When Do Merger Benefits To Directors Constitute Disabling Conflicts?
As the Delaware Supreme Court narrows the avenues for post-closing challenges to mergers (see our discussions of the implications of the Corwin and Cornerstone decisions here, here, here and here), we expect that plaintiffs' lawyers will increasingly seek to base their merger suits on specific allegations of conflicts that may have tainted the oversight of processes to sell companies in hopes of supporting claims for breaches of the duty of loyalty and the applicability of the enhanced scrutiny of the entire fairness doctrine. Given that virtually every merger includes some special merger benefits for directors that may be susceptible to an attempt at such a claim, it is timely that the Delaware Court of Chancery issued a decision over the summer of 2016 that provides useful guidance on how to evaluate the most common of special merger benefits to insiders: protection against exposure to pre-merger claims.
Merger agreements regularly protect the directors and officers of target corporations from pre-merger claims through assurances of indemnification, expense advancement, and insurance coverage. Although these protections constitute a special benefit for these insiders that is not shared with the other stockholders, they are not generally viewed as grounds for claims of disabling conflicts. These merger agreement benefits are typically redundant assurances to comply with pre-existing, ordinary course commitments to these insiders and therefore, except for the incremental outlay for the customary purchase of a six-year D&O tail policy, do not increase costs. Moreover, while the D&O tail policy to cover the outgoing target directors is an incremental transaction cost, the amount is usually immaterial and insufficient to support a claim that this payout somehow diverted money that would otherwise have been allocated in the course of negotiations to the merger consideration to the stockholders. Perhaps most importantly, the deference to a merger agreement's grant of these benefits to a target's directors and officers is grounded in the reasonableness of such protection as a quid pro quo for taking on the high-pressure position of navigating a public company through a sale process. Without the customary granting of these benefits in merger agreements, the attraction of qualified individuals to serve as fiduciaries for public companies contemplating strategic alternatives would be difficult.
Nonetheless, there are scenarios where directors of...
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