Gaining Perspective: Directors’ Duties in the Context of “No-Shop” and “No-Talk” Provisions in Merger Agreements

Monday, January 1st, 2001 at 12:00 am by Kimberly J. Burgess
Kimberly J. Burgess, Gaining Perspective: Directors’ Duties in the Context of “No-Shop” and “No-Talk” Provisions in Merger Agreements, 2001 Colum. Bus. L. Rev. 431

When two corporations enter into a merger agreement, even the friendliest of transactions is subject to the risk of non-consummation because the stockholders of the target company are required to approve the merger. Although uncommon, the stockholders may vote to reject the transaction as proposed. More frequently, as a result of the proxy system’s public notice to stockholders, a second or “bust-up” bidder might use information of the pending transaction to formulate a proposal superior to the one already offered to the stockholders. In anticipation of these risks, acquirors and target corporations frequently embed protective measures into merger agreements to increase the probability of a successful merger. For example, merger agreements commonly grant the aquiror a stock lockup for up to twenty percent of the target’s stock or provide for the payment of a termination fee by the target of up to three or even five percent of the target’s market value. These measures are usually defended as compensation to the first bidder for costs (including opportunity costs) of its fruitless pursuit; however, they may also deter a potential second bidder and possibly coerce shareholder approval of the proposed transaction. Merger agreements also contain provisions that limit the ability of the target to pursue or consider alternative bids, so-called “no-shop” or “no-talk” provisions. These provisions are designed to restrict the flow of information to alternative bidders about the target’s potential availability for an alternative transaction and limit or prevent the disclosure of business and financial information that could facilitate a second bidder’s bid formulation.

The Delaware Court of Chancery recently questioned the use of no-shop and no-talk provisions in three cases, which I will illustrate in Part II. These cases sparked a heated debate within the legal community regarding both the rationale of these decisions and their practical relevance to corporate practice. Part III explicates the recent literature and I will attempt to point out where its explanations are incomplete. After providing a foundation for understanding Delaware fiduciary duty of care jurisprudence in Part IV, I will develop my argument in Part V that the best interpretation of the Chancery Court’s jurisprudence in this area is that the board of directors has a continuing, non-derogable duty that does not end until the merger is actually closed, a duty that requires directors to remain appropriately informed about matters that could materially affect stockholder interests and to take appropriate action to avail themselves of such information.

The sources of this duty lie within both statutory and doctrinal grounds. First, the nondelegable statutory duty of directors to manage the business and affairs of the corporation includes the duty to do so with all material information. Second, the doctrine of the fiduciary duty of care requires that the board of directors act on an informed basis. Any contract provision abrogating the board’s ability to do so is contrary to these duties. These two bases are not the same. A board might fulfill the requirements of one but not the other and each provides a sufficient basis to invalidate director action that does not meet the obligations of the duty.

In practical terms, this means, first, that a board of directors may properly commit to a no-shop provision (assuming that entering into the initial merger agreement satisfies the conditions of the business judgment rule and further assuming the agreement does not invoke Revlon-type duties),*434 but second, the board may not agree to a no-talk clause because it is effectively a “willful blindness” that is inconsistent with its continuing fiduciary obligations and statutory responsibility for the management of the business and affairs of the corporation.

This position is consistent with rational stockholder expectations, since shareholders faced with a merger vote will want an information agent to collect and evaluate the relevant material information, especially events subsequent to the signing of the merger agreement. The board of directors, which has general duties to act as an information and bargaining agent on behalf of the corporation and its stockholders, is best situated to fulfill that role. Indeed, the board’s role as stockholder bargaining agent is the ultimate justification for measures such as poison pills, which block a hostile bidder’s direct access to stockholders. A no-talk provision that interferes with the board’s capacity at this critical period is not part of a rational stockholder bargain. Admittedly, denying the board of directors the ability to contract into a no-talk agreement may adversely affect the ultimate completion of the merger and, therefore, the initial bidder’s incentives to participate. These impairments, however, can be compensated through alternative solutions, such as termination fees and stock lockup provisions. By contrast, the damage realized by the stockholder for the loss of an effective information agent during this crucial period is not easily remediable by ex post compensation. It follows that the continuing information obligation is rightly seen as part of the board’s statutory and fiduciary obligations and directors should not be able to contract otherwise.

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