Director’s Undisclosed Conflict Prevents Application of Business Judgment Rule in Acquisition

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City of Fort Myers General § Employees’ Pension Fund v Haley, which was commenced in the Delaware Court of Chancery, grew out of the merger of equals between Towers Watson & Co. and Willis Group Holdings Public Limited Company.   Although Towers had stronger performance and greater market capitalization, under the agreement’s terms, Willis stockholders were to receive the majority (50.1 percent) of the post-merger company. Towers stockholders were to receive a $4.87 per-share special dividend and would own the remaining 49.9 percent of the combined company.

Upon the merger’s public announcement, several segments of the investment community criticized the transaction as a bad deal for Towers and a windfall for Willis.  Proxy advisory firms recommended that the Towers stockholders vote against the merger, and one activist stockholder began questioning whether Towers’ management’s incentives were aligned with stockholder interests. The parties questioned whether Towers would be able to obtain stockholder approval.

Also after announcing the merger, ValueAct Capital Management, L.P., an institutional stockholder of Willis, through its Chief Investment Officer, Jeffrey Ubben, presented to John J. Haley, the Chief Executive Officer and Chairman of Towers who was spearheading the merger negotiations, a compensation proposal with the post-merger company that would potentially provide Haley with a five-fold increase in compensation. Haley did not disclose this proposal to the Towers Board.

In light of the uncertainty of stockholder approval, Haley renegotiated the transaction terms to increase the special dividend to $10 per share. Towers eventually obtained stockholder approval of the renegotiated merger. The transaction closed in January 2016, and the companies merged to form Willis Towers Watson Public Limited Company, or Willis Towers. Haley became the CEO of Willis Towers and was granted an executive compensation package with a long-term equity opportunity similar to ValueAct’s proposal.

Plaintiffs alleged that Haley breached his duty of loyalty by negotiating the merger on behalf of Towers while failing to disclose to the Towers Board the ValueAct compensation proposal provided by Ubben.  Plaintiffs alleged that the proposal misaligned Haley’s incentives at a critical juncture in the negotiations, and incentivized him to seek no more of a dividend than he believed necessary to secure the Towers stockholders’ approval.

The Court of Chancery dismissed the claims, holding that the business judgment rule applied because “a reasonable board member would not have regarded the ValueAct proposal as significant when evaluating the proposed transaction,” and further holding that plaintiffs had failed to plead a non-exculpated bad faith claim against the Towers directors.  For the reasons noted below, the Delaware Supreme Court reversed the Court of Chancery’s decision.

The Delaware Supreme Court noted the claims asserted against Haley focused on the conduct of a single director, and that in order to rebut the presumption of the business judgment rule, Plaintiffs must adequately allege that:

  • the director was “materially self-interested” in the transaction,
  • the director failed to disclose his interest in the transaction to the board, and
  • a reasonable board member would have regarded the existence of the director’s material interest as a significant fact in the evaluation of the proposed transaction.

The Court noted that “Material,” in this context, means that the information is “relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in decision making.” The Court stated the other directors were aware of a potential conflict in that Haley would earn greater compensation after the merger.  However, the Court found the Plaintiffs adequately alleged that the undisclosed proposal altered the nature of the potential conflict that the Towers Board knew of in a material way. Specifically, the Plaintiffs alleged that the Board would have found it material that its lead negotiator had been presented with a compensation proposal having a potential upside of nearly five times his compensation at Towers, and that he was presented with this Proposal during an atmosphere of deal uncertainty and before they authorized him to renegotiate the merger consideration.

The Court rejected Defendants’ assertion that the alleged failure to disclose was not material because ValueAct’s presentation, even if deemed to have been a proposal, was not binding on anyone. The Court stated the fact that the proposal was a not concrete agreement and had milestones requiring “Herculean” efforts did not relieve Haley of his duty to disclose the proposal to the Towers Board, particularly in an atmosphere of considerable deal uncertainty.

The Court also concluded that Plaintiffs adequately alleged that Haley failed to inform the Towers Board of his deepened interest in the transaction. That Haley kept the Towers Board generally apprised of negotiations, as the Court of Chancery found, did not rebut Plaintiffs’ contention that Haley failed to adequately disclose his self-interest to the Board. While Haley may have discussed the compensation proposal with another officer, the officer was not a Board member.

Plaintiffs also adequately plead that a reasonable Board member would have regarded Haley’s material interest in the Proposal as a significant fact in evaluating the merger.  Plaintiffs alleged that a Board member who was also Compensation Committee Chair testified that “he would have wanted to know that Haley was discussing his compensation at the future company with Ubben and ValueAct, but did not receive such information, let alone information as to the magnitude of the raise that Haley stood to receive.”

Accordingly, the Delaware Supreme Court reversed the Court of Chancery’s opinion and remanded for further proceedings.

As this was before the Court on appeal of a motion to dismiss the Court did not make any finding that any Defendant breached a fiduciary duty.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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