Fasken's Guide To Directors' Duties And Special Committees In Public M&A

1. Overview

Public M&A is high stakes both for the company and its board and the decisions made throughout the process can be subject to market and legal scrutiny.

While appeasing all stakeholders may be difficult, directors can take comfort that courts will generally not second-guess a board's business judgment provided its decision-making is diligent, informed and impartial. The focus is on process rather than an expectation of perfect decision-making as judged with the benefit of hindsight.

To help boards ensure their public M&A deliberations meet the requisite level of rigour and independence, we've synthesized key strategic and legal considerations. Taking care to ensure a well-run process is typically a worthy investment for assisting in the board's satisfaction of its duties and for increasing deal certainty for all parties.

2. Immediate Considerations

Although each of the following are discussed in greater detail later in this guide, it is important they are addressed by directors as early as reasonably possible during the dealmaking process.

(a) Director Independence and Potential Conflicts

Questions of independence and potential conflicts of interest are critical to a proper board process. Business reality is such that many directors, particularly independent or outside directors, have relationships and interests beyond the company that can give rise either to an actual or perceived conflict of interest. This is a highly situation-specific analysis that turns on the circumstances of the particular director, potential transaction and related parties. 

(b) Whether to Form a Special Committee

While forming a special committee is only mandated in limited situations, doing so remains best practice in many circumstances. Numerous factors require consideration and balancing. Where a special committee is deemed required or prudent, attention then turns to crafting an appropriately scoped formal (and board-approved) mandate. The internal practical and political issues a special committee and its mandate can sometimes raise may also require careful navigation.

(c) Conflict of Interest Transactions

Certain public M&A transactions attract increased regulatory burdens and scrutiny. These are (1) insider bids, (2) issuer bids, (3) business combinations, and (4) related party transactions, collectively known as "conflict of interest transactions." Given that regulators have detailed specific (and heightened) expectations in these circumstances, target boards should approach these deals particularly cautiously.

(d) The Importance of Recordkeeping

Diligent recordkeeping from the inception of a potential transaction is crucial to avoiding problems later on. Among other things, this greatly facilitates (1) demonstrating compliance with the board's duties, (2) attracting the protection of the business judgment rule, (3) preparing the transaction's public disclosure (e.g., information circular, court materials, etc.), and (4) responding to any regulator requests for information or materials.

3. Director Independence

Per the fiduciary duty of loyalty, from the inception of a potential change of control transaction all directors must disclose any relationships or interests that create (or could reasonably be seen as creating) a conflict in connection with the deal. This duty remains ongoing over the deal and as a director's personal circumstances might change.

Independence is highly situation-specific and depends on the circumstances of the particular director, potential transaction and related parties. The critical consideration is whether the director's impartiality or judgment could actually be impaired or, equally importantly, be reasonably questioned by shareholders or regulators, as a result of a particular relationship or interest.

Certain directors are generally not considered independent in the public M&A context:

• Management directors for the inherent conflict of interest as employees of the company susceptible to being replaced post-closing.
• Directors with a significant equity interest in, or some other material relationship with, a counterparty (or likely counterparty or reasonably anticipated competing bidder).

While casual social connections typically don't raise concerns, joint or related business interests can raise reasonable doubts regarding the director's impartiality. However, courts have acknowledged that a potential conflict of interest should be balanced against the reasonable benefit obtained by including the director in dealmaking, e.g., their particular expertise and experience in M&A.

Deliberations regarding a director's independence should be recorded. In particular, where it's decided a director's external relationships or interests do not compromise the director's impartiality, this may need to be publicly disclosed and explained.

4. Special Committees

A special committee in public M&A is an ad hoc group of independent directors selected to lead or oversee the deal and report back to, and make recommendations to, the full board. It is important to note that a special committee will generally not have decision-making responsibility for material matters; rather, the board will typically reserve the responsibility for making key decisions with respect to a potential transaction in the context of a special committee's recommendations.

The formation of a special committee is only strictly required by securities law in public M&A in connection with an insider bid. However, they are commonly used – and considered best practice – in numerous other public M&A contexts for both legal and business reasons. A special committee can:

• Effectively neutralize actual or perceived conflicts of interest, and have regularly been endorsed by securities regulators and courts towards this end.
• Resolve various practical challenges raised by public M&A dealmaking, including its high intensity, extensive materials and frequent meetings (often called on short notice) for which the broader board may not have time or capacity.

A board will typically establish a special committee when conducting an auction of a public company (e.g., to run the auction process and evaluate offers) or upon an unsolicited takeover bid (e.g., to contemplate defensive measures). However, special committees are also very often formed amid friendly, bilateral public M&A deals (e.g. to ensure an impartial evaluation of the proposed transaction's merits in light of all applicable stakeholder interests).

(a) Timing of Formation

Whether to form a special committee should be addressed as early as reasonably possible during dealmaking. Similarly, once decided prudent to form a special committee, doing so should promptly follow. Generally speaking, the only negative to premature formation is additional costs and resources. However, an appropriately scoped special committee mandate and process should mitigate against unnecessary expense.

On the other hand, securities regulators have strongly criticized – and delayed deals – for tardy special committee formation. They have also warned that, in conflict of interest transactions, special committees should not be bound by negotiations predating the committee's involvement.

Overall, the benefits of the special committee will be greatly diminished if established past a point where alternatives are limited or, in hindsight, the full board's ultimate decision appears having already been a foregone conclusion.

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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.