What The Star Decision Means For M&A In Australia

In brief

Directors and management teams are asking what Justice Lee’s recent decision Star Entertainment (Star) means for M&A.

The decision does not call for any radical change in how major M&A processes are run, nor should it deter companies from pursuing deals. 

However, the case provides useful guidance on ways to apply a “buffer of safety” for directors and officers of a company in the deal-doing process. We have set out below some pointers, informed by Star, on how to do deals safely.

What happened in Star?

ASIC alleged that Star’s executive and non-executive directors breached their duties of care and diligence for reasons including:

• an executive director and officers failed to escalate money laundering risks to the board, and 
• the non-executive directors failed to identify and interrogate “red flags” in the information available to them. 

Justice Lee found:

• various members of the management team breached their duties as officers by failing to give the board a complete and accurate picture of the risks Star was facing, particularly on money laundering risks – a very serious issue for a casino business;
• the non-executive directors were cleared, they had not breached their duties. Justice Lee confirmed that the expected standard is not perfection or to get involved at an operational level, but to take reasonable steps to guide and monitor the management of a company.

The Star case was far from the realm of M&A transactions, but the judge drew on principles from the James Hardie litigation which did relate to a deal. In James Hardie, the directors were found to be in breach of duty for approving a resolution to release a transaction-related ASX announcement which was found to be misleading. 

What does this mean for M&A?

1. Sharper scrutiny of board decision-making - but no fundamental change to M&A activity or practices

The judge emphasised that his decision does not change the law governing directors’ duties. The fundamental principles relevant to choosing whether or not to do a deal – that directors must engage on an active, informed and independent basis and act in the best interests of shareholders – have not changed. 

2. Apply the “golden rules” of board decision-making

Instead, Star sharpens the focus on how a decision to transact is made and documented. 

The golden rules for a board in making business decisions, including in a transaction context, remain: 

1. The board should adequately inform itself – including through the management team and advisers where relevant
2. Manage any conflicts appropriately
3. Directors should apply their “full brain”, considering broadly and applying other knowledge they have about the company’s business
4. Then make decisions in what they genuinely consider to be the best interests of the company – which in the context of a change of control transaction is often considered to effectively mean the interests of shareholders as a whole.

At least in major M&A with experienced advisers, the following processes are very helpful for the board and management teams to show that they informed themselves:

• due diligence reports; 
• financial adviser presentations on valuation, market analysis and evaluation of alternatives; and 
• due diligence committee processes to test the disclosure. 

It is helpful if:

• the board scrutinises adviser scopes to satisfy themselves that they are not too narrow to be meaningful; 
• the directors test and challenge the information by asking questions, and this is minuted appropriately – not as a script but in enough detail to show that the board as a whole applied test and challenge;
• the board considers the major key risks as part of this, including in the context of their existing knowledge of the company – and again, that this is captured appropriately in the minutes.
   

3. What information should come to the Board?

Justice Lee said that the board is responsible for controlling the information it receives. He was critical of the length of board documents, including detailed appendices, and the late arrival of board papers, in some cases immediately before the board meeting started.

These are live issues in M&A, where often “time kills deals” and decision-making time frames can be very tight. As general principles:

1. It is the responsibility of the management team, with input where required from any external advisers, to determine what materials go to the board.
2. There are some documents which must be provided to the board, and read in full by directors. These depend on the transaction. An example is where formal disclosure is made by the company, which the board needs to sign off on – for example a prospectus or bidder’s statement. Only immaterial changes from the board-approved version can be delegated to management.
3. Certain documents are usefully provided to the board in full – such as a scheme implementation deed, given it will become a public document. However, it is not necessary for all directors to read it in full. It would be reasonable for directors to rely on a summary prepared by the company’s legal advisers and an explanation of the document and what to focus on at the board meeting itself.
4. Where documents are provided to the board but on the basis it is a choice by directors whether to read them should they be interested in that further information, that should be made clear either on the face of the document or clearly minuted.
5. he board should be given sufficient time to consider the materials before it. Where there is not genuine commercial urgency, last minute board papers should be avoided.
6. Where there is genuine commercial urgency – as there often is with M&A - and limited time with the papers, it is important that those who are close to the deal step the board through the papers and highlight the points which the board should focus on. This is consistent with Justice Lee’s guidance that the management team should provide insight, not just information.
7. Use your advisers and ask them the tough questions. Particularly on major or strategic M&A, it is protective for the Board to have the advisers attend Board meetings and the directors to ask them questions directly. As well as specific questions based on the papers and the directors’ existing knowledge, open questions can be useful, like: “What are the things I should worry about on this deal?” “If you were to put the case for us not doing this deal, what would it be?” 

4. Additional layer of defence in M&A: the business judgment rule

In M&A transactions, there is usually an additional layer of protection for directors that was not available in Star – the business judgment rule. A director will satisfy their duty of care and diligence if they make a reasonably informed ‘business judgment’ in good faith that they rationally believe it is in the best interests of the company.

ASIC in Star alleged that the directors breached their duties because they collectively failed to properly oversee and address the risks facing Star’s business. Since there was no ‘business judgment’ or discrete decision which the board made, the business judgement rule could not apply.

In contrast, an M&A deal should almost always satisfy this threshold – M&A processes naturally involve a series of decisions to take or not to take action that relate directly to the company’s business operations. Provided each director turns their minds to the decision at hand and informs themselves to the extent reasonably appropriate, they can benefit from this protection.
 

5. Board minutes are the ultimate source of truth: seek advice and record decisions carefully

As touched on above, one of the most important takeaways for boards during M&A processes is Justice Lee’s reminder that “what occurred, and what can be proven to have occurred, are not always the same thing.” It is essential that directors and management bear in mind, particularly in fast-paced M&A processes, that should something go wrong, the court will treat board meeting minutes as the ultimate source of truth.

In Star, in their attempt to rely on the business judgment rule, the directors argued that they had made a conscious decision to continue Star’s relationship with a foreign gambling junket, which amounted to a business judgment. Justice Lee said that if the directors had made that kind of conscious decision, it would reasonably be expected that the conclusion and basis for it would be recorded in board meeting minutes. Without any reference in the minutes to this kind of decision, he could not find that it had been made.

This issue also arose in ASIC’s earlier case against the directors of James Hardie. There, the directors denied that they had approved the release of an ASX announcement, but the meeting minutes told a different story. The High Court took the minutes on their face as evidence of what they described – that the announcement had been tabled and approved by the board.

What does this mean for directors involved in M&A processes? To protect themselves and maximise the likelihood they can rely on the business judgment rule in the future, boards should check they are comfortable that the decision to take or not to take action in relation to a deal, and the basis for making it, is recorded, consistent with the director’s recollection.

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.