
This article focuses on issues that have arisen during M&A transactions due to corporate law within the several states. In particular, this article addresses the fiduciary duties of the buyer’s and target’s board of directors, stockholder approval, and appraisal rights.
Fiduciary Duties of Target Board of Directors
Each board of directors has the fiduciary duty of loyalty and care. However, if there is a possible breach of the duties, the first question is to determine what standard of review ought to be applied. There are generally three standards of review that might apply, depending on the type of transaction that is taking place:
- Business Judgment Rule – This is a presumption that the business decisions of the board of directors were made on an informed basis, in good faith, and in the best interest of the company. This is the general standard unless there is a showing of gross negligence on the part of the board. Some transactions, however, call for a higher standard of scrutiny.
- Enhanced Scrutiny – This standard is applied whenever the transaction results in a “sale of control”, a trigger of a defensive mechanism within the company, there are interested directors, or if there is an interested controlling stockholder.
- Revlon Duties – This standard arises primarily in the event the business is being auctioned and requires the board of directors to demonstrate that it acted reasonably when approving the sale of control and in securing the best price for the sale.
- Unocal Standard – This standard arises when the corporation triggers a defensive mechanism in response to a hostile attempt to gain control of the company. For a board of directors to get the business judgment rule, it must prove (1) there was a reasonable basis for believing corporate policies were in danger, (2) the mechanism was reasonable compared to the threat that is posed.
- Entire Fairness – The standard is comprised of two components: fair price and fair dealing. This standard will arise if the decision was made by interested directors. That is, the directors have something to gain from the transaction on an individual level.
Sale of Control
A sale of control occurs when the target company is accepting bids for the sell of the corporation. When accepting bids, this increases the standard of review and creates additional duties for the board of directors. This is called the Revlon standard. These additional duties ensure that stockholders are fully informed before a decision is made.
Directors also need to know when a sale of control is occurring. The main test is to determine how much of the sale is done with cash. If the majority of the sale is done with cash, the sale may be considered a sale of control. Additionally, if the sale includes stock where one organization receives a controlling majority in making business decisions, a sale of control has occurred.
Defensive Mechanisms
This standard arises when the corporation triggers a defensive mechanism in response to a hostile attempt to gain control of the company. For a board of directors to get the business judgment rule, it must prove (1) there was a reasonable basis for believing corporate policies were in danger, (2) the mechanism was reasonable compared to the threat that is posed.
Interested Directors
An interested director is a director who either appears on both sides of the transaction (buyer and target) or they are expected to receive a financial benefit from self-dealing.
Fiduciary Duties of the Buyer’s Board of Directors
The buyer’s board of directors also has the fiduciary duty of loyalty and care. The primary distinction is that the applicable standard is nearly always the business judgment rule, absent any gross negligence. However, the buyer’s board is likely to take extra steps to ensure the process is properly documented. This includes obtaining a fairness opinion. Additionally, buyers need to be careful not to help the target breach any fiduciary duties if it is aware that the target may be in breach of those duties.
Director and Stockholder Approval
Director
The point of obtaining director and stockholder approval is to ensure that all approvals prevent any self-dealing. During the meeting, directors are expected to identify conflicts of interest (primarily by conducting a conflict’s check) to ensure there is no self-dealing, take attendance and record minutes, and receive presentations. These presentations are going to discuss the M&A proposal (probably from the CEO), procedure (likely from the lawyers), financial records, etc. The point is to properly inform the directors so they can make an informed decision and thus combat any potential claims there was a violation of the duty of care. All of this is done before the vote. As for the requirements of the vote, those will be found in the organizational documents (if there is no organizational documents, then state law has default rules).
Stockholder
Depending on the type of transaction will determine how much stockholder approval is required. This is largely dictacted by state law which varies significantly from state to state.
Merergers
Stockholders will always have a vote when the transaction is a merger (both the buyer and the target stockholders). This is because the nature of the corporation will be fundamentally different once a merger is complete.
Asset Acquisition
A stockholder vote will be required from targets if the sale of the corporation includes “substantially all” of the target’s assets. For buyers a stockholder vote is not required. This is because a business is free to buy stuff without being hindered by a vote every time a business purchase is made.
In other words, there general rule is that a target’s shareholders are not entitled to vote in theory, but practically a vote will be taken because most asset acquisitions result in the sell of substantially all of the targets assets. A buyer does not need to vote at all.
Stock Acquisition
In a stock acquisition, targets generally have the right to a shareholder vote. The exception is a short-form merger. In a short-form merger, if the buyer has aquired 90% of the stock, then they can force the acquisition of the remaining 10% without a vote.
A buyer does not need to obtain a stockholder vote to conduct a stock acquisition.
Appraisal Rights
An appraisal right, also known as the “dissenter’s right,” gives stockholders (with the right to vote) the option of obtaining a judicial determination of the value of their shares. Basically, the court gives an appraisal price of each share and the stockholder accepts that price instead of the agreed price in a merger. A corporation will often avoid a merger to avoid any costly legal battles associated with minority shareholders claiming their appraisal right.
This remedy is available in every state for mergers. In Delaware, the remedy is not available for asset and stock acquisition (a few states allow the remedy for the other types of acquisitions). Further, there may be circumstances where the right is suspended—for instance, publicly traded companies may not have appraisal rights.