At a glance: executive liability for M&A transactions in USA

Standard of liability

What is the standard for determining whether a board member or executive may be held liable to shareholders in connection with an M&A transaction?

There are three general standards: business judgment rule, enhanced scrutiny, and entire fairness.

The default standard of review is the business judgment rule, under which the court will presume the defendants acted in accordance with their fiduciary duties. As long as the defendants can proffer a rational business justification for their decision, the court will not second-guess their decision.

Enhanced scrutiny is the intermediate standard of review. Forms of enhanced scrutiny apply to certain transactions involving a sale or break-up of the company and to defensive actions taken by boards in response to takeover proposals. To satisfy enhanced scrutiny, defendants must generally show that ‘their motivations were proper and not selfish’ and that ‘their actions were reasonable in relation to their legitimate objective’ (Firefighters’ Pension Sys v Presidio, Inc, 251 A.3d 212, 249 (Del. Ch. 2021)).

The most onerous standard is entire fairness review. Once entire fairness review applies, the board must prove to the court that ‘the transaction was the product of both fair dealing and fair price’ (Id).

The standard of review is frequently dispositive of the outcome in M&A litigation. If the business judgment rule applies, the board’s decision will generally be upheld. On the other hand, entire fairness review favours plaintiff shareholders, because it places the burden on the board to prove that all aspects of its decision were objectively fair. Entire fairness review is also fact-intensive, and usually resolved at trial rather than by pre-trial motions.

Does the standard vary depending on the type of transaction at issue?

Yes, in certain cases. When a corporation initiates an auction to sell or break up the company for cash, or abandons a long-term strategy in response to a bidder’s offer and seeks alternative cash transactions to break up the company, or the M&A transaction involves a ‘change of control’, Revlon duties may attach to the board’s decision. When Revlon duties apply, the board’s goal is to get the best price for the shareholders from the sale of the company. Courts will review the board’s decision under a form of enhanced scrutiny, where the board bears the burden of proving that it acted reasonably to maximise shareholder value. Interested transactions, such as going private transactions involving a controlling shareholder, are reviewed under the entire fairness standard in certain circumstances.

M&A transactions that do not involve a potentially interested party, such as a merger between corporations without a controlling shareholder or a sale to an unaffiliated financial sponsor, are generally reviewed under the business judgment rule.

Does the standard vary depending on the type of consideration being paid to the seller’s shareholders?

Yes, in certain cases. The type of consideration may determine whether Revlon duties attach to a board’s decision to approve an M&A transaction. In a sale of a company for cash, where the shareholders’ interest in the company would be terminated by the transaction, Revlon duties generally apply and boards must maximise the present value for the shareholders. In a sale for stock that does not involve a change of control, such as when control of the merged entity remains in a large and fluid market, Revlon duties do not apply to the board’s decision. M&A transactions that offer a mix of cash and stock as consideration are evaluated case by case, but US courts tend to find that Revlon duties apply where 50 per cent or more of the consideration is in cash.

Does the standard vary if one or more directors or officers have potential conflicts of interest in connection with an M&A transaction?

Yes, in certain cases. If a majority of the directors on the board have a material conflict of interest with respect to the M&A transaction, the board’s decision is usually reviewed under the entire fairness standard. In some circumstances, if an interested director was able to control or dominate the board as a whole, the court may also apply entire fairness review to the board’s decision. Under entire fairness review, the board must show that the transaction was the product of both fair dealing and fair price.

Does the standard vary if a controlling shareholder is a party to the transaction or is receiving consideration in connection with the transaction that is not shared rateably with all shareholders?

Yes, in certain cases. Courts typically review M&A transactions that involve a controlling shareholder who ‘competes with other stockholders for consideration or otherwise receives a non-ratable benefit at the expense of minority shareholders’ under the entire fairness standard (In re Viacom Inc Stockholders Litig, 2020 WL 7711128, at *16 (Del Ch 2020)). But if the transaction replicates an arm’s-length transaction by, at the outset, conditioning the transaction upon the ‘approval of an independent, adequately-empowered Special Committee that fulfils its duty of care’ and the ‘uncoerced, informed vote of a majority of the minority stockholders’, then the business judgment rule applies and the court will not second-guess the transaction (Flood v Synutra Int’l, Inc, 195 A.3d 754, 755–56 (Del. 2018)). If only one of those two procedural safeguards exists, courts will review the transaction under the entire fairness standard but shift the burden of proving unfairness onto the plaintiff.