M&A in 2012: Use of Special Committees in M&A Transactions. Wednesday, March 28, :30 p.m. 1:30 p.m. (CDT)

Transcription

1 M&A in 2012: Use of Special Committees in M&A Transactions Wednesday, March 28, :30 p.m. 1:30 p.m. (CDT)

2 Speakers Marilyn Mooney Chair, M&A Practice Group Fulbright & Jaworski L.L.P. Washington, D.C. Janet Clarke President and Founder Clarke Littlefield LLC Boca Raton, FL 2

3 Continuing Education Information If you are requesting CLE credit for this presentation, please complete the evaluation that Fulbright will send via tomorrow. If you are viewing a recording of this web seminar, most state bar organizations will only allow you to claim selfstudy CLE. Please refer to your state s CLE rules. If you have any questions regarding CLE approval of this course, please contact your bar administrator. If you should have any questions regarding credit, please Terra Worshek at tworshek@fulbright.com. 3

4 Administrative Information Today s program will be conducted in a listen-only mode. To ask an online question at any time throughout the program, simply click on the question mark icon located on the tool bar in the bottom right side of your screen. We will try to answer your question during the session if time permits. Everything we say today is opinion. We are not dispensing legal advice, and listening does not establish an attorney-client relationship. This discussion is off the record. Anything we say cannot be quoted without our prior express written permission. 4

5 Purpose A special committee could be needed when the majority of the members of a board of directors has, or could appear to have, a conflict of interest in the transaction or matter at hand. A special committee helps provide assurance that the corporate decision has not been coerced or unduly influenced by the interested directors. 5

6 Purpose Special committees help reduce exposure in transactions where: a majority of the board has a conflict of interest with respect to such transaction; a minority of the board that controls or dominates a majority of the board has a conflict of interest with respect to such transaction; or such transaction involves a merger of the company with an entity controlled by a controlling shareholder. 6

7 When to Establish a Special Committee 7

8 When to Establish Special Committee To decide whether a special committee is necessary: Identify and analyze conflicts Evaluate advantages and disadvantages 8

9 Identify and Analyze Conflicts Conflict must be material Existence of some immaterial self-interest, absent further evidence of disloyalty, is insufficient to be viewed as disabling conflict 9

10 Disabling Conflicts Most obvious conflict exists where director is on both sides of transaction or has material financial interests adverse to corporation, whether directly or indirectly through an entity doing business with company 10

11 Disabling Conflicts Other examples include: Director s family member or other close relative has material interest in or with respect to transaction Director s fees materially in excess of what is usual and customary Differential consideration is paid regarding multiple classes of stock Corporation buys back stock from director or his or her employer 11

12 Disabling Conflicts Other examples continued: Expanded director indemnification provided by buyer in merger agreement for directors subject to personal liability Management director in arm s length transaction will receive substantial change-in-control payments or substantial payments in exchange for future consulting services or non-competition covenant 12

13 Examples Where Special Committees Frequently Used 1. Going private or freeze out transactions where a controlling or significant stockholder wishes to eliminate the public minority 2. Leveraged buy-outs in which management is participating and will have an interest in surviving company 3. Other M&A transactions such as in hostile or negotiated takeover where sr. management will maintain positions 4. Stockholder derivative litigation 13

14 Conflicts Considerations Special committee may be unnecessary if majority of board is disinterested in transaction and does not otherwise have conflict of interest In such cases, interested directors can recuse themselves from deliberations and decisions and communications regarding proposed transaction 14

15 Conflicts Considerations Other conflict transactions that do not typically merit formation of special committee include: Where director has conflict of interest, if there is no concern that the director dominates or controls board Employment agreements, stock option grants, and other compensation arrangements 15

16 Ongoing Evaluation The need to establish a special committee is context specific and may change as transaction evolves Throughout the process, a board must be alert to any potential conflicts and be prepared to establish a special committee if facts and circumstances require it 16

17 Advantages Review Standards Establishing an effective special committee may: Confer protections of the business judgment rule for transaction otherwise subject to entire fairness standard Shift the burden of proof to the party challenging a transaction subject to entire fairness standard Demonstrate that the challenged transaction satisfies entire fairness test 17

18 The Business Judgment Rule Decisions made by board are typically subject to the business judgment rule Under the rule, there is presumption that in making a business decision, the directors acted on an informed basis, in good faith, and in honest belief that action taken was in best interest of the company 18

19 The Business Judgment Rule Generally, the rule does not apply to the following conflict transactions: Majority of board has financial or other interests adverse to the corporation Minority of board has interests adverse to company, if minority controls or dominates board as a whole Majority of board will receive material personal or special benefit, even if incidental to transaction Transactions with a controlling shareholder 19

20 Entire Fairness Standard With respect to these conflict transactions, Delaware courts will review a board s actions under the entire fairness standard Strictest standard for review of board actions under Delaware law 20

21 The Entire Fairness Standard Transaction is entirely fair if it mimics a hypothetical arm s length negotiated transaction Standard has two components: Fair dealing focuses on process by which board considers, negotiates, and approves transaction Fair price focuses on economic and financial considerations relied upon when valuing transaction 21

22 Advantages Review Standards Even if procedural effect of special committee process merely shifts burden of proof in litigation, the practical benefits are significant: Constitutes strong evidence that transaction satisfies fair dealing component of entire fairness standard Settlement value of litigation and risk of personal liability for directors falls if burden of proof is shifted to the party challenging transaction 22

23 Observations Use of special committee where unnecessary could potentially make a transaction more vulnerable to litigation than if no special committee was used May cause stockholders to question transaction May cause court to review the transaction under the entire fairness standard instead of the business judgment rule even if directors were disinterested and independent 23

24 Observations If board otherwise employs proper process, special committee will add layer of complexity and could slow down transaction Potentially increased financial costs due to the need to engage: Independent financial and legal advisors in addition to company s own advisors 24

25 Observations May create non-financial costs such as creating factions or division within board Where relevant, a controlling stockholder relinquishes an element of control over process that its equity interest and board representation would generally be sufficient to carry 25

26 Forming a Special Committee 26

27 Formation Fundamental requirement that special committee be composed of directors who are independent and disinterested regarding transaction at issue Otherwise, work of committee will be vulnerable to attack regarding its objectivity and impartiality in dealing with conflicts 27

28 Formation - Disinterest Disinterested directors should choose committee members Each committee member should have no direct or indirect interest in proponents of transaction 28

29 Formation - Disinterest Factors that generally disqualify a member include: Current material financial or employment relationship with a controlling stockholder or its subsidiaries Significant prior business dealings with a controlling stockholder Personal or other relationship with a controlling stockholder that would imply that member is beholden to stockholder 29

30 Formation - Independence Factors that generally will not disqualify a member include: Stock ownership in company Director elected by majority stockholder Financial interest solely because director will continue to be director in surviving company 30

31 Formation - Disinterest Delaware Supreme Court has held that a director is interested when: Director will receive personal financial benefit from transaction that is not shared equally by stockholders; or Corporate decision will have materially detrimental impact on director, but not on corporation or stockholders (Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)) 31

32 Formation - Independence Delaware Supreme Court has held that a director is independent when that director s decision is based on the corporate merits of the subject matter before board rather than extraneous considerations or influences (Aronson A v. Lewis, 473 A.2d 805, 812 (Del. 1984)) Director cannot appear to be controlled by controlling stockholder 32

33 Formation - Independence Director who is otherwise independent under NYSE and NASDAQ standards may still not be considered independent for purposes of serving on special committee 33

34 Formation - Compensation Compensation of Special Committee Should be set in advance by the company in consultation with company counsel and special committee counsel Can be under fixed, per-meeting, or mixed arrangement Should not be excessive or dependent on outcome of transaction 34

35 Formation - Size Under Delaware law, committee may be composed of one or more directors But committee of one person is highly problematic and should be avoided Appointing new directors to serve for the purpose may be necessary Recommended to have at least three but not more than five directors 35

36 Formation Outside Advisors Special committee needs independent financial and legal advisors to help evaluate transaction Committee should select its own chairman, where relevant, and independent legal and financial advisors Interested party should not be involved in selection 36

37 Formation Advisor Compensation Compensation arrangements with advisors and terms thereof (fixed, contingent, mixed) should be set by committee Wholly contingent and excessive compensation should be avoided 37

38 Formation - Mandate Mandate of special committee defined by resolutions adopted by board Scope of resolutions should coincide with fiduciary responsibilities of committee in specific context of transaction Committee should not be constrained by narrow mandate 38

39 Formation - Mandate Delaware Court of Chancery has emphasized that members must have proper understanding of mandate. See Gesoff v. IIC Industries, Inc., 902 A.2d 1130, (Del. Ch. 2006) Otherwise, court may find process flawed, and the legal benefits of special committee will not be conferred 39

40 Formation - Mandate Board minutes as to committee s formation, composition, and mandate should be carefully prepared Record should also demonstrate that committee is aware of its responsibilities and can meet them without being limited or constrained by board or management 40

41 Formation Authority Generally, special committee should at least have authority to: Retain independent counsel and financial advisors at company expense Investigate proposed activities subject to potential conflict Determine the advisability of the proposed transaction Prevent any board decision to approve the proposed transaction without recommendation of the special committee 41

42 Formation Authority Must have real bargaining power to be effective Before burden is shifted to challenging party, courts evaluate whether committee s capacity and performance accurately approximated arm s length negotiation; not just whether committee had ability to say no to transaction 42

43 Formation Authority Two recent Delaware Court of Chancery opinions suggest that special committee may not confer legal benefits unless committee has full authority of board in relation to challenged transaction In re CNX Gas Corp. S holders Litig., 4 A.3d 397 (Del. Ch. 2010) In re Southern Peru Copper Corp., C.A. No CS, 2011 WL (Del. Ch. Oct. 14, 2011) 43

44 In re CNX Gas Corp. S holders Litig. Court of Chancery endorsed strong form special committee model in relation to controlling stockholder in freeze-out transaction Held that to receive the business judgment review, transaction needed to have: approval from special committee of independent and disinterested directors; and approval of corporation s disinterested stockholders (majority-of-the-minority approval) 44

45 In re CNX Gas Corp. S holders Litig. Court found that transaction at issue failed to satisfy first prong (disinterested and independent special committee approval) because the [s]pecial [c]ommittee was not provided with authority comparable to what a board would possess in a third-party transaction. 45

46 In re Southern Peru Copper Corp. Court of Chancery endorsed strong form special committee model in relation to corporation s acquisition of foreign company owned by corporation s controlling stockholder Resolutions authorizing committee did not give express authority to negotiate with controlling stockholder or to explore other strategic alternatives 46

47 In re Southern Peru Copper Corp. Court criticized limited mandate and found that the committee failed to negotiate at arm s length like a third party in the [s]pecial [c]ommittee s position. [B]y acting like a third-party negotiator with its own money at stake and with the full range of options, the [s]pecial [c]ommittee would have put [the controlling stockholder] back on its heels. 47

48 Operation of Special Committee Process 48

49 Operation Special committee should act as a disinterested and independent board considering an arm s length transaction and negotiation Committee should supply role of surrogate for energetic, informed, and aggressive negotiation that one would reasonably expect from an arm s length adversary 49

50 Operation Access to Information Committee should have sufficiently broad authority to obtain not only outside advice, but also access to all employees and relevant information in company s possession Committee should inquire i about and have access to information relating to previous negotiations, valuations, precedents, historical information, etc. that have reasonable relationship to transaction Company should appoint a point person for the Committee 50

51 Operation Interaction with Management Special Committee should pay special attention to interaction with management and General Counsel. Flow of information necessarily changes. 51

52 Operation Active Participation Committee must exercise power in informed and active manner to shift burden to challenging party Committee should not take passive role as to terms of proposed transaction Committee should regularly meet with advisors and give direction and consider valuation and other material issues But committee should not rely exclusively on delegation to advisors to negotiate terms 52

53 Operation Confidentiality Advice to special committee and deliberations thereof should be kept strictly confidential, particularly from interested persons and their advisors With publicly traded entities where insider trading laws apply, committee should adhere strictly to no comment response in reaction to any outside inquiry 53

54 Operation Record Keeping Court will thoroughly examine record of proceedings Record should demonstrate informed and engaged nature of committee Minutes of committee s deliberative processes should be carefully prepared Price increases and improvements in other material terms should be well-documented 54

55 Questions Marilyn Mooney Chair, M&A Practice Group Fulbright & Jaworski L.L.P. Washington, D.C. Janet Clarke President and Founder Clarke Littlefield LLC Boca Raton, FL 55

56 Continuing Education Information If you are requesting CLE credit for this presentation, please complete the evaluation that Fulbright will send via tomorrow. If you are viewing a recording of this web seminar, most state bar organizations will only allow you to claim selfstudy CLE. Please refer to your state s CLE rules. If you have any questions regarding CLE approval of this course, please contact your bar administrator. NY CLE Number If you should have any questions regarding credit, please Terra Worshek at tworshek@fulbright.com. 56

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