In any change-of-control business transaction, the decision by the target company’s board of directors to approve the deal is subject to heightened scrutiny by the courts. These days, virtually every M&A deal is sure to attract at least one strike suit challenging the board’s decision, so it is essential that the board’s decision-making process be robust and untainted by any conflicts of interest.
One way in which a board can insulate its decision-making process is to employ a special committee of independent, outside directors to evaluate and negotiate any potential sale. Although boards are not required by law to use special committees when brokering change of control transactions, Delaware courts have repeatedly held that the use of a special committee can be powerful evidence of a fair and adequate process. That is especially true where (i) the contemplated transaction is with a controlling stockholder or (ii) a majority of the directors are conflicted, two situations where courts will employ the even-more exacting “entire fairness” standard of review. As the Delaware Supreme Court recently noted, “the effective use of a properly functioning special committee of independent directors” is an “integral” part “of the best practices that are used to establish a fair dealing process.” Read More
Four derivative lawsuits against Facebook’s directors relating to alleged disclosure issues surrounding the company’s initial public offering have a new status: Dismissed. Last month, Judge Robert Sweet of the Southern District of New York dismissed the suits on standing and ripeness grounds, finding that IPO purchasers have no standing to pursue claims related to alleged misconduct that took place before the IPO. The dismissed derivative suits were “tag-along” actions that largely parroted allegations made by investors in a parallel securities class action also pending before Judge Sweet, and had sought to hold Facebook’s directors liable for damages the company might incur as a result of the securities class action.
In dismissing the suits, Judge Sweet held that plaintiffs who buy stock in an IPO lack standing to pursue derivative claims based on alleged misstatements in an IPO registration statement. As Judge Sweet explained, in order to have standing to sue derivatively on behalf of a company, a plaintiff must have owned stock in the company at the time of the alleged misconduct. The registration statement that the plaintiffs allege to have been misleading, however, was finalized and filed with the SEC two days before the IPO. Judge Sweet rejected plaintiffs’ attempts to create standing by arguing that the wrong continued through the date of the IPO because the directors did not correct the allegedly misleading statements by that date. Read More
When a shareholder makes a demand on a company to pursue litigation, the company’s board can look to generally well-developed law to determine how to evaluate the demand. Though there is no one particular procedure a board must employ, there are numerous cases that explain how the board must inform itself about the demand in order to reach a good faith, “rational business decision” about whether to accept or refuse.
The rules for considering a shareholder demand are pragmatic, and afford corporate boards a dependable road map for responding to shareholder requests.
One open question (at least in Delaware, where it matters most) has been whether a board’s informed, good faith decision to defer action on a demand constitutes a “rational business decision” that is protected by the business judgment rule. Delaware courts have long held that while an informed board can refuse a demand, the one thing a board cannot do is nothing. At the same time, however, corporations often face the circumstance where there are follow-on shareholder litigation demands entirely duplicative of existing litigations or investigations. In those circumstances, a board could have any number of business justifications for wanting to defer action on the demand until the ongoing proceedings are resolved, but that would seem to violate the rule against doing nothing.
Genius rock lyricist Geddy Lee of RUSH once wrote “If you choose not to decide, you have still made a choice.”
Accordingly, the Ninth Circuit and certain federal district courts have recognized that a board’s informed, good faith decision to defer action on a demand during pending litigation or investigations is itself a decision that can be shielded by the business judgment rule. For example, in 2009, the Ninth Circuit found there was a “compelling” business justification for deferring action on a demand where the company’s pursuit of the demand’s allegations could be cast as an admission of wrongdoing in ongoing litigation. Read More