Delaware Recognizes Reality of Merger Negotiations in Upholding Application of Business ‎Judgment Rule

In In re Towers Watson & Co. Stockholders Litigation, 2019 WL 3334521 (Del. Ch. July 25, 2019), the Delaware Court of Chancery applied the business judgment rule to dismiss a stockholder suit challenging the $18 billion merger of equals between Towers Watson & Co. and Willis Group despite allegations of imperfections in the merger negotiations.[1]  The Delaware courts, in examining particular merger transactions, have frequently found that aspects of the negotiation process resulted in negating use of the business judgment rule.  In the Towers case, the Court upheld use of the business judgment rule and, in doing so, recognized the realities of the merger negotiation process and looked at the totality of that process to determine if the alleged imperfections were material to the ability of the board to exercise their judgment in evaluating the proposed transaction consistent with their fiduciary duties.

As is often the case, the board allowed management, in this case the Towers CEO (who also was a director), to take the lead in negotiating the merger.  It was clear he was to be the CEO of the combined company.  The merger  involved a cash dividend to Towers stockholders to equalize value, originally in the amount of $5.00 per share, which was not well received by the market.  The dividend amount was renegotiated, with the CEO indicating in the negotiation that $10.00 was the “minimum increase necessary,” which is the dividend amount that was agreed upon.  At the same time, the CEO discussed potential compensation arrangements, which discussions allegedly were not disclosed to the Towers board.  The plaintiffs claimed that the undisclosed conflict of interest negated application of the business judgment rule and that the board acted in bad faith allowing the conflicted CEO to lead the negotiations.

The Court disagreed.  First, it found that management is often involved in the negotiation of a merger and that in this case other directors were involved and the board met before approving the initial transaction and the renegotiated terms.  Next, the Court found that the compensation proposal here was not material to the board’s consideration of the transaction.  The Court noted that the board knew the CEO favored the transaction because he expected to be CEO of the larger combined entity at a likely higher salary, the board was kept generally appraised of the merger negotiations, and the compensation discussions only involved proposed compensation, with actual compensation negotiations occurring after the merger closed.

Although the defendants prevailed in this case, the Towers decision is a reminder of the importance of structuring merger negotiations to avoid or minimize conflicts.  As a starting point, the board should be aware of and consider ways to mitigate potential conflicts.  For example, when management is likely to have a role in the combined entity, while it is normal for management to be involved in the negotiations, independent directors also should be involved and the board should be regularly kept informed.  Each situation will be different and will require different approaches, but transparency is a key factor.  In addition, it has become common practice to defer compensation discussion to late in the process, ideally after the deal terms have been agreed upon so that there is little issue about value being shifted from stockholders.  That is not always possible and, as this case illustrates, there may be need to renegotiate deal terms.  At a minimum, it is helpful if the board is kept fully informed of those compensation discussions.

[1] This case is an example of when the presumption of the business judgment rule applies without need to resort to the Corwin doctrine (see Corwin v. KKR Fin. Hldgs. LLC, 125 A. 3d 304 (Del. 2015) (fully informed, uncoerced stockholder approval in unconflicted transaction results in business judgment review)).  The business judgment rule presumptively applied because the transaction involved a mostly stock-for-stock merger of two widely held, publicly traded companies without preclusive deal protection devices and thus did not trigger enhanced scrutiny under Revlon (see Revlon, Inc. v. MacAndrews & Forbes Hldgs, Inc., 506 A. 2d 173 (Del. 1986)) or Unocal (see Unocal Corp. v. Mesa Petroleum Co., 495 A. 2d 946 (Del. 1985)).

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