Editor: Please tell our readers about your practice.
Behrens: The focus of my practice is securities and shareholder litigation.I regularly defend companies, boards of directors and officers in securities fraud class actions, breach of fiduciary duty suits, and corporate control disputes, like proxy contests. I also do general litigation, some white collar criminal defense and internal investigations.
Editor: As the economy continues to show slow signs of improvement, what is the outlook for M&A activity? What factors might fuel a rebound?
Behrens: Merger and acquisition activity already has been picking up. The first half of 2010 was the most active M&A market since 2007, and the deal activity in the month of August reportedly was the most active for that month since 1999. The stars all seem to be aligning for that trend to continue more strongly for 2011.
Over the past two years, private equity funds generally had been pulling out of the M&A market, and there consequently is a huge amount of cash on the sidelines in the private equity sector. Likewise, disciplined public companies that were concerned about general economic uncertainty focused on cost cutting and reducing their spending, and thus also accumulated a great deal of cash on their balance sheets. The amount of cash available to make deals, coupled with a thawing of credit markets making financing available, creates a situation where strong companies and private equity funds are poised to become very acquisitive.And there are many attractive acquisition targets available, especially companies whose stock prices are undervalued given the volatility in the stock market.
Editor: How might lingering economic unsteadiness affect potential transactions?
Behrens:Well, if the economy slides backwards or credit markets freeze back up, M&A activity likewise will stall.But if there is a slow and steady improvement in the economy, we can expect M&A activity to continue to trend upward. Many companies have had their stock prices punished severely over the last two years - in some cases, too severely.Many of these companies have strong products or prospects, making them attractive acquisition targets, but may be undervalued because of a prior lack of fiscal discipline, weakness in commodity prices, or general economic malaise.Combine the high number of attractive targets with the great deal of available cash looking for opportunities and we have very favorable conditions for M&A activity to grow.
Editor: An M&A transaction can leave businesses susceptible to shareholder litigation. What potential claims should executives prepare for when considering a merger or acquisition?
Behrens: First, the word "susceptible" in your question is an understatement. These days, shareholder litigation following an announcement of a major M&A transaction is a virtual certainty. M&A litigation has been skyrocketing. According to one recent report, one-third of all the shareholder litigation filings in the nation during the third quarter of this year were challenges to M&A transactions. Obviously this is in part due to the fact that there has been an increase in M&A transactions generally.But another factor is a phenomenon within the shareholder plaintiffs' bar.Securities fraud class action filings have been declining to some degree.The plaintiffs' lawyers who typically filed those cases have steadily shifted focus to filing breach of fiduciary duty cases, many of them being challenges to M&A transactions.
Despite the frequency of public reports of lawsuits challenging M&A transactions, I am constantly surprised that many directors and officers - particularly those who have not been through a significant M&A transaction before - don't believe they'll be sued if they are negotiating what they think is a favorable deal for shareholders and if they observe the right processes.Their logic is understandable, but it just simply isn't the case. The lawsuits come even if the process has no obvious problems and even if the deal seems objectively to be a very favorable deal for the shareholders.
M&A lawsuits typically allege that the directors of the acquisition target company breached their fiduciary duties in approving the transaction in question.The acquiring company and other defendants are alleged to have aided and abetted in those fiduciary duty violations. The plaintiffs often assert that the transaction price is inadequate, that the directors failed to exercise due care to maximize the price being offered, that the transaction is coercive to shareholders because of so-called deal protection measures included in these agreements, and that the public disclosures associated with the transaction are inadequate or misleading. Typically it is alleged that some or all of the directors have some form of conflict of interest or that they did not exercise due care in the transaction process.
Editor: If litigation does arise, what defenses are available to the company and its directors and officers?
Behrens: The key defense is the business judgment rule, which is a presumption that directors have acted in good faith and on an informed basis in making their decisions, and therefore those decisions are entitled to deference by a court. Based on that presumption directors will be shielded from liability unless there is a reason why the business judgment rule should not apply.Business judgment rule protection may be compromised if there is a disabling conflict of interest for a majority of the decision makers; if the directors are deemed to have acted in a grossly negligent manner; or if they have abdicated their duties altogether. So it is essential to be aware of potential or even perceived conflicts of interest and deal with them so they don't compromise the full protection of the business judgment rule. Obviously it is also very important to follow corporate formalities and processes and to document everything from beginning to end.
Generally it has been my experience that directors do take their fiduciary duties very seriously and that they do devote extensive time and attention to the decision or transaction in question. It is important to make sure that the company's documentation of the board's processes (including minutes from meetings) reflect the earnestness, diligence and care with which directors have approached their task.
Editor: You have a national practice but are headquartered in Texas. Are there litigation advantages or defenses that Texas companies have that companies from other states do not?
Behrens: The conventional wisdom has been that Delaware is the best state in which to incorporate. There are many reasons for that, one being that the Delaware courts are perceived to have a greater familiarity and sophistication with respect to corporate law. It is true that Delaware courts see a vast amount of corporate litigation, have a sophisticated judiciary, and a well- developed body of law. That said, Texas corporations have been given some significant advantages that are not necessarily available in Delaware. The Texas Business Organizations Code contains some very pro business provisions, including provisions designed to preserve for the board of directors the power to make corporate decisions, including about litigation, and to make it more difficult for shareholders to challenge those decisions. For example, in most circumstances shareholders who have complaints can only file a shareholder derivative suit seeking remedies for the company, not for themselves. Unlike in Delaware, shareholders of Texas-incorporated companies generally cannot sue directors directly to recover damages for themselves.
In addition, shareholders of Texas companies always must first make a demand on the board of directors requesting that the board assert the company's claims before they can file a lawsuit.Except in rare circumstances, the shareholder must wait for 90 days after sending the demand before commencing a suit. If a lawsuit is filed by the shareholder, a special committee of disinterested, independent directors can conduct an investigation regarding the allegations and obtain a mandatory stay of the litigation for 60 days (which can be renewed with leave of court) while the special committee determines how to proceed with respect to the litigation. If the special committee determines that the litigation would not be in the company's best interests for a host of reasons related to either the merits or other legitimate considerations, they can request that the case be dismissed. The court will normally then dismiss the case unless a plaintiff can show that the review process was done by directors who are not disinterested and independent or that the review process was not done in good faith. And unless such a showing is made, discovery will be limited to review of the special committee's process in making its determination about the litigation, not the underlying conduct that was originally challenged.
In light of what the Texas legislature has done in this area, it is worth taking a second look at the conventional wisdom regarding the relative advantages of incorporating in Delaware versus Texas.
Editor: Are there best practices to help mitigate the risks of M&A litigation?
Behrens: Company directors and officers should be aware that when an acquisition overture comes in, no matter how informal it seems, it likely has a fair amount of planning behind it.The overture likely has been preceded with at least some degree of due diligence by the person who floats the proposal. Someone at the inquiring company has at the very least reviewed the public filings of the target company. With this in mind, it is important when faced with this situation to have early involvement from a highly competent corporate securities lawyer who is experienced in the M&A area. There are all kinds of traps for the unwary when the process of entertaining a proposal begins to unfold. For example, depending on how things transpire, you may inadvertently trigger a disclosure obligation in what seems to be a preliminary conversation.
When the target company gets to the point of evaluating an acquisition overture, long before any suit happens, the most important thing is to meet early and to have a fairly rigorous review of any actual or perceived conflict of interest on the part of the directors who will be charged with making a decision on a potential transaction. As mentioned, one way that you can lose a business judgment rule protection is in the case of decision makers who are operating under some actual or apparent conflict of interest.
Dealing with conflicts early is key and there are a couple ways to do it. One is to have directors who seem to have the appearance of a conflict recuse themselves from any negotiations or decision making. Another way is to appoint a special committee of disinterested and independent directors to evaluate what to do with the proposal and to consider alternative proposals. If you've done a good job of vetting conflicts early, you can avert litigation problems later. Another cardinal rule is to thoroughly document the process from day one as well as engage competent counsel, and if appropriate, an independent financial advisor to assist in the negotiation and finalizing of the transaction.
Editor: Isn't it also important to get a fairness opinion from a third party?
Behrens: It's not always required, but sometimes it can be very beneficial. This would be part of the information that the directors will consider in determining whether to approve the transaction and recommend its approval to the shareholders.It also can become a key piece of evidence regarding whether the transaction is fair to shareholders.
Editor: What other recommendations can you offer directors considering an acquisition proposal?
Behrens: When confronted with a possible M&A transaction, do things that are consistent with best practices and that help you preserve business judgment rule protection.Address potential conflicts of interest, observe corporate formalities, act on an informed basis, devote the requisite time and attention, follow up on questions until satisfactory answers are provided, make sure to have full participation of the decision makers, and obtain advice on a timely basis from both your legal advisors and your financial advisors. Directors who have specialized knowledge should be called upon to make use of that in the transaction process. The last thing is to make sure that you have thorough documentation because in an eventual litigation the meetings of the board, and the materials that were given to the board, will be on trial.