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Oil & Gas M&A Portal Providing Access to a Library of InsightAn Overview of FiduciaryDutiesFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Oil & Gas M&A Portal Providing Access to a Library of InsightTarget Company BoardProcess – In GeneralFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
What does the board of directors do? Fundamental principle of corporate law: “The business and affairs of every corporation organized under thischapter shall be managed by or under the direction of a board ofdirectors .” (DGCL §141(a))Directors serve as agents to the owners of the corporation(stockholders)Directors do not directly manage the business of the company,but they are ultimately responsible for the management of thecorporationThe Board discharges its duties by appointing and supervisingofficers who run the day-to-day operationsOfficers are subject to the same duties as directorsOil & Gas M&A Portal Providing Access to a Library of Insight3
How do directors fulfill their role? The Board should be informed about the business, includingresults of operations, and should understand the company’sstrategies and corporate plansThe Board should be involved in and approve major decisions forthe corporations (such as entering into significant transactions)Oil & Gas M&A Portal Providing Access to a Library of Insight4
What are the directors’ duties to the corporation and thestockholders?Two PrimaryFiduciaryDutiesDuty of CareDuty ofLoyaltyOil & Gas M&A Portal Providing Access to a Library of Insight5
Oil & Gas M&A Portal Providing Access to a Library of InsightDuty of CareFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Duty of Care The duty to make careful, informed decisions by assuming anactive role throughout the entire decision-making process. In sodoing, directors should: Assure themselves that they have the information required to takeaction;Devote sufficient time to reviewing such information; andObtain, if useful, the advice of experts Directors may rely on information, opinions, reports or statementspresented by any other person as to matters reasonably believed to bewithin such other person’s professional competence when that personhas been selected with reasonable care by or on behalf of the corporation(DGCL §146)Oil & Gas M&A Portal Providing Access to a Library of Insight7
Duty of Care (cont’d) Additional Considerations: Non-Delegation: The duty of care cannot be delegated to otherdecision-makersRecordkeeping: The board should establish an adequate record ofthe entire decision-making processOil & Gas M&A Portal Providing Access to a Library of Insight8
Duty of Care – what makes a good process?InvestigationDeliberation Was the Board engaged in the process? Did directors attend meetings? Did directors question management and ask for moreinformation? Did the Board consult with financial advisors? Legal experts? What materials did the Board review and consider? How often did the Board meet and how long was each meeting? Was there ample time for the Board to gather the requisiteinformation and deliberate? Practical Note: Many clients are under significant timeconstraints and it is not uncommon for management to press tomove forward with a “great deal” ASAP. However, ample timemust be built in for the Board to adequately understand thetransaction and deliberateOil & Gas M&A Portal Providing Access to a Library of Insight9
Oil & Gas M&A Portal Providing Access to a Library of InsightDuty of LoyaltyFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Duty of Loyalty The duty to act in the best interest of the corporation and itsstockholders by not putting any personal interest ahead of theinterests of the corporation or its stockholders. This duty isimplicated when: Directors stand on both sides of a transaction or otherwise stand toreceive a benefit not shared with the stockholders (an “interested”director); orDirectors are beholden to a party with an interest in the transaction (a“non-independent” director)Oil & Gas M&A Portal Providing Access to a Library of Insight11
Duty of Loyalty (cont’d) Directors can have interests that differ from the stockholders ifthey currently have or stand to receive: Rollover of equity or options;Compensation or benefits arrangements post-transaction;Parachutes or other change-in-control payouts; orIndemnification, advancement or insuranceTo resolve such conflicts, utilize a combination of: Full disclosure of conflicts to board and stockholders;Procedural safeguards throughout the transaction process; andSpecial transaction committeesOil & Gas M&A Portal Providing Access to a Library of Insight12
Oil & Gas M&A Portal Providing Access to a Library of InsightJudicial Review of BoardActionFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Judicial Review of Board Action Courts evaluate Board decisions using different standards ofreview: Business Judgment RuleEnhanced Scrutiny: RevlonUnocalEntire FairnessOil & Gas M&A Portal Providing Access to a Library of Insight14
Oil & Gas M&A Portal Providing Access to a Library of InsightJudicial Review of BoardAction – Business JudgmentRuleFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Business Judgment Rule The presumption that, in making business decisions, the directorsof a corporation acted on an informed basis, in good faith and inthe honest belief that the action taken was in the best interest ofthe company and its stockholdersWhat this means: Directors’ actions will be upheld if it can be attributed to any rationalbusiness purposeThe presumption may be overcome only if a plaintiff pleads factsshowing that a board has acted: Disloyally,In bad faith, orWith gross negligenceOil & Gas M&A Portal Providing Access to a Library of Insight16
Business Judgment Rule (cont’d) Policy Reasons for the Business Judgment Rule: Courts are not well-positioned to make routine business decisionsStockholders have selected the board to run the companyEncourages beneficial risk-takingAttracts qualified individuals to serve as directors by minimizing theirfinancial riskOil & Gas M&A Portal Providing Access to a Library of Insight17
What is the function of the Business JudgmentRule? The BJR is a judicial standard of review, not a duty The lens through which a court may judge the propriety of boardactionIf the BJR is satisfied, directors are not personally liable, and acorporate action will not be overturnedThese conditions are generally presumed, with the challengerbearing the burden of proving that one of the conditions was notsatisfied“Substantive second-guessing of the merits of the businessdecision is precisely the kind of inquiry that the businessjudgment rule prohibits.” In re the Dow Chemical CompanyDerivative Litigation (Del Ch. 2010)If one of the conditions of the BJR is not satisfied, the “entirefairness” standard appliesOil & Gas M&A Portal Providing Access to a Library of Insight18
Oil & Gas M&A Portal Providing Access to a Library of InsightJudicial Review of BoardAction – Enhanced Reviewunder RevlonFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Enhanced Review Under Revlon In the context of a change of control, the board must take effortsto achieve the highest value reasonably attainable for thestockholdersChange of Control: What qualifies (in general): A stock-for-stock merger when there would exist a post-mergercontrolling stockholderThe sale of a non-controlled company for consideration that is a blend ofcash and stock, where the cash consideration makes up 50% of the salepriceWhat does not qualify (in general): A pure stock-for-stock merger between two non-controlled companiesThe mere relegation of the target’s stockholders to a minority position in apost-merger combined companyOil & Gas M&A Portal Providing Access to a Library of Insight20
Enhanced Review Under Revlon (cont’d) Highest Value: Price is not the only relevant factor. Other factors include: Proposed or actual financing;Questions of illegality;Risk of nonconsummation;Bidder’s prior business experiences; andBidder’s business plans and their effect on the stockholdersNecessary Sale Process The decision as to which process will produce the best value forstockholders falls under the business judgment rule, provided theboard exercises the duty of care and loyaltyOil & Gas M&A Portal Providing Access to a Library of Insight21
Oil & Gas M&A Portal Providing Access to a Library of InsightJudicial Review of BoardAction – Enhanced Reviewunder UnocalFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Enhanced Review Under Unocal Hostile takeovers usually lead to the replacement of managementand the board of directorsBut in friendly transactions, the Board and management mayremain with the corporation or get attractive severance packagesBecause there is an inherent conflict of interest when the Boardseeks to fend off unwanted suitors, the Delaware courts will applya heightened standard of review: the Unocal / Unitrin standardOil & Gas M&A Portal Providing Access to a Library of Insight23
Enhanced Review Under Unocal Applies when directors unilaterally adopt defensive mechanismsin response to an alleged threat to corporate control or policy.Such defensive mechanisms must pass a test of reasonablenessand proportionality Reasonableness: The board must show that it had reasonablegrounds to believe that a danger to corporate policy andeffectiveness existedProportionality: The board must show that the defensive mechanismwas reasonable in relation to the threat posed, meaning: The action was not coercive or preclusive; andSuch action falls within a range of reasonablenessOil & Gas M&A Portal Providing Access to a Library of Insight24
Enhanced Review Under Unocal (cont’d) Additional Considerations Delaware courts will consider the preclusive nature of all dealprotections included in a transaction—even those that take placeoutside the context of a hostile threatThe idea of reasonableness overlaps with Revlon’s enhancedscrutiny standard – deal protection mechanisms cannot unreasonablyinterfere with the board’s obligation to obtain the highest valuereasonably attainableOil & Gas M&A Portal Providing Access to a Library of Insight25
Oil & Gas M&A Portal Providing Access to a Library of InsightJudicial Review of BoardAction – Entire FairnessFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Entire Fairness Requires directors to demonstrate the inherent fairness of thequestioned transaction or decision, and that they acted in goodfaith How it works: Step One: If a plaintiff rebuts the presumptive protections of the businessjudgment rule, entire fairness review is triggeredStep Two: The defendant will then have the burden of demonstrating thatthe transaction was “entirely fair,” meaning a showing of: Fair Price – involves economic and financial considerations, including marketvalue, earnings, future prospects, any other element that affects the value ofthe company’s stockFair Dealing – how the transaction was initiated, structured, negotiated,disclosed to the directors, and how approvals were obtained from the directorsand stockholdersStep Three: HOWEVER, the defendant can shift the burden back to theplaintiff through the use of either: A Special Committee; orApproval of a majority of the minority stockholdersOil & Gas M&A Portal Providing Access to a Library of Insight27
Oil & Gas M&A Portal Providing Access to a Library of InsightJudicial Review of DealProtectionsFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Short Review of Deal Protections Buyers prefer to utilize deal protection mechanisms to ensurefulfillment of their fiduciary duties, while targets use dealprotection mechanisms to limit the risk of third-party interferenceGenerally, there are few bright-line rules governing the use ofdeal protections; as such, deal protections must be analyzed as awhole and in light of the history of the transactionFor a more in-depth discussion of various deal protectionmechanisms, refer to the slide presentation titled “DealProtection Mechanisms”Oil & Gas M&A Portal Providing Access to a Library of Insight29
Oil & Gas M&A Portal Providing Access to a Library of InsightChallenges to the PublicCompany DealFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Challenges to the Public Company Deal Four Basic Challenges: PriceProcessDisclosureCoercive/Preclusive Deal ProtectionsResolving Challenges to Public Company Deals In resolving stockholder suits, courts may: Require additional disclosures;Require changes to the deal terms; orIssue an injunction or settlementOil & Gas M&A Portal Providing Access to a Library of Insight31
Oil & Gas M&A Portal Providing Access to a Library of InsightDirector Protection fromPersonal LiabilityFebruary 2016Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom,France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins’ associated office in the Kingdom of Saudi Arabia. Copyright 2016 Latham & Watkins. All Rights Reserved.
Director Protection from Personal Liability Best Practice: Act with due care, in good faith and without conflictLimited Liability: A director will not normally be liable for monetarydamages to the company or the stockholders as a result of anybreach of fiduciary duty except for: Any breach of the duty of loyalty;Any act or omission which involves intentional misconduct or aknowing violation of the law; orUnlawful dividends or stock repurchasesOil & Gas M&A Portal Providing Access to a Library of Insight33
Director Protection from Personal Liability Indemnity Expense Advancement Most directors of public companies are entitled to indemnity forlosses by reason of being a director as long as the director: (1) actedin good faith and in a manner reasonably believed to be in, or notopposed to, the best interests of the company; and (2) in the case ofa criminal matter, had no reasonable cause to believe the conductwas unlawfulMost public companies provide for director expense advancement indefending a claim, subject to the director undertaking to repay theseadvances if indemnification is later determined to not be availableD&O InsuranceOil & Gas M&A Portal Providing Access to a Library of Insight34
Oil & Gas M&A Portal Providing Access to a Library of Insight Fundamental principle of corporate law: “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors .” (DGCL §141(a)) Directors serve as agents to the owners of the corporation
