Do you sit on the board of a company that could face a merger or acquisition one day? As a director or officer, do you know what steps to take to minimize your risk during the litigation that ensues nearly 100 percent of the time a public company is acquired?
In my last post, I discussed the possibility of the frivolous M&A litigation wave starting to recede in the state of Delaware – but that’s just one state. Given the fact that the average M&A transaction garnered seven lawsuits in 2013, planning for litigation should start long before you even entertain the idea of a sale.
At Woodruff Sawyer we’ve seen what research confirms: the most common M&A litigation allegations include “the deal terms not resulting from a sufficiently competitive auction, the existence of restrictive deal protections that discouraged additional bids, or the impact of various conflicts of interests, such as executive retention or change-of-control payments to executives.”
Luckily, we have countless court decisions that provide directors and officers with a “how-to guide” when it comes to protecting their shareholders and themselves during M&A.
The landmark case in the 1980s that delineated the rules Ds and Os should follow during an M&A is Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. These rules are commonly referred to as “Revlon duties.”
To fulfill their Revlon duties, a company’s directors and officers must create and follow a process that is designed to obtain the best price for stockholders during a sale. As referenced in this post at the Harvard Law School blog, Revlon “is not an independent duty, but rather a restatement of directors’ duties of loyalty and care.”
Understanding these duties is the first step to effective planning before the M&A litigation onslaught hits.
1. Duty of Care
The duty of care requires Ds and Os to diligently pursue the interests of the shareholders who elected them. In the context of the sale of a company, this means creating a process designed to ensure the best possible price for shareholders.
There isn’t a one-size-fits-all solution when it comes to constructing an appropriate sales process; no Delaware-gold-stamped sales process “checklist” exists. Ds and Os must use good judgment to construct a deliberate, systematic sales process on their own.
In order to do so, a board should become familiar with a variety of deal-protection devices such as no-shop provisions, break-up or termination fees, matching or topping rights and so on. The board must understand the impact these types of provisions would have on maximizing shareholder value. Failure to do so can also be grounds for litigation.
Executing on the board’s duty of care and calibrating appropriate deal-protection devices may need interpretation and analysis. One way a Ds and Os can protect themselves and optimize the outcome for shareholders is to seek advice from litigation counsel, in addition to advice from the company’s deal counsel.
This discussion should fall within the scope of attorney-client privilege. Thus, while the fact of this counseling session will be reflected in board minutes, the actual content of the discussion should not be.
This way directors can freely ask the questions for which they need answers in order to create the best possible outcome of a sale, without being fearful of creating a record that will be used against them.
Finally, contemporaneous documentation of the board’s exercise of its fiduciary duties is critical. It’s this documentation that best demonstrates a board’s exercise of its duties. You will want to make sure that formal meetings are being held, and that their minutes recorded and approved in a timely manner.
2. Duty of Loyalty
The duty of loyalty requires that directors act in an independent manner and keep shareholders’ best interests in mind. An example of this in the context of the sale of a company is the admonition that a director shouldn’t favor one buyer over another for reasons other than maximizing shareholder value.
Consider the situation in which a potential acquiror makes promises to allow the target’s board members and/or management to stay on after the sale. This attractive inducement is also potentially a conflict of interest.
To address these types of conflicts, consider forming a special committee comprised of independent directors to drive the sales process. When doing so, consider the following:
- Form the special committee as early as possible to receive maximum value. Usually, this happens after management becomes aware that there is a serious offer forming, or right after the first offer comes in. However, it could be much sooner for reasons reflected in the next bullet point.
- Have the special committee determine the scope of the types of offers and buyers the board will entertain. You want to avoid prematurely cutting off avenues of discussion that might otherwise be fruitful.
- Avoid delegating too much authority to any member of the management team. Courts are very critical of allowing management to run a sale process with little or no oversight by the board, especially when management may have a reason to favor a particular buyer or set of terms that might be good for management but suboptimal for the shareholders.
3. Appropriate Disclosure
When shareholders are being asked to sell their company, they must have all the appropriate disclosures needed in order to make an informed decision. Boards can be vulnerable on the question of disclosure—how much is so much that it becomes useless to shareholders? How much is too little? Plaintiffs have made a lot of hay on this point.
Many merger objection suits settle for nothing more than enhanced disclosure, and then plaintiffs’ attorneys seek fees for having performed this service. Not all the disclosure enhancements are worthwhile; indeed, some seem like window dressing designed to allow plaintiffs to take the position that they did something so that they can be paid.
Courts are onto this “game,” and of late have been less and less impressed. For example, the Delaware Court of Chancery has attempted to emphasize the importance of materiality when considering whether plaintiffs’ attorneys deserve to be paid massive fees for convincing companies to issue additional M&A-related disclosure.
What Else Can You Do to Prepare for M&A Litigation?
In addition to creating an objective and transparent sales process, avoiding and/or addressing conflicts of interest and issuing appropriate disclosures, there are other ways to plan for M&A litigation well before a sale is on the horizon. If you’re a director or officer, consider the following:
- Update your personal indemnification agreement with your company. Ask someone who represents the board to review the indemnification agreement to ensure you have the most protective language possible, paying special attention to change-of-control provisions.
- Confirm your D&O insurance policy is designed well. D&O policies are highly technical contracts, so you need an expert to analyze them. Pay special attention to change-of-control provisions and language that prevents the knowledge and acts of another person (another director, for example) from being attributed to you.
In my next post, I’ll expand on insurance best practices in the M&A context.
The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: email@example.com.