Three recent opinions from the Delaware Chancery Court in shareholder derivative actions focus on conflicts of interest involving those negotiating on behalf of acquired public companies and their advisors. In each case, the court was critical of flaws in the sale process undertaken by the sellers and their advisors, but declined to enjoin the transaction, preferring a damage remedy rather than preventing stockholders from voting upon a sale at an attractive price with full disclosure of the potentially flawed sale process. Although the opinions focus primarily on the sellers and their advisors, a tainted sale process can also create significant issues for the buyer.
Costs. Even if the buyer is not a named defendant, it will incur significant additional costs pursuing a settlement or dismissal. It may also be responsible for the payment of plaintiffs’ attorney fees and, though much less frequently, damages to the aggrieved shareholders.
Deal certainty. Although courts generally have been reluctant to enjoin attractively priced sales to third parties or to modify the terms of the acquisition agreement to impose go-shop or other curative remedies, at some point the lack of a deep pocket to fund a post-closing damage award may outweigh the inequities of jeopardizing a transaction. Imposition of these remedies will subject a transaction to delay and greater market risk, and leave it vulnerable to interlopers.
Indemnification obligations. Depending on the indemnification arrangements in place at the target company or provided by the buyer in the acquisition agreement, and subject to statutory and public-policy limitations on indemnifying breaches of duty of loyalty, buyers may bear the cost of monetary damage awards entered against directors or officers of the acquired company.
Aiding and abetting. While uncommon, it is possible for a buyer to be found to have aided and abetted the target directors’ breaches of fiduciary duty, particularly in circumstances where the buyer has knowledge of wrongdoing by the fiduciary or is perceived as exploiting conflicting loyalties among the target’s directors.
These issues all raise the question of whether there are ways for buyers to avoid or mitigate these risks when entering into transactions that become the subject of derivative suits. First, buyers should be careful not to breach obligations imposed upon them, such as anti-teaming provisions or restrictions on furnishing confidential information in a confidentiality agreement; that breach in itself could be a path to buyer liability. Buyers should also be sensitive to situations that create the appearance of potential conflicts of interest or otherwise provide the basis for claims that the negotiating process was tainted. This is especially true for private-equity buyers in circumstances where the target management will retain a stake in the ownership post-closing.
Among the factors that might lead a court to take claims more seriously are:
- The target CEO or senior management is pursuing the transaction or negotiating terms without prior board authorization, or is the sole negotiator in a private-equity transaction without participation by an independent director or financial advisor.
- The target has publicly announced alternative strategies, such as the sale of certain assets or a spin-off, and the seller is being advised by a “conflicted” advisor.
- The buyer (or its affiliates) have a long-standing or significant relationship with the target’s financial advisor, or if the financial advisor requests the opportunity to participate in the financing of the buyout.
- Common directors serve on the boards of both the buyer and the target.
- Waivers of bid process guidelines or requirements, including standstill provisions, are applicable to the buyer without clear target board (or board committee) authorization.
- Request for a special (preferential) arrangement for one or a subset of shareholders, such as a premium to the acquisition price paid to the public.
- Expected post-closing business relationships between the buyer and affiliates of the target, including one or more large stockholders.
Sensitivity to these situations and working with the target’s advisors to effectively eliminate conflicts will best position the parties to defuse potential litigation landmines.
Peter S. Golden is a partner and Abigail Pickering Bomba a corporate partner, both resident in the New York office of Fried Frank.