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By Michael Greene
June 10 -- Attorneys are playing a bigger role in providing guidance during mergers and acquisitions deals, likely as a result of the complicated issues that arise, such as identifying investment banker conflicts, the use of special committees and concerns over appraisal rights.
Transactional attorneys discussed these topics and provided tips June 4 during a M&A panel at the Practising Law Institute’s ''Delaware Law Developments 2015: What All Business Lawyers Need to Know.”
The panelists generally agreed that transactional attorneys are becoming more involved in helping directors identify potential investment banker conflicts of interest.
Identifying such conflicts is a very difficult problem to manage and “I wish the banks would get a little bit more open to it,” said Robert A. Profusek, the global practice leader for M&A at Jones Day.
He added that investment bankers are not quite there when it comes to disclosing all their prior relationships before they provide fairness opinions.
In addition to a lack of disclosure, Profusek observed that problems in identifying conflicts also arise because of the complex relationship between the bankers and the companies negotiating deals.
Echoing this sentiment, Jeffrey D. Marell, a partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP who co-leads the firm's North American M&A practice, said ultimately a large private equity firm that has paid the bank lots of financing fees over the years may emerge as the winning bidder, but “you can't know at the beginning how it's going to end up.”
Is it true that an investment bank doesn't have some conflict if the potential buyer is private equity firm KKR & Co. LP, Profusek asked, noting that the private equity firm is a potential buyer in almost every transaction.
However, Richard Hall, a partner at Cravath, Swaine & Moore LLP who heads the firm's M&A practice for the EMEA, said part of the problem with addressing conflicts is that using the term “banker conflict is itself profoundly misleading.” According to Hall, the concept of conflicts is being misapplied in the investment banker context.
“We lawyers have taken a word that means something to us because we have rules about conflicts and applied that terminology and mind-set somewhere else, and that is wrong,” he said. “That is why you can have two investment bankers stand up and one of them say 'we are always conflicted, get over it,' and then have second one stand up and say 'there is no such thing as investment banker conflicts,' and they are literally both correct.”
Identifying investment banker conflicts of interest is a very difficult problem to manage and “I wish the banks would get a little bit more open to it.”
Robert A. Profusek,
partner, Jones Day
Despite what he perceives as a misapplication of the concept, Hall believes there are two questions that attorneys should ask their clients when guiding directors on the conflicts issue.
“The first question is did the board of directors act reasonably in selecting its financial advisors,” he said, noting that attorneys spend a lot more time now than 10 years ago talking to directors about the facts that go into selecting an investment banker.
Smart directors make decisions up front about who they are going to retain and how much they are going to compensate their advisers, he added.
The second question is when the bank gives it advice, “is it reasonable for the board of directors to rely on that advice?”
When misalignments of interests are severe, there should be a discussion about why the board is relying on its investment bank rather than going somewhere else for advice, he said, adding that such a discussion should include whether there is somebody else that can give conflict-free advice and what are the benefits of bringing in a second banker.
Clare O'Brien, a partner at Shearman & Sterling LLP, said that one way a board can protect itself from certain conflicts is by bringing in a second banker.
On top of protecting the company from conflicts, O'Brien pointed out potential practical benefits for engaging a second banker, such as having two sets of eyes and the ability to allocate different tasks.
However, Andre G. Bouchard, chancellor of the Delaware Chancery Court, showed some skepticism about using a second bank. “To me the second banker is like a red flag,” he said, noting that it gives him reason to pause.
Despite the commercial realities of how deals are done, he said that it doesn't strike him that there are finite number of bankers out there, so that companies can't find one that is conflict-free.
Bouchard conceded that there may be legitimate reasons for having a second bank and what ultimately is critically important is the record the parties create by the time it reaches the court.
“To me the second banker is like a red flag.”
Andre G. Bouchard
Chancellor, Delaware Chancery Court
In non-banking M&A matters, the panel also addressed when a board should create a special or transactional committee related to a potential deal.
It all starts at the very beginning by creating a plan to get the board and ultimately the shareholders to the right place, Hall said.
If there is a specific board-level misalignment of interest such as that the plan will depend on excluding certain directors from the process, then consider a special committee, Hall said.
“It's about thinking ahead,” Marell said, especially where a private equity buyer is likely to emerge as a contender. He added that boards may want to consider setting up a committee at the outset not because there is an issue, but because of the possibility of conflicts arising based on the potential buyer universe.
Hall added that some boards may want to consider creating transactional committees so that deals can be supervised on a more regular basis. The transactional committee is very different from a special committee because it has little decisionmaking power, he noted. Moreover, it is used to solve administrative problems, whereas special committees are used to address issues related to director independence.
In addition, the panel also addressed appraisal rights.
Much of the recent debate over appraisal rights has revolved around appraisal arbitrage--where appraisal rights are purchased after the public announcement of a planned merger.
The Delaware State Bar Corporation law section recently proposed two modifications to Delaware General Corporation Law §262 to address concerns that the appraisal stature is being abused, including one that would provide corporations with the option of limiting the accrual of interest on appraisal awards . However, the proposed legislation, which still has not been introduced in the Delaware General Assembly , did not include any direct limitation on appraisal arbitrage.
In an April letter, law firms argued that the proposed amendments don't go far enough to prevent abuse .
Gregory P. Williams, a director at Richard Layton & Finger PA who leads the firm's corporate department, said he is not convinced that interest is driving the recent rise in these types of appraisal claims. The equity players, the funds we are talking about, don't view this as a debt obligation, but instead view it as equity investment, he said.
He added that many companies may forgo the option that the proposed DGCL amendments would provide because their cost is not that much different than the interest rate, he said. They may just want to litigate the difference.
Profusek voiced his concern about allowing appraisal rights in such situations, adding that it doesn't seem like good public policy.
Williams added that appraisal litigation as an investment vehicle is a new concept and that questions remain about whether the statute should be amended because it was put in place for a different purpose.
However, Chancellor Bouchard noted that critics of appraisal arbitrage may take solace in the fact that a number of recent chancery court decisions have found the merger price as the best estimate of the company's value ; .
However, Bouchard voiced concerns about whether appraisal litigation is turning into fiduciary litigation.
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