BAF.

608E

Mergers and Acquisitions

Professor Martin Dierker
Lecture Notes Part 3
Applicable standards for buying and
selling a company
Applicable standards for bu
ying and selling a company
Introduction
Board of directors
 The governing body of a corporation
◦ Does not manage firm, but
◦ Oversees managers
 Similar to parliament in an indirect dem
ocracy such as UK or Germany
 Board members are held to higher ethic

al standards than other employees

 Certainly when buying or selling a comp

any
Fiduciary duties
Generally, board members have 2 main duties
1. Duty of care
Be properly informed about decisions
Make reasonable decisions and oversight
using their skill and experience
2. Duty of loyalty
Act in good faith and in best interest of
company
Cannot take advantage of being board mem
ber for personal gain.
Background
 In the past, little oversight over board members
 This changed completely in 1980s
◦ Legal courts more active
◦ Hostile takeovers became much more common
 Board members collaborate with lawyers in defense
 Mistakes likely to lead to lawsuit by raiders
 Today, M&A deals are often subject to lawsuits
◦ Example: Daimler-Chrysler deal was structured as
“merger of equals”, but CEO stated Daimler is control
◦ Shareholder lawsuit settled from US$ 300 million
 Careful with leaving email or SMS evidence
In general circumstances…
 … board members have wide discretion
 Just follow the business judgement rule; ie
 “A court will not second-guess a board’s

decision as long as it believes that members

acted in good faith and honestly believed the
action was in company’s best interest”
◦ Just check for unethical motivation such as fraud,
staying in office, bad faith, being uninformed
◦ Smart or stupid decision is irrelevant
What the board should pay att
ention to in any deal
 Intrinsic value of assets
◦ As opposed to market value!
 Whether management’s reports and docu-
ments are trustworthy –
◦ ask questions and discuss
 Can consider non-cash concerns such as deal
structure, timing, appropriate or not, risk of
deal falling through, value of securities,
impact on stakeholders
What the board should pay att
ention to in any deal (part 2)
 Managers’ potential conflict of interest
◦ Appoint a special committee?
 Verify that 3rd party reports are trustworthy
◦ Cannot simply rely on outsiders such as advisors
 Transaction costs and fees
◦ Especially for investment banks
 Board members are self-interested to prevent
company being taken over, so takeover
defenses must be justified
Applicable standards for bu
ying and selling a company
When buying or selling a com
pany
Buying or selling a company…
 … are different.

 Shareholders of buying company keep control

◦ Thus, simply follow business judgement rule

 Sale of company: Control switches from one

group of shareholders to another
◦ Courts will protect minority shareholders!
 Who may be harmed by sale
 So fiduciary duties change when selling!
The Revlon Standard
 Revlon v MacAndrews & Forbes (1986)
 Pantry Pride made hostile takeover bid for

Revlon
 Revlon resisted
 Revlon board instead accepted friendly bid by

Forstmann Little at lower price

◦ Revlon board liked that as it benefited debt holders
 Pantry Pride sued and won
The Revlon Standard
 Delaware Supreme Court said:
 [Once it is decided that the company was for sa
le,] “the duty of the board had thus changed fro
m the preservation of Revlon as a corp
orate entity to the maximization of the compa
ny’s value at a sale for the stockholdersbenefit.”

 Thus, if company is for sale, fiduciary duty of sh

areholders changes to obtain best price for shar
eholders.
◦ Cannot consider other stakeholders!
The Revlon standard
 Is important, because often 2 or more buyers c
ompete
 Easy to apply when deciding between two c
ash deals
 When deal contains some stock, board can s
till judge intrinsic value of stock
 We will examine in MCI Takeover case study
 Revlon standard applies when control changes
◦ Not the case in merger of equals (Paramount v Time)
◦ Unless there is a new controlling shareholder
(Paramount vs QVC)
Applicable standards for bu
ying and selling a company
Other important regulations
SEC antifraud rule 10b-5
 Most famous for insider trading
 But very often used to file shareholder lawsuita

round M&A with equity issue

◦ Example: AOL – Time Warner case
◦ 3 years later, shareholders sued after massive losses:
“… AOL materially misrepresented its revenues and
numbers of subscribers…” [around the merger]
“As a result of AOL’s misstatement of its financial c
ondition, its share price at the time of the merger was
substantially inflated”
◦ University of California claimed its 11.3 million shares
thus lost over US$450 million.
Details on Rule 10b-5
A company is liable under rule 10b-5 if
 It has misrepresented or omitted a fact
 This fact is of material importance
 It must have happened knowingly
 This occurred in connection with buy/sale of s

ecurities (eg in M&A stock deal)

 The person suing relied on this info for their d

ecision-making
 As a result of this, a loss was incurred
 +a technical condition “interstate commerce”
Securities litigation in the US
 Is relatively low profile
 But is a substantial part of legal system
 Winning a 10b-5 suit is not easy
 But it is much easier to not be dismissed
 Then, the case goes to trial
 Legal costs and reputational costs are high
 Thus, the lawsuit will often be settled
 Details in Barclays-Del Monte case
Applicable standards for bu
ying and selling a company
Standards for investment bank
s
Mergers and Acquisitions…
 … are one of the largest sources of profits for invest
ment banks
◦ Goldman Sachs 2015: Advise on $1.77 trillion in deals, for $3
.47 billion in fees.
 Companies rely on their advice
◦ Who hires them: Board or management
 But investment banks also have severe potential conflic
ts of interest
◦ Especially when sell-side advisors also provide deal financi
ng (“Stapled finance”)
 We will investigate in detail in Barclay’s and Del Monte
case
◦ Also has example of shareholder class-action lawsuit