M&A Corporate Governance: Oversight of the Board’s Financial Advisors
Recent decisions in the Delaware Court of Chancery highlight the need for increased oversight of financial advisors by corporations engaging in M&A transactions. The board of directors or the special committee, as the case may be, must ensure that the actions taken by investment bankers are aligned with the interests of shareholders.
A recent case in Delaware, In re Del Monte Foods Co. Shareholder Litigation, is illustrative of the need for the board of directors to be fully informed regarding the actions of its financial advisors in M&A deals and to provide greater oversight of these advisors. In Del Monte Foods, the Delaware court made a preliminary determination to temporarily enjoin a stockholder vote scheduled to approve the leveraged buyout of Del Monte Foods Company and required the prospective parties to the transaction to provide further remedial disclosure to stockholders regarding potential financial advisor conflicts. Furthermore, the Delaware court enjoined certain protective provisions in the merger agreement, such as termination fees and right-to-match provisions pending the stockholder vote. In its analysis, the Delaware court criticized the passivity of Del Monte’s board of directors, noting that the board granted its financial advisor permission to provide buy-side financing before the parties to the transaction had agreed to a price, even though this caused Del Monte to have to pay an additional $3 million for a fairness opinion from a second financial advisor. When the initial financial advisor asked to be permitted to run the go-shop upon an agreement in price, the board agreed, despite what the Delaware court observed as that financial advisor’s potential conflict of interest and the availability of other financial advisors to manage that process.
Another recent decision in the Delaware Court of Chancery, In re El Paso Corporation Shareholder Litigation, further highlights the pitfalls of board passivity regarding the potential conflicts and actions of its financial advisors. The El Paso litigation involved the proposed $21.1 billion acquisition of El Paso Corporation by Kinder Morgan Inc. During negotiations for the proposed transaction, a financial advisor owned approximately $4 billion of Kinder Morgan’s stock and controlled two of the company’s board seats while simultaneously advising the target company, El Paso. Further complicating matters was the fact that the financial advisor’s lead energy banker on the transaction did not disclose his personal ownership of approximately $340,000 in Kinder Morgan stock. It is unclear whether the board inquired into such personal ownership.
One of the key takeaways from the El Paso litigation concerns the Delaware court’s criticism that the board of directors and the financial advisor did not properly “cabin” the role of the financial advisor in light of a potential conflict. In this case, when a second financial advisor was hired to mitigate the potential conflict and provide independent advice to El Paso, the role of the initial financial advisor in advocating that the second financial advisor should receive no fee unless El Paso agreed to the takeover by Kinder Morgan “tainted the cleansing effect” of such independent advice and called into question the objectivity of the fairness opinion issued by the second financial advisor, according to the Delaware Court of Chancery.
In another recent case, In re Southern Peru Copper Corp. Shareholder Derivative Litigation, the Delaware Court of Chancery, although deeply critical of the financial advisor to Southern Peru Copper Corporation in regards to its acquisition of a 99.15 percent stake in Minera México, S.A.B. de C.V., from Grupo México, S.A.B. de C.V., stopped short of questioning the financial advisor’s objectivity and the objectivity of the fairness opinion produced by the financial advisor, in part because it had worked for a flat and non-contingent fee. InSouthern Peru, the court took the special committee and investment banker to task for seemingly deviating from normal valuation practices in an attempt to find the deal fair, as opposed to objectively trying to reach a determination of the fairness of the consideration changing hands in the transaction. A judgment in the amount of approximately $1.26 billion was rendered.
The key takeaway in light of these recent decisions in Delaware is that the board of directors (with the help of its counsel) must anticipate potential issues that may affect a transaction before they occur. It is the transactional lawyer’s job to help the board of directors think “around the corner” and actively evaluate the proposed actions of its financial advisors at all stages of a transaction. Regarding conflicts, the board of directors must take an active “hands-on” approach in vetting financial advisors during the initial selection process and engage in the active questioning of both financial advisors and company management to fully inform themselves of any such conflicts. As a corollary, all issues before the board regarding potential conflicts should be memorialized in detail in the applicable board meeting minutes. In Delaware and other stockholder jurisdictions, as opposed to stakeholder jurisdictions, when a sale of control is considered, the goal of maximizing shareholder value must be paramount to the board of directors. Transactional lawyers and the board of directors must ensure that the planning and decisions made by managers, financial advisors and the board itself properly reflect this goal. In order to fulfill its fiduciary duty, the board of directors must exercise greater control in the transaction process and ensure that the compensation and services of its financial advisors are aligned with the best interests of company shareholders.