LEGAL EYES
Protection Against Fiduciary Claims
in a Sale or Merger Transaction
BY JENNIFER L. VERGILII
In the context of a sale or merger transaction, directors of the target entity are subject to fiduciary duties.
These duties are subject to scrutiny, especially in the scenario where security holders do not equally share
in the proceeds of the transaction. Careful preparation, planning and documentation can, however,
significantly protect directors from claims of breach of their fiduciary duties.
JENNIFER L. VERGILII
Partner, Calfee, Halter
& Griswold
In the context of a sale or merger transaction, directors of the target entity are subject to fiduciary duties. These duties are subject to scrutiny, especially in the scenario where security holders do not
equally share in the proceeds of the transaction. Careful preparation,
planning and documentation can, however, significantly protect directors from claims of breach of their fiduciary duties.
By way of background, directors are subject to the duties of care
and loyalty during their service to the corporation. In addition, with
certain sale or merger transactions, directors are subject to additional
so-called Revlon duties to ensure that reasonable efforts are made to
secure the highest price reasonably available to the target. When a
potential sale or merger transaction leads to a direct conflict in interests between preferred and common shareholders, directors must
fulfill the contractual rights of preferred shareholders first. However,
once these contractual rights have been satisfied, directors may favor
the interests of common stockholders over preferred stockholders if
the interests of the two constituencies differ.
Strategies that may be pursued to limit director personal liability
for claims include a limitation of liability clause in the target’s certificate of incorporation (see for example, §102(b)( 7) of the Delaware
General Corporation Law), obtaining or increasing coverage of directors and officers liability insurance (D&O insurance), a “fiduciary
out” in the transaction document, and the use of an independent
committee of directors to evaluate any potential sale or merger. Let’s
look at some of these scenarios.
When directors are faced with a potential sale or merger transaction,
their decisions are generally subject to the “business judgment rule.”
This rule presumes that directors making a business decision “acted
on an informed basis, in good faith and in the honest belief that the
action taken was in the best interests of the company.”
The business and affairs of a corporation are generally managed
by the corporation’s directors. In performing those duties, directors
must abide by the duties of care and loyalty, as spelled out in a 1986
case, Revlon, ;Inc. ;v. ;MacAndrews;&;Forbes;Holdings, ;Inc. These are
usually referred to as “Revlon duties.” The duty of loyalty requires
that a director put the best interests of the corporation above his or
her own personal interests. The duty of care requires that a director
perform his or her duties in the manner that an ordinarily prudent
person would in a similar situation.
Directors of a Delaware corporation may be exculpated from violations of the fiduciary duty of care if the corporation has a §102(b)
( 7) provision in its certificate of incorporation. Section 102(b)( 7) of
the Delaware General Corporation Law provides that a corporation
may limit the personal liability of a director for monetary damages
for breach of a fiduciary duty as a director, except in cases where
1.) the director breaches the duty of loyalty to the corporation or its
shareholders, 2.) the director participates in acts or omissions not in
good faith or which involve knowing or intentional misconduct or 3.)
the director engages in a transaction in which the director obtained
an improper personal benefit.
When directors are faced with a potential sale or merger transaction, their decisions are generally subject to the “business judgment
rule.” This rule presumes that directors making a business decision
“acted on an informed basis, in good faith and in the honest belief
that the action taken was in the best interests of the company.”
Quoting ;Aronson ;v. ;Lewis, 473 A.2d 805, 812 (Del. 1984). Delaware
courts will not substitute their own judgment for that of the board
of directors if a board decision can be “attributed to any rational
business purpose.” Quoting Unocal ;Corp. ;v. ;Mesa ;Petroleum ;Co., 493
A.2d 954 (Del. 1985).
There are three situations in which Revlon duties will attach: 1.)
when a company initiates an active bidding process to sell itself or
breakup the company, 2.) following a bidder’s offer, the target abandons its long-term strategy and seeks a transaction that will result
in the breakup of the company and 3.) when a proposed transaction
