Cross-border mergers and acquisitions can provide tremendous business opportunities for companies looking to expand globally. Reduced labor and operational costs, new technology and vast new markets for existing products are just some of the benefits companies look to take advantage of when considering entering new geographical areas. However, in analyzing cross-border deals M&A professionals must be conversant with the risk factors associated with the vigorous and cooperative anti-corruption efforts being taken by regulators around the world. While these anti-corruption efforts are increasingly legislated through many jurisdictions, the most significant attention remains focused on the efforts undertaken by the United States in this area.
Posts Tagged ‘Mayer Brown’
Starting in February 2013, the Iran Threat Reduction and Syria Human Rights Act (the “Threat Reduction Act”) will impose new reporting requirements on U.S. domestic and foreign companies that are required to file reports with the U.S. Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the “Exchange Act”). In particular, Section 219 of the Threat Reduction Act added new Section 13(r) to the Exchange Act. Under Section 13(r), Annual Reports on Form 10-K, Annual Reports on Form 20-F and Quarterly Reports on Form 10-Q filed pursuant to Exchange Act Section 13(a) must include disclosure of contracts, transactions and “dealings” with Iranian and other entities. Section 13(r) is effective beginning with reports with a due date after February 6, 2013.
The Staff of the Division of Corporation Finance of the SEC (the “SEC Staff”) has provided helpful guidance on implementation of these new requirements in Exchange Act Compliance and Disclosure Interpretations Questions 147.01-147.07 (available at http://www.sec.gov/divisions/corpfin/guidance/exchangeactsections-interps.htm). However, many questions remain, and the following questions and answers represent the consensus views of the undersigned law firms.
None of the firms subscribing to this report intends thereby to give legal advice to any person. The undersigned firms recommend that counsel be consulted with respect to matters addressed in this report. The answers below may need to be modified based upon unique facts and circumstances.
A large corporation is sued over the alleged breach of a substantial contract. Due to the complex nature of the contract, the corporation’s business executives frequently sought advice from in-house counsel when entering into, and performing under, the agreement. The corporation’s in-house counsel has concerns that sensitive documents reflecting attorney-client communications—or even in-house counsel’s own work product—may be produced by mistake, given the volume of email and electronic documents that must be reviewed quickly.
Clawback Provisions Provide Protections and Cost Savings
Even when a party to a litigation employs precautions to prevent the inadvertent disclosure of privileged documents, some privileged materials are likely to slip through. Recognizing this likelihood, litigants commonly enter into “clawback agreements” at the start of discovery. Typically, a clawback agreement permits either party to demand the return of (that is, to “claw back”) mistakenly produced attorney-client privileged documents or protected attorney work product without waiving any privilege or protection over those materials.
Clawback agreements allow parties to specifically tailor their obligations (if any) to review and separate privileged or protected materials in a manner that suits their needs. For example, before discovery begins, the parties can agree on how they will search for and separate privileged or protected materials from their document productions. So long as the parties abide by the agreement, they will be permitted to take back any privileged or protected material inadvertently produced. Thus, parties can reduce their exposure to costly and time-consuming discovery disputes over whether the protection of privileged material was waived by its production.
The aftermath of the recent acquisition of Lyondell by Basell provides a striking example of the risk that directors face if they approve a cash merger financed in substantial part through borrowing and the target then fails. The deal was characterized as an “absolute home run” by Lyondell’s financial advisor.  But less than thirteen months after the closing of the merger in December 2007, Lyondell filed for bankruptcy. A litigation trust established by the bankruptcy court to marshal the debtor’s assets has sued Lyondell’s former directors, seeking damages on the theory that the merger, while beneficial to Lyondell’s shareholders, unlawfully mistreated Lyondell’s creditors by causing the company to become insolvent.  The case is pending. To add to the directors’ problems, the excess directors’ and officers’ insurance carrier has declined coverage on several grounds, among them that, because the litigation trust stands in Lyondell’s shoes, this is an “insured v. insured” matter not covered by the D&O policy. 
In Airgas, Inc. v. Air Products and Chemicals, Inc., No. 649, 2010 (Del. Nov. 23, 2010), the Delaware Supreme Court, reversing the Chancery Court, held that a bylaw amendment moving up Airgas’s annual meeting by eight months was inconsistent with the company’s charter provision creating staggered terms for directors and permitted an improper removal of directors without cause.
Airgas has been the subject of a hostile takeover attempt by its competitor, Air Products, since October 2009. Air Products made its first tender offer for 100% of the Airgas shares at $60 per share on February 11, 2010. Between February and Airgas’s September 15, 2010 annual meeting, Air Products raised its bid twice, eventually to $65.50 per share. Each bid was rejected by the board of Airgas as undervaluing the company. As part of its takeover attempt, Air Products launched a proxy contest to gain control of Airgas’s staggered board by nominating three candidates for election at the 2010 annual meeting and proposing amendments to Airgas’s bylaws. Each of Air Products’ director nominees was elected by the Airgas stockholders at the 2010 meeting.
In Versata Enterprises Inc. v. Selectica, Inc., No. 193, 2010 (Del. Oct. 4, 2010), the Delaware Supreme Court addressed the validity of a shareholder rights plan, or “poison pill”, for the first time in a number of years. The court upheld the adoption of a poison pill with a 4.99% trigger designed to protect a company’s net operating losses (“NOLs”) and the subsequent adoption of a “reloaded” poison pill to protect against future threats to those net operating losses.
Delaware courts have recently ruled on the validity of a shareholder rights plan, or “poison pill,” in two situations that presented issues of first impression under Delaware law. On August 12, 2010, Vice Chancellor Strine, in Yucaipa American Alliance Fund II, L.P. v. Riggio, C.A. No. 5465-VCS (Del. Ch. Aug. 12, 2010), upheld the use of a poison pill with a 20 percent threshold to delay a possible takeover of Barnes & Noble by funds controlled by Ronald Burkle, even though the founder and chairman of Barnes & Noble, Leonard Riggio, controlled more than 30 percent of the company’s outstanding common stock.
Less than a month later, on September 9, 2010, Chancellor Chandler, in eBay Domestic Holdings, Inc. v. Newmark, et al., C.A. No. 3705-CC (Del. Ch. Sept. 9, 2010), rescinded a poison pill adopted by the directors of craigslist because the court found that the purpose of the pill was to punish eBay, the holder of about 28 percent of craigslist’s outstanding common stock, rather than to protect the company or its shareholders from economic harm. These cases demonstrate the willingness of the Delaware courts to uphold the use of poison pills when directors can make a reasonable argument that they are being used to protect the economic interest of shareholders and the unwillingness of those courts to permit the use of poison pills in other circumstances.
Michael Torres, who is my colleague at Mayer Brown LLP, and I have written a paper titled Directors’ Monetary Liability for Actions or Omissions Not in Good Faith, based on a paper we submitted to the Ray Garrett Jr. Corporate and Securities Law Institute at Northwestern Law School. It has long been established that damages are available against directors when they engage in self-dealing or similar actions in situations in which they have a conflict of interest. Few issues in U.S. corporate law, however, are as controversial as whether directors should be exposed to damages for their actions or omissions in situations in which they do not have a conflict of interest. Advocates of such damages awards argue that they are appropriate in extreme cases of directorial misconduct and an important deterrent to future misconduct. Opponents of such awards argue that courts cannot reliably distinguish between extreme cases of misconduct and routine cases of negligence, and that well-qualified persons will not serve as directors if they are exposed to this type of monetary liability.
Since the enactment of section 102(b)(7) of the Delaware General Corporation Law, it has been clear that directors could still be responsible for damages for breaches of the duty of loyalty involving conflicts of interest – for example, being on both sides of a transaction to which the corporation was a party – and could not be held liable for money damages for breaching their duty of care, even if they were grossly negligent. The question was whether there was any real-world basis for imposing damages on directors in situations in which they did not breach their duty of loyalty on conflict of interest grounds.
Beginning in the middle 1990s with the Caremark decision, the Delaware courts answered that question in the affirmative by making it clear that certain conduct of directors who did not have a conflict of interest could constitute acts or omissions not in good faith that would expose them to damages. As the law has developed, there has been no bright line rule defining such conduct. Consequently, there is no shortcut to examining the cases decided inside and outside of Delaware in determining where the law now stands. Most of these cases were brought as derivative lawsuits, and the reported decisions were issued in deciding defendants’ motions to dismiss because of the plaintiffs’ failure to make a demand on the company’s board of directors. We briefly analyze a number of these decisions, dividing them into cases in which the directors are accused of failing to act and therefore violating their duty of oversight and cases in which the directors are accused of acting improperly. We reached the following conclusions from this analysis:
1. The courts are anxious to limit monetary liability for bad faith to situations in which directors knowingly countenanced wrongdoing or knowingly engaged in wrongful conduct. The test laid down in Stone v. Ritter, 911 A.2d 362 (Del. 2006), for bad faith oversight is that the directors knew that they were not discharging their obligations of oversight because they 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 their operations. The test for bad faith action laid down in In re the Walt Disney Company Derivative Litigation, 906 A.2d 27 (Del. 2006), is intentional dereliction of duties or a conscious disregard of one’s responsibilities. Thus, the case law, in both the oversight and the action situations, indicates that bad faith has a mens rea requirement: bad faith requires scienter, i.e., an illicit state of mind. Anything less is no more than gross negligence, which Disney defined as not bad faith.
2. However, the line between bad faith and negligence or gross negligence can be blurry, especially in merger or sale cases. It is arguably difficult to distinguish between the bad faith conduct of the director held liable in In re Emerging Communications, Inc. Shareholders Litigation, 2004 WL 1305745 (Del. Ch. 2004), for permitting an unfair transaction and the director in Gesoff v. IIC Industries, Inc, 902 A.2d 1130 (Del. Ch. 2006), or the directors in McPadden v. Sidhu, 964 A.2d 1262 (Del. Ch. 2008), who permitted unfair transactions but were exonerated because their conduct, while negligent or grossly negligent, did not rise to bad faith. It is possible that Emerging Communications is an anomaly because lawsuits challenging directors’ good faith, absent a conflict of interest, in merger and sale transactions have been mostly unsuccessful. See, in addition to Gesoff and McPadden, In re Lear Corporation Shareholder Litigation, 2008 WL 5704774 (Del. Ch. 2008), and Lyondell Chemical Company v. Ryan, 2009 WL 790477 (Del. 2009).
3. McCall v. Scott, 239 F.3d 808 (6th Cir.), amended on denial of rehearing, 250 F.3d 997 (6th Cir. 2001), and In re Abbott Laboratories Derivative Shareholder Litigation, 325 F.3d 795 (7th Cir. 2001), suggest (admittedly based on a small sample) that courts outside of Delaware may be more inclined to allow oversight claims to proceed than Delaware courts are. Indeed, Guttman v. Huang, 823 A.2d 492 (Del. Ch. 2003), Stone v. Ritter, Desimone v. Barrrows, 924 A.2d 908 (Del. Ch. 2007), Wood v. Baum, 953 A.2d 136 (Del. 2008), and In re Citigroup Inc. Shareholder Litigation, 964 A.2d 106 (Del. Ch. 2009), are all Delaware cases in which oversight claims were dismissed, with AIG Consolidated Derivative Litigation, 965 A.2d 763 (Del. Ch. 2009), being a counterexample.
4. The courts appear to be drawing a distinction between directors’ oversight or actions resulting in bad business decisions that did not result in illegality or fraud and those that did. In the former case the courts tend not to find bad faith. See Citigroup, Gesoff, Disney, McPadden, Lear and Lyondell. In the latter case the courts will find bad faith if the complaint supplies particularized allegations of a knowing failure of oversight or knowing misconduct. See McCall, Abbott, AIG, Ryan v. Gifford, 918 A.2d 341 (Del. Ch. 2007), and In re Tyson Foods Consolidated Shareholder Litigation, 919 A.2d 563 (Del. Ch. 2007). The courts are concerned that the availability of damages for bad faith not lead to directors being second-guessed for business decisions that were merely wrong.
The paper is available here.
Editor’s UPDATE: We recently received a memorandum from Sullivan & Cromwell LLP that provides a detailed discussion of the implications of the decision in Lyondell Chemical Co. v. Ryan. The memo is available here.
My colleagues William Kucera, Christian Fabian and Erik Axelson have prepared a memorandum further analyzing the Delaware Supreme Court’s recent decision in Lyondell Chemical Co. v. Ryan. The memorandum highlights several key aspects of the decision that provide guidance to M&A practioners in counseling clients and structuring transactions. First, Lyondell clarifies when a board’s Revlon duties apply. By finding that Revlon duties apply “only when a company embarks on a transaction — on its own initiative or in response to an unsolicited offer — that will result in a change of control,” the Supreme Court emphasized the role of the company and its directors in determining when Revlon duties are triggered, as opposed to when third-party actions, such as a Schedule 13D filing or publicly disclosed unsolicited overture, generally inform the market that a third party is interested in acquiring a company. The Supreme Court’s refusal to impose Revlon duties before a board takes affirmative steps to begin negotiating the sale of the company is an important concept for practitioners and M&A professionals because it generally allows for the target company, through its actions, to control whether Revlon duties apply. Guided by this principle, the Supreme Court signaled that a target company will be justified in deciding to take a “wait and see” approach in response to a third-party overture that arguably puts the target company in play, where that approach is the product of a deliberate decision by an independent, disinterested board.
The Lyondell decision also emphasizes the high bar that must be cleared in order to establish a breach of a duty of loyalty based on a failure to act in good faith. Because loyalty claims for failure to act in good faith are reserved only for situations where the board “knowingly and completely failed” or “utterly failed” to undertake its responsibilities, there is a high burden of proof to overcome to impose liability on the directors. Indeed, the Supreme Court acknowledged that an extreme set of facts is required to sustain a disloyalty claim premised on the assertion that disinterested directors intentionally disregarded their fiduciary duties. Notably, however, the Supreme Court suggested that the bar is much lower when a claim is based on a breach of duty of care, meaning directors need to be concerned about exercising care and establishing a careful, deliberate and well-documented process in reviewing a sale of control transaction.
The memorandum is available here.
In my paper Would Changes in the Rules for Director Selection and Liability Help Public Companies Gain Some of Private Equity’s Advantages?, to be published in Volume 76 of the University of Chicago Law Review, I examine whether changes in existing legal rules governing how public company directors are chosen and the extent to which public company directors can be held liable for damages if they do not have a conflict of interest would be likely to increase the ability of public companies to obtain some of the benefits that companies owned by private-equity sponsors appear to have. It is widely believed that companies owned by private-equity sponsors have significant advantages over public companies. Among the advantages of private equity cited by commentators are: (1) better governance and a greater willingness to take risks, (2) the ability to focus on long-term issues and a more stable shareholder base, (3) the ability to attract better management talent, (4) creating a sense of urgency, (5) the ability to use leverage more effectively, (6) avoiding the costs imposed by the Sarbanes-Oxley Act, and (7) freedom from shareholder suits. It would be helpful if public companies could gain some of these advantages. My conclusion is that, while changing the rules for selecting directors would not be worthwhile, a reduction in the potential liability of directors for damages in situations in which they do not have a conflict of interest would be likely to increase the ability of public company companies to mirror the effectiveness of private-equity portfolio companies without creating other problems that would be unacceptable.
The paper is available here.