Take-Privates: The Public Company Target Mindset

SMART SUMMARY

• In a take-private transaction involving a public company, the public company board is responsible for negotiating the transaction as a fiduciary of the target stockholders.
• The target board is necessarily guided by fiduciary duties that require the directors be fully and adequately informed and act in the best interests of the corporation and its stockholders, which have implications on interactions with the target.
• Sponsors undertaking a take-private have a vested interest in a well-run target process because the inevitable challenge to the board's action can delay closing and, in certain transactions, can arise on a post-closing basis.
• As a result, the negotiation of a public company transaction can take more time than a private company acquisition and results in public disclosure as to the process undertaken by the board.

Introduction

Several key legal and strategic considerations must guide the target's process in a take-private transaction. Central among these is the need to "create a record" of negotiating a transaction that evidences the target board's satisfaction of its fiduciary duties to the corporation and the target's stockholders. A flawed board process could delay the closing of the transaction and, in certain transactions, may expose the sponsor to post-closing stockholder litigation challenging the target board action. As a result, a sponsor looking to engage in a take-private has a vested interest in ensuring the target board action is supported by a well-run process that withstands judicial scrutiny.

The Target Board Controls Negotiations

In a public company acquisition, the board of directors of the target must be actively engaged and oversee the negotiations on behalf of the target. Public company stockholders—the real party in interest—are by their nature disperse and, unlike in many private company acquisitions, do not have a direct seat at the negotiating table. Instead, the board acts on behalf of the target stockholders, guided by their fiduciary duties. These duties have a significant impact on the negotiation of the transaction and the target's process.

Under Delaware law, directors of a corporation owe two core fiduciary duties: the duty of care, which requires directors to be fully and adequately informed and act with care for the corporation, and the duty of loyalty, which requires that directors act in the best interest of the corporation, disregarding their personal interests. These same duties apply to the boards of public and private companies alike. However, the impact of these duties on deal process is more pronounced with the heightened litigation risk that accompanies the public stockholder base of a public company.

The Target Board Process Takes More Time

A target board evaluating a take-private transaction must ensure its directors arrive at a fully and adequately informed decision that is in the best interests of the corporation and its stockholders. Although Delaware courts generally apply a presumption of validity to business decisions of a board, courts generally apply "heightened scrutiny" to determine if the board's actions were "reasonable" in the context of the sale of a target for cash. Accordingly, in a take-private transaction, the public company board will be keenly focused on developing a solid record that the board acted reasonably in making decisions regarding the sale process and took the sufficient amount of time to be adequately informed in making those decisions.

A well-run process that implements procedural mechanisms can support the validity of a target board's action. Although these mechanisms necessarily add time to negotiations, they are consistent with developing a strong record to support the board's determination to sell. These include:

• Decisions Designed to Maximize Value. In a take-private transaction where a target is being acquired for cash, a target board may be required to demonstrate that it acted reasonably to obtain "the best price reasonably available" to stockholders. Although there is no specific roadmap of actions that the board must take, the target board is required to choose a "reasonable route" to value maximization under the facts and circumstances.
• Obtaining a Fairness Opinion. Although not legally required, a target board's reliance on a fairness opinion can serve as evidence that the board exercised due care in being fully and adequately informed in evaluating a transaction. A board is "fully protected" under Delaware law in relying in good faith upon opinions by any person as to matters the director "reasonably believes are within such person's professional or expert competence and who has been selected with reasonable care." Accordingly, the target board must consider the reputation, expertise as well as independence and potential conflicts in engaging a financial advisor and relying on a fairness opinion.
• Delaying Negotiations with Management. A take-private transaction in which directors or members of management may have a continuing role following the closing may raise the specter of an actual or perceived conflict of interest, and trigger additional procedural protections in conducting a sale process as well as additional disclosure requirements under SEC rules. A target board will often require that discussions with members of management regarding rollovers, future employment terms or compensation and benefits arrangements be postponed at the outset—until price and other material transaction terms have been finalized and, in certain circumstances, after receipt of stockholder approval of the transaction. Sponsors, as serial acquirors, often view relationships with management as key to a transaction, so complying with these restrictions at the outset can be frustrating, but are necessary to protect the transaction.