Court Ruling Hands QVC Big Win in Battle for Paramount : Merger: Delaware justices find that company’s board acted improperly in pursuing only ‘friendly’ offer from Viacom.

WILMINGTON, Del. —  The Delaware Supreme Court handed QVC Network Inc. another huge victory in the battle for Paramount Communications Inc. on Thursday, in effect ordering Paramount’s directors to auction off the company.

In upholding a lower court decision that blocked a merger between Paramount and Viacom Inc., the state’s highest court shocked observers with a ruling even more sweeping than the Chancery Court’s. If QVC ultimately prevails in the takeover fight, Viacom now stands to lose not only $500 million worth of stock options that were thrown out by the lower court, but also a $100-million “break-up fee” that the lower court left in place.

Paramount, which is incorporated in Delaware, said in a statement that it will “promptly establish procedures applicable to all bidders for an orderly and fair process,” acknowledging that it has no further legal recourse.

While QVC’s current offer for Paramount exceeds Viacom’s, many stock traders expect both companies to submit higher bids.

A Delaware Chancery Court judge last month ruled that Paramount’s board acted improperly in pursuing a friendly buyout by Viacom and refusing to consider a rival offer from QVC. Viacom and Paramount agreed to merge in September, only to have their plans quickly disrupted by a hostile offer from QVC.

Following two hours of lively oral arguments, the Supreme Court on Thursday agreed with the lower court that because the Viacom-Paramount deal would have transferred control of Paramount to Viacom Chairman Sumner Redstone, Paramount’s directors had a special duty to be sure that Paramount shareholders were getting the best possible deal.

In addition, the court found that the stock option agreement, the break-up fee, and the selective use of a “poison pill” were defensive measures “improperly designed to deter other potential bidders.” Thus, it upheld the lower court’s ruling blocking completion of the Paramount-Viacom deal as long as those provisions were in place.

While the lower court focused its criticism on Paramount’s cursory review of QVC’s Nov. 15 tender offer, the Supreme Court found that the board had been equally negligent when it agreed to a revised merger deal with Viacom on Oct. 24.

Paramount, in its statement, said the court’s decision had “expanded existing law.” Whether the decision truly establishes a precedent, however, will not become clear until the Supreme Court issues a formal opinion sometime in the weeks ahead.

The court did not formally dictate what must happen next, but it laid out a series of principles that it said Paramount’s board should have followed. If the board does not adhere to such procedures now, QVC is likely to return to court to enforce them.

The court said Paramount is obliged to fully explore the QVC offer, determine whether the Viacom offer could be improved and generally obtain all relevant information and establish a process by which “the directors could consider these matters fairly and deliberately.”

The Supreme Court decision, like the Chancery Court ruling, amounts to a devastating indictment of the conduct of Paramount’s board and management.

After the court ruling, QVC Network Chairman Barry Diller said, “We’re gratified that the Supreme Court upheld” the lower court. He added, “Paramount sure could have saved a lot of sweat and strain on an awful lot of people if they’d done the smart thing from the beginning.”

Because QVC had not appealed the lower court’s decision leaving the $100 million break-up fee in place, the Supreme Court did not formally throw it out. It did, however, say that it considers the fee an improper defensive measure--just as the stock option was--and thus QVC can easily come back to court and ask that it be thrown out if Paramount does not abandon it voluntarily.

The ruling came after the markets closed. Paramount shares jumped $2.75 to close at $82 on the New York Stock Exchange. On the American Stock Exchange, Viacom Class A closed unchanged at $49 and Viacom Class B eased 12.5 cents to $44.50. QVC lost $1.125 to $43.625 on Nasdaq.

Separately, the Wall Street Journal reported Thursday that the Securities and Exchange Commission has launched a probe into trading in Viacom shares before and after its merger deal was reached with Paramount. The newspaper said the SEC is also looking into Viacom stock purchases by WMS Industries Inc., a company 24.9%-owned by Redstone.

A Viacom spokesman said, “Neither Viacom nor anyone associated with it has received any calls from the SEC about the WMS investment in Viacom.”

Two Viacom sources, speaking on the condition of anonymity, confirmed that the company had been contacted several weeks ago in an informal inquiry into trading, which often occurs in a takeover battle.

The Delaware Chancery and Supreme Court have significantly changed their views on corporate takeover battles in the last few decades. Here is a brief rundown of some key decisions.

* QVC vs. Paramount, Viacom (December, 1993): Supreme Court upheld lower court’s ruling prohibiting Paramount from using a “poison pill” anti-takeover defense in order to merge with Viacom, stopping Viacom from using a “breakup option” against Paramount. Key precedent set: If there is a change of control, a fair auction must take place and no encumbrance such as an anti-takeover policy or stock breakup defense can prevent an impartial auction of the corporation.

* Paramount vs. Time Inc. (July, 1989): Supreme Court upheld lower court’s ruling denying Paramount’s request for an injunction against Time’s tender offer for Warner Communications. Time proceeded with its offer for Warner; Paramount dropped its hostile tender offer for Time. Key precedent: Management can snub a takeover offer if such a takeover would disrupt an established strategic plan. Warner and Time merged for $14 billion.

* Robert Maxwell vs. Macmillan Inc. (November, 1988): Chancery Court denied British publisher Robert Maxwell’s request to throw out a lockup stock agreement between Macmillan and Kohlberg Kravis. Supreme Court reversed lower court, blocking the Macmillan/Kohlberg merger, calling the bidding process “tainted.” Key precedent: Once a corporation has decided to sell itself, it must conduct an impartial auction. Macmillan and Maxwell merged for $2.5 billion.

* Revlon Inc. vs. MacAndrews & Forbes Holdings Inc. (September, 1986): Key precedent: Supreme Court ruled that the directors of a corporation have a duty to get the best price for the stockholders at the sale of the company, and they cannot take measures that violate this duty, such as prematurely ending the bidding process or making exclusive “no-shop” agreements that prevent it from negotiating with other bidders.

* Pantry Pride vs. Revlon (June, 1985): Key precedent: Supreme Court ruled that as soon as management realizes its company won’t remain intact, it must hold an auction to find the highest sale price for shareholders.

* Unocal Corp. vs. Mesa Petroleum (May, 1985): Key precedent: Supreme Court ruled that directors may act reasonably to fend off a takeover if they believe their company faces danger, but the response must be proportional to the threat.

Sources: Court briefs, Times wire services