What are the board of directors' duties during the sale of a company? That is, when the seller is experiencing a change of control or a merger or acquisition?
Fiduciary Duties During The Sale of a Company
As always, the board must observe its duty of care and the duty of loyalty. The duty of care requires the directors to gather the necessary information to decide the appropriate buyer. The duty of loyalty means that the board cannot act in their self-interest, such as preserving their jobs, rather than in the interest of the shareholders. In addition, the duty of disclosure, which is “the application in a specific context of the board’s fiduciary duties of care, good faith and loyalty" [see Note 1], requires the directors to provide full and materially accurate information to shareholders so that they can make an informed decision about which offer to accept. [See Note 2].
Revlon Duties To Shareholders
When a change of control becomes inevitble, the board of directors' fiduciary duties shift from focusing on the corporation's survival and effectiveness of its policy to the interests of the shareholders. In the landmark case Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), the Delaware Supreme Court held that once the board decides to sell the company, the duty of the board changes from preserving the corporate entity to maximizing stockholder value. Once the company is up for sale, it is in Revlon mode and the board's Revlon duties are as follows:
...the directors’ role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for stockholders at a sale of the company. [See Note 3].
The contours of Revlon duties have subsequently been clarified. The 2007 In re Topps Company Shareholder Litigation case included allegation that Topps' board of directors violated its Revlon fiduciary duties by favoring the one group's bid through its misusing the standstill agreement to prevent Topps' stockholders from considering an alternative bid that they could find more favorable than the other group's bid. In ruling in favor of the plaintiff shareholders, the Delaware Chancery Court explained:
The so-called Revlon standard is equally familiar. When directors propose to sell a company for cash or engage in a change of control transaction, they must take reasonable measures to ensure that the stockholders receive the highest value reasonably attainable. Of particular pertinence to this case, when directors have made the decision to sell the company, any favoritism they display toward particular bidders must be justified solely by reference to the objective of maximizing the price the stockholders receive for their shares. When directors bias the process against one bidder and toward another not in a reasoned effort to maximize advantage for the stockholders, but to tilt the process toward the bidder more likely to continue current management, they commit a breach of fiduciary duty. (Emphasis added.) [See Note 4].
Implications of Revlon Duties for Mergers and Acquisitions
Revlon duties require the board to take reasonable steps to maximize shareholder value in the sale of a company. This obligation has two significant implications for mergers and acquisitions.
1. The winning bid will be higher.
In the absence of Revlon duties, the board could, for example, choose to stop the bidding process early on by enacting deal protection and lock-up devices. A process that forecloses bidding fails to maximize shareholder value compared to a competitive buying process. [See Note 5].
2. The winning buyer will pay a higher premium, reducing the chances of success for the merger or acquisition.
When faced with multiple bids, the selling shareholders are likely to choose the highest price most of the time. The sale is the last opportunity for the shareholders to obtain a return on their investment, so they will be motivated to accept the highest premium for their shares. Many shareholder suits brought regarding the sale of a company focus on the board of directors' alleged failure to uphold their Revlon duties.
A high premium raises the bar that the buyer must exceed in order to successfully create value through the deal. For instance, a buyer who pays a 25% premium versus a 15% premium has that much a higher hurdle to jump in order to realize a positive return. When the premium paid is higher, the management of the surviving company will have to achieve greater cost and strategic synergies.
Thus, while the selling shareholders may benefit from a bidding process through which the board satisfies its Revlon duties, the likelihood of a positive outcome may be reduced. The irony is that where a large portion of the consideration is the buyer's stock, the selling shareholders will have to bear the risk that the merger or acquisition will destroy shareholder value.
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Note 1. Malpiede v. Townson, 780 A.2d 1075, 1086 (Del. 2001).
Note 2. Malone v. Brincat, 772 A.2d 5, 10 (Del. 1998).
Note 4. In re The Topps Company Shareholders Litigation, 926 A.2d 58 (Del. Ch. 2007).
Note 5. Revlon, 506 A.2d at 182-184.