By Keith A. Pagnani and Stephen R. Pratt
Keith A. Pagnani is a partner and member of Sullivan & Cromwell's Mergers & Acquisitions practice. Recently he was recognized as a “Dealmaker of the Year” by The American Lawyer for his role advising Alcon, Inc.'s independent directors committee in Alcon's acquisition by Novartis AG. He has broad experience representing buyers, sellers, special committees of independent directors and financial advisers on a wide range of domestic and international merger and acquisition transactions. He is also co-head of the Firm's Healthcare and Life Sciences Group, and frequently speaks on M&A and corporate matters. Stephen R. Pratt is an associate in Sullivan & Cromwell's General Practice Group. He has advised buyers, sellers and a special committee of independent directors on public and private mergers and acquisitions and private equity transactions. His experience includes both domestic and cross-border transactions and representations in multiple industries, including banking, manufacturing, aviation, gaming, real estate and telecommunications.
With the continued proliferation of deal-related lawsuits in recent years, the uncomfortable market reality for company boards and their advisors is that nearly all merger transactions will be subjected to legal challenges. Current research shows that 94 percent of deals announced in 2013 valued at more than $100 million were challenged.1 These suits often take a similar form--plaintiff shareholders allege that the selling company's board violated its fiduciary duties by approving a merger at an inadequate price, running a flawed sale process (in certain cases, tainted by director, officer and/or financial advisor conflicts of interests), and making insufficient disclosures to shareholders.
While the majority of these suits settle before the transaction closes (often for non-cash relief and attorneys' fees),2 insulating directors from further deal-related liability, Delaware courts have recently shown a willingness to reject settlements that they deem insufficient to justify the release of claims. These rejected settlements often involve so-called “disclosure-only” settlements that require the board to provide additional information to shareholders. With court-rejected settlements, directors who thought they had escaped liability could face additional exposure if plaintiffs' attorneys accept the court's invitation to take another bite at the apple by proceeding to a trial on the merits. Due to the prevalence of deal-related lawsuits and a growing risk of court-rejected settlements, the bottom-line is a board's going-in assumption should be that just about every aspect of a sale process will be meticulously scrutinized after a merger has been announced.
A useful byproduct of the constant flow of legal challenges to merger transactions is that an increasingly robust body of case law has developed that provides a “playbook” for well-advised directors to follow when undertaking a sale process. While these court opinions are contextual and decided based on the unique facts and circumstances relating to the transaction in question, they often describe conduct standards that are generally applicable to most sale processes. What follows is practical guidance based on the lessons learned from certain recent Delaware court decisions to assist directors of Delaware corporations in avoiding notable pitfalls, professional embarrassment and potential liability while thoughtfully approaching and executing a sale process.
• Consider investing time in “sunny day” planning and information gathering. Directors should remain cognizant of the fact that Delaware courts are generally less likely to second-guess decisions made by disinterested and independent boards that are knowledgeable about a company's business, industry, prospects and available strategic options. In these days when many company boards can be consumed by the considerable time spent addressing regulatory and compliance issues, it is important for directors also to understand their company's strategy and prospects. They can do so by regularly assessing management's stand-alone projections and track record of achieving past projections, as well as the implications of those projections on the company's intrinsic value and strategic alternatives. Doing so both now and in the future will help directors position themselves to nimbly react to any inbound expressions of interest.
• Ensuring consistent messaging. Boards should maintain an active dialog among its members and with management to ensure the proper communication of any inbound transaction interest. In that regard, directors would benefit from implementing a formal policy requiring the reporting to the board of any unsolicited approach. By doing so, boards make clear to their members and management that ultimate oversight of a sale process belongs to the board as a whole. Boards should also have an established protocol for responding to inbound interest or a transaction opportunity generally. To guard against sending mixed messages, boards may find it helpful to implement, and adhere to, a “one-voice” policy where any response to inbound interest comes from a board's appointed “one voice” (e.g., the CEO or lead director). Because transaction opportunities can unexpectedly arise, boards would also benefit from keeping a roster of potential advisors that they can quickly call upon for advice and meeting with those advisors on a periodic basis. Process defects--especially those early in a sale process--can prove difficult to remedy and may expose directors to liability, particularly if the court later determines that a director acted for an improper motive (e.g., any non-stockholder-directed motive).
• Be sensitive to, and identify and address, conflicts of interest. A line of recent decisions highlights that Delaware courts remain keenly interested in actual and potential conflicts of interest, including conflicts involving directors, management, the board's advisors and controlling/significant shareholders. These cases emphasize that throughout a sale process, boards must actively seek to identify and address actual or potential conflicts of interest. Directors should be particularly diligent in identifying and evaluating the implications of a financial advisor's compensation structure and other relationships. Timely identification of conflicts will permit boards to take appropriate actions to cabin conflicts when possible, minimize the risk that the sale process will be tainted by conflicts issues and permit the board to satisfy its obligation to fully disclose to shareholders the scope of potential and actual conflicts. On the other hand, boards should be aware that courts do recognize the difficulty of finding a financial advisor that is “conflict free.” The key is to identify any issues and then determine and implement the right course of action with a thorough understanding of the trade-offs involved. In responding to financial advisor conflicts, boards should be mindful that the simple act of engaging a second financial advisor may not be sufficient to cure conflicts of a board's lead financial advisor. In such instances, Delaware courts will closely examine the extent of the second financial advisor's involvement and effectiveness and assess whether the lead financial advisor tainted the sale process or the board's decision-making despite the involvement of a second “conflict-free” financial advisor. Boards should be especially mindful that conflicts issues are often tied to duty of loyalty claims for which directors cannot be exculpated from personal monetary liability, and as to which insurance may not be available.
• The sale process must be performed at all times under the leadership and supervision of the board. Implementing a strong and effective process remains a key defense for directors. Directors certainly may delegate to management and their advisors during a sale process, but they should do so only after providing clear instructions specifying the authority granted. Even after delegating authority, boards will be well-served to maintain an active role throughout a sale process by holding periodic, well-documented formal meetings and receiving regular updates from the persons authorized to handle the day-to-day aspects of the transaction. It is critical that directors not allow management, advisors and others to get out ahead of the process by exceeding the authority granted. For that reason, directors should monitor their representatives' and management's activities and consider setting-up a reporting and oversight process for the full board. A guiding principle of Delaware law is that a board's decisions should be based upon an adequate informational basis. To become well-informed, directors should request guidance from their advisors throughout the sale process, critically examine valuation materials (which should be periodically provided by the board's financial advisor), consider the pros and cons of the timing of the sale process and assess the (relative) value of keeping the company as a stand-alone enterprise.
• Prevent the process from being biased in favor of certain bidders. Unless favoring a certain bidder is justified based on the objective of maximizing the deal value, boards should take steps to ensure that individual bidders and classes of bidders are not favored by management to the shareholders' detriment. These steps may include chaperoning and overseeing management's interactions with potential bidders (especially potential financial bidders), establishing specific parameters for when management can engage in discussions with bidders about post-consummation employment and compensation arrangements and providing clear instructions to financial advisors about the scope of any market check. Reasoned decisions by a well-informed board for excluding certain potential bidders from the sale process (e.g., because of competitive concerns) should be carefully deliberated and contemporaneously documented to fully describe the board's reasoning.
• Take steps to ensure that an accurate record is being developed and maintained throughout the sale process. Boards should regularly approve contemporaneous minutes of board and committee meetings, and the minutes should contain enough detail to ensure that directors will get credit for their “good deeds.” It is also critical for directors to recognize the perpetual nature of e-mail and the fact that they cannot control the substance of responses sent by others. All electronic correspondence will be subject to meticulous scrutiny by plaintiffs' attorneys for any evidence that contradicts board minutes and other process-related records prepared to support a board's actions. A contemporaneously developed record that is not undermined by other unnecessary documentation will greatly assist boards in later demonstrating to the court that it was well-informed and actively managed the sale process.
While board decisions will continue to be second-guessed by plaintiffs' attorneys and scrutinized by courts, the good news is that there are certainly steps that well-advised directors can take to mitigate the risk of deal-related liability and professional embarrassment. The practical guidance described above is intended to assist directors in creating an effective and defensible sale process and lessening the possibility of bad results for boards of selling companies.
1See Cornerstone Research, Shareholder Litigation Involving Mergers and Acquisitions--Review of 2013 M&A Litigation.
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