Mergers & acquisitions
Section 0:
Introduction to the
M&A course
Prof. Amitai Aviram
Aviram@illinois.edu
University of Illinois College of Law
Copyright © Amitai Aviram. All Rights Reserved
S16
© Amitai Aviram. All rights reserved.
Introduction to the M&A course
Overview of the Introduction Section
• Administrative details
• BA boot camp
2
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Administrative details
What is M&A?
•
On July 2011, BHP Billiton (a multinational mining company)
acquired Petrohawk (a publicly-traded Houston-based oil & gas
company) for $12.1B in cash + $3B of assumed debt
–
•
Petrohawk owned/leased ~1M acres of land containing 3.4T cubic feet of
natural gas reserves
This is an example of an M&A deal. What does that mean?
3
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Administrative details
4
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
•
•
•
–
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
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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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)
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Key players in M&A deals
•
Main players
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–
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•
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)
YB
XB
YS
XS
Supporting players
–
–
Many deals involve X merging not with Y but with Y’s subsidiary, so another
player is acquirer’s subsidiary (S): usually wholly-owned & with no business
activity
Rival acquirers (Y2, Y3 , etc.): other firms that are trying to buy X
5
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Administrative details
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What law do we need to study?
•
From a lawyer’s perspective, is an M&A deal different from a
commercial acquisition?
–
•
BHP can buy land containing 3.4T cubic feet of gas, or it can buy Petrohawk
First, the similarities. In both types of acquisitions the boards of the
contracting parties need to negotiate a deal that would:
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–
•
Comply with appropriate process to transfer the rights
Address expected risks that may derail the deal after it was signed
In this course, we address these:
–
–
Section 2a covers process of transferring control in a firm
Section 2c covers addressing expected risks in the acquisition agreement
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7
What law do we need to study?
•
But these are just 2 of 6 sections we cover in the course. The
remaining 4 need to address a major difference between
commercial acquisitions & M&A deals:
–
•
If X wants to buy Y’s land, X must agree with Y’s board; but if X wants to buy Y
itself, X can either deal with Y’s board or with Y’s shareholders (& often both)
Result…
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What is M&A?
•
–
–
–
–
M&A negotiations are 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)
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What law do we need to study?
•
YB
XB
YS
XS
The relationships in black lines are market relationships (each party
can play “hardball” with the other); relevant issues in an acquisition
include:
–
–
•
Process of transferring control of X: Section 2a
Addressing risks that may derail deal between signing & closing: Section 2c
The relationships in red are fiduciary relationships (board has most
authority, but owes FD to SHs); leverage between board & SHs
depends on:
–
–
SHs’ ability to exercise their voting rights (to replace board, amend bylaws,
force an issue on the firm’s agenda, etc.): Section 1b
SHs’ ability to sue if board exceeds authority or breaches FD: Sections 1c, 2b
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Administrative details
Our course’s structure
Chapter 1 (BA4): Shareholder activism
a. Shareholding
b. SH voting
c. SH litigation
Chapter 2 (BA5): Dealmaking & Dealbreaking
a. M&A basics
b. M&A litigation
c. Crafting acquisition agreements
10
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Introduction to BA
11
Classes
• Check out the course schedule for class topic & pre-class assignment:
http://www.law.illinois.edu/aviram/MA_out.htm
• There are two class types:
– Lectures (L)
• Before class you read assigned case(s) from the course materials packet
• In class I lecture & may call on people or ask for volunteers for some questions
• After class, you should review my lecture notes, to supplement your class notes
– Application (A)
• Before class you listen to a video of my lecture (on YouTube – the link is on the class schedule)
• Make notes of the legal frameworks/rules that are covered & when they apply (you don’t have
to fully understand how they apply – we apply them in class)
• Cases/notes in the materials packet are optional for application classes, unless I say otherwise
• In class you work in groups with the students next to you on problems that exercise the
material covered in the lecture
• Material for the exam includes the legislation that’s in the course
packet (for both L & A classes) and my lecture notes, but you don’t
need to prep for that prior to class (just know it for the exam)
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Introduction to BA
Resources
• Here, have my lecture notes…
– All of my lecture notes are available online (on PowerPoint slides)
– They are likely to change just before a lecture (as I prep)
– I recommend you read them after each class, to clarify what you didn’t
understand in class & augment your notes (my notes are part of material for
the exam)
• Accessing materials
– Course schedule, lecture notes, past exams, course outline & syllabus are all
posted and regularly updated here: http://www.law.illinois.edu/aviram/
• 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: aviram@illinois.edu; Room 326
12
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Introduction to BA
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Exam
• Take-home exam
– All students must take the exam, unless they received permission from me to
do a project in lieu of the exam
– Exam will be e-mailed to you at 10am at your choice among these days:
Thursday, May 5
Friday, May 6
Monday, May 9
– Course deadline: Thursday, April 28 (until midnight)
– You must e-mail my assistant by the course deadline with your choice among these
three dates; if you don’t, you’ll receive the exam on the first day it takes place
– My administrative assistant is Clyde Gabriel (cgabriel@illinois.edu)
– 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 the course)
– Past exams (with model answer) available at: http://www.law.illinois.edu/aviram/Exams.htm
• Course deadline is also deadline for answering student questions
(both face-to-face & by e-mail)
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Introduction to BA
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Supplemental reading (only if you’re interested)
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•
•
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•
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For Chapter 1 (BA4)
Bainbridge, Corporate Law (2nd ed., 2009)
For Chapter 2 (BA5)
Bainbridge, Mergers & Acquisitions (3rd ed., 2012)
For business & business law immersion
The Wall Street Journal, Sections C (Money & Investing) & B (Business & Tech.)
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/)
•
•
“Adopt a firm”
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–
•
•
To help you make the material we study more concrete,
you may want to “adopt” a public firm
As you study new material, research your adopted firm to
see how the material we studied is relevant to that firm
E.g., be familiar with your adopted firm’s bylaws & articles of incorporation,
so you can find what rules it has regarding SH voting or SH litigation
Follow news about SH activists & M&A deals affecting your adopted firm, etc.
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Introduction to the M&A course
Overview of the Introduction Section
• Administrative details
• BA boot camp
15
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BA boot camp
16
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)
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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 (SH who controls firm’s board) influences the board to enter a
transaction that diverts value from the 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
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Topics imported
• You will need for this course knowledge (from the BA course) of the
following issues:
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–
–
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Constitutional documents (“ConDocs”): the charter & bylaws
Corporate actors: authority of firm’s agents & autonomous fiduciaries
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
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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
–
Charter [DGCL §242(b)]
•
•
–
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)])
Bylaws [DGCL §109]
•
•
SHs always allowed to amend
By default board can’t amend bylaws, but charter may allow board to amend
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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
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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.
• 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 act in way that violates 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
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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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•
Firm is a stock corporation, has limited liability & perpetual existence
Firm may conduct any lawful act or activity
Director FD is limited to & director/agent right to indemnification is extended
to the maximum degree allowed by law
Board may amend bylaws
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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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)
• Autonomous fiduciaries (act on firm’s behalf, not subject to firm’s control, but
legally required to act in firm’s interest)
– Board of directors (“board”) & board committees
– Incorporators
– 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
• Stewards (act on firm’s behalf, not subject to firm’s control & not legally required
to act in firm’s interest)
– SH meeting
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Corporate actors: how collective actors act
• Collective actors 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 1b)
• 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)]
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Corporate actors: authority
• Authority can be granted by law, agreement or approval
• Authority created by approval: Under R3A §2.01 authority created when:
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–
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Manifestations by B that are perceived by A…
cause A to reasonably believe that A is authorized to act in a certain way on B’s behalf
R3A §2.02(1): A has authority for acts that are “necessary or incidental” to achieving B’s objectives
• 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, or as authorized by board
(limits on committee authority in DGCL §141(c))
– SH meeting
• Exclusive to SH meeting
– Electing directors
– Appointing firm’s independent auditor
– Precatory (non-binding) SH resolutions
• Jointly with board
– 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
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Corporate actors: firm’s duties to its actors
• 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 autonomous fiduciaries, governed by DGCL §145
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Corporate actors: bypassing a conflict of interest
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•
•
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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
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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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FD analysis: challenging an actor’s behavior
•
•
–
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B can challenge A’s behavior for lacking authority and/or for
breaching fiduciary duties
Authority is irrelevant when an inaction is challenged
Authority is always irrelevant for controllers, since they don’t act on firm’s behalf
Analyzing a FD breach allegation
1.
2.
3.
4.
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Duty (does A owe B a fiduciary duty?)
Flaws
Determine applicable Standard of review
•
•
For agents: always agency SoR
For autonomous fiduciaries: BJR, entire fairness or enhanced scrutiny
•
Application of SoR to each potential flaw
[Approval (if behavior of/attributable to B waived the FD breach)]
Regarding prior approval, consider 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:
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•
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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 an exculpation clause, a challenge based on unintentional
negligence of a director, that requests a remedy of damages (as opposed to an
injunction) will fail
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FD analysis: duty
• Directors
– Each director owes a FD to the firm (and to its SHs)
• Agents
– Agents owe a FD to the principal (firm’s agents owe a FD to the firm)
• SHs
– SHs do not owe a FD to the firm or to other SHs
– Exception: SHs who are controllers owe FD in exercising control of the firm
(discussed in Section 1a2)
29
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FD analysis: flaws
FD analysis: types of legal flaws
Negligence
Self-dealing
Bad faith
Negligent act
Negligent inaction
Conflict of interest
Unauthorized benefit
Corporate waste
Illegality
Disregard of duty
Failure to disclose
• Negligence: acting with insufficient effort/care
• Self-dealing
– Having a conflict of interest with respect to the challenged behavior; and/or
– Receiving an unauthorized benefit from the fiduciary position
• Bad faith: acting not in B’s interests, without evidence of self-dealing
31
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FD analysis: SoR selection flowchart
Stewards don’t owe FD;
end of analysis
Steward
What type of
actor is A?
Agent
Agency SoR
applies
Yes
Entire fairness
applies
Yes
Enhanced
scrutiny applies
Autonomous
fiduciary
Was A
self-dealing?
No
Did A deploy power against B
or act to facilitate a change of
control in the firm?
No
BJR applies
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FD analysis: SoR
• Enhanced Scrutiny
– Applies when:
•
•
A deploys corporate power against SHs to achieve greater good for firm
–
Board interferes with SH voting rights (Blasius)
–
Board implements actions that make it impossible or economically
unfeasible for SHs to sell their shares to someone (Unocal)
A embarks on a transaction that will result in a change of control (Revlon)
32
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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
•
•
•
•
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
34
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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
– 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
– Test for determining whether opportunity was derived from the fiduciary
position (Guth v. Loft) (no single factor is dispositive; court balances all factors)
•
•
•
•
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
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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, given:
•
•
–
Importance of the challenged act to firm/SHs
Objective time constraints
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
37
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FD analysis: application (BJR - negligence)
Example (Van Gorkom)
SH sues board for approving the sale of corp for $55/share
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)
38
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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”
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FD analysis: application (BJR - bad faith actions)
•
BJR rebutted & actor breached FD if:
–
Illegality: actor knowingly violates the law
–
Corporate waste: transaction is so one-sided that no business
person of ordinary, sound judgment could conclude that the
corporation has received adequate consideration
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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.)
• 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)
42
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FD analysis: summary
BJR analysis (application stage)
Step 1
Neg. act
Neg. inaction
Bad faith act
Bad faith inaction
Van Gorkom test
Automatic
(for inaction)
Tests for illegality
& corp. waste
Automatic
(for inaction)
Gross negligence
Gross negligence
Automatic breach if
BJR rebutted
Tests for disregard of
duty (Stone) &
failure to disclose
(BJR rebutted?)
Step 2
(FD breached?)
• Entire fairness
– General test: was A’s behavior in B’s interest?
– Test for transactions: fair process + fair price
– Test for usurping business opportunities: Guth test
• Enhanced scrutiny
– Quasi-BJR (legitimate purpose + good faith + reasonable investigation); and
– Reasonableness (is act a reasonable way to achieve the purported purpose?)
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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)
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Approval: elements
Elements of ratification
1.
2.
3.
4.
5.
6.
7.
Appropriate approver
Attributability
Approval: Unambiguous
Approval: Informed
Approval: Uncoerced
Approval: Appropriate scope
Approval: Timely
Exam tip: if ratification is an issue, describe the behavior that may be
ratification, then discuss only the elements that are not clearly satisfied
(“unambiguous” element almost always requires discussing)
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Approval: appropriate approver
• 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
• Approval of authority cannot exceed the authority the approver has
– Authority to approve may be implied 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)
• Approver must have legal capacity at time of approval [R3A §4.04]
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Approval: appropriate approver
• When a firm is the beneficiary, someone must approve on its behalf.
Appropriate approvers are:
– Board
• Board can approve behavior of corporate actors (based on its plenary authority
under DGCL §141(a) & on DGCL §144, 204), as long as it doesn’t have CoI with
the firm regarding the behavior that is approved
– SH meeting
• SH meeting can cure directors’/officers’ self-dealing by approval (DGCL §144)
• SH meeting (together with board) can approve unauthorized acts that would
have required a SH vote to be properly authorized (DGCL §204)
• When approving, SH vote must be specifically designated as a ratification; SHs
can only approve acts that don’t require a SH vote to become legally effective
[Gantler v. Stephens (Del. 2009)]
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Approval: attributability
• Actor’s behavior (subject of the approval) is attributable to B
–
A must have acted or purported to act on B’s behalf [R3A §4.03]
•
E.g., if A bought a car for someone other than B (such as for A herself), B can’t ratify
– B must exist at the time of the act [R3A §4.04]
• E.g., if A bought a car for B-Co, a corporation that she is about to form (but hasn’t
yet formed), B-Co isn’t bound by the deal (since B didn’t exist) & can’t ratify it
• Firm can adopt (rather than ratify) a pre-incorporation act:
– Adoption doesn’t relate back to time of contract’s formation
– Adoption doesn’t release A from liability
– Act doesn’t have a flaw that renders the act void (rather than voidable):
• Illegality
• Corporate waste
• Lack of corporation authority (ultra vires): but unanimous SH ratification insulates
the board from future SH challenge
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Approval: unambiguous
• R3A §4.01(2) – B approves an act by either:
– Express approval: manifesting assent that the act shall affect B’s legal relations
• Express approval must comply with formal procedures (e.g., 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)
– Implied approval: conduct justifying 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
• When B is a firm, implied approval possible by the board, but not by SHs (SH
acquiescence is inherently ambiguous)
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Approval: unambiguous
• Approval procedure when B is a Delaware corporation
– Lack of authority: DGCL §204 (approval by board & in some situations also by
SH meeting and/or court) (effective since 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 board’s plenary powers (DGCL §141(a)), following common law of agency
• Follows the normal process for board acts (written consent / call+quorum+vote)
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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
– Material facts: Facts that a reasonable person would consider relevant to the
decision whether to approve
– “All material facts” refers only to those facts A knows/has notice of
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Approval: uncoerced
• Approval is ineffective in favor of a person who causes it by
misrepresentation or other conduct that would make a contract
voidable (duress, undue influence) [R3A §4.02(2)(a)]
• Ratification is ineffective in favor of A if B ratifies to avoid a loss [R3A
§4.02(2)(b)]
– 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 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)
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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]
• Prior consent of self-dealing 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)]
– Not likely to be relevant to ratification, because ratification is typically of
specific acts (if specific acts were not disclosed, ratification is likely uninformed)
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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 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 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
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