will result in a change of control. See In;re;Smurfit-Stone;Container;
Corp. ;Shareholder ;Litigation, ;C. A. No. 6164-VCP, at 30-31 (Del. Ch.
May 20, 2011).
In these situations, the duty of the directors is not to preserve the
corporate entity, but to maximize the sale value of the corporation for
the benefit of the company’s shareholders. The fact that the board
must consider Revlon duties does not prevent the directors from
engaging in defensive measures such as lock-ups, but these defensive
measures must elicit bidders. Delaware courts have made it clear that
there is no particular process to value maximization that must be
followed to meet the requirements of Revlon. See In ;re ;Dollar ; Thrifty ;
Shareholder ;Litigation, 14 A.3d 573, 595 (Del. Ch. Sept. 8, 2010).
So long as the target corporation has an independent, well-informed
board acting reasonably and in good faith to maximize value, a court
will not substitute its judgment for that of the board of directors.
When a director is considering a sale or merger transaction in
which the interests of the common and preferred shareholders
diverge, special care must be taken. If there are specific contractual
provisions that specify what a preferred shareholder’s rights are, the
board must abide by those rights alone — the board is not required to
give further benefits to the preferred shareholders above and beyond
such contractual provisions. Thus, as long as any contractual obligations are satisfied, preferred shareholders will typically have no claim
for breach of fiduciary duty against a director. Nemec ;v. ;Shrader, 991
A.2d 1120, 1129 (Del. 2010).
However, when there are no specific contractual provisions that
detail a preferred shareholder’s rights in a sale or merger, the board
of directors must attempt to “do its best to fairly reconcile the
competing interests of the common and preferred” shareholders. LC ;
Capital ; Master ; Fund, ; Ltd. ; v. ; James, C.A. No. 5214-VCS, at 22-23
(Del. Ch. Mar. 8, 2010).
Issues most often arise in sale and merger transactions where
corporations have both common and preferred stockholders and the
transaction consideration is not allocated equally among the classes.
The most heightened scenario is when preferred shareholders
receive all or a significant portion of the consideration pursuant to
their contractual rights and common shareholders receive little or no
consideration. Particularly in these circumstances, all or certain of the
following protective measures should be taken to protect the directors
of a target’s board from successful claims of breach of fiduciary duty:
• Reallocate a portion of the merger consideration from the preferred
to the common stockholders so that the common stockholders
receive some merger consideration. This will obviously require
the consent of those classes of stock adversely impacted. When
implementing the reallocation, include a reference in the certificate
of incorporation of the target that it is subject to the “transaction
documents.” In the transaction documents, recipients of merger
consideration agree to release the target and its directors from
claims. If not already there, include a “§102(b)( 7)-type” provision
in the target’s certificate of incorporation. This will not exculpate
directors for breaches of the duty of loyalty, but it will help protect
against alleged violations of the duty of care.
• Make sure the target corporation has appropriate D&O insurance
coverage. If coverage needs to be increased, have this be a
condition to signing rather than closing in case claims arise
between signing and closing.
• Obtain a fairness opinion. Ideally, this would be from an independent
banker rather than the banker involved in the transaction and
would include opinions of fair value for each class of stock rather
than an opinion that the “entire” transaction is fair from a financial
point of view.
• Fiduciary claims are separate and distinct from dissenters/
appraisal rights. Therefore, even if a security holder has not
asserted its dissenters/appraisal rights and has received merger
consideration, he or she is not barred from asserting a breach of
fiduciary obligation claim. The statute of limitations for fiduciary
claims varies from state to state so be sure to negotiate a survival
period for breach of fiduciary duty claims that is at least as long as
the statute of limitations.
• Where security holders appoint the target’s directors and such
security holders have an obligation to indemnify such directors
pursuant to contract or other governing documents, require
indemnification from such security holders to the extent such
indemnity amounts are not otherwise covered by insurance.
• The transaction document should provide that the target’s board has
a “fiduciary-out” if it gets a better offer between signing and closing.
Negotiate a market break-up fee and no-solicit provisions so that the
buyer is protected but the target can continue to receive bids.
• Thoroughly document the process and motivations of the board
so there will be a greater chance the business judgment rule will
not be rebutted. Use a reputable investment banker in the target’s
industry to “shop” the target. Document that the target exhausted
other possibilities before accepting an offer where certain security
holders take a haircut — for example, current and new investors
are unwilling to invest additional funds and traditional financing
avenues have been exhausted.
• If possible, make sure directors are common shareholders rather
than preferred shareholders. Courts have found that in transactions
where the interests of common and preferred shareholders diverge
and the common shareholders file a claim, directors who own
preferred stock may be interested, while directors who hold
common stock are usually not interested. If the board is composed
of a majority of directors with ties to the preferred shareholders
rather than common shareholders, appoint a special committee
to review the transaction on behalf of the common shareholders.
An issue related to breach of fiduciary claims, but one that is
beyond the scope of this article, is whether a buyer can be held liable
for aiding and abetting the target corporation’s board in connection
with its breach of fiduciary duty. In order to prevail on this claim,
a plaintiff must prove that 1.) there was a fiduciary relationship
between the security holder and the target’s board, 2.) the duty was
breached and 3.) the buyer knowingly participated in that breach.
Delaware courts have stated that a third-party bidder negotiating at
arms’ length with the target corporation will rarely be liable for aiding
and abetting. See In ;re ;Del ;Monte ;Foods ;Co. ;Shareholders ;Litigation,
2011 WL 532014, at 20 (Del. Ch. Feb. 14, 2011). Despite this, a
potential acquirer may be liable to the shareholders of the target
corporation if the bidder and the target board “conspire in or agree to
the fiduciary breach.” Id. ;at 21.
Potential acquirers are permitted to negotiate a lower price through
arms’ length dealings with the target board, but the bidder is not
permitted to exploit a target’s fiduciary breach by demanding terms
that force the target board to prefer its own interests over the interests of the target’s shareholders. abfJ
JENNIFER L. VERGILII is a partner in Calfee, Halter & Griswold’s M&A
practice group. Her practice focuses on counseling publicly and
privately held clients with respect to a wide range of general corporate and business matters as well as mergers and acquisitions. She
can be reached at 216.622.8568 or
jvergilii@calfee.com.
