Archive for June, 2013

Mergers and Acquisitions and how directors comply with their duties.

Deal protection provisions are among the most negotiated terms in a transaction, as a result of the interest of sellers to prevent new bidders to interfere with their offers, given the effort and resources dedicated to it until the signing day.


Sellers would be interested in letting the window open, both because of a higher price perspective, and because under certain jurisdictions, (such as Delaware), those provisions can`t be so onerous that a higher bidder is precluded from appearing.


The options for a target board are, (or have been in the past):


–         No talk provision: it prohibits the board to respond even to unsolicited higher bids. In was dropped in Delaware in 1999 by a sample of court decisions.

–         No shop provision: it allows the board to respond to any unsolicited offer potentially leading to a higher price. Those provisions, (break-up fees, matching rights, fiduciary termination rights, force-the-vote provisions, change of recommendation, etc.) protect the bidder and let directors fulfill their duties. Those provisions are to be judged as a whole, and different business circumstances in each particular case need to be considered. Since 2007, the fact that the number of transactions has declined, has led the balance more in favor of bidders that in favor of sellers, although reasonableness remains the criterium to follow.

–         Go shop provision: it gained momentum in the 2006-2008 period, and was a balance between the need for a quick deal and the recognition that a post-signing market check is to be done in order for directors to fulfill their (Revlon) duties to pursue the shareholders best interest. The provisions, although tightly fixed, have been adapted in recent times, (Websense and BMC cases), so that

  • In some cases (Websense) the rule is a no-shop, with a go-shop limited to certain bidders who were already active before the announcement. These bidders qualify for a low fee, provided they act in certain limited delays.
  • In other cases (BMC) the rule is a go-shop but excluding from the low break-up fee those bidders already present and analyzing the transaction before the announcement.

Basically, as Mr. Wolf from Kirkland states, “there is room for creativity to tailor market terms to the real-world circumstances of a particular transaction, which is precisely what courts expect boards and their advisors to do.


–         Hybrid go shop provisions: in the realm of LBO/MBO in the period 2006-2008, generally with a single financial sponsor, some doubts emerged as for the no-shop provision adequacy for the target boards fiduciary duties; when there was a lonely bidder until signing or announcement, (whether a private equity firm or strategic or industrial purchaser), there was a big concern about the no-shop really discharging directors` fiduciary duties, so that in those cases the go-shop dominated the arena. In certain cases, though, a hybrid solutions appeared, as in Pfizer/Wyeth, Hewitt/Aon and Pfizer/King. It did not include the marketing period, but it let the reduced break-up fee for unsolicited offers if appearing in a month (or so) after the announcement. The solution avoids management distraction from business in the competing offer search period, but still keeps the market-check after the announcement, which itself acts as a call for interested bidders. And the reduced fee works in favor or directors duties`compliance.


Apart from deciding on the procedure, a board needs to consider other facts, such as:


–         The case that managers might have change in control provisions, so that they could have a conflict of interest,

–         The case that any manager or director might have a relationship with any bidder,

–         The fact that not all offers need to be presented in the same terms, for the same assets, etc., so that the evaluation of alternatives by board must be thoroughly weighted


This may remain as a general recommendation: every step, whatever decision standard is followed, needs to be dealt very carefully.


Based on several Harvard Law School Forum on Corporate Governance and Financial Regulation:


–         Deal Protection — One Size Does Not Fit All, by David Fox from Kirkland & Ellis, November 28, 2009

–         Test-Driving a Hybrid Go-Shop, by David Fox from Kirkland & Ellis, November 28,2010.

–         Custom (Go-)Shopping, by Daniel E. Wolf, from Kirkland & Ellis, June 21, 2013

–         From Vigilance to Vision, by Jennifer Mailander, Corporation Service Company, May 29, 2013.



LBOs leading to bankruptcy: how can directors protect themselves and creditors?

Scott J. Davis and William R. Kucera, in a Director Notes paper edited by the Conference Board, analyze this kind of transaction, where a large part of a cash merge is financed through debt. It is a not so rare that a certain time afterwards, the target company fails to comply with its obligations, not being able to repay principal and/or interest, to all creditors, preexistent, (that could not oppose), and those financing the transaction, (perfectly aware of the new situation).


A typical case is the acquisition of Lyondell by Basell. Just a year after the merge, the target filed for bankruptcy. The Court sued the former directors, for having approved a transaction that although beneficial to shareholders, introduced a large risk for creditors.


Curiously, those directors had been sued by shareholders under Revlon vs. McAndrews & Forbes doctrine, for failing to obtain the best value for shareholders once they approved a change in control, although without Courts favored them. But the positive resolution is used by plaintiffs now arguing directors acted against creditors legitimate interests.


Theories used to sue directors in cases like this are described below:


–         Payment to shareholders as an unlawful distribution, (one that forces the company into bankruptcy). An opinion by outside experts may help directors discharge their responsibilities. The fact though, is an acquisition is a different animal than a distribution.

–         The case is also made that directors breach their fiduciary duties to creditors or the company while accepting too much debt for the capacity of the target. But some bylaws prohibit companies from seeking compensation for the breach of the duty of care; second, it can also be argued that when approved, the company was not insolvent, and duties to creditors don`t appear until the company becomes actually insolvent.

–         Sometimes creditors argue directors violated state or federal fraudulent transfer or conveyance statutes.


Those are the claims in the Lyondell case, in particular that they breached their fiduciary duties of good faith, care and loyalty.


What can be done so that directors remain protected against such claims?


In general, directors need to be sure that they have a strong case if litigation ever takes place. For that they need to be able to show that they analysed the case and considered the insolvency event as improbable.


At least, in order to be able to strongly argue that, they need to evaluate -prior to accepting the leveraged transaction- the post transaction financial situation and expected evolution of the company, in terms of solvency.


In fact, directors should look for additional comfort, asking for management`s informed advise, outside advisors counsel, or representations from the buyer as for the post transaction solvency of the target.


In particular a third-party opinion on post closing solvency is not usual, but could be the best option.


In general, directors need to be able to act with the belief that they complied with their duties, (loyalty, care, good faith…).


Minority interests in Management or Controlling Interest Buyouts

In a previous post we dealt with the issue of the protection of minority shareholders, in the case of takeover bids made by controlling shareholders mainly. We will now include Management buyouts in our reasoning.

Should regulatory bodies be charged with the oversight of management or controlling shareholders` buyouts? What are the duties of directors and management in these cases?

Management buyouts are transactions in which managers purchase the shareholders` stakes, and take the company private. Controlling shareholders that hold executive positions have lately used to their advantage their privileged access to information, and their control over disclosures made about the proposed transaction. Cases like Dell, where the founder, still the first executive and a big shareholder, has offered to purchase the shares he does not own, (with the financial help of others) have again raised the concern of whether those transactions are fair, and whether the controlling shareholders, the managers and the board have done all the necessary to protect the interest of minority shareholders.

There is nevertheless a set of best practices that have been built over the last years to help all the actors deploy their activity fairly. These measures include:

–         Creation of a Special Committee of independent directors that, with the help of independent advisors, will initiate so-called Go-Shop activities, in order to search and find alternative offers in the market.

–         A majority of shareholders outside the buyout group should approve the transaction, so as to assure that independent shareholders are the ones to decide.

–         In some cases, the buyout group conditions its bid to the compliance of the previous provisions.

Courts in Delaware usually established a difference between the following two cases:

First, when the buyout group is made of managers but does not yet have a controlling interest in the company. In that case, if a majority of not involved –so, independent- shareholders approved the transaction, the Court would apply the business judgement rule, thus blocking any further court procedure.

Second, when the group is a controlling shareholder. In that case, Courts requires a higher standard, the so-called “Entire fairness review”. This means that Courts will guess if both “fair price and fair dealing” occurred.

Nevertheless, a recent decision by a judge has changed that sharp distinction, in the sense that, whenever there are enough tools in place to remove the conflict, (such as an independent committee and approval by majority of independent shareholders), Court estimates the Entire fairness review does not hold anymore, (MFW Shareholders Litigation).

But are those procedures enough? Do they really protect minority shareholders from abuse?

In Cain and Davidoff, the first measure, (independent committee), and even a board that strongly negotiates with management to obtain the best price for minority shareholders, is said to often produce a higher premium, which was not the case for the second measure, (the majority of the minority to vote in favor). Go-shop provisions don`t show good results either, as too often the shopping is not an actual auction.

Davidoff also points out that premiums in general are lower when the process is led by managers who are not directors, which would recommend a higher protection level.

Peter Henning introduces disclosure as a relevant element, when minority interests are at stake: as the regulatory bodies require certain aspects of the transaction to be disclosed, whenever companies declare or give information to the market, they are forced to be truthful and honest. In the case of Revlon, a Court declared proved that the company received an offer for the minority interests and also the information that it was not fair; after that, the company did everything to avoid receiving formal notices about that fact, so as to avoid its disclosure to the independent directors and the market. Disloyalty includes fraud, but also all activities entailing deceptive effects for third parties, the judge said, which is why the Revlon case is so relevant as it opens the window for a much more active role of Courts in this kind of case.

Anyway, those recent cases are likely to be appealed, so the debate will remain hot for some time.

Based on:

– Steven Davidoff: The Management Buyout Path of Less Resistance, June 2013, NYT.

– Peter J. Henning: A Warning Shot on Management Buyouts, June 2013, NYT.


Should third parties be allowed to reward directors at all?

There has recently been a lot of debate and regulation about Compensation to Directors by firms. Discussions include Non executive directors fixed or variable pay, equity compensation, long versus short-term compensation, the connection between pay and independence, and many other things, such as disclosure and  binding or not binding “say on pay” by shareholders.

But, what about the possibility that outsiders, shareholders or not, might reward directors, some or all of them? The debate has arisen after two hedge funds, (Elliot Management in Hess Corp. and Jana Partners in Agrium), bought respective stakes in the companies, arguing for change after years of underperformance versus peers. Both proposed a partial slate of directors, and also offered them if elected, (and if certain objective conditions were met), big rewards, (fixed amounts per percentage point of stock appreciation or percentages of the fund`s return).

The first answer by the affected firms against the proposed practice referred to the loss of independence by those directors, and the short-termism in which they would decide on company matters, (more linked to the long-term). Hedge funds opposed alignment increases, and also that they would be offering those packages to their nominees, not being able to withdraw the offer, so that directors` independence would be preserved.

There has been a public debate after these disclosures among academics and practitioners, and we will deploy the main arguments in what follows, both against and in favor of this practice. Some of those arguing against even recommend that a particular bylaw feature be introduced by companies that would veto the practice, and we will also comment that possibility.

Arguments in favor:

  1. Alignment, as rewards would be connected to stock price appreciation.. This is very relevant when, as in most companies attacked by shareholder activists, previous performance has been deceiving.
  2. It generates a certain value to the rest of shareholders, for which they would not be paying, as the reward is due by a particular shareholder.
  3. Independence: it should not be legally considered lost, as nominees still would remain independent from management. Even if there is a close tie to those sponsoring them, there is no reason to believe they lose their independence to act as such where it is legally required, (Compensation committees for example, and even in Audit Committees). The subject kept aside, independence would be lost if the sponsor could at a certain point decide to withdraw the compensation proposal, so as to execute a pressure in favor of certain decisions, but this is not the case.
  4. Those payment arrangements are needed if companies are to attract the most qualified directors.

Arguments against the practice:

  1. Loss of independence, as a third-party interest would be served, (shareholder or not). Some (Bainbdridge, for instance), strongly assert it would be a danger to introduce this self-interest feature between directors and their duty of loyalty to the corporation and all shareholders.
  2. It introduces short-termism in the boardroom.
  3. It creates a different class of directors, with much higher pay levels, which might generate unnecessary controversies in the boardroom for an external factor, and even entail a spiral of director pay.
  4. Those highly paid directors would presumably assume much more risk that those only paid normal fees, (the highest paid to NED`s near 500.000 USD), and would not act as a barrier to excessive risk-taking by executives.
  5. Some (Prof Coffee) state that, given late developments in capital markets, (ownership concentration, higher institutional investors power, removal of poison pill and other defenses), the additional ability of bribing directors should not be allowed to hedge funds or other institutional investors.

What should be done, as suggested by those against the practice?

  1. Prof. Coffee recommends that the law evolves so a director, , can only be said to be independent, it they are independent from management (current regulation) but also from those who sponsored or nominated them.
  2. The law firm Watchell, Lipton, Rosen & Katz propose that companies modify their bylaws so as to prohibit shareholder activists -or any agent other than the company- to compensate directors, (in all forms and size).

Should the Watchell-Lipton bylaw be adopted by companies? A general view is that W-L tries -as in many proposals by this firm- to disturb shareholder activism and help entrenched boards and management. A second argument is this bylaw would make it difficult to attract the best director candidates. Thirdly, W-L appears to consider directors brought by activists as more likely to breach their fiduciary duties than incumbents and management.

An additional topic to he considered is that in fact, there could be a wide variety of third parties interested in paying incentives to directors. M&A firms, or any other third-party could have an interest that could be (truly or not) dressed with the robe of the long-term shareholders` interests.

The Council of Institutional Investors in the US has rejected third-party bonuses or performance payments for directors.

In any case, it is very probable that this debate will continue, and many different realities might well contribute to its effervescence.