9 million breakup fee and the optioned assets into escrow accounts over which Merrill apparently exercised unilateral control. SCM’s management and the Board’s advisers presented the various agreements to the SCM directors more or less as faits accompli, which the Board quite hastily approved. As the district court found, the Board “knew or should have known” that its approval of the Asset Option Agreement would effectively foreclose further bidding for SCM. Op. at 855. The effect was to preclude shareholders from achieving any value higher than that agreed upon by SCM management and Merrill. In short, the Board appears to have failed to ensure that alternative bids were negotiated or scrutinized by those whose only loyalty was to the shareholders.

Ill

Having determined that the synergies of evidence showing a prima facie case of breach of the duty of care effectively shifted the burden of justification to SCM, we now consider SCM’s claims of justification. First, SCM argues that it presented evidence to rebut Hanson’s extensive evidence that the option prices were undervalued. A director’s obligation to protect the financial interests of the corporation, and thereby the shareholders, see, e.g., Data Probe, No. 92138-1983 at 8, may not be compromised by a competing interest in other legitimate corporate purposes, such as fending off a hostile takeover bid. When engaging in defensive maneuvers, such as a lock-up option, a director’s primary obligation is to ensure the overall fairness, including a fair option price, to the shareholders. See Revlon, 501 A.2d at 1249 (noting differential of $75,000,000.00 between option price and lowest estimate of value in target’s investment banker’s opinion); cf. Norlin, 744 F.2d at 266 n. 11 (noting lack of cash consideration for defensive stock issuance). Of course, a court need not, and here the district court clearly did not, ascertain “the ‘precise value’ ” of the optioned assets to determine the validity of the lock-up option, at least for preliminary injunction purposes. Cf. Alpert v. 28 Williams St. Corp., 483 N.Y.S.2d at 675, 473 N.E.2d at 27 (analyzing fairness of cash-out merger transaction). The inquiry is not whether the asset option prices represented fair value as a factual matter, but whether SCM met its burden of justifying the fairness of the lock-up option by adducing legally sufficient evidence to render inappropriate the remedy of a preliminary injunction purposes. Cf. Alpert v. 28 Wil-Pigments for $350 million would represent the highest price per ton (over $1000 per ton) of industrial capacity for which a Pigments business has ever been sold. Assuming this to be true, the assertion is nonetheless unpersuasive. On cross examination, Overlock of Goldman Sachs was asked whether he had told the board that “tonnage” represented “a lousy way to value [Pigments], but you talked about tonnage, correct?” Overlock answered “Yes, we did.” Tr. 1186. Indeed, the minutes of the September 10 board meeting reflect that Overlock told the Board that capacity is “not necessarily the best” benchmark of the value of Pigments. PX 27 at 5-6. The Board does not appear to have posed follow-up questions. Further, Overlock testified, as is surely the ease, that “a very significant” measure of the real value of Pigments, as with Consumer Foods, .is in the expected earnings of the business, Tr. 1185-86, and it was clear to one and all that Pigments was most likely to continue to bring the most promising and important share of earnings to the corporation. And it is undisputed that in valuing Pigments SCM’s litigation analysis looks to only 1985 and 1986 earnings, the two lowest actual and projected earnings years in a ten-year sequence.

SCM also points to a document prepared on August 7, 1985 by Rothschild Inc., Hanson’s investment bank, which estimated the value of Pigments at $345 million. See SCM Corporation Discussion Notes, PX 73. However, these notes were based on admittedly incomplete data — Rothschild did not then have available the fiscal year-end Form 10-K filed September 27 — and were not intended to provide comprehensive or final valuation determinations. In composing the document, Rothschild estimated the value of the Chemicals Division at $490 to $565 million, id. at 11, but its estimation of the value of Pigments quite clearly did not reflect — because Rothschild was not aware of — the fact that Pigments accounted for some 88% of the operating income of the Chemicals Division in 1985, according to testimony by Overlock.⁸ Given that the Discussion Notes provide only brief descriptive vignettes of SCM businesses without the year-end 10-K, this oversight is hardly surprising. Rothschild reevaluated its estimate of the value of the Pigments business on the basis of documents, including those of Goldman Sachs, and depositions that became available in the course of this litigation. Noting SCM’s high quality Dupont technology, Rothschild valued the titanium dioxide business, which generates 85% or 90% of Pigments’ operating income, in excess of $400 million. Adding in the rest of SCM’s Pigments business and taking into account the price-earnings multiples, Rothschild valued the total Pigments business at $450 to 500 million.

Hanson produced substantial evidence at the eight-day hearing that the optioning of the “crown jewels” demonstrates that the directors failed to meet their duty of inquiry and had an inadequate basis for concluding one way or the other that the prices were “within the range of fair value.” First, as to Pigments, optioned at $350 million, Overlock, SCM’s own investment banker at Goldman Sachs, testified that, using Goldman Sachs’ own valuation charts, PX 51, and applying thereto price-earnings ratios that Overlook accepted as appropriate, the value of that division is between $420 and $544 million. Tr. 1085-86. Applying an average ratio of market price to book value for companies that Goldman Sachs compared to SCM’s Pigments, a value of $465 million was obtained. Tr. 1089. Indeed, in addition to Rothschild, two other financial institutions valued Pigments at substantially higher than the options price. Bear Stearns, one of Hanson’s deponents, valued Pigments at $420 to 500 million based on Goldman Sachs data. Tr. 766-67; PX 65-69. Kohlberg, Kravis, Roberts & Co., one of the first potential “white knight” leveraged buyout firms that SCM management contacted in August, valued Pigments at about $550 million as part of its consideration as to whether it would make a tender offer for SCM stock. R-43. The lowest of all of these estimates of value, $420 million, suggests a $70 million undervaluation in the optioned price as to Pigments, a differential that would suggest serious undervaluation. See Revlon, 501 A.2d at 1248-1249 (questioning shareholder benefit where, to secure additional $1 per share, Board optioned certain divisions at price $75 million below Revlon’s own investment banker’s lowest estimate of fair value).⁹

Regarding Consumer Foods, Hanson again adduced considerable evidence that the business was optioned at a considerably undervalued price. Simonson from Prudential testified that Borden was interested in buying Consumer Foods for $105 million and that Merrill hoped to get $125 million. Tr. 356-57, 377-80. “Base Case # 10,” a document prepared by Merrill and SCM management, placed a July 1, 1986 sale value on Consumer Foods of $100 million. PX 54. On the basis of this document and deposition testimony of representatives of SCM, Merrill, Prudential and Goldman Sachs, a partner at Bear Stearns valued Consumer Foods at approximately $100 million or a range between $90 and 110 million. Tr. 677. Cooper-Mullin from Rothschild noted that “no document was produced in discovery which reflects a valuation or divestiture of the Consumer Foods business at less than $100 million prior to the grant of the Lock-Up Option.” PX 74 at 11, 11 23. Indeed, Overlock, the principal negotiator for SCM at the negotiations with Merrill regarding the asset options admitted that he had never seen the above-mentioned Base Case # 10 document. Tr. 1115. It is also undisputed that the Goldman Sachs negotiator’s first counteroffer to Merrill regarding Consumer Foods was $90 to 95 million.¹⁰

The above evidence notwithstanding, the district court made no findings as to Hanson’s claim that the Pigments and Consumer Foods businesses were optioned at prices far below their fair value. Rather, the district court held:

Questions involving valuation of particular segments of large companies are precisely the type of questions into which the business judgment rule is designed to preclude courts from inquiring. Courts cannot become mired in valuation issues and should not second-guess directors’ decisions on such issues absent a strong showing that the directors somehow breached their fiduciary duties.

No such showing has been made in the instant case.

Op. at 857. Although the district court conceded that “ [tjhere are several aspects of the independent directors’ actions which trouble the Court,” id. at 858, and made clear that its decision “is by no means intended to convey the impression that this Court condones or approves of the actions taken by SCM’s board in granting the lockup options,” id. at 858, the court denied Hanson’s motion for a preliminary injunction to restrain SCM and Merrill from exercising the lock-up option.

We conclude that the district court erred in declining to consider evidence, which the court admittedly found troublesome, which was importantly related to the critical issue of the value of the optioned assets. The court erred in failing to recognize that Hanson had presented a prima facie case of breach of fiduciary duty, and thus should have considered the extensive evidence on whether the option prices were indeed “within the range of fair value.” On the crueial issue of valuation, then, the district court presents no findings of fact for us either to uphold or to find clearly erroneous. Appellate courts, of course, are not precluded from inquiring into the evidence in the record when necessary to resolve legal issues. Even where the district court has made specific findings, a reviewing court can overturn those findings when it “is left with the definite and firm conviction that a mistake has been committed.” Anderson v. City of Bessemer, — U.S. —, 105 S.Ct. 1504, 1511, 84 L.Ed.2d 518 (1985) (quoting United States v. Gypsum Co., 833 U.S. 364, 395, 68 S.Ct. 525, 542, 92 L.Ed. 746 (1948)). Because we need not make a specific determination as to value of the optioned assets at this preliminary injunction stage of the proceedings, we do not remand to the District Court to make a finding of valuation. However, we believe that the appellants present evidence sufficient to raise a very serious question that the assets, in terms of what may be the outer parameters of valuation, were significantly undervalued, and that the SCM directors failed in the evidentiary hearings before the district court to present legally sufficient evidence to the contrary, or to otherwise justify their actions. Thus, the district court’s legal error in declining to reach the important evidence of valuation does not preclude this court from reversing with directions to grant a preliminary injunction, pursuant to Congress’ mandate to us under 28 U.S.C. § 1292(a)(1). See Omega Importing Corp. v. Petri-Kane Camera Company, 451 F.2d 1190, 1197 (2d Cir.1971) (Friendly, C.J.) (“... Congress would scarcely have made orders granting or refusing temporary injunctions an exception to the general requirement of finality as a condition to appealability, 28 U.S.C. § 1292(a)(1), if it intended appellate courts to be mere rubber-stamps save for the rare cases when a district court has misunderstood the law or transcended the bounds of reason”). Accord, Coca-Cola, 690 F.2d at 315.

SCM’s second attempt at justification is to argue that the purpose of the lock-up option is to achieve a better bid for the shareholders. Primary purpose analysis is undoubtedly a sound.theory of lock-up option justification, and is tested in pertinent part according to whether the lock-up option objectively benefits shareholders. Cf N.Y. Bus.Corp.L. § 717 (“ordinarily prudent person” standard); see also Revlon, 501 A.2d at 1250 (“objective needs of shareholders”); Bennett v. Propp, 41 Del.Ch. 14, 22, 187 A.2d 405, 409 (Del.Sup.1962) (directors may justify stock purchase as “in the corporate interest”); Norlin, 744 F.2d at 265-66. Whatever good intentions the directors might have had, they have pointed to little or no evidence to rebut the evidence discussed above that suggested that they failed to ensure that their acts would redound to the benefit of SCM and its shareholders. Indeed, the district court found that the directors “knew or should have known” that the lock-up option would end the bidding. Op. at 855. The directors thus face the difficult task of justifying a lock-up option that is suspect for foreclosing bidding, see Thompson v. Enstar, Nos. 7641, 7643 and for thereby impinging upon shareholder decisional rights regarding corporate governance, see Norlin, 744 F.2d at 258.

Viewing the LBO proposal in its entirety, we cannot see how the deal redounds to the benefit of SCM and its shareholders. For the benefit of an offer superi- or to Hanson’s $72 cash bid by at best one dollar and change, and which arbitrageurs would value at no more than $.75 to $1.00 higher than Hanson’s $72 bid, according to Overlock,¹¹ the board approved immediate release of a $6 million “hello again” fee, and approved management’s transfer into escrow of the $9 million “break-up” fee payable upon a third party's acquisition of one-third of SCM’s common stock. The Board additionally optioned 50 percent of SCM’s operating income from two prime businesses at conceivably well below fair value, according to the abundant evidence before the district court. Cf Revlon, 501 A.2d at 1249 (noting costs of securing additional $1 per share). Of course, the tendering shareholders would appear to get the benefits but not pay the costs of this arrangement if the LBO were to be consummated and the new entity were a financial success. However, serious questions are presented as to whether the shareholders would be economically harmed by effectively being forced to tender if the lock-up option is not enjoined. Those who do not tender will either become remaining twenty percent holders with appraisal rights which may be valued less because of the lock-up options, and who will be forced out in the second-step of the merger, or, if the requisite two thirds do not tender to Merrill, will be left facing the prospect of the transfer of effectively half the company for inadequate consideration, in addition to the already effected diminution of the corporate treasury resulting from the considerable fees paid by SCM in the course of its defensive tactics.¹² Thus, the SCM-Merrill LBO appears to benefit shareholders, if at all, only so long as it succeeds all the way through the merger stage and the new entity is a financial success. But if the buyout falls short of its ultimate goal, non-tendering shareholders may bear all of the potential risks of an aborted effort, including the risk of significant undervaluation. Indeed, it is the prospect of inadequate consideration that coerces shareholders to tender, and thereby serves as the means by which SCM's managers and directors could wrest from the shareholders the power to make the independent ownership choices that Judge Kaufman saw as the prerogative of shareholders alone, “in accordance with democratic procedures.” See Norlin, 744 F.2d at 258.

SCM argues that the above concerns notwithstanding, its offer must be upheld as facilitating competition in the market for control of SCM. The argument is flawed because it assumes that a competing bidder is not handicapped by the existence of the option. This is not a case where only in hindsight could the directors have known that the terms of their offer could ultimately harm shareholders. Cf Thompson v. Enstar, Nos. 7641, 7643 at 9-10. Here, as the district court found, the directors knew or should have known that the lock-up option would foreclose any better offers. Op. at 855. Since the option threatens inadequate consideration, a competing bidder is deterred from making a tender offer, unless conditioned on the withdrawal or invalidation of the subject lock-up, for substantially the same reasons that shareholders are deterred from resisting the SCM-Merrill offer. Both Hanson and other SCM shareholders must be concerned that if the SCM-Merrill deal is consummated through the merger stage, then to be left holding shares is to bear the risk of undervaluation.

Indeed, the deterrence to Hanson is even greater than to a small shareholder who does not have or expect to have a blocking position. For, assuming SCM and Merrill achieve a two-thirds majority, the small shareholder most likely risks only being forced to tender under the 20% debenture provision in the SCM-Merrill $74 offer or resorting to appraisal rights. By contrast, hypothetically, Hanson, as the likely largest minority shareholder, holds enough shares to thwart not only the merger but also the 20% freeze-out, and consequently risks holding over one third of a denuded company, a risk that it concededly took in acquiring the additional shares involved in Hanson I. Thus, if the lock-up option is not invalidated, and if it indeed threatens to dissipate the company for inadequate consideration, then Hanson’s only rational move is to tender into the SCM-Merrill offer, thereby ending the bidding. In sum, we think the offer forecloses rather than facilitates, competitive bidding. Cf. Thompson v. Enstar, Nos. 7641, 7643.

The foregoing compels us to ask the question that the district court failed to consider, but that the court in Revlon wisely raised: “What motivated the directors to end the auction with so little objective improvement?” Revlon, 501 A.2d at 1249. In Revlon, the inescapable conclusion was that the Board seemed to want the LBO partner “in the picture at all costs.” Id. In the present case, the SCM Board, by its lack of due care, appears to have achieved the same questionable result.

IV

(For all the above reasons, we think that Hanson has raised serious questions going to the merits sufficient to make them a fair ground for litigation/’ We further believe that irreparable injury to the stockholders, including Hanson, is at stake, and that the balance of hardships in this case tips decidedly in Hanson’s favor. For if the lock-up option is exercised without completion of the merger, SCM will likely be broken up for inadequate consideration, thus effectively precluding Hanson or any other bidder from seeking to gain control. Once shareholders tender into the SCM-Merrill $74 offer, the company will essentially become privately held, and Hanson would be virtually precluded from seeking to acquire it, short of the virtually inconceivable possibility of judicial valuation and forced sale. It certainly seems “doubtful that any damage claim against the directors can reasonably be a meaningful alternative.” Gimbel v. The Signal Companies, 316 A.2d 599, 603 (Del.Ch.), aff'd, 316 A.2d 619 (Del.Sup.1974). This harm is not protected by the business judgment rule, given Hanson’s prima facie showing of breach of the duty of due care as discussed above. Further, the mere threat of the exercise of the option, as discussed above, operates to coerce Hanson and other SCM shareholders into tendering for potentially less than optimal consideration, now tangible in the form of Hanson’s higher cash offer of $75. Cf. Asarco, Inc. v. M.R.H. Holmes A Court et al., 611 F.Supp. 468, 480 (D.N.J.1985); Applied Digital Data Systems, Inc. v. Milgo Electronic Corp., 425 F.Supp. 1145, 1162 (S.D.N.Y.1977). Further, the consequences portend irreparable harm to Hanson, a substantial shareholder, given the possibility of major structural changes to the corporation, even though SCM will have the $430 million in cash that it receives for the exercise of the option. Another possibility is that Merrill might later sell corporate assets to finance its LBO debt. Cf. Mobil Corp. v. Marathon Oil Co., 669 F.2d 366 (6th Cir.1981), cert. denied, 455 U.S. 982, 102 S.Ct. 1490, 71 L.Ed.2d 691 (1982) (injunctive relief necessary to ensure that “Crown Jewel Option” (oil field) will not be depleted by white knight option grantee). We believe that the market forces ca.n best be permitted to determine the outcome of this contest if the lock-up option is preliminarily enjoined. See Seagram & Son, Inc. v. Abrams, 510 F.Supp. 860, 862 (S.D.N.Y.1981). This remedy, of course, does not preclude SCM from renewing its defensive efforts on other legitimate terms, or on a basis that is beyond challenge, cf. Revlon, 501 A.2d at 1251, a possibility that we view as highly significant in weighing the balance of hardships.

The order of the district court is reversed, and the ease is remanded for prompt issuance of a preliminary injunction enjoining SCM, Merrill, and any other parties acting in concert with or on behalf of SCM or Merrill from exercising or purporting to or seeking to exercise the lock-up option considered herein. Judgment to be entered in accordance with this opinion.

It is so ordered.

1 . The Record in this case is enormous, spanning some thirty volumes, and will be cited hereafter as follows: references to the transcript of the preliminary injunction hearing are cited as "Tr. _references to plaintiffs’ exhibits are cited as "PX_references to defendants’ exhibits are cited as “DX_references to other documents in the Record are cited as "R-” The transcript appears in Volumes H-K of the Record, and the Exhibits in Volumes L-CC.

2 . Hanson further points out that SCM’s management initially retained Goldman Sachs as SCM's "exclusive" financial adviser regarding the Hanson offer, Tr. 1116, and that the head of the negotiating team on the SCM LBO from Prudential Insurance Co., a potential co-financing partner with Merrill, noted in the so-called "Prudential Notebook”: "Lipton rep[resentin]g m[ana]g[emen]t,” PX 103 at P-003044.

SCM, in response, points out that on August 25 the Board approved retention of Wachtell Lipton and Goldman Sachs to serve "at the pleasure of the board and not the management.” Tr. 525; PX 16 at 11. Further, SCM points out that Goldman Sachs has underwritten SCM securities and, in August 1985, conducted a due diligence review of SCM in connection with a contemplated debt offering. Tr. 858-59. Further, SCM also notes that Wachtell Lipton represented SCM in a proxy contest in 1980, and since then has periodically advised the board on developments in the mergers and acquisitions field. Tr. 27-28, 1296-97. The district court noted that both Goldman Sachs and Wachtell Lipton at all relevant times have advised "SCM and the SCM Board." Op. at 852.

3 . Hanson argues that the transfer of the $9 million break-up fee into escrow, along with the "crown jewels,” was wholly unauthorized by the Board. Since Hanson did not seek a preliminary injunction as to the fees, that issue is not properly before this court.

4 . The district court found that the terms of the option provision contemplated the triggering of the option upon a third party's acquisition of one-third of the outstanding shares on a primary, not a fully diluted, basis. It further found that Hanson triggered the option as a result of its stock purchases on September 11, 1985. Op. at 854. Although Hanson contests the district court’s finding as to the basis for computing when the option is triggered, we need not reach this issue since we preliminarily hold the option itself invalid.

5 . The minutes of the September 10 Board meeting indicate that Overlook informed the Board that the book value of Consumer Foods was $56 million, that the 1985 and projected 1986 earnings were $6 million and $5.2 million respectively, that the price-earnings ratios for those years were 13.3 times and 15.4 times respectively, and that the option price of $80 million represented 43.6% over book value. PX 27 at 5. As to Pigments, the minutes indicate that Overlook informed the Board that the book value was $280 million, that 1985 and projected 1986 earnings were $34.4 million and $44 million respectively, that the price-earnings ratios for those years were 10.2 times and 8 times respectively, and that the option price of $350 million represented 25% over book value. Id.

6 . As a result of its September 11 purchases, Hanson had 3,416,600 shares, representing approximately 33.6% of SCM’s shares outstanding on a primary basis. R-60 at ¶¶ 3-5. However, SCM argues that because of delays on the part of SCM’s transfer agent, the fact of Hanson’s triggering the Option was not apparent to SCM until Hanson purchased additional shares on October 2-4.

7 . Specifically, Hanson stated that the offer was conditioned on the return of the optioned businesses and the $9 million break-up fee to SCM from the escrow account. On October 9, Hanson announced that its offer would no longer be conditioned on the return of the $9 million fee to SCM. PX 200 at 16.

8 . It is true that Mr. Cooper-Mullin of Rothschild admitted on cross exa'mination that Rothschild’s August 7 Discussion Notes suggests that the value of SCM's titanium dioxide business was approximately $300 million assuming a price of $1,000 per ton. On redirect examination, however, Cooper-Mullin pointed out the distinctions that he was precluded from making on cross examination: the difference between estimating a lowest figure on a capacity basis for an "undistinguished capacity” and valuing a particular entire pigments business. SCM’s Dupont technology renders its Pigments business "a lot better than undistinguished capacity,” and therefore the value of SCM’s titanium dioxide business is likewise "substantially higher” than an undistinguished capacity valued at $1,000 per ton. Tr. 491-92.

Indeed, even the August 7 Discussion Notes suggests valuations consonant with the other evidence. The document offers three valuations: (1) Going concern — $490 million for the entire Chemicals Division; (2) Capacity of the " [titanium dioxide] business aloné' — $300 million “minimum value”; and (3) Acquisition price — $568-710 million. The document’s conclusion is that the Chemicals Division is worth $490 to 565 million. On this basis, Pigments, which generates 88% of the Chemicals Division income according to Overlock, would be worth approximately $431.2 to 462 million.

9 . We note that a prima facie showing of lack of due care is distinct from a prima facie showing of corporate waste, which may constitute a cause of action against directors separate and distinct from breach of the duty of loyalty or due care. See Ludlum v. Riverhead Bond & Mortgage Corp., 244 A.D. 113, 278 N.Y.S. 487 (2d Dep’t 1935). It might well be that Hanson’s evidence was sufficient to establish a prima facie case of waste, even given the considerable burden of proof required under that cause of action. See Cohen v. Ayers, 596 F.2d 733, 739 (7th Cir.1979) (applying New York law) (plaintiff must show that "no reasonable businessman could find that adequate consideration had been supplied’’); accord, Aronoff v. Alhanese, 85 A.D.2d 3, 5, 446 N.Y.S.2d 368, 371 (2d Dep’t 1982) ("The objecting stockholder must demonstrate that no person of ordinary sound business judgment would say that the corporation received fair benefit.”). However, we need not reach the issue of waste given the sufficient grounds presented herein in support of a preliminary injunction. See Revlon, 501 A.2d (enjoining lock-up option without specifically noting waste); Data Probe, No. 92138-1983 (same).

We find unpersuasive the district court’s efforts to distinguish Revlon. See Op. at 858. First, although Revlon’s fourteen-member board included six directors who held prominent management positions, and while most of the remaining directors had associations with entities that did business with Revlon, Revlon, 501 A.2d at 1243 n. 2, the absence in the present case of such indicia of disloyalty does not limit the likelihood of a breach of the duty of due care. Second, although the hostile bidder in Revlon expressly intended to outbid every offer by the "white knight," id. at 1245, here the district court expressly found that the SCM directors “knew or should have known” that the lock-up would foreclose additional bidding — by Hanson or any other bidder. Op. at 855. Third, while the Revlon court noted that the option price was $75,000,000.00 below the lowest fair value placed upon it by Revlon’s own investment banker (Goldman Sachs), Revlon, 501 A.2d at 1249, here the option price of Pigments alone was $70,000,000.00 below the lowest fair value placed upon it in any of the testimony specifying a purported fair value — and this differential represents a greater proportion of the option price than that represented by the differential in Revlon. Finally, while the Revlon board acted to protect note or debtholders instead of shareholders, Revlon, 501 A.2d at 1249-1250, here the SCM board appears to have failed to protect steadfastly shareholders interests in the face of a management-interested LBO, and, through junk bond financing, to have subordinated in significant part the equity of existing SCM shareholders to the future debt of the acquired company.

10 . $420 million, which the evidence suggests may represent the low end of the range of fair value for Pigments, is 20% higher than the $350 million option price. This differential is greater than the percent differential between $600 million, the apparently lowest material valuation of Revlon’s health aids divisions, and $525 million, the option price therefor. See Revlon, 501 A.2d at 1245, 1249. $90 million, the lowest value for Consumer Foods adduced in Hanson’s evidence, is 12!/2% above the option price. Significantly, the Bear Stearns partner stated that although he could understand how one could conceivably value Consumer Foods at $80 million, he could not "conceive of the basis at which someone arrives at 350” million dollars for Pigments. Tr. 767-68.

11 . According to Overlock, arbitrageurs, who are among the most sophisticated investors, would value the $74 LBO offer at about $72.50 in view of not just the cost of money but the "risk” involved in connection with the use of the “junk bonds.” Tr. 1180-81. Precisely what risk or risks he was referring to was not developed in the record, although such risk or risks might involve the collapse of the "junk bond” market or the failure of the new corporate entity due to an unserviceable debt resulting from the LBO. According to Overlock, arbitrageurs would also value Hanson’s $72 cash offer between $71.50 and $71.75. Tr. 1181.

12 . The $16.5 million in fees to Merrill represents a dimunition in value equal to approximately $1.25 per. share if the $74 LBO does not succeed.