Transcript www.law.illinois.edu

Mergers & acquisitions
Section 0:
Introduction to the
M&A course
Prof. Amitai Aviram
[email protected]
University of Illinois College of Law
Copyright © Amitai Aviram. All Rights Reserved
S16D
Introduction to the M&A course
Overview of Section 0
• Administrative details
• BA boot camp
2
© Amitai Aviram. All rights reserved.
Administrative details
What is M&A?
•
Mergers & acquisitions (“M&A”) are transactions with two goals:
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Transfer/consolidate control in a firm and/or acquire new assets & liabilities
Types of M&A transactions
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Freezeout
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•
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Takeover
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Someone who didn’t control the firm now controls it or wholly owns it
Control change: Acquirer now either controls or wholly-owns Target
Asset change: assets of the two firms are combined
Merger of equals
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3
Shareholder who controlled firm now owns 100% of the firm
Control change: former controller (Acquirer) now wholly owns the firm (Target)
Asset change: none, unless firm combined with controller’s other assets
Two firms combine, neither firm’s SHs controls the combined firm
Control change: combined firm now owned by both parties’ shareholders
Asset change: assets of the two firms are combined
True mergers of equals are rare; usually, one firm wants the deal more than
the other (it’s the Acquirer, the other is the Target)
© Amitai Aviram. All rights reserved.
Administrative details
What is M&A: key players in M&A deals
•
The obvious players are the parties to the M&A transaction
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Many deals involve X merging not with Y but with Y’s subsidiary
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Acquirer’s subsidiary (S): usually wholly-owned & with no business activity
Some deals draw rival acquirers to also bid for X
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Rival acquirers (Y2, Y3 , etc.): other firms that are trying to buy X
But what makes M&A more complicated (and exciting) is that each
firm has a board of directors (“board”) & shareholders (“SHs”), who
may have different views about the deal
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4
Target (X): firm that is being acquired
Acquirer (Y): firm that is trying to buy X
Target’s board (XB); Target’s SHs (XS)
Acquirer’s board (YB); Acquirer’s SHs (YS)
© Amitai Aviram. All rights reserved.
Administrative details
What is M&A: key players in M&A deals
•
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5
M&A is typically a 3-way fight between YB, XB, XS
The two parties that ally are likely to defeat the third
If YB & XB ally vs. XS, it’s a friendly deal (lower price, terms appealing to XB)
If YB & XS ally vs. XB, it is a hostile deal (higher price, terms unappealing to XB)
If XB & XS ally vs. YB, there will be no deal (X will refuse it)
© Amitai Aviram. All rights reserved.
Administrative details
What is M&A: course structure
•
We already know the powers & duties of boards (from the Business
Associations course); to understand the balance of powers between
the three sides, we need to study the powers of SHs
•
So, in the first half of the M&A course, we will study SH activism
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The second half of the course will cover dealmaking & dealbreaking
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1a: Governance framework (FD analysis, types of SHs, FD of controlling SHs)
1b: SH litigation
1c: SH voting
2a: M&A mechanics: procedures for conducting M&A deals
2b: The M&A dance: what YB & XB do to enhance bargaining position?
2c: M&A litigation: how does FD analysis apply in the context of M&A
2d: Documenting the deal: what’s in an acquisition agreement & why?
© Amitai Aviram. All rights reserved.
Administrative details
The exam
• Take-home exam
– Exam will be e-mailed to you at 9am at your choice of these three days:
Thursday, May 7
Friday, May 8
Monday, May 11
– You must e-mail my administrative assistant (Athena Newcomb) by Thursday,
April 30, 5pm, with your choice among these three dates
– If you didn’t e-mail your choice by the deadline, you will receive the exam on
the first day it takes place
• Time limit
– Exam responses must be e-mailed to my administrative assistant by 10am on
the day following the day it was e-mailed to you (even if it’s a weekend)
• Exam structure: issue spotter
– Traditional essay-type law school exam question
– Word limit: 1,000 words
– More info on the exam in the exam prep session (last class of semester)
– Past exams (with model answer) available at: http://www.law.illinois.edu/aviram/Exams.htm
• Deadline for answering student questions (both face-to-face & by email): Thursday, April 30, 5pm
7
© Amitai Aviram. All rights reserved.
Introduction to M&A
Project in lieu of exam
• Instead of taking the exam, you may submit a project
– Teaching module picks a topic studied in the course (typically, one sub-section; e.g., 1c3
– principal’s liability in torts) & creates alternative or supplemental materials to teach
the same topic
• Module can include new cases, practical application of the material, etc.
• Product you submit should include:
– PowerPoint slides used to teach the material
– Teaching notes that provide information professor needs to know to use slides in class, plus a
statement explaining why you structured the module the way you did & what you believe are
the strengths of the module compared to the material as it was taught in the course
• Product you submit may include other aids, such as relevant video clips, scanned
images, excel spreadsheets etc.
• Module should provide enough content to teach a 75-minute class (~20 slides)
– Case study (plus teaching notes) for one of the sections of the course
• Case (typically 7-12 pages, plus exhibits): this is the part students read
• Teaching notes: explains to the prof teaching goals, suggested solution, extensions (other
issues that can be addressed by extending the case), how the case developed in reality
• Information on creating a case study is available on my website at:
http://www.law.illinois.edu/aviram/Aviram-Writing_case_studies.pdf
8
© Amitai Aviram. All rights reserved.
Introduction to M&A
Project in lieu of exam
• Deadline
– Project is due same time as deadline for questions (April 30, 5pm)
– E-mail project to my administrative assistant (Athena Newcomb) as 1 or more
attached files
• Anonymity
– Projects are graded anonymously (like exams) so the only identifying marks on
them should be the 4-digit exam ID number
– To maintain anonymity, you can’t tell me your specific project, consult with me
about your project or have me look at drafts of your work
• But you may ask me general questions that don’t identify your project
– Due to anonymity, projects don’t qualify for ULWR
• Finality of choice between exam & project
– A student who submitted a project can’t withdraw it & can’t take the exam
– A student who didn’t submit a project by the deadline must take the exam on
one of the days it is administered
• Attendance & participation
9
– Must comply with class attendance/participation standard throughout the
entire semester, whether you take the exam or submit a project
© Amitai Aviram. All rights reserved.
Administrative details
Resources
• Talking to me outside of class
– Please e-mail prior to meeting with me
• Suggest when you would like to meet (not limited to office hours)
• Describe what issues you want to talk about
– E-mail: [email protected]; Room 326
• Accessing materials
– Slides, past exams, reading assignments (outline) & syllabus are all
posted and regularly updated on my website
– http://www.law.illinois.edu/aviram/
10
© Amitai Aviram. All rights reserved.
Administrative details
Reading assignments
•
Pre-class assignments
– Lecture video (on YouTube – I will send you the link for each class)
• The lecture slides are available at: http://www.law.illinois.edu/aviram/)
– Course materials packet (notes, cases, legislation) on law school’s intranet course page
• Legislation is part of exam material; cases/notes optional unless I say otherwise
– Optional reading
• For sections 1a-1c: Bainbridge, Corporate Law (2nd ed., 2009)
• For sections 2a-2c: Bainbridge, Mergers & Acquisitions (3rd ed., 2012)
• For business & business law immersion
• The Wall Street Journal, Sections C (Money & Investing) & B (Marketplace)
• The Business Lawyer, American Bar Association Business Law Section
• Harvard Law School Forum on Corporate Governance & Financial Regulation
(http://blogs.law.harvard.edu/corpgov/)
• Business Law Today, American Bar Association Business Law Section
• The Deal Professor Blog (http://dealbook.nytimes.com/category/deal-professor/)
11
© Amitai Aviram. All rights reserved.
Administrative details
Class types
• A course schedule is posted a few slides ahead
• Schedule specifies topic, material covered in each class & class type
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12
Lecture (L): 8 classes (including 2 classes to watch a movie)
Application (A): 11 classes
Review (R): 5 classes (including exam preparation class)
Lawgaming (G): 4 classes
© Amitai Aviram. All rights reserved.
Administrative details
Class type: Lecture
• In most cases, this covers background (rather than applied) material
• Pre-class student responsibilities
– Review the slides of the relevant sub-section before class
• Class content
– I lecture & occasionally call on volunteers; students may ask questions
– Volunteer participation (no cold calling)
13
© Amitai Aviram. All rights reserved.
Administrative details
Class type: Application
• Covers applied material (directly used in exam/problem/case)
• Pre-class student responsibilities
– Watch before class the video of the lecture (I will provide the YouTube link
ahead of time)
– Make sure you understand the material in the slides – i.e., what legal issues
does it cover and how to analyze those issues if they appeared in a
case/problem/exam
• Class content
– See it: I present examples that apply material taught in the video lecture
– Do it: group exercises that apply material taught in the video lecture
– Review it: class discussion of the group exercise
14
© Amitai Aviram. All rights reserved.
Administrative details
Class type: Review
• Opportunity to ask questions at the end of a section
• Pre-class student responsibilities
– Note anything that isn’t clear about the material (from assignments, lecture &
application classes) so you can ask me in class
– See if the new material is relevant to your firm
• Class content
– “Reverse Socratic”: I cold-call students to ask me questions about the material (that
they didn’t understand or understood but thought complicated)
– Open Q&A: opportunity for all students to ask questions about the material
– “Adopted firm” corner: I cold call on people to tell me how the new material would
be relevant to their “adopted firm” or their “lawgame firm”
15
© Amitai Aviram. All rights reserved.
Administrative details
Class type: Lawgaming
• Apply the material in a simulation (teams of students representing firms)
• Pre-class student responsibilities
– Before first lawgame, receive a team assignment (typically, you continue with
your team in later lawgames, unless your firm was acquired)
– No assignments before most lawgames (but your team may decide to prepare)
• Class content
– Game stage: teams pursue their goals, creating legal documents and releasing
information in the process
– Review stage: we discuss the experience of some/all of the groups – what did
they do & why
16
© Amitai Aviram. All rights reserved.
Administrative details
Lawgaming: team assignments
• Team types include
– Strategic firms: make products/services (by owning several “business elements”)
– Financial firms: invest money in strategic firms and/or their business elements
• Hedge funds
• Private equity
• Institutional investors
– Supporting institutions
• Judges: decide on arguments (SH litigation lawgame)
• Proxy advisory services: recommending to SHs how to vote (SH voting lawgame)
• Media: journalists, collecting & publicizing information (M&A dance lawgame)
• When I assign students to a firm, I will call it by its color (designating
its type) and number: e.g., Blue 1, Red 3; the team will then decide
on a name for the firm
– Once teams are formed, each blue/red team will receive a sheet describing
firm’s strategy/preferences, business elements (blue)/shares (red) owned,
shareholders (blue) & other information about the firm
17
© Amitai Aviram. All rights reserved.
Administrative details
Lawgaming: team assignments
• Selecting into teams
– Fill your names in this spreadsheet,
in appropriate spot
– You can authorize a friend to fill your
name on the spreadsheet
– If your “team” is less than 3 people,
complete an existing team rather
than start a new one
– If you’re indifferent about team
assignment, write your name in the
“don’t care” column
• Filling the gaps…
– I aim for roughly equal numbers of Blue & Red teams
– I aim for as many members in Green team as there are either Blue/Red teams
– If I can’t do this using the “don’t care” column & excess Green team members, I will
need to break up Blue/Red teams, starting with later members, then later teams
18
© Amitai Aviram. All rights reserved.
Administrative details
Course schedule
• Class on Monday, May 4 is cancelled
• In lieu of this class, I will extend the
March 17 class to 3-hours (3:00-5:45),
and we will watch “Barbarians at the
Gate”, a movie that will give you the
sense of what an M&A battle
between multiple acquirers looks like
19
Date
1/20
1/26
1/27
2/2
2/3
2/9
2/10
2/16
2/17
2/23
2/24
3/2
3/3
3/9
3/10
3/16
3/17
“
3/30
3/31
4/6
4/7
4/13
4/14
4/20
4/21
4/27
4/28
#
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Section
--1a1
1a2
--1a3
1b1
1b2
1b3+1b4
------1c1
1c2
1c3
--------2a1
2a2
2a3
--2b1
2b2
2b3
-------
Type
L
L
L
G
A
A
A
A
G
G
R
L
A
A
G
R
L
L
L
A
A
R
L
A
A
G
R
R
© Amitai Aviram. All rights reserved.
Topic
Introduction to the M&A course
“Imports” from BA1
Share ownership
Lawgaming: Forming the firms
Controllers
SH voting mechanics
Board FD in influencing SH voting
Proxy solicitation in public firms/Controlling the agenda
Lawgaming: Understanding your firm & rivals
Lawgaming: Battle over SH meeting
Review of section 1b
Litigation concepts
Derivative actions
SH inspection
Lawgaming: Suing the firm
Review of section 1c
Movie: “Barbarians at the gate”
[Movie continued]
Basic M&A concepts
Share acquisitions
Mergers & asset sales
Review of section 2a
The M&A dance
Takeover defenses
M&A litigation
Lawgaming: M&A dance
Review of section 2b
Exam preparation
Administrative details
Adopt a firm / adopt a director
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To help you with lawgaming (and the rest of the course), please pick
a public firm and a director in a public company that you “adopt”
The adopted director will become your persona in lawgames
•
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As part of pre-class preparation, research your
adopted firm to see how the material we studied
is relevant to that firm
•
20
But don’t get too attached – if more than one student picks the same director,
I will have to randomly pick who gets to be that person, and other students
would need to pick another director
Don’t adopt a director if you are on a green team
E.g., when we study constitutional documents, find & read
your adopted firm’s bylaws & articles of incorporation; when
we study controllers, find out who are the major SHs in your
firm, and whether the firm has any procedures to address
(or has recently addressed) transactions with the controllers
© Amitai Aviram. All rights reserved.
Administrative details
Adopt a firm / adopt a director
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Finding information on public firms
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Google News, Yahoo! Finance, etc.
EDGAR (Electronic Data Gathering, Analysis, and Retrieval system): All
companies registered under the Securities Act or Securities Exchange Act
must make certain public disclosures; SEC places those online on EDGAR
(www.sec.gov/edgar/searchedgar/companysearch.html)
Disclosure types include:
•
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Registration of securities (various forms)
Form 10-K (annual report);
Form 10-Q (quarterly report);
Form 8-K (episodic, within four business days)
New material developments
Disclosures made to parts of the public (analysts, public speaking events)
Form 14 A [PRE14A; DEF14A] (proxy materials)
Forms 3/4/5 (beneficial ownership of securities)
Exercise (Answers: 4 million; Robert L. Ryan)
Steve Jobs, CEO of Apple (AAPL) spoke at a trade show on Jan. 15, 2008 and
stated the number of iPhones that Apple has sold to date. Find that number.
Who is the chair of the audit committee at Hewlett-Packard Company (HPQ),
as of January 2008?
© Amitai Aviram. All rights reserved.
Introduction to the M&A course
Overview of Section 0
• Administrative details
• BA boot camp
22
© Amitai Aviram. All rights reserved.
BA boot camp
What is corporate law
• Corporate law (in the broad sense of the law of business organization,
including agency law, partnership law, LLCs, etc.) is the law that
governs acting through others (the act of one on another’s behalf)
– The one who acts is the corporate actor (A); the one on whose behalf the actor
is acting is the beneficiary (B); a person interacting with A in connection with
the matter on which A is acting on behalf of B is the third party (T)
• Acting through others raises two sets of legal issues
– External relationships (corporate compliance): addressing when A’s behavior
changes the legal relationship between B and T (e.g., contract/tort liability)
– Internal relationships (corporate governance): mitigating the agency problem
(A’s incentive to “shirk or steal”, that is – to fail to put B’s interests before A’s
own interests)
23
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BA boot camp
Tunneling
• How does A “steal” from B? This is often called “tunneling”
– A conducts a transaction between B & A, skewed in favor of A
• Excessive compensation for A (excessive money, perks, stock options, etc.)
• A buys/rents/borrows an asset from B at below market price
• A sells/lets an asset to B at above market price
– A makes personal use of the position of acting on B’s behalf, or of information
that belongs to B (e.g., obtained by A in acting on B’s behalf)
• Usurping business opportunities (diverting the opportunity from B to A)
• Insider trading (buying or selling shares in market with advantage of non-public
information A has by virtue of his position)
– Controller (“C”; SH who controls firm’s board) influences the board to enter a
transaction that diverts value from the minority shareholders (“MSHs”) to C
• Freezeout: C acquires sole ownership of firm, paying MSHs less than fair value
• Sale of control: Firm enters agreement to sell itself to T, with C receiving
undeserved preferential terms compared to the MSHs
24
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BA boot camp
Governance solutions
Morality/identity
Bonding: Align a party’s welfare with the group’s
collective welfare
Performance-based compensation
Intervention: Have government enforce appropriate
behavior by whomever acts for the group
Private ordering (contract)
Public paternalism (regulation)
Private paternalism (FD)
Voice: Allow a party unilaterally to express dissent in
a manner that may affect the group’s behavior
Approval
Protest
Exit: Allow a party unilaterally to end her association
with the group without losing her share of the value
produced by the group
Termination
Dissociation
Alienation
25
© Amitai Aviram. All rights reserved.
Joint ownership
BA boot camp
Topics imported
• You will need for this course knowledge (from the BA course) of the
following issues:
– Constitutional documents (“ConDocs”): the charter & bylaws
– Corporate actors: authority of firm’s agents & organs, and framework for when
their behavior binds the firm
– Fiduciary duty (“FD”) analysis: evaluating whether a corporate actor violated FD
– Approval: evaluating whether a flawed act of a corporate actor was cured
through the beneficiary’s ratification or prior consent
26
© Amitai Aviram. All rights reserved.
BA boot camp
Constitutional docs
• A firm’s constitutional documents regulate the firm’s legal internal
relationships (between the firm, SHs & the board)
• Charter (“Articles of Incorporation” in MBCA; “Certificate of Incorporation” in DGCL)
• Bylaws
• Creation of constitutional documents
– Charter [DGCL §101(a)]: incorporator
– Bylaws [DGCL §109]: Until stock is issued – board; after – SHs (charter may also allow board)
• Amendment of constitutional documents
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Charter [DGCL §242(b)]
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•
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Bylaws [DGCL §109]
•
•
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First, board must adopt the proposed amendment
Then, SHs approve the proposed amendment (in some circumstances, SHs vote
in separate groups [DGCL §242(b)(2)])
SHs always allowed to amend
By default board can’t amend bylaws, but charter may allow board to amend
© Amitai Aviram. All rights reserved.
BA boot camp
Constitutional docs: charter contents
• Charter: mandatory terms [DGCL §102(a)]
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Firm’s name
Address of firm’s registered office and name of its registered agent
Nature of the business to be conducted (“any lawful act or activity”)
Name/address of incorporators and initial directors
Specify if firm is not a stock corporation (in which case, conditions of
membership must either be specified, or refer to bylaws)
– “A statement of the designations and the powers, preferences and rights, and
the qualifications, limitations or restrictions [on firm’s stock]”
– Number of authorized shares & share par value
• Charter: optional terms [DGCL §102(b)]
– “Any provision for the management of the business and for the conduct of the
affairs of the corporation, and any provision creating, defining, limiting and
regulating the powers of the corporation, the directors, and the stockholders […]”
– “Any provision which is required or permitted […] to be stated in the bylaws
may instead be stated in the certificate of incorporation […]”
– SH preemptive rights
– Supermajority requirements for SH or board votes
– Opting out of limited liability or perpetual existence
– Limits on directors’ fiduciary duty
28
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BA boot camp
Constitutional docs: bylaw contents
• DGCL 109(a): bylaws may address any subject “not inconsistent with law
or with the certificate of incorporation, relating to the business of the
corporation, the conduct of its affairs, and its rights or powers or the
rights or powers of its stockholders, directors, officers or employees.”
• Valid bylaw content (Boilermakers Local 154 Retirement Fund v. Chevron Corp. [Del.Ch. 2013])
1.
Bylaws are subordinate to the law & charter
2.
Valid subject matters include
3.
Bylaws dictate process, not substantive decisions
4.
5.
29
• So, anything that the law says should be in the charter (e.g., authorized shares, rights of
shares) is not valid bylaw subject matter
• Bylaw can’t order directors to violate FDs (only charter can)
• Business/affairs of firm
• Rights/powers of firm, SHs, directors, officers & employees
•
Court: “[B]ylaws typically do not contain substantive mandates, but direct how the
corporation, the board, and its stockholders may take certain actions.”
Bylaw isn’t invalidated because it can be abused; if a particular act abuses the
bylaw, that act can be challenged
Board-amended bylaw may diminish an existing SH right
© Amitai Aviram. All rights reserved.
BA boot camp
Constitutional docs: assumptions for exam
•
On the exam, assume that the corporations mentioned in the fact
pattern have the following terms in their constitutional documents,
unless the fact pattern states otherwise
Charter
•
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•
Bylaws
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Firm is a stock corporation, has limited liability & perpetual existence
Firm may conduct any lawful act or activity
Director FD is limited to the maximum degree allowed under §102(b)(7)
Board may amend bylaws
Chairperson of the board is authorized to call a board meeting
Board is authorized to call both annual & special SH meetings
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BA boot camp
Constitutional docs: finding on EDGAR
• Find your firm’s most recent 10-K (annual report)
– Go to the exhibit listing/schedule (Item 15)
– Charter will be Exhibit 3.1; Bylaws will be Exhibit 3.2
– Most of the time, the documents will be incorporated by reference (i.e., instead
of including them, the Exhibit will say in which past filing they were included),
so go to that filing
• Confirm charter/bylaws were not amended since the last 10K. Check:
– Proxy statements since last 10K (DEF14A or PRE14A) – check if solicitation
involved a vote on an charter or bylaw change
– Exhibit list (Item 6) of all 10-Qs since the last 10K
– 8Ks that have an Item 5.03
31
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BA boot camp
Corporate actors
• Agents (A)
– Restatement (Third) of Agency (“R3A”) §1.01: An agency relationship is
created when A & P manifest assent that A shall act • On P’s behalf
• Subject to P’s control
– For this course, officers are agents (law is ambiguous about this)
• Organs – act for the firm, but not subject to the firm’s control
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–
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Board of directors (“board”)
Board committee
SH meeting
Incorporator
• Controllers (C)
– C is a SH/group with enough control rights to control the agenda (force a SH
vote on an issue) & then win the vote
– C doesn’t have authority to act on firm’s behalf, but firm’s board has an
incentive to act according to C’s wishes
32
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BA boot camp
Corporate actors: how organs act
• Organs act by approving resolutions, either by:
– Written consent
• Board: requires unanimity [DGCL §141(f)]
• SH meeting: requires SHs having no less than the minimum # of votes
needed to take the action at meeting in which all shares entitled to vote
were present [DGCL §228(a)]
– Meeting (rules for SH meetings discussed in Section 1c)
• Call (authority to call meeting + appropriate notice)
– Board: No statutory notice requirement, but abuse breaches FD
• Quorum
– Board: by default, majority of total # of directors (may be modified in charter,
but no less than 1/3); presence via teleconferencing [DGCL §141(b),(i)]
• Vote
– Board: by default, majority of directors present at the meeting [DGCL §141(b)]
33
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BA boot camp
Corporate actors: authority
• Authority can be granted by law, agreement or approval
– Agents: is A an agent (R3A 1.01) & does A have actual authority (R3A 2.01)?
– Organs: is A an organ & does a law, agreement or approval grant A authority?
• Organ authority created by law
– Board: All firm’s powers not reserved to others by law/charter (DGCL §141(a))
– Board committees
• As stated in charter/bylaws
• As authorized by board (limits on authorizing committees @ DGCL §141(c))
– SH meeting
• Exclusive to SH meeting
– Electing directors
– Appointing firm’s independent auditor
– Precatory (non-binding) SH resolutions
• Jointly with board
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–
–
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Charter amendments
Mergers / sale of all or substantially all of firm’s assets
Dissolution of the firm
Ratification of certain unauthorized corporate actions (DGCL §204)
• Either SH meeting or board
– Bylaw amendments
– Ratifying breach of FD
34
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BA boot camp
Corporate actors: firm’s duties to its actors
• Contract & tort law
• E.g., express & implied terms of contract between actor & firm
• B owes a duty of good faith & fair dealing to A (R3A §8.15)
• Duty not to frustrate A’s justified expectations, when contract lacks specific
language governing the issue, and B’s conduct frustrates purposes reflected in
contract’s express language
• E.g., Professor agrees with research assistant that he will get an extra $100 if he
shows up at prof’s office at 8am. Prof later changes mind, locks office doors so RA
can’t enter office at 8am.
• Duty to warn A about unreasonable risks involved in the agency, if risk is
foreseeable to P & A is unlikely to become aware of risk on his own
• B has a duty to indemnify A for expenses & losses that are incurred in
the exercise of A’s authority
• For agents, governed by R3A §8.14(2)
• For organs, governed by DGCL §145
35
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Corporate actors: bypassing a conflict of interest
•
•
•
•
•
When A has a conflict of interest, best procedure is to isolate the
conflicted A from both negotiating the transaction & approving it
That’s easy when A has a non-conflicted superior or board – just
have A recuse herself, declare her conflict & let the superior agent
or the board negotiate the transaction without A’s involvement
When a majority of directors are tainted, a good way to cut them
out of the loop is to create a board committee of independent
directors and authorize the committee to handle the transaction
Best practices of such delegation to an independent committee are:
Transaction negotiated & approved by a special committee or an
independent board majority
–
–
–
–
36
Committee is independent
Committee satisfied its duty of care
Committee authorized to freely select its advisors (& they’re independent)
Committee authorized to use firm’s full bargaining power (e.g., implement
takeover defenses) & to consider all of the firm’s options
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Corporate actors: external relationships
• T as plaintiff
– Enforcing a contract agreed to with a firm’s agent:
•
•
•
•
Agency relationship + actual authority / ratification (retroactive actual authority)
Apparent authority
Estoppel
If P is undisclosed: agency relationship + “virtual apparent authority”
– Enforcing a contract agreed to with a firm’s organ
• If act is not authorized by law, firm is not bound by it
• If act is authorized by law, firm is bound by it
– If act is ultra vires (authorized by law but prohibited by charter): firm is
bound unless SH or the AG sue to enjoin it, in which case T is compensated
but doesn’t get anticipated profits of contract [DGCL 124(1)]
– Holding firm liable for the tort of the firm’s actor (agent or organ)
•
•
•
•
37
A acted with actual authority or firm ratified the tortious act
Firm was negligent in selecting/controlling A
Respondeat superior: A was an employee acting within scope of employment
A’s acted with apparent authority & act constituted/concealed the tort
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Corporate actors: external relationships
• T as defendant
– Firm can sue T based on contract law, torts, agency, etc.
– T doesn’t owe a FD to the firm or its SHs unless another
relationship creates a FD (e.g., T is firm’s agent)
– T may be liable to firm for aiding & abetting a breach of FD by an
actor for the firm; elements required [Malpiede v. Townson [Del. 2001]]
1.
2.
3.
4.
38
Existence of a fiduciary relationship;
Breach of the fiduciary's duty;
Knowing participation in that breach by T; and
Damages proximately caused by the breach
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Corporate actors: internal relationships
•
A beneficiary can challenge an actor’s behavior for lacking authority
and/or for breaching fiduciary duties (“FD”)
–
–
–
If authority is granted by approval, use the approval framework
Authority may have a procedural aspect (require particular process for A to act)
Authority is irrelevant when an inaction is challenged
•
•
Analyzing a FD breach allegation
1.
2.
3.
Flaws
Duty (does A owe B a fiduciary duty?)
Determine SoR for each flaw
•
•
4.
–
39
Authority is always irrelevant for controllers, since they don’t act on firm’s behalf
For agents: always agency SoR
For organs: business judgment rule (“BJR”), entire fairness or enhanced scrutiny
Application of SoR to each potential flaw
[Approval (if behavior of/attributable to B waives FD breach)]
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FD analysis: flaws
• Negligence: acting with insufficient effort/care
– Negligent action
– Negligent inaction
• Self-dealing
– Having a conflict of interest (“CoI”) with respect to the challenged behavior
– Receiving an unauthorized benefit from the fiduciary position
• Bad faith: acting not in B’s interests, without evidence of self-dealing
–
–
–
–
40
Illegality (knowingly violating criminal law)
Corporate waste
Conscious disregard of a known duty
Failure to disclose
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FD analysis: duty
• Directors
– Each director owes a FD to the firm (and to its SHs)
– Exculpation: Under DGCL §102(b)(7), a firm can have a clause in its charter that
eliminates or limits directors’ personal liability for monetary damages for
breach of FD, except:
• Self-dealing & bad faith (acts/omissions not in good faith, involving intentional
misconduct or knowing violation of the law, and acts/omissions where director
derived improper personal benefit)
• Unlawful dividend payment/stock repurchase
– So, if a firm has this clause, a challenge based on unintentional negligence that
requests a remedy of damages (as opposed to an injunction) will fail
• Agents
– Agents owe a FD to the principal (firm’s agents owe a FD to the firm)
• Officers
– The law is not clear as to whether officers are agents or organs
– For this course, treat officers as agents
• SHs
– SHs do not owe a FD to the firm or to other SHs, except that SH may owe FD in
exercising control of the firm
– This exception is discussed in Section 1a3
41
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FD analysis: SoR (determining appropriate SoR)
• Agency (emphasizes beneficiary discretion)
– Applies to all agent acts/inactions
• BJR (emphasizes actor discretion)
– Default SoR for organ acts/inactions (applies when neither entire fairness nor
enhanced scrutiny is the applicable SoR)
• Entire fairness (emphasizes judicial discretion)
– A (agent/organ/controller) is self-dealing (has CoI or receives unauthorized
benefit from the fiduciary position)
• Enhanced Scrutiny
– Applies when A deploys corporate power against B, (allegedly) to achieve
greater good for the firm
• A adopts takeover defenses (Unocal)
• A limits ability to sell shares, to preserve tax benefits (Selectica)
• A runs SH meeting in way that interferes with SHs’ vote (Blasius)
– The test: quasi-BJR (did actor make a business judgment, was actor
independent & did actor act in good faith?) + reasonableness (is act a
reasonable way to address threat?)
42
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FD analysis: SoR (entire fairness)
• Entire fairness SoR applies if A has CoI with respect to the challenged
behavior, or received an unauthorized benefit from fiduciary position
• When does a collective body (e.g., the board) have CoI?
– Actor has CoI if 50% or more of its members have CoI
– Example: Board composed of 4 directors votes 4-0 to hire Ann
• If 0 or 1 director has CoI, BJR applies
• If 2 directors or more have CoI, entire fairness applies
• Which members have CoI? (Cinerama v. Technicolor [Del. 1995])
– Member who was aware (at time of act) of a personal interest (with respect to
the challenged act) that contrasts with the firm’s interest
– Member who was controlled or dominated by someone who has CoI
• Standard for domination (Beam v. Stewart): “[… F]acts that would support the inference
that… the non-interested director would be more willing to risk his or her reputation
than risk the relationship with the interested director.”
– Member who was unaware (at time of act) of another person’s CoI, if the other
person violated a duty to disclose their interest to the member
•
•
•
•
43
Other person is an actor for the firm (e.g., director, officer, agent)
Info relates to other actor’s decision-making or oversight functions
Info is material to the discharge of those functions
Disclosure doesn’t violate a superior duty
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FD analysis: application (agency)
• Negligence: Test is ordinary negligence (R3A §8.08)
• Self-dealing: automatic breach (no fairness test)
• No bad faith categories
– But “bad faith” acts may violate other categories of FD; e.g.:
• Failure to disclose/disregard of duty caused by CoI is self-dealing
• Negligent failure to disclose/conscious disregard of duty is negligence
• Illegal or wasteful acts may be seen as exceeding authority
44
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FD analysis: application (entire fairness)
• Under entire fairness, self-dealing breaches FD only if act was unfair
to the corporation & its SHs
• Fairness analysis for acts
– Was taking the act (e.g. hiring CEO’s spouse) fair to the firm?
– Were terms of act (e.g., employment contract) similar to what firm
would have received in an arm’s length transaction?
• Fair process (for determining price/other terms) – indirect assessment
• Fair price (valuation/comparison) – direct assessment
• Fairness analysis for omissions
– FD breached if an unauthorized benefit was derived from the fiduciary position
– Test for determining whether opportunity was derived from the fiduciary
position (Guth v. Loft) (no single factor is dispositive; court balances all factors)
•
•
•
•
45
Was the corporation financially able to take the opportunity?
Was the opportunity is in the corporation’s line of business?
Did the corporation have an interest or expectancy in the opportunity?
By embracing the opportunity, would the officer/director create a conflict between
his/her self-interest and that of the corporation?
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FD analysis: application (BJR)
• When BJR is the applicable SoR, application of the SoR takes 2 steps:
1.
2.
BJR rebutted? (Does court defer to A’s discretion?)
FD breached? (Applying judicial discretion, did A’s behavior breach FD?)
• Step 1 (BJR rebutted?): court defers to A (no FD breach), unless –
– A didn’t make a business judgment (inaction or negligent act)
– A didn’t act in good faith pursuit of a legitimate corporate interest
• Step 2 (FD breached?): Once BJR is rebutted, FD is breached –
– If legal flaw was negligence, FD is breached if act was grossly negligent
– If legal flaw was a bad faith action, FD is automatically breached
– If legal flaw was a bad faith inaction, certain tests for whether FD was breached
46
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FD analysis: application (BJR - negligence)
•
Negligent inaction
–
–
•
BJR is rebutted (no business judgment to defer to)
FD is breached if inaction was grossly negligent (see later slide)
Negligent act: to see if BJR is rebutted –
Identify necessary expertise & information – depends on:
•
•
–
Nature of the challenged act
Importance of the challenged act to corporation/SHs
Did actor acquire necessary expertise & information?
•
•
Reliance on actor’s own knowledge/expertise
Reliance on advisors (DGCL §141(e))
– Expertise
– Independence
– No abdication of decision
Note: whether an act amounts to a business judgment is a matter of the
procedure of reaching the decision, not the substance of the decision
47
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FD analysis: application (BJR - negligence)
Example (Van Gorkom)
SH sues board for approving the sale of corp for $55/share
SoR: BJR, rebutted
•
•
–
–
–
CoI/bad faith: No CoI, illegality or waste
Inaction? No (challenge addresses board’s action)
Carelessness? Yes
•
Necessary expertise & information (this is a very important decision)
– Legal analysis of merger agreement
– Valuation of the company
– Knowledge on how to best auction the company
• Did actor acquire necessary expertise & information?
– Reliance on actor’s own knowledge/expertise
– Reliance on advisors (Romans/Van Gorkom)
» Expertise (Romans did not do a valuation; VG has law degree)
» Independence (Van Gorkom was nearing retirement)
» No abdication of decision (Hardly any deliberation; board not proactive)
48
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FD analysis: application (BJR - negligence)
• If negligence is alleged & BJR rebutted, FD is breached only if actor
was grossly negligent
– McPadden v. Sidhu (Del.Ch. 2008):“gross negligence is conduct that
constitutes reckless indifference or actions that are without the bounds
of reason”
• When an action (but not an inaction) is allegedly grossly negligent, if
BJR is rebutted due to carelessness, then the action was grossly
negligent (so FD was breached)
– When an inaction is allegedly negligent, BJR automatically rebutted, so you now
need to analyze whether inaction was grossly negligent
49
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FD analysis: application (BJR - bad faith actions)
•
BJR rebutted & actor breached FD if:
–
–
Illegality: actor intentionally violates the law (including fraud)
Corporate waste: transaction is so one-sided that no business
person of ordinary, sound judgment could conclude that the
corporation has received adequate consideration
•
50
Alternative test: actor is motivated by purpose other than SH welfare or
actor’s self-interest
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FD analysis: application (BJR - bad faith inactions)
• BJR always rebutted (inaction); FD is breached when:
– Failure to disclose
• Actor must disclose to other actors (e.g., board, board committee, SHs) all
material info reasonably required for them to act on behalf of corp
– Info relates to other actor’s decision-making or oversight functions
– Info is material to the discharge of those functions
– Disclosure doesn’t violate a superior duty (imposed by law, confidentiality
agreement, ethics rule, etc.)
51
• E.g.: since SHs elect the directors, board would act in bad faith if it failed to
provide SHs all material info is has relevant to deciding whether to elect the
proposed candidates
• When info isn’t related to facilitating another actors’ acts, failure to disclose
may still breach FD if it qualifies as a bad faith disregard of duty (i.e., if it
passes the Stone test)
– Conscious disregard of a known duty: either actor “utterly failed to implement
any reporting or information system or controls”; or having implemented such
a system or controls, “consciously failed to monitor or oversee its operations,
thus disabling [itself] from being informed of risks or problems requiring
[actor’s] attention” (Stone v. Ritter)
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FD analysis: summary
FD analysis: types of legal flaws
Negligence
Self-dealing
Bad faith
Negligent act
Negligent inaction
CoI
Unauthorized benefit
Illegality
Corporate waste
Disregard of duty
Failure to disclose
FD analysis: SoR & Application stages
Neg. act
Neg. inaction
Bad faith act
Bad faith inaction
Self-dealing
SoR
BJR
BJR
BJR
BJR
Test for selfdealing (apply
entire fairness)
App.
Van Gorkom test
Automatic
(for inaction)
Tests for illegality
& corp. waste
Automatic
(for inaction)
Fairness test
Gross negligence
(almost automatic)
Gross
negligence
Automatic breach
if BJR rebutted
Tests for disregard
of duty (Stone) &
failure to disclose
(BJR
rebutted?)
App.
(FD
breached?)
52
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Approval: general principles
• Approval is behavior by (or attributed to) B, that cures a legal flaw in
A’s behavior
– If approval takes place before A’s behavior, it is called prior consent
– If approval takes place after A’s behavior, it is called ratification
• Revoking approval
– Valid ratification can’t be revoked (i.e., once ratified, act can’t be un-ratified)
– Prior consent can’t be revoked after the act takes place; whether it can be
revoked before the act takes place depends on the agency agreement (by
default, yes)
• Rights of “fourth parties” (parties other than P, A & T)
– Prior consent doesn’t diminish rights of persons not parties to the transaction,
as a general matter of contract law
– Ratification doesn’t diminish pre-ratification rights of persons not parties to the
transaction, under R3A § 4.02(2)(c)
• E.g., A is P’s financial manager. Without actual/apparent authority, A gives T an
option to purchase P’s Google shares for $50K. P then agrees to sell the shares
to S for $40K. When T tells P he wants to exercise the option, P ratifies A’s
agreement with T. S can enforce his contract to buy the shares for $40K (but P is
also liable to T for damages for breach of contract, because he ratified)
53
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Approval: elements
1.
Appropriate approver
• Identity (B or person w/authority to approve & no CoI)
• Attributability (A’s behavior is attributable to B)
• Capacity
2.
Appropriate approval
• Unambiguous
• Informed
• Timely
• Appropriate scope
Elements in blue must always be discussed; other elements should be
discussed if fact pattern suggests they are an issue
54
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Approval: identity
• Appropriate approvers are:
– The beneficiary (person on whose behalf A acted or purported to act)
– Person who has authority to approve on behalf of B & doesn’t have CoI with B
regarding the behavior that is approved
• Authority to approve: may be assumed if person has authority to conduct on
behalf of the beneficiary the same behavior that is subject to approval (unless
specifically prohibited from approving or delegating that behavior)
– Example 1: Suppose Amy’s unauthorized purchase of Blackacre was ratified not
by Paul but by Alex (another agent of Paul). Alex is an appropriate approver if
Paul authorized him to buy property at $210K (or to ratify such deals)
– Example 2: if Paul authorized Alex to buy property at $210K, but specifically
prohibited him from delegating the purchase to others, the authority to
approve is not assumed (since if he approved Amy’s act it would amount to a
delegation of his authority to Amy)
• No CoI with beneficiary
55
– E.g., In example 1 above, if Alex gets a commission if the sale goes through but
not if it doesn’t, he can’t approve the transaction
– Rule means that approver
(other than beneficiary) can’t approve his own acts
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Approval: identity
• In the context of an organ’s behavior, appropriate approvers are:
– A person who has authority to approve on behalf of the beneficiary
• Board
– Board can approve behavior of corporate actors (based on its plenary
authority under DGCL §141(a) & on DGCL §144, 204)
– As with agency law, board can’t approve its own acts & can’t approve acts
regarding to which board has CoI (e.g., no approval of controlling SH’s behavior)
• SH meeting
– SH meeting can cure directors’/officers’ self-dealing by approval (DGCL §144)
» Not clear if SH meeting can approve other behavior of corporate actors; even
if it lacks authority to approve, approval may be construed as waiving a SH’s
right to sue for the legal flaw that was purportedly approved
– When approving, vote must be specifically designated as a ratification, and
SH meeting can only approve acts that don’t require a SH vote to become
legally effective [Gantler v. Stephens (Del. 2009)]
56
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Approval: attributability & capacity
• Actor’s behavior is attributable to beneficiary
–
A must have acted or purported to act on B’s behalf [R3A 4.03]
•
E.g., if Amy bought Blackacre for someone other than Paul (such as for herself), Paul can’t ratify
– B must exist at the time of the act [R3A 4.04]
• E.g., if Amy bought Blackacre for PaulCo, a corporation that she is about to form
(but hasn’t yet formed), PaulCo isn’t bound by the deal (P couldn’t create
manifestations of authority) & can’t ratify it (PaulCo didn’t exist when Amy signed
deal to buy Blackacre)
– No public policy reasons to prevent B from approving
• Void acts (can’t be ratified)
– Lack of corporation authority (ultra vires) (but unanimous SH ratification
insulates board from future SH challenge)
– Bad faith actions (illegal acts & corporate waste)
– Probably also conscious disregard of duty
• Voidable acts (can be ratified): lack of actor authority, negligence, self-dealing &
failure to disclose
• Approver must have legal capacity at time of approval [R3A 4.04]
57
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Approval: unambiguous
• R3A 4.01(2) – B approves an act by:
– Manifesting assent that the act shall affect B’s legal relations; or
– Conduct that justifies a reasonable assumption that B consents
• E.g., B knowingly accepts the benefits of A’s act, even if B manifests
disagreement to accepting the act’s legal consequences
• Approval requires objective or externally observable indication that B
consents to A’s act
• Related to ambiguity, R3A 4.02(2)(b) makes ratification ineffective in
favor of A if B ratifies to avoid a loss
– So, if B ratifies to avoid a loss, B is liable to T, but A may be liable to B
– E.g., A is B’s financial manager. A lends B’s money to T without actual/apparent
authority. T becomes insolvent & B files a claim in T’s bankruptcy proceeding.
Filing the claim doesn’t release A from liability for exceeding actual authority.
– Not relevant for prior consent (if B gave prior consent, she wasn’t “trapped”
into approving by the threat of a loss)
58
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Approval: unambiguous
• Implied approval is interpreted from the approver’s behavior, rather
than expressly framed as an approval
– E.g.: ratification implied by unambiguous acquiescence
– Implied approval by the board is possible if it is unambiguous, but implied
approval by SHs is probably impossible (inherently ambiguous)
• Express approval is framed as an approval
– To be unambiguous, express approval must comply with formal procedures for
call, quorum & vote
– There are specific statutory rules for the process of approval of a transaction
flawed by self-dealing or lack of authority (see next slide)
59
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Approval: unambiguous
• Approval procedure
– Lack of authority: DGCL §204 (approval by board & in some situations also by
the SH meeting) (effective April 1, 2014)
– Transactions in which a director/officer has CoI: DGCL §144(a), either:
• Approval by a majority of disinterested directors (even if disinterested directors
do not compose a quorum)
• Approval “in good faith by vote of the shareholders” (in Fliegler the court said
this requires a vote of the majority of disinterested SH)
– Any other act: no statutory authorization for approval, but approval is possible
under the board’s plenary powers (DGCL §141(a))
• Follows the normal process for board acts (written consent or call/quorum/vote)
• Hypo
– Hypo: Acme’s board consists of A, B, C, D & E. They vote to ratify a contract
between Acme & A’s husband (B, C & D do not have CoI). Only A, B and C show
up for the vote. Do they have a quorum? [Note DGCL §141(b), §144 (b)]
– A, B & C all vote in favor of the contract. Was it approved? [Note §141(b), §144(a)(1)]
60
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Approval: informed
• Approval is valid only with “knowledge of [all] material facts involved
in the original act” [R3A §§4.06, 8.06(1)(a)(ii)]
– Unless B was aware of such lack of knowledge
– Probably “all material facts” refers only to those facts A is aware of (since there
are always some uncertainties that neither A nor B know of)
– Material facts: Facts that a reasonable person would consider relevant to the
decision whether to approve
• Related to this, R3A §4.02(2)(a) says ratification is ineffective in favor
of a person who causes it by misrepresentation or other conduct that
would make a contract voidable (duress, undue influence)
– E.g., A buys car for B from T without actual or apparent authority. T persuades
B to ratify by falsely telling him car has a new engine. B not bound to T.
61
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Approval: timely
• Ratification ineffective if “circumstances that would cause the
ratification to have adverse and inequitable effects on the rights of
[T]” occurred [R3A § 4.05]
– T withdraws from the transaction
• B hires A to identify houses B might want to purchase. A sees that T is asking for
a very low price for his house, so she buys the house from T on B’s behalf with
no actual or apparent authority. T learns there was no authority & notifies B he
withdraws from the transaction. B then ratifies. Ratification is ineffective.
– Material change of circumstances that makes it inequitable to bind T
• E.g., A sells B’s house without actual or apparent authority. B’s house then
burns down. B cannot ratify the sale.
– Ratification after rights have crystallized (ratification timed so that T is deprived
of a right or subjected to liability)
• E.g., T gives B an option to buy stock, which expires on May 3rd. Without actual
or apparent authority, A purports to exercise the option on B’s behalf on May
2nd. B ratifies on May 4th. T is not bound by the ratification.
• Prior consent is always timely
62
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Approval: appropriate scope
• Ratification (but not prior consent) must encompass “the entirety of
an act, contract or other single transaction” [R3A §4.07]
• Approval of self-dealing (ratification/prior consent) must address a
specific act/transaction or acts/transactions of a specified type that
could reasonably be expected to occur in the ordinary course of the
agency [R3A §8.06(1)(b)]
• Approval of authority cannot exceed the authority the approver has
63
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FD analysis: Review
• Fact pattern
– Two corporations, A & B
– A’s board has 5 directors: Zoe, Yogi, Xena, Wendy & Victor. Directors Zoe and
Yogi each own 15% of A’s shares, and 5% of B’s shares. The other directors do
not own shares in A or in B.
– After thorough deliberation & reliance on expert advice, A’s board unanimously
votes in favor of a contract to buy widgets from B corp. Price is 20% above
market rates; B has reputation for reliability.
– When board votes on contract, Zoe & Yogi do not disclose that they own shares
in B. However, Xena & Wendy know that they own shares in B.
– After approving the contract, board calls a SH meeting to ratify the contract,
providing adequate notice & disclosing all relevant information. Owners of 70
of A’s 100 outstanding shares are present at the meeting. 40 shares (including
Zoe & Yogi’s shares) vote in favor of ratification; 30 shares vote against.
– SH of A corp. sues A’s directors, challenging the contract with B
64
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FD analysis: Review
• First, make sure you are using the right analysis framework
– SH (beneficiary) is suing its firm’s directors (actors): insider analysis
• Authority: no flaws
–
–
Firm’s authority: no evidence that charter restricted firm’s authority to buy
widgets, so no ultra vires
Actor’s authority: board has authority to manage business & affairs of firm
(DGCL 141(a)), which includes entering contract to buy widgets
• Fiduciary duty
a)
Flaws
Negligence
Self-dealing
Bad faith
Negligent act
Neg. inaction
CoI
Illegality
Corporate waste
Disregard of duty
Failure to disclose
Unauthorized benefit
b) Duty: defendants owe the firm FD as directors
65
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FD analysis: Review
• Fiduciary duty
c)
•
•
SoR
–
–
–
Corporate waste claim: BJR applies
CoI: entire fairness applies if 50% or more of directors have CoI
Zoe & Yogi’s ownership in B makes them benefit if A overpays
Zoe & Yogi had duty to disclose CoI to other directors (info is material to deciding on contract,
disclosure doesn’t violate a superior duty). Victor unaware of the conflict, so he is also considered
conflicted.
3 of 5 directors have CoI: entire fairness applies to CoI claim
d) Application
•
•
–
–
–
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BJR (corporate waste claim): is contract so one sided that no reasonable person
could conclude that firm received adequate consideration? No, it could make sense
to pay more for better widgets (or reliable supply), so corporate waste claim doesn’t
rebut BJR
Entire fairness (CoI claim): would firm enter this contract under these terms if
directors had no affiliation to B corp.?
Did A buy widgets from anyone in the past, or was deal designed for B’s sake?
Did process to buy widgets mimic arm’s length transaction?
Price is higher than market price, but B’s reputation is better than average. What price does B
charge others? What price do other firms with similar reputation to B charge?
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FD analysis: Review
• Approval: if deal was unfair, did SHs ratify?
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Identity: Yes, SH can ratify as ultimate beneficiaries
Fact pattern does not raise issues regarding attributability & capacity (act
tainted by CoI is voiable & ratifiable; would be void & unratifiable if corporate
waste claim was successful)
Unambiguous: No
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Vote designated as ratification & act doesn’t require SH approval (Gantler)
Call: board can call SH meeting & gave adequate notice
Quorum – Majority of shares entitled to vote: Yes (70 out of 100)
Vote – usually, majority of voting power present, but under Fliegler, for
ratification need majority of disinterested voting power present. Here, only 10
of 40 disinterested votes favor ratification
Informed: Yes (according to fact pattern)
Fact pattern does not raise issues regarding timeliness or appropriate scope
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