September 28, 2016

Director Conflicts: Next Big Thing in M&A Litigation?

This Cleary blog speculates on what the future of M&A litigation in a post-Corwin environment might look like:

As the Delaware Supreme Court narrows the avenues for post-closing challenges to mergers, we expect that plaintiffs’ lawyers will increasingly seek to base their merger suits on specific allegations of conflicts that may have tainted the oversight of processes to sell companies in hopes of supporting claims for breaches of the duty of loyalty and the applicability of the enhanced scrutiny of the entire fairness doctrine.

Public company merger agreements routinely contain provisions – such as indemnification covenants – protecting directors from pre-merger claims.  If director conflicts become fertile ground for litigation, will these arrangements be subjected to greater scrutiny?  Probably not:

Although these protections constitute a special benefit for these insiders that is not shared with the other stockholders, they are not generally viewed as grounds for claims of disabling conflicts.  These merger agreement benefits are typically redundant assurances to comply with pre-existing, ordinary course commitments to these insiders and therefore, except for the incremental outlay for the customary purchase of a six-year D&O tail policy, do not increase costs.

Other contractual provisions protecting directors from pre-deal claims may be subject to closer scrutiny. The Delaware Chancery Court’s recent decision in In re Riverstone National provides a framework for evaluating when arrangements like this may present an issue:

– The personal benefit to the directors must be real, as opposed to highly contingent. Thus, the potential claims from which the directors are being protected by the merger agreement must not be hypothetical claims, but ones that appear to be claims that would have survived motions to dismiss by the defendant directors.

– At the time of the negotiation of the merger agreement, the defendant directors benefitting from these merger agreement provisions must be aware of both these imminent exposures to pre-merger claims and the beneficial provisions in the merger agreement.

– The potential liability against which these director are being insulated must be of a magnitude that is material to the directors in question.

John Jenkins