In 2010, Delaware courts issued a number of decisions that will have a significant impact on M&A transactions and related shareholder litigation going forward. Rather than summarizing each decision, this article distills key themes from the cases relating to fiduciary duties and shareholder litigation and provides practical tips for companies conducting M&A transactions and for their advisors.
Not surprisingly, given the focus of the Delaware courts, the 2010 cases offer many insights into directors' fiduciary duties and actions that directors should take to comply with these duties. In particular, the cases provide guidance on directors' Revlon duties, which require directors to undertake a sound process to obtain the best value reasonably obtainable for the company's shareholders. Boards can enhance their compliance with the Revlon standard by taking some or all of the following actions.
1. Well-Informed Directors. The 2010 cases serve as a reminder of the courts' favorable view of well-informed directors – directors who understand their company's market value, its sale prospects, and the market in which the company operates. If a board bases its decision to pursue a particular course of action in a sale on its firm understanding of the company and its prospects, the courts are likely to defer to the board's judgment. Boards considering a sale should receive regular updates (preferably from expert financial advisors) on the value of the company and analysis of other transactions in the industry in which the company operates, and should conduct periodic reviews of the company's results and projections.
2. Independent Directors. The Delaware courts view a sale process that relies almost entirely on management, who may be conflicted, as less sound than a process that includes robust involvement by independent directors. Companies should encourage active involvement by independent directors in any sale process and should allow the independent directors to deliberate about the merits of the transaction in the absence of management and insiders. Management also should provide prompt updates to the independent directors about the transaction's progress.
3. Experts. Delaware law permits directors to rely on advice provided by advisors and experts, and the cases in 2010 reaffirmed the Delaware courts' approval of this reliance. Outside experts, such as financial advisors, accountants and outside counsel, can and should help boards of directors focus on relevant considerations when structuring a transaction process, and should remind directors of these considerations as various possible courses of action are discussed. Experts can also help directors understand the sale prospects for a company and the likelihood that particular bidders would be interested in acquiring the company.
4. Strategic Buyers. Delaware courts are more skeptical of financial buyers than strategic buyers, and the courts therefore scrutinize directors' discharge of their fiduciary duties more closely if strategic buyers are not involved in the transaction process. This is due in part to the likelihood that the target's management will be retained by the financial buyer and will receive a significant equity stake in the company after closing and therefore may be subject to divided loyalties. Consequently, strategic bidders should be included in a sale process, if practical. If a board determines to include only financial buyers in a transaction process, the appropriate board and committee minutes should reflect the basis and rationale for that decision.
5. Single-Bidder Strategy. The courts reminded us in 2010 that Revlon does not require directors to auction a company or to follow any one particular sale process. The soundest process may involve negotiating and signing a definitive agreement with a single bidder, if that bidder is the most logical acquirer or if signing the definitive agreement may prompt other bidders to propose a higher price. The key is for a board to develop a written record, including board minutes, that thoroughly demonstrates why the board chose a single-bidder process. Such a record can help the courts understand the reasonableness of the board's actions. Facts cited to support a single-bidder strategy in 2010 cases include: the demonstrated unwillingness of other logical bidders to pay top dollar; other bidders' likely difficulties in financing an acquisition; the risk of non-consummation of a transaction (for regulatory or other reasons) with other bidders; and the ability to obtain a post-signing topping bid by including seller-favorable deal protection terms (such as a "go-shop" provision or a relatively low termination fee) in the definitive agreement.
6. Detailed Minutes. The importance of taking accurate and complete minutes of board and committee meetings, especially in connection with an M&A transaction, is a theme that Delaware courts have emphasized for several years. In a number of recent cases the court noted with disapproval the absence of any written record regarding a particular issue critical to the case. These cases remind companies and their advisors to make sure that minutes from board and committee meetings thoroughly document the significant topics that were discussed at the meetings. Minutes carefully taken and approved relatively contemporaneously with the meeting can serve as critical evidence if a transaction is challenged and will document the full nature of a board's discussions even if the memory of the individuals later deposed is faulty.
7. Beneficiaries of Fiduciary Duties. The 2010 cases remind us that the same fiduciary duties that apply to directors of public corporations also apply to privately-held corporations. Breaches of fiduciary duties may be even more likely to occur in privately-held companies, where directors may rely less on expert advisors and sale processes may be less developed.
In several opinions, the Delaware Chancery Court took lawyers representing shareholder plaintiffs to task for failing to adequately prosecute the cases that they had brought against corporations in sale transactions. In several others, the court went out of its way to compliment the activities undertaken by plaintiffs' counsel. These cases have resulted in more vigorous prosecution of cases by plaintiffs' counsel and more frequent document requests and depositions in connection with litigation challenging M&A transactions. To prepare for shareholder litigation relating to a proposed M&A transaction, companies and their advisors should take the following actions:
1. Warning of Likely Litigation. Counsel should inform directors and officers early in the transaction process that litigation is likely, and that the directors and officers should be mindful of the litigation threat when drafting and sending emails, taking notes of conversations and meetings, and generally conducting the sale process.
2. Note Taking. Counsel, directors, and officers should destroy notes taken at board and committee meetings, as these notes are often not carefully prepared and may reflect the biases of the note taker. Much of the most interesting evidence in a significant 2010 case consisted of notes taken by the general counsel of a company that was defending itself against a potential hostile acquisition. These notes provided the court with a lot of contextual information that was not always helpful to the company.
3. Termination Date. When preparing an acquisition agreement, the parties should consider the potential shareholder litigation implications of the drop-dead date specified in the agreement (that is, the date after which either party may unilaterally terminate the agreement). In several 2010 cases, the court mentioned the drop-dead date as being relevant to the timing of the litigation and the remedies afforded to plaintiffs. In one such case, the drop-dead date was set for a short period of time (approximately 90 days) after the agreement was signed. The proximity of the drop-dead date to the signing date prompted the attorneys and the court to act promptly in connection with the litigation arising from the transaction.