Conflict Transactions: Upping the Ante at a Time of Anxiety

ICLG The International Comparative Legal Guide to: Mergers & Acquisitions 2012 A practical cross-border insight into mergers and acquisitions Published by Global Legal Group, with contributions from: Albuquerque & Associados Lenz & Staehelin Ali Budiardjo, Nugroho, Reksodiputro Lorenz Andreas Neocleous & Co LLC Mannheimer Swartling Advokatbyrå AB Arzinger Nishimura & Asahi Bech-Bruun Pachiu & Associates Cárdenas & Cárdenas Abogados Santa Maria Studio Legale Associato Covington & Burling LLP Schoenherr Cravath, Swaine & Moore LLP Skadden, Arps, Slate, Meagher & Flom LLP Dittmar & Indrenius Slaughter and May Elvinger, Hoss & Prussen SNR Denton & Co Gide Loyrette Nouel Steenstrup Stordrange Goltsblat BLP Stikeman Elliott LLP Hengeler Mueller Tonucci & Partners Herbert Smith LLP Wachtell, Lipton, Rosen & Katz J & A Garrigues, SLP Webber Wentzel Karanovic & Nikolic Yigal Arnon & Co. Koep & Partners Zhong Lun Law Firm Lee and Li, Attorneys-at-Law Žurić i Partneri d.o.o., law firm Chapter 5 Conflict Transactions: Upping the Ante at a Adam O. Emmerich Time of Anxiety Wachtell, Lipton, Rosen & Katz Trevor S. Norwitz Overview conflict transaction’s fairness. That is why almost all conflict transactions feature one or both of these procedural devices. No task facing the independent directors of a public corporation Although the basic rules have not changed, recent court decisions demands greater focus and care than a change of control or other show the Delaware Court of Chancery to be taking a more active major transaction in which a controlling shareholder or senior stance in policing conflict transactions. This increased judicial management stands on the opposite side. Whether the conflicted suspicion is not aimed solely at traditional fiduciary targets such as party has absolute control and insists that it is only willing to special committees, inside management or controlling shareholders, entertain a specified proposed transaction, or whether the directors but has focused also on advisors and other transaction participants have greater power and influence – or even full legal power – over whose own motivations have been suspected of being in conflict a potentially conflicted transaction, these are among the thorniest with the best interests of a company’s shareholders. Recent situations that can face directors and their advisors, and recent decisions serve as a cautionary reminder that even where a Delaware cases have raised the stakes and heightened the anxiety. company’s board of directors is independent or uses one or more of As always, however, paying close attention to the process by which the conflict cleansing mechanisms described above, great care such transactions are pursued and ensuring that independent should be exercised by the board to ensure that it remains actively directors are actively engaged, properly informed, and empowered engaged in the process and that any potential conflicts of interest to exercise their good faith judgment – together with a healthy dose are proactively identified and properly addressed. of common sense – can alleviate the risks and help navigate a path through the briar patch. In recent years, conflict transactions have garnered substantial The Basics: The Lynch Doctrine and the attention and have been subjected to more than a little judicial Importance of an Active Board skepticism. Whether a classic case in which a fiduciary stands on Since the Delaware Supreme Court’s 1994 ruling in Kahn v. Lynch both sides of a deal, or a transaction which merely raises a risk that Communication Systems, Inc.,2 it has been clear that when managerial self-interest could steer the process away from the best considering a shareholder challenge to a true conflict transaction – interests of public shareholders, courts in the U.S., and especially in that is, one in which a controlling shareholder stands on both sides Delaware, tend to view such transactions with suspicion and accord of the transaction – the court will apply the “entire fairness” test, them intense scrutiny. Specifically, when a conflict transaction notwithstanding the use of either an independent special committee between a corporation and a controlling party is challenged in court, or a majority-of-the-minority shareholder vote condition. The use the interested fiduciary ordinarily bears the burden of of either procedural mechanism will, at most, shift the burden of demonstrating that the transaction was “entirely fair” to the proving the transaction was unfair to the challenging shareholder- corporation and its shareholders. In considering whether this plaintiff.3 Under Lynch and its progeny, in order to shift the burden, burden is met, a Delaware court will consider, in a holistic manner, a special committee generally should be properly constituted (that both the process by which the transaction was negotiated – whether is, be composed of genuinely independent directors), have an there was “fair dealing” – and whether the consideration provided appropriately broad mandate, and be properly advised. Recent represented a “fair price”. decisions have further suggested that in order to effect a shift in the Where the conflict transaction was negotiated and approved by a burden, the special committee also must have actually negotiated in properly functioning special committee composed of independent an effective manner.4 directors, the “entire fairness” standard continues to apply, but the Although Lynch involved a paradigmatic case in which a burden of proving that the transaction was not fair shifts to the controlling shareholder stood on both sides of a transaction, shareholder-plaintiff, on the sensible theory that such a mechanism Delaware courts approach with similar suspicion transactions in approximates the negotiating dynamics of an arm’s length bargain which management insiders have a special role, such as a leveraged between the company and a third party. Similarly, the burden is buyout where members of management will “roll” their equity into, shifted where a conflict transaction is approved or ratified by a fully and stay on as executives of, the surviving entity. So, for example, informed majority of the unaffiliated shareholders because such a if a company is exploring strategic alternatives or conducting a sale condition disables the self-interested fiduciary from both process in which private equity alternatives may be proposed, has unilaterally initiating and approving the deal.1 Indeed, the courts received a buyout proposal, or has agreed to be sold to a private in Delaware have observed that either or both of an independent equity buyer, the board should (as the court likely will) take note of bargaining structure and a majority-of-the-minority vote condition, the risk that management and their level of enthusiasm and although not conclusive, will serve as powerful evidence of a ICLG TO: MERGERS & ACQUISITIONS 2012 WWW.ICLG.CO.UK 17 © Published and reproduced with kind permission by Global Legal Group Ltd, London Wachtell, Lipton, Rosen & Katz Conflict Transactions cooperation (including as to participation in any sale or go-shop not utilise both protections. While ostensibly decided within the process, in providing information to strategic competitors or other traditional rubric delineated by Lynch, these decisions exhibit a potential transaction partners) may be influenced by self-interest. heightened skepticism towards conflict transactions and an There are a variety of techniques that an actively engaged board can increased willingness to impose severe sanctions where the court use to address such risks and protect the integrity of the sale process deems it appropriate (even based on a preliminary factual record), in which an LBO is being considered as an alternative. and to question the motives and integrity of transaction participants Management should be instructed to be even-handed among and financial advisors. potential bidders in providing information and cooperation. In In re Southern Peru Copper Corp. Shareholder Derivative Representatives of the board’s advisors can act as “chaperones” at Litigation, public shareholders challenged the sale by Grupo meetings between management and bidders to ensure that the México, S.A.B. de C.V. of its 99.15% interest in Minera México, process is not “tainted” by inappropriate communications between S.A.B. de C.V., an unlisted private Mexican corporation, to bidders and management. In this connection, it is important that the Southern Peru Copper Corporation,9 a publicly traded company board not only receives appropriate advice but that this advice and also controlled by Grupo México. the board’s deliberations are properly reflected in the record of the Recognising from the outset the self-interested nature of Grupo transaction. México’s merger proposal, the Southern Peru board established an As a general rule, the more serious the conflict, the greater the need independent special committee whose “duty and sole purpose”, for board involvement and oversight. In a true conflict situation, according to the board resolution forming it, was “to evaluate the even the approval by an independent special committee (or board [merger] in such manner as the Special Committee deems to be comprised of independent, non-management directors) will not desirable and in the best interests of the stockholders of [Southern protect the transaction in an entire fairness review where the Peru]”. The special committee hired independent legal and committee or board is found to have taken a passive

Load more