As I detailed in recent blog posts (here and here), these days virtually every public company M&A transaction is likely to involve M&A-related litigation. For that reason, M&A litigation represents a significant liability exposure for directors and officers of the companies involved in the M&A transaction and they have a keen interest in taking steps to try to reduce that exposure.
These concerns are the topic of a new paper from Chubb entitled “Director Liability Loss Prevention in Mergers and Acquisitions” (here). The paper was written by D&O maven Dan Bailey of the Bailey and Cavalieri law firm. (Readers know that The D&O Diary is a big fan of Dan’s; we recently published a guest post by Dan on Cyber Liability issues.) The paper “reviews the basic legal duties of directors in this context and summarizes many loss control procedures for directors when addressing a proposed M&A transaction.”
The paper notes at the outset that directors “are routinely rewarded” for their hard work on a proposed M&A transaction “by being sued.” The shareholder plaintiffs “typically allege the directors acted improperly in investigating, negotiating, approving, rejecting or disclosing the acquisition transaction, regardless of how thoroughly and prudently the directors acted.” Though the lawsuits cannot be prevented, “directors can increase the defensibility of those lawsuits and improve the quality of their decision-making process with respect to a proposed acquisition by anticipating and implementing various loss prevention practices.”
The paper outlines the basic legal principles that define the standard of conduct for directors of the target company. The paper then goes on to outline the steps directors can take to try to manage their liability exposure. Among other things, the paper states that “directors should create a record demonstrating that they carefully and thoroughly considered relevant information regarding the proposed transact.” Directors should also “obtain advice from experienced, qualified and independent experts in each of the relevant substantive areas.” In addition, “only independent and disinterested outside directors should act on behalf of the company with respect to the proposed transaction.” In addition, “directors should seek to obtain the best value available for the company,” in the specific ways that the paper enumerates. Finally, the company must manage the timing and content of its disclosures of the transaction in order to try to minimize disclosure-related risks.
There are also a number of transaction-related pre-litigation strategies the company can implement to improve the companies ability to defend the inevitable litigation. These include, among other things, amending the by-laws to designate a specific jurisdiction as the exclusive venue for shareholder suits involving governance issues; retaining qualified defense counsel in advance of the transaction; develop an external communication protocol to reduce disclosure –related risks; and the provision of detailed directors training in anticipating of the takeover process, including the “likely sequence of events, recommended governance practices and various best practices related to the proposed transaction.”
Finally, the paper reviews the indemnification and insurance issues relevant in the M&A context. Among other things the paper discusses the need for the target company to have in place prior to the closing “a prepaid, noncancelable, extended run-off policy that cannot be amended or affected in any way by the acquiring company or subsequent management.”
Another M&A related insurance topic that the paper does not discuss is the possible need for representations and warranties insurance protection. Readers may be interested to note that the Professional Liability Underwriting Society (PLUS is hosting a webinar on Tuesday March 19, 2013 at 11:00 am EDT on the topic of Representations and Warranties insurance coverage. Information about this free webinar can be found here.
D&O Year in Review: Once again, my good friends at Troutman Sanders have published their annual roundup of D&O insurance coverage decisions. The publication, which is entitled “D&O Professional Liability: A Year in Review,” which provides a comprehensive overview of coverage decisions from the world of D&O in the last year, can be found here.
Board Minutes: I recently was asked to attend a meeting of the board of directors of a large financial institution client. While I was in the meeting, one director asked my views about board meeting minutes: should the board minutes be very detailed? Or should they be bare-boned? Which was better from a risk management standpoint? From the way the director asked the question, I knew that that was a topic on which he himself had strong views, and his manner also suggested that this topic was an issue of some debate at the board level. I looked across the table to the company’s general counsel, to see how I should handle the question. Her face said “Don’t throw me under the bus.” So all I said was that the question of board minutes is an important topic that should be discussed with your in-house counsel and if needed your outside counsel.
The question about the appropriate level of detail in board minutes is a recurring question. There is, in fact, no single right answer. The correct answer will vary, depending on the age and size of the company, as well as the advice of the company’s counsel. There are a number of important considerations to keep in mind, which are reviewed in a March 6, 2013 JD Supra Law News article written by Stephen Honig of the Duane Morris firm and entitled “Director Liability: Corporate Minutes as Trojan Horse” (here). The article reviews the liability issues that may arise from the board minutes and also reviews how the ground rules change as companies mature and grow larger. The article reviews the legal touchstones and lays out the basic ground rules. The article concludes by saying that directors “should remember that they are protected if they utilize robust process in the board room and are well-served if they document that process.”
Is a Pending Appellate Decision Interpreting Morrison Off the Docket?: For some time, we have been awaiting a ruling from the Second Circuit in the hedge fund claimants’ appeal of a district court dismissal of their action against Porsche and certain of its directors and officers. The hedge funds, which had shorted Volkswagen stock in the belief that its share price would fall, claimed that Porsche misled investors by denying through much of 2008 that it intended to acquire VW. Porsche later disclosed that it had been positioning itself to acquire the company.
As discussed here, in a December 30, 2010 ruling, Southern District of New York Harold Baer granted the defendants’ motions to dismiss. In granting the motion, Baer relied on the U.S. Supreme Court’s decision in National Australia Bank v. Morrison. Judge Baer found that because the securities underlying the swap instruments the hedge funds had acquired were traded on the German stock exchange, acquiring the swaps was the “functional equivalent of trading the underlying shares on a German exchange."
The hedge funds filed an appeal of Judge Baer’s dismissal. As discussed here, while the appeal was pending, the Second Circuit issued a ruling in the Absolute Activist Value Master Fund case interpreting Morrison’s application to non-exchange traded securities. The court held that in order to pursue a securities claim in connection with a transaction in non-exchange securities, the claimant has to allege either “irrevocable liability was incurred or title transferred within the United States.” I noted at the time that the Absolute Activist Value Master Fund case The Second Circuit’s holding in the Absolute Activist Value Master Fund case, in which the Second Circuit said among other things that the identify of the securities involved in the transaction is not determinative, would seem to suggest that the district court’s holding in the Porsche case may not withstand scrutiny on appeal.
Ever since the Second Circuit issued its ruling in the Absolute Activist Value Master Fund case, observers have been awaiting the Second Circuit’s ruling in the Porsche case. However, on March 6, 2013, Bloomberg reported (here) that the hedge funds have filed a motion to withdraw their appeal in the Porsche case. The Second Circuit must grant the motion to withdraw, but assuming it is granted, it appears that the appeal would be withdrawn, meaning that the lower court dismissal of the case would stand. The Bloomberg article notes that four cases against Porsche and certain of its directors and officers remain pending in Germany. It appears that the hedge funds may have decided to focus their efforts on the Germany cases.
In any event, if the Second Circuit grants the motion to withdraw, the long-anticipated resolution of the hedge funds’ appeal of the dismissal will not be forthcoming. That would mean at a minimum that the Absolute Activist Value Master Fund ruling will continue to represent the standard for securities cases involving non-U.S. entity defendants whose shares do not trade on U.S. exchanges.
I can’t help having a “that’s too bad” reaction. I have been looking forward to seeing what the Second Circuit was going to do with the appeal in the Porsche case.
One Director Defendant in Latest FDIC Failed Bank Suit: As the FDIC has been ramping up its litigation against the directors and officers of failed banks, one of the things that has been hard to figure is how the agency decides who it is going to sue. Sometimes it files cases only against former bank officers, sometimes it includes director defendants. And now in the latest case to be filed, the FDIC has filed a suit against only a single director defendant. However, in this case, there is some information available to explain why the one director was the only defendant.
On February 22, 2013, the FDIC, acting in its capacity as the receiver of the failed Carson River Community Bank, filed an action in the District of Nevada against James M. Jacobs, a former director of the bank. A copy of the FDIC”s complaint can be found here. Regulators closed the bank on February 26, 2010, which means that the agency filed its compliant just before the third-year anniversary of the bank’s closure. The sole defendant is described in the complaint as the co-founder and as a stockholder of the bank, as well as a director in the bank. Importantly for purposes of the suit, the complaint also states that Jacobs also had ownership interests in certain Oklahoma banks that participated in some of the loans that the FDIC referenced in the complaint.
As detailed in a March 1, 2013 memo by W. Bard Brockman of the Bryan Cave law firm (here), according to the FDIC’s complaint, the three subject loans were participated out to two Oklahoma banks owned by Mr. Jacobs’ family and for which Mr. Jacobs served as a director. The other directors on the Senior Loan Committee knew about Mr. Jacobs’ interest in the participating banks, but they did not know that Mr. Jacobs allegedly had secretly arranged for the Oklahoma participating banks to have preferential rights to repayment upon default. The Oklahoma banks were ultimately paid in full and Carson River Community Bank sustained most of the loss on the loans. This conduct, the FDIC alleges, constituted a breach of Mr. Jacobs’ fiduciary duty to Carson River Community Bank.
Brockman speculates that there may be an additional reason why the other loan committee members were not named as defendants because “Nevada has a very forgiving standard of liability for corporate directors. Under the Nevada corporate code, a director is not liable unless it is proven that: (a) the director’s act or failure to act constituted a breach of his fiduciary duties; and (b) the breach of those duties involved intentional misconduct, fraud or a knowing violation of law.” Brockman suggests that the FDIC must not have had sufficient facts to support an allegation that the other directors had committed “intentional misconduct, fraud, or a knowing violation of the law.” Brockman concludes by noting that this case is “a true factual outlier and it does not signal a trend that the FDIC will target single director defendants.”
A Break in the Action: For the next few days, I will be traveling overseas on business. The D&O Diary’s publication schedule (such as it is) will be disrupted for the next few days. I hope to resume the normal publication schedule during the week of March 18, 2013.
And Finally: A recurring topic of interest to everyone here is the question of why The Netherlands is sometimes referred to as Holland. This topic is amusingly explained in the accompanying video (with more information on the topic than you might have thought possible). Enjoy. (Sorry about the short commercial at the beginning.)