One of the more delicate challenges that can arise for a target board in the context of a potential control transaction is how to manage the issues that can arise as a result of a substantial shareholder having a nominee on the board. Usually nominees are also directors, officers or employees of their appointer and as such, owe duties of loyalty and confidentiality both to the target company and to their appointer in their respective capacities.
The participation of the nominee in the preparation of a defence against a potential proposal or in responding to any approach that is actually received can become fraught with issues. These issues stem from theoften pivotal role that a substantial holder will have in any control proposal: for even if the shareholder doesn’t themselves become a bidder, they may become involved with actual or potential bidders who may, depending on the size of the holder’s stake, want to obtain their support for a proposal for greater deal certainty (such as by entering into a pre-bid agreement with the holder).
If a nominee director remains involved in a defence they will invariably obtain access to highly sensitive information, such as the board’s deliberations about the company’s value (including the value at which it might be prepared to recommend a proposal) as well as general information about any proposals that are received by the target (or about the bidders who provided them). Were such information to be passed on to the appointer by the nominee this may be detrimental for the target (and even a bidder), depending on how it is used by the appointer.
The involvement by a substantial shareholder’s nominee in board decisions concerning an offer may also be inappropriate (or appear to be so) depending on the circumstances including, most importantly, the level of participation by the appointer shareholder in any proposal under consideration (or which is in competition with that proposal). In many instances, it is actually the appearance of propriety that is most critical to a target, particularly given that the market understands that an appointing shareholder’s position may change throughout the course of a transaction.
So there are both strategic and reputational reasons why a target may want to exclude a nominee director from participation in the planning or implementation of any takeover defence. The most convenient (and the most common) means to restrict a nominee’s access to information about a takeover defence is for the target board to establish a sub-committee to whom the board delegates broad powers to make decisions in relation to the conduct of a defence.
Can a target exclude a nominee director from being involved in a takeover defence?
Unfortunately for target boards there is no hard or fast rule as to whether and when a target can exclude a nominee director from the preparations for, or conduct of, a takeover defence.
The Corporations Act doesn’t contain any provisions which deal specifically with the position of a nominee director in a takeover context. The provisions which require directors of public companies to declare personal interests and to be excluded from deliberations of the board on those matters are not generally triggered just because the director’s appointer has an interest in a matter the subject of a board discussion. In many cases this gap in the law is made up by the target and the appointing shareholder having put in place appropriate protocols to manage potential conflicts that may arise from time to time.
What is clear is that each director of a target has an obligation to exercise care and diligence in discharging their role, which includes participating in board meetings and deliberations on matters material to the operation of the company. It is an incident of this that a director is entitled to all corporate information as is necessary to discharge their statutory and fiduciary duties (unless it is clear that they will misuse such information to gain an advantage for themselves or someone else, or otherwise cause detriment to the target). If the appointing shareholder is or is likely to become a bidder, we consider that a target company could assume that any information provided to them by the nominee would give them an advantage for these purposes. Nominee directors are personally liable for any misuse of information that they are provided in carrying out their role.
From the nominee’s perspective there is also the potential for he or she to have liability for decisions that are either made without their participation and input or which they participate in making but without the benefit of the same level of information as other board members. The law in this area is not straightforward and there isn’t any judicial authority to point to which provides that a nominee who is excluded from participation or from some information has their statutory and fiduciary duties of care reduced commensurately.
The right of a nominee director to participation and information may only be lost if it can be proved by the target that the director is, or is about to, act in breach of his or her fiduciary duties to the company and intends to aid that process through their use of that information. Obtaining evidence of an improper purpose in seeking access to information is typically very difficult in most situations.
A nominee director is obliged to exercise his or her powers and discharge his or her duties in good faith in the best interests of the target and for a proper purpose. The nominee will have exactly the same duties to the appointer if he or she is also a director or officer of the appointer. So, the primary issue for a nominee is whether he or she can serve the target’s interests and the appointer’s interests at the same time.
There are situations where the conflict may become impossible to resolve. Given the potential for irreconcilable conflicts of duty and duty to arise where an appointer is bidding for the target and a nominee is also an officer of the appointer, it is customary in that situation to rely on the formation of a sub-committee which excludes the nominee.
Ultimately, however, if a nominee director is prepared to take a bullish view of what he or she is entitled to do consistently with his or her duties and refuses to step aside, it is incumbent on the target board to take the step of refusing access to the nominee, accepting the risk that the director may decide to try enforce their rights in court (or, alternatively, to resign as a director). In situations where the appointer has not approached the target to make a proposal, or announced a bid, it may be challenging for a target to establish the grounds necessary for a court to support the director’s exclusion.
Where the nominee director has been appointed subject to the terms of an agreed protocol which provides for access to be restricted in the event of a conflict, the target board’s position is better since it typically can exclude a nominee in the event of a conflict existing or being likely (without also needing to be able to prove that the nominee will breach his or her duties).
In practice, how these sensitivities are dealt with will depend on a number of factors, most of which are not necessarily legal, such as the dynamics of the board; the personalities and views of the chair and other directors will also be important, as will the target’s assessment of the appointer shareholder’s commercial intentions (ie is it possible they may become a bidder or become involved in supporting a bid?).
Is a nominee director entitled to pass on sensitive information to his or her appointer?
As with the question of excluding a nominee director, there is no straightforward rule about when a nominee director may pass on to an appointer the information he or she obtains in their capacity as a director of the target company.
A nominee director is obliged not to improperly use information they obtain because they are a director to gain an advantage for themselves or another person or to cause detriment to the target. A nominee is also obliged generally to maintain the confidentiality of target information that is confidential in nature. If the nominee is also an officer of the appointer, he or she will owe the same duties to that entity. These duties continue even after ceasing to act as a director.
Essentially, a nominee cannot, consistently with his or her duties, disclose sensitive information back to the appointer if this would harm the target or benefit the bidder (or someone else). A nominee may on the face of it be permitted to do so under the terms of a protocol but given that a company cannot exempt a person from liability to the company incurred by that person as an officer of the company, there must be significant doubt whether the existence of a protocol can prevent a breach of duty. In addition, most board papers will be confidential and it is not uncommon for protocols not to extend to board papers (at the appointing shareholder’s request) to minimise the risk that the appointing shareholder may be saddled with inside information.
There are a number of complex issues that may arise in a takeover context which, taken together, tend to support the segregation of the nominee, so far as possible, from participation in the preparation and execution of any takeover defence:
- If the nominee learns of the board’s views about valuation or about potential interest in the company from bidders, then if the nominee learned that the appointer was also contemplating making a bid, the nominee would be placed in an untenable position (to disclose or not to disclose that information which would clearly be of assistance to the appointer). In any case, whether or not a nominee who continues to participate actually receives such information, there will be a perception that they have, which is negative for the target (and potentially also for the appointing shareholder).
- If the appointer does make a bid, to what extent is the appointer deemed to have the knowledge of the nominee director? Generally a body corporate will be deemed to have the knowledge that its officers hold. Where the nominee is also a director of the appointer, this problem is particularly acute. However, provided that the nominee is excluded from participation on the takeover defence by the target, then the appointer can take a fair degree of comfort from the fact that the continuous disclosure provisions would require the target to have disclosed any other materially price sensitive information the nominee may have been privy.
- If the appointer does actually receive information from the nominee because the nominee decides to pass that information on, the appointer may become an insider (for example, because it learns about an undisclosed proposal from another bidder). This would restrict its ability to dispose of or acquire securities in the target unless that information became generally available.
Every situation where a target or potential target has on its board nominee directors requires careful consideration of the actual and potential conflicts that may arise for those directors in discharging their responsibilities to the company.
Typically, issues will only arise where the nominee’s appointer is likely to bid or become associated with another bidder, for the target.
In those cases, there are strong reasons for the benefit of not just the target, but the nominee and the appointer as well, for the nominee to be excluded from ongoing involvement in a takeover defence.
A board protocol which permits the target to exclude the nominee from participation in the event of a potential, perceived or actual conflict of interest will assist a target when a nominee proves obstinate (even in the face of an oncoming conflict). However, a nominee director should not assume that merely because they have not been prohibited by the target under the protocol from passing confidential and sensitive information back to their appointer that their compliance with the protocol will absolve them from breaching their statutory and fiduciary duties.