Last month, the Dow Chemical Company fired two senior executives accused of purportedly engaging in unauthorized discussions with third parties concerning a potential takeover bid for the company. In a sense, the timing of their alleged actions could not have been worse, as Delaware courts have recently released a number of (predominantly critical) decisions on the topic.
Delaware courts have expressed increasing skepticism as to management's intentions in negotiating buyouts due to inherent conflicts of interest. In some cases, such as In re Netsmart Techs., Inc. and Louisiana Mun. Police Employees’ Ret. Sys. v. Crawford (also known as the Caremark case), where they found that management?s interests have been materially unaligned with those of shareholders, the courts have required additional disclosure of all material information regarding the fairness of the offer and the preceding negotiations.
In contrast, in 2005, the Delaware Court of Chancery approved of the sale process implemented by the board of directors of Toys R Us, Inc. to sell the entire company to a private equity group. In this case, the court rejected the plaintiff?s argument that the CEO had an improper motivation to support the deal due to the more than $60 million he stood to gain as a result of the transaction. The court lauded the process adopted by Toys special committee whereby the CEO did not [tilt] the process towards any bidder and only negotiated his own compensation package after the board had settled on a strategic option.
Not all companies subject to Delaware judicial review have been so fortunate. In early 2007, the Delaware Court of Chancery expounded upon the role management should play in buyouts in two cases. In Netsmart Techs, Inc., the court found the special committee failed to explore transactions with strategic buyers and failed to adequately supervise management in the sale process.
The court considered the negotiation process defective because the board did not actively balance the conflicting incentives of shareholders and management. As a result, the court ordered disclosure of all material information related to the negotiations. In Caremark, the court also expressed concern over the personal incentives of the company's CEO in favoring the merger with CVS over competing offers. Because of the CEO's possible interest in promoting one transaction over another, the court ordered the directors to disclose all material information about the transaction.
In the current cases involving Dow Chemical and its two executives, the Delaware Chancery Court may have the opportunity to again address the relationship between management and the board in connection with a buyout. The court may also address the questions left unanswered in its 2006 decision involving SS&C Technologies (In re SS&C Techs., Inc., Shareholders Litigation). In that opinion, the court questioned whether it was prudent for the CEO to use information and resources of the corporation without board authorization to arrange a buyout. Because the issue was not raised by the plaintiffs, the court felt it was not appropriate to address the question at that time.
Whether the Dow Chemical cases will go to trial in Delaware remains to be seen. What is certain, however, is that management's use of proprietary company information to formulate a buyout without board approval is likely to be deemed a violation of management's duty of loyalty owing to Delaware corporations. Participation by management in negotiating buyouts should be carefully supervised by the board, even in the early stages of transaction negotiations.