DealLawyers.com Blog

This Sullivan Cromwell alert says special board committees are the exception, not the rule, and argues that they should be treated as such, because using them comes with costs and risks. As of earlier this year, the circumstances under which a special committee may be necessary have been further narrowed, at least in Delaware. That’s because the DGCL now includes a new statutory presumption of disinterestedness and offers “safe harbor” protections for controlling stockholder transactions if they are either approved by an independent committee or approved or ratified by disinterested stockholders (not both, except in take private transactions).

So when are special committees necessary or appropriate? Not surprisingly, when there are material conflicts of interest or where the market or a court might question the board’s independence for other reasons. For example:

Potential material conflicts include a director having particularly close personal or business relationships with an interested party.

An executive director investing in the private equity fund taking a company private, such that he or she becomes part of the buyer group, for example, could give rise to a material conflict.

However, directors merely owning equity awards in the company or being the target of an activist’s criticism would not, absent other factors, constitute a material conflict requiring the formation of a special committee. Moreover, a more efficient and less problematic approach may be to recuse the director.

However, top executives simply benefiting from change-of-control payments, retention bonuses or accelerated equity awards as a result of an M&A transaction would not create a disabling conflict.

Sometimes, recusal of the conflicted director or an executive session that excludes management participants may be a better approach. For example,

In the activist defense context, special committees can do more harm than good since they divide boards by design – the very dynamic activists seek to exploit. When faced with an activist threat, Delaware courts do not impose heightened fiduciary duties on boards beyond the traditional duties of care and loyalty. Since all directors have an inherent interest in the outcome of an activist attack, there is typically no conflict that warrants establishing a special committee.

[Forming a special committee] can burden the company with an inefficient decision-making process and even risk jeopardizing a proposed transaction that could otherwise be in the best interests of stockholders.

It can also cause serious rifts among board members as to who serves on the special committee and who does not.

[Forming a special committee] can increase transaction expenses, increase the risk of leak, create conflicting advice among external advisors and slow down the transaction process.

Forming a special committee unnecessarily may also signal vulnerability to the market and create an inaccurate appearance of material conflicts, which can, paradoxically, attract more litigation.

Finally, the article suggests a few other methods of handling conflicts:

Where management has a conflict, management will typically still play a role in creating the projections, but the board will take an active role in reviewing the projections (including, on occasion, asking management to run “sensitivities”). On very rare occasions where management’s conflicts are material, a special committee or board may engage an independent advisor to develop separate projections or review management’s projections.

Boards can always consider establishing transaction or ad hoc working groups, which may include the CEO and select directors particularly suited for the role (such as directors with more M&A experience and availability), to receive more frequent updates. These informal working groups (sometimes referred to as committees) typically do not have independent decision-making authority, but rather serve to facilitate the full board’s transaction oversight without incurring unnecessary costs and burdens.

Activists also tend to make requests for the creation of special committees to oversee a strategic corporate review. The working group alternative could satisfy these requests while leaving the ultimate determination on the outcome of the strategic review with the full board.

– Meredith Ervine