Fiduciary Duties in M&A Transactions
The board of directors of a corporation owe fiduciary duties to the corporation and its stockholders under Delaware law. In most general matters, the actions and decisions of the board and the company’s officers are viewed through the standard of the business judgment rule. In a change in control transaction, however, a court reviewing the actions of a board will apply a heightened standard, and the actions and decisions of the board and officers become subject to a greater level of scrutiny. Courts often examine the board’s decision-making process, the reasonableness of actions taken and the information on which decisions are based. To build a strong case against potential litigation during a significant transaction, companies and their boards should be well informed about their duties and follow best practices for evaluating, structuring and approving a deal.
The fiduciary duties of the board of directors include the duty of care and the duty of loyalty. To satisfy these duties, directors must act in good faith and in a manner they reasonably believe to be in the best interests of the corporation and the corporation’s stockholders. Courts typically use the business judgment rule when reviewing actions taken by a board of directors. Applying the business judgment rule means that courts defer to the judgment of directors and presume that they acted in the best interests of the corporation if they acted in good faith, on a fully informed basis and with due deliberation.
In mergers, sales and some other significant transactions, courts more carefully scrutinize the decisions of the board, which means that directors are potentially exposed to greater liability. In these situations, a court’s standard of review may change from the business judgment rule to enhanced scrutiny until certain actions are taken. Under the enhanced scrutiny standard of review, a court will examine the board’s overall decision-making process, including the quality of the information that the board consulted, the procedures that the board followed, and whether directors put the interests of the corporate entity and its stockholders above their own interests. Delaware courts reason that in these transactions there is a greater possibility that a conflict of interest exists in which directors will take action to benefit themselves at the expense of stockholders.
To satisfy the enhanced scrutiny standard, directors must demonstrate that they fulfilled their duty of care and duty of loyalty in pursuing the transaction and that their actions and decisions were reasonable under the circumstances. The duty of care requires directors to act in a manner that the director believes to be in the best interests of the corporation. In the context of a significant transaction, this duty requires that directors take steps to become informed about the material elements of the proposed transaction and to ensure that they have received all relevant information to make a decision. The duty of loyalty requires directors to act in good faith. Directors must put the interests of the corporate entity and its stockholders above their own interests. In a transactional context, directors should be able to show that they took affirmative and reasonable actions with respect to maximizing value for the stockholders and seeking out and considering alternatives to the transaction.
As a starting point when engaging in a significant transaction, directors and officers should consider the following suggestions:
Exercise oversight of negotiations and the transaction process. Consider assigning a special committee of disinterested directors to the transaction, particularly if some members of the board have a personal interest in the transaction. Directors and officers who are interested parties in a transaction should not be part of negotiating the terms.
Select independent financial advisors and obtain a fairness opinion. Carefully review corporate valuations and the methodologies used for corporate valuations.
Consider strategic alternatives and conduct a market check to confirm that the proposed transaction is the best option in terms of stockholder value.
Engage legal counsel early in the process for specific guidance.