How Can a Shareholder Challenge a Merger?

February 14, 2011

Happy Valentine’s Day.  Mergers are often seen as a “marriage” between two companies.  Not to spoil today’s mood, but this post shows how shareholders question the motives behind some of those “marriages.”

In an earlier post, I compared views on the abundance of shareholder lawsuits challenging mergers between the NY Times Dealbook and the Wall Street Journal.   So, if all of these shareholders are filing lawsuits, how does the process work?  Well, to file a “deal case”  it only takes one shareholder to file suit.  The shareholder must hold the stock at the time the deal was negotiated and continue to hold it until the deal closes (when the stock gets cancelled).

All of these lawsuits basically allege that the company’s board members breached their fiduciary duties by selling the company via an unfair process that resulted in an unfair price (or deal terms that preclude a better price).   Ultimately, the suits try to establish that a board did not act in the shareholders’ best interest in selling the company, therefore, settling (or obtaining a judgment) that increases the payout to shareholders, or, at least, gives shareholders more information about the deal.

Basically, under Delaware law, board members have a fiduciary duty to maximize shareholder value, but are given the presumption of the “business judgment rule”  which gives significant deference to a board’s actions.  In a buyout situation, however, sometimes a board’s decision to sell (or its process in selling) the company is subject to “enhanced” scrutiny, as first articulated in Revlon Inc. v. MacAndrews and Forbes Holdings Inc., 506 A.2d 173 (Del.  1986).  Since Revlon, these duties are consistently referred to as “Revlon” duties, and provide the basis for most shareholder suits challenging deals.

Under Revlon, once the board decides that the company is up for sale, it must obtain the highest price reasonably available for shareholders.   There is no certain outline a board has to follow, but it must act in good faith in selling the company.  The better lawsuits can show that the board acted in bad faith in choosing one buyer over another, or “consciously ignored its duties” by selling the company without proper information about the company’s true value.

If shareholders can establish breaches of fiduciary duty, they can hold board members liable for the difference between the sale price and a “fair” price.  These suits rarely, if ever, get to the point where the board is in danger of real personal liability.  Instead, before that happens, the buyer will recognize that the deal is in jeopardy, and pony up a fair price.  Or, in certain cases, another buyer will emerge with a better price.

All of this is a way for shareholders to scrutinize, and try to obtain a better deal for their shares.  The process and law is much more complicated and fact specific, but above is the basic concept.

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