A recent decision of the Delaware Court of Chancery (In Re Tele-Communications, Inc. Shareholders Litigation) focuses on issues that boards should consider when establishing a special committee and retaining financial advisers. While the deficiencies of the particular committee in the case are obvious, the deficiencies in the retention of the financial advisers are more complex.
The case involved AT&T’s acquisition of Tele-Communications, Inc. (TCI) in 1999 through a merger in which the holders of high-voting stock received a 10% premium over the consideration received by the holders of the otherwise identical regular voting stock. The high-voting stock was held primarily by certain board members, whereas the regular voting stock was primarily held by the public. Aware of the potential conflict of interest, the board of TCI established a special committee to review the transaction.
Considerations in Establishing a Special Committee
- Appropriate composition. Special committee members must be independent and disinterested in the context of the particular transaction. The TCI special committee consisted of two directors—one who held only regular voting stock and another who held predominantly high-voting stock. The Court determined that the latter’s membership on the special committee was problematic.
- Clear mandate. A special committee should have a clear mandate that is reflected in the written record and understood by the committee members. The Court observed that each of the committee members had a materially different understanding of the committee’s mandate and commented that this disagreement initiated "a structural flaw that fissured throughout the process that followed."
- Appropriate compensation structure. The compensation of the special committee’s members should be clearly established at the outset and be appropriate and reasonable, not only in absolute amount but also with regard to the objectives of the committee. It was recommended initially that the committee members be "reasonably compensated" for their efforts, but no specifics were set out. Following the special committee’s approval of the transaction, the board approved a payment of US$1 million to each committee member (for what appeared to be four meetings over the course of a week). The Court questioned this level of compensation and concluded that the "suspiciously contingent compensation" impugned the independence of the committee.
- Committee should be fully informed. In making a decision whether or not to recommend a particular transaction, a special committee should ensure that it is fully informed of all relevant material facts. The Court concluded that the special committee was not fully informed about the historical trading premium of the high-voting stock and the general lack of premiums for high-voting stock in comparable acquisition transactions.
Considerations in Retaining Financial Advisers
- Separate advisers. A special committee should consider whether it is appropriate to rely on the company’s legal and financial advisers or whether it should retain separate advisers. Company advisers bring the advantage of familiarity with the company and the transaction. On the other hand, separate advisers bring an independent perspective. Typically, special committees will at least have separate legal advisers. The Court questioned "the quality and independence of the advice received" as a result of the special committee’s reliance on the company’s legal and financial advisers.
- Appropriateness of fee structure. The Court noted that the contingent compensation of approximately US$40 million that was paid to the financial adviser (who also delivered a fairness opinion) "creates a serious question of fact as to whether [the financial adviser] could provide independent advice to the special committee." In at least one other recent decision, a Delaware court has approved the use of contingent fees for financial advisers to the board as a whole.
- Fairness of different treatment of shareholders. The financial adviser concluded that the price offered to each class of stockholders was fair. However, the Court held that even though the regular voting stockholders received a 37% premium over the market price of their shares, this was insufficient in the circumstances and that the special committee should have requested an opinion about the fairness to the regular voting stockholders of the premium payable to the high-voting stockholders. This suggests that when dealing with different treatment of separate classes of stock, a special committee should examine not only the absolute fairness of the transaction to each class independently but also the relative fairness of the different treatment.
This decision highlights the need for directors and other participants in M&A transactions to carefully consider the manner in which a special committee is established and operates and the role played by its financial adviser. Failure to appropriately address these matters can jeopardize the successful completion of a transaction and lead to potential liability for directors.
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