In the "change of control context," which arises where the merger consideration is predominantly cash, Delaware courts have held that a board of directors has an obligation to exercise its fiduciary duties for the purpose of obtaining the highest value reasonably available for the stockholders. This is often referred to as a board's Revlon duties, after the case in which it was established. There is a "change in control" for purposes of the Revlon duties in an all-cash merger, in a merger where there is an acquirer with a controlling stockholder, and in a merger where the cash consideration is 50% or more of total consideration.
When a board of directors' decision is challenged by stockholders alleging breach of fiduciary duty, Delaware courts can apply one of three standards of review: the business judgment rule, entire fairness, or enhanced scrutiny.
The business judgment rule states that a court should not substitute its own business judgment for that of a corporation's board of directors. Under business judgment rule review, in a lawsuit alleging breach of fiduciary duty, the court will presume that directors satisfied their duties of care and loyalty by acting on a fully informed, good faith basis and in a manner believed to be in the best interests of the stockholders. The court will defer to the business judgment of a corporation's directors and grant a motion to dismiss the lawsuit, unless the plaintiff can allege facts that demonstrate that there is a reasonable basis for questioning whether the board satisfied either the duty of loyalty or the duty of care.
Entire fairness review applies in cases where a board's actual conflicts tainted its decision making-e.g., a majority of directors were either on both sides of the transaction or were not independent of directors who were on both sides of the transaction. If the entire fairness standard of review is applied, the burden is on the directors to demonstrate that both the decision-making process and transaction price were fair to the stockholders.
When the Revlon duties apply in a change-of-control merger transaction, enhanced scrutiny is the legal standard of review (unless the entire fairness standard is applicable). Rather than deferring to the board under the business judgment rule, a court will examine whether the board's actions were reasonable under the circumstances as a good faith attempt to secure the highest value reasonable attainable. The standard is whether the board made a reasonable decision, not whether it was a perfect one, and board liability requires bad faith or a knowing violation of its fiduciary duties. Importantly, under Revlon the fiduciary duties of a board do not change, but the board's duties of care and loyalty have to be exercised for the purpose of obtaining the highest value reasonable available for the stockholders.
In re Rural/Metro Corp. stockholders litigation, RBC Capital Markets LLC engaged to represent Rural/Metro Corp. in a merger transaction, was also lobbying to provide financing to the acquirer, Warburg Pincus LLC for the transaction, and was trying to leverage its role with Rural/Metro to gain advantage in providing financing in connection with another acquisition within the industry. RBC was found to have manipulated the negotiations process in Warburg's favor. Rural/Metro's board was not provided with valuation analysis until three hours before its meeting to approve the deal, and the valuation metrics provided were found to have been manipulated to make Warburg's offer look more favorable. It was also determined that RBC provided the acquirer with information about the internal dynamics of Rural/Metro board's deliberations. The investment banking firm's undisclosed conflicts and conduct in this cash-merger transaction caused the board to be uninformed as to the actual value of the company and to provide misleading disclosure to its stockholders, in violation of the board's fiduciary duty of care. As a consequence, RBC was held liable for aiding and abetting the board's breach of fiduciary duties and ordered to pay stockholders $76 million in damages. The Delaware Supreme Court ruled that third parties, such as RBC, can be liable for damages if their actions caused a board to breach its duty of care, even if directors are not directly liable for the breach. The court stated that simple negligence on the part of the directors can be the basis for third party liability, even though director gross negligence is the standard of care when director personal liability is at issue. In this regard, the laws of Delaware and most other states allow a company's charter to include an exculpation provision that shields directors from personal liability even where they are found to be grossly negligent in breach of their duty of care. The court also ruled that RBC's conduct resulted in a faulty sales process and as a consequence the board failed to obtain the best value reasonably available, in violation of its Revlon duties. The court stated that directors need to be active and reasonably informed when overseeing the sales process, including identifying and responding to actual or potential conflicts of interest.
In re PLX Technology Inc. stockholders litigation, the stockholders alleged that the board breached its duty of care by failing to identify and tax adequate measures to understand and address a financial advisor's conflicts, that the lead investment banker on the fairness opinion committee was working simultaneously on a purchase for the acquirer, from which one could reasonably infer that certain information was improperly shared and contributed to a potentially unreasonable sale process, that the banker had possibly skewed financial projections, as it presented lower than historical growth rates, and that the banker only disclosed the extent of its extensive relationship with the acquirer on a simultaneous deal on day before rendering its fairness opinion. The court declined a motion to dismiss the suit, noting that the target's board had failed to identify conflicts early in the sales process and had compounded the failure by failing to continuously and diligently oversee the banker's actions. The court noted that generic disclosure that had been made to the disinterested stockholders who approved the transaction was not sufficient to overcome the significant conflicts. The court suggested that the company's sale committee could have hired a second investment advisor to recommend corrective action, released other bidders from their standstills, recalibrated deal protection measures, sought new bidders or fired the banker and restarted the process.
Once the business judgment standard of review is determined to apply to the board's decision because of a fully informed, uncoerced vote of the disinterested stockholders, dismissal of claims of failure to perform duties of care and loyalty in the context of Revlon duties is warranted. However, A financial advisor whose bad faith actions cause its client boards to breach their fiduciary duties can nevertheless be held liable for aiding and abetting even if the board itself cannot be held liable for the breach. The financial advisor liability requires plaintiff to prove scienter and therefore protects financial advisors from due-care violation.
To do list:
- Identify potential deal partners first and do the research and ask questions and document recent deals that may be considered conflicts before engaging advisors regarding potential conflicts;
- Include in the engagement letter that the advisor may not perform deal advisory services to the potential deal partners during the engagement;
- Include in the engagement letter that should the board determine in its reasonable judgment that a conflict has developed or been discovered, the advisor will reduce its fee so an independent advisor can be brought in to confirm the first advisor's work.
No comments:
Post a Comment