Because of the growing risk of litigation by unhappy (or simply opportunistic) shareholders following the sale or acquisition of a company, corporate governance practices during the M&A process face increasing scrutiny.
In a recent article titled "Documenting the Deal: How Quality Control and Candor Can Improve Boardroom Decision-making And Reduce The Litigation Target Zone", forthcoming in The Business Lawyer, Leo Strine, Chief Justice of the Delaware Supreme Court, sets forth some best practices for directors and legal and financial advisors "to conduct an M&A process in a manner that: i) promotes making better decisions; ii) reduces conflicts of interests and addresses those that exist more effectively; iii) accurately records what happened so that advisors and their clients will be able to recount events in approximately the same way; and iv) as a result reduces the target zone for plaintiffs' lawyers".
This post is a quick overview of the insight provided in Chief Justice Strine's article, and is intended to provide directors with some useful information that may help them make better decisions to promote value maximization for shareholders and to protect themselves from unnecessary litigation risk while maneuvering through the M&A landscape.
Chief Justice Strine says that when faced with the sale of a company, the directors of that company should...
- Take control of the process: The directors need to be involved in the process from the beginning and should have protocols in place to prevent unauthorized management activity relating to the sale of the company. This is particularly important, from a conflict of interest perspective, if management is both proposing and negotiating the transaction. There should be protocols in place that prevent the CEO, or senior management generally, from engaging in certain activities without the prior approval of the board, including: (i) entering into understandings with buyers, (ii) providing confidential information to potential buyers; and (iii) involving other members of management or employees. When such corporate protocols are not in place, the board of directors may find themselves struggling to catch up and, depending on the stage of the transaction, may no longer have the full range of actions available to them to protect themselves or the shareholders.
- Actively manage conflicts: Where a conflict of interest exists, it is critical that the conflict is "surfaced, contained, and addressed" and that the impartial members of the board of directors are granted strong decision-making power throughout the process. The business judgment rule depends upon impartial decision-making. Where there is a conflict of interest, the independent directors should obtain the best advisors possible within the financial capacity of the company. If the interested parties retain the company's usual advisors, this may cause the independent directors to settle on less qualified advisors who fail to have a strong understanding of the company's business and affairs. In this case, the independent directors do not position themselves to control the process and, depending on the circumstances, may not adequately prepare themselves to make the reasonably informed decisions required to be protected by the business judgment rule.
- Choose advisors carefully: Independent directors should choose legal advisors early in the process so that the legal advisors can assist the board with dealing with conflicts, retaining appropriate financial advisors and reaching prudent decisions with respect to certain legal issues, such as the creation of a special committee and committee composition. Independent directors should seek financial advisors who have a breadth of deal and market experience to draw upon to "keep management honest" and to ensure the shareholders are treated fairly. The main purpose of financial advisors is not to provide a fairness opinion full of disclaimers and caveats, but it is to provide the business advice necessary for the independent directors to make prudent and informed business decisions. When choosing advisors, independent directors need to be wary of conflicts of interests. If a legal or financial advisor has a conflict of interest, directly or indirectly, this taints the impartiality of the directors' decisions and may call into question the legitimacy of the process.
- Take the time: The directors' legal and financial advisors must impress upon their clients the duty to be reasonably informed and should provide them every opportunity to fulfill that duty. Directors should receive materials to review and consider key issues in advance of any meeting so the directors can digest the information and follow up as necessary. This will also likely increase the value of discussions at the meeting itself.
- Document the process: Even if the directors
approach every decision on reasonably informed basis, with prudence
and a clear intention to act in the best interests of the company,
the litigation risk remains unless there is evidence documenting
the process. The record should show:
- the business advice given by the financial advisors at all key stages, including decisions to remove potential buyers from the buyer pool;
- at each major decision or moment of judgment, why the board acted and upon whose advice;
- consistent detail in the minutes of board meetings that provides clarity as to the issues before the board and the specific actions to be taken in response; and
- documents that indicate material changes and the reasons for those changes, including changes to the numbers and assumptions – a redline or blackline document is a useful tool to document changes and to ensure that directors are made aware of any revisions to the business valuation throughout the process.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.