This article continues my series on obligations (and rights and responsibilities) of the board of directors during a merger and/or acquisition transaction. The first in the series detailed the directors’ basic duties of care, loyalty and disclosure. The second discussed the availability of indemnification and/or exculpation and the importance of acting in good faith. This third blog in the series will take a more in-depth look at a directors’ duty of loyalty in a merger and acquisition transaction.
Duty of Loyalty
The duty of loyalty demands that there be no conflict between the director’s duty to the company and their own self-interest. A director breaches that duty when he appropriates a corporate asset or opportunity or uses his corporate office to promote, advance or effectuate a transaction between the corporation and himself or a related party which isn’t entirely fair to the corporation.
Business Judgment Rule
The business judgment rule will not protect a director where there is a violation of the duty of loyalty. Moreover, a director cannot rely on either exculpation or indemnification for a violation of the duty of loyalty but they may be able to rely on these protections for a violation of the duty of care, or even the sub duty of good faith. Accordingly in McPadden v. Sidhu, 964 A.2d 1262 (Del. Ch. 2008) the court found gross negligence but not a breach of the duty of loyalty where the director accepted a price at the lowest end of the valuation range, did not ensure a thorough sale process and was not actively involved in negotiations and other aspect of the sale. As there was no violation of the duty of loyalty, the case was dismissed in reliance on an exculpation provision in the Certificate of Incorporation.
Delaware General Corporate Law
Some states, including Delaware, statutorily codify the duty of loyalty, or at least the impact on certain transactions. Delaware’s General Corporations Law Section 144 provides that a contract or transaction in which a director has interest is not void or voidable if: (i) a director discloses any personal interest in a timely matter; (ii) a majority of the shareholders approve the transaction after being aware of the director’s involvement; or (iii) the transaction is entirely fair to the corporation and was approved by the disinterested board members.
The third element listed by the Delaware statute has become the crux of review by courts. That is, where a director is interested, the transaction must be entirely fair to the corporation (not just the part dealing with the director). In determining whether a transaction is fair, courts consider both the process (i.e. fair dealing) and the price of the transaction. Moreover, courts looks at all aspects of the transaction and the transaction as a whole in determining fairness, not just the portion or portions of the transaction involving a conflict with the director. The entire fairness standard can be a difficult hurdle and is often used by minority shareholders to challenge a transaction where there is a potential breach of loyalty and where such minority shareholders do not think the transaction is fair to them or where controlling shareholders have received a premium.
Informing Shareholders
To protect a transaction involving an interested director, it is vital that all directors take a very active role in the merger or acquisition transaction; that the interested director inform both the directors, and ultimately shareholders, of the conflict; that the transaction resemble an arm’s length transaction; that it be entirely fair; that negotiations are diligent and active and that the advice and counsel of independent third parties, including attorneys and accountants, be actively sought
The Author
Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions
Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.
Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (“Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (“Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.
Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.