This article offers a brief overview of the role of the Board of Directors in mergers and acquisitions. By better understanding the board’s role, directors (and officers) can increase stockholder value, reduce conflict within the organization, and mitigate litigation risk.

Overview

The question, what is the board’s role in M&A?, raises two separate but related questions:

• How does the role of the board differ from the role of management?
• How does the board’s role in M&A differ from the board’s role in the company’s other business activities?

These questions arise for many reasons, including the following:

• Directors are sensitive to the prerogatives of management but focused on fulfilling their own responsibilities.
• Many directors have experience with M&A, either as officers of their own companies, or directors of other companies that have engaged in transactions, or as professional advisors – bankers, accountants, consultants, or attorneys – with M&A expertise.
• Transactions that rise to the board-level are significant events, but at many companies are sufficiently infrequent that directors and management may not have thoroughly vetted procedures or an adequate understanding of their respective roles.
• The interests of directors and senior managers in some transactions may not be entirely aligned.
• In the current environment, everyone is concerned about litigation.

Returning to the two questions above:

• Directors and officers play fundamentally different roles within a corporation. Under Delaware law, “[t]he business and affairs of every corporation . . . shall be managed by or under the direction of a board of directors . . ..” As a practical matter, most companies are managed under the direction of the board: the board oversees management, and management is responsible for the company’s day-to-day activities. At the highest level, the board is responsible for approving or setting the strategy for a business, and management is responsible for executing that strategy. Expressing this allocation of responsibilities colloquially, only the board can govern, and only management can manage.
• The role of the board in M&A varies with the significance of a transaction. Consistent with the role of the board generally, a board should be relatively uninvolved with insignificant transactions and increasingly involved as transactions become more significant. The board should be highly involved in major, strategic acquisitions and in sales of the company or all, or substantially all, of its assets.

The Board’s Role in M&A Generally

It’s helpful to think of M&A as one of the ways that a company can execute its business plan and deliver value to its shareholders. Directors play many roles within the organization, but among their principal functions are:

• Setting strategy
• Monitoring corporate performance and management
• Overseeing risk management
• Counseling the CEO on the most difficult challenges facing the business
• Championing good governance
• Offering constructive criticism

All of these roles are relevant to M&A. In practice, directors play the same role in transactions that they do in all other aspects of the company’s business – oversight and governance – with some roles and responsibilities that are specific to the M&A context.

On the buy side, the board’s higher level perspective provides a special vantage point from which the board can help maximize stockholder value:

• The board is responsible for approving a company’s strategic plan, and the board should evaluate proposed acquisitions in the context of that plan.
• The board has a strategic view of the company’s resources – both financial and managerial – and the board should assess whether a proposed transaction is the best use of those resources.
• The board selects the CEO and can influence the selection of senior management. If the board wants the company to grow through acquisitions, the board needs to take appropriate steps to ensure that the management team includes individuals with the skills required to execute transactions and integrate the businesses that are acquired.

All of these are strategic, board-level issues that the board should evaluate – and that only the board can evaluate – before the company embarks on an acquisition.

Consistent with their responsibility for strategy, governance, and oversight, directors should bring a strategic perspective to their review of proposed acquisitions that rise to the board-level. Directors should carefully probe the financial underpinnings of proposed acquisitions, which may be premised on unrealistic assumptions about growth and cost-savings. Directors should be aware of the principal reasons why acquisitions do not achieve their anticipated results, including:

• Overpayment for the target
• An incomplete understanding of the business being acquired (including its liabilities and intellectual property)
• Cultural clashes
• Failures in integrating the acquired business

Directors should review these issues with management. On these issues, in particular, directors have a perspective that is informed by a range of experience, sympathetic to the company’s goals, and separated from the pressures of the deal, and directors have the standing to challenge over-optimistic assumptions and emphasize the importance of integration.

Board Responsibilities in Connection with a Sale of the Company

On the sell-side, the situation is a bit different because a sale transaction, particularly a sale of the company as a whole, can be the best opportunity for stockholders to achieve a premium for their investment. Here, too, the board’s principal role is strategy, governance, and oversight, with added considerations that arise in connection with a sale. One of these considerations pervades the sales process; two arise at the commencement of any process.

• In some transactions, generally known by the name of the leading Delaware case, Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., the board is obligated to secure the best price reasonably available for stockholders. While the precise contours of the Revlon doctrine are beyond the scope of this article, in general, a sale of the company for cash triggers Revlon duties. For this reason, boards should begin with the end in mind: they should assume that their decisions may need to withstand scrutiny under Revlon, and they should act throughout the process to maximize stockholder value.
• Before initiating a sales process, the board should assess whether this is an opportune time to sell the company. Under Delaware law, the decision on whether to sell or not sell the company is a decision for the board. Even if the company receives an offer at a premium to the company’s current market value, the board – with the assistance of its advisors – can assess whether stockholder value would be maximized by selling at that time, in response to that offer, or selling at a different point in the business cycle or at a different point in the company’s development, taking into account the company’s long-term strategic plan and whether the company’s stockholders are better served by the company remaining independent.
• With the assistance of its professional advisors, the board should adopt a process that maximizes stockholder value. Under Delaware law, there is no single blueprint for the sale of a company, and the answer will vary depending on the company’s situation. But, in general, a thorough market check before signing an agreement, and the ability to accept superior offers that emerge after signing, help establish that the board has endeavored to maximize value for stockholders. A good process also helps mitigate litigation risk.

While the sales process is unfolding, the board should oversee the process, guiding management and the company’s advisors with a view to maximizing stockholder value and fulfilling the board’s Revlon duties.

At the conclusion of the process, the board will consider an agreement establishing the terms of the sale. Under Delaware law, the board of a company that wishes to merge with another entity must adopt a resolution approving a merger agreement and declaring its advisability to the company’s stockholders. Similar requirements apply to sales of all or substantially all of a company’s assets.

Directors want their decisions to withstand any legal challenge that might be asserted in connection with a sale. Different legal standards might apply to such a case; Revlon duties are discussed above. Some board decisions will be subject to “business judgment” review. The business judgment rule establishes a presumption that directors, in making a business decision, acted on an informed basis and in good faith. If the business judgment rule applies, the directors’ decision will be sustained if it can be attributed to a rational business purpose, even if, with the benefit of hindsight, the decision proves to have been unfortunate. The business judgment rule will not apply if the directors’ decision involves self-dealing or a conflict of interest, and the business judgment rule will apply only if directors act with due care – the business judgment rule does not protect gross negligence.

In connection with a sale of the company, a board typically requests a “fairness opinion” from a financial advisor. A sell-side fairness opinion is an opinion as to whether the consideration to be received in a proposed transaction is fair, from a financial point of view, to a company’s stockholders. The opinion is typically accompanied by a presentation that assesses the value of the transaction, using several methodologies.

Fairness opinions, together with presentations by management and the board’s advisors, and the board’s own knowledge of the company, its industry, and its prospects, provide the key foundation for directors’ exercise of due care and their informed, careful review of a proposed sale. The board’s active oversight of the sales process and its instructions to management and advisors throughout the process should focus on ensuring that the directors obtain the best deal reasonably available for stockholders.

Related-party Transactions

Related-party and conflict transactions provide a contrast to the typical buy- and sell-side situations, described above. Related-party transactions include any transaction with, but particularly a sale of the company to, a controlling stockholder, management, or an entity affiliated with a controlling stockholder or management (including a buyout in which management is participating). Conflicts of interest, or possible conflicts, can arise from many circumstances, including:

• Management favors one transaction because it involves greater compensation for management than competing deals.
• A controlling stockholder will receive somewhat more consideration per share than minority stockholders: a control premium.
• A controlling stockholder’s preferences for the transaction (for example, cash versus stock, taxable versus tax-free, or timing) differ from the preferences of other stockholders, so that the controlling stockholder is arguably getting a better deal than other stockholders, even though it receives the same price per share as other stockholders.

For convenience, we use the term “related-party transaction” to describe both related party and conflict situations.

From the board’s perspective, a critical difference between a typical transaction and a related party transaction is that, when the company is considering a related party transaction, the board must step out of its role of oversight and governance and play a more active role in the deal. In a related party transaction, management or a controlling stockholder is on one side of the table. The board – typically through a special committee – is literally on the other side of the table, actively representing the interests of stockholders.

In a related party transaction, or in evaluating a transaction that involves a conflict, the board should form a special committee comprised solely of independent directors. (It is helpful if the committee consists of two or more directors.) The resolutions establishing the committee should grant the committee broad power, including the power not to recommend any transaction. The committee should have the authority to retain independent advisors, including legal and financial advisors of the committee’s choosing. The financial advisor’s compensation should not be entirely contingent on the completion of a transaction. The members of the committee should stay informed and be diligent; the committee should zealously represent its constituents and should vigorously negotiate the terms of any deal.

Conclusion

The board’s principal responsibility is to protect and enhance stockholder value. Mergers and acquisitions offer one way that stockholder value can be increased.

The board’s principal role is strategy, oversight, and governance. Except in the unusual case of a related party transaction, where the board must plan an active role in negotiating the deal, the board’s role in M&A is consistent with its responsibilities for strategy, governance, and oversight.

On the buy-side, the board should make a number of strategic decisions before the company undertakes acquisitions, and the board should review proposed acquisitions from a strategic perspective with a particular focus on the assumptions that underlie the deal and the importance of integrating the acquired business.

On the sell-side, particular where the board is considering the sale of the company, the board should assess the timing and adopt a process. The board should stay actively involved throughout the process, overseeing management and the company’s advisors. At the conclusion of the process, the board should assess the proposed agreement and determine whether to recommend it to stockholders. Throughout, directors should act carefully and on an informed basis.

By properly exercising their responsibilities, and providing the advice and perspective that can come only from directors, the board can help increase stockholder value, reduce tension within the organization, and mitigate litigation risk.

Also contributing to this article:

Michael J. Levitin - WilmerHale - michael.levitin@wilmerhale.com