A recent Delaware Chancery Court decision raises questions about several well-established merger transaction procedures that prior court rulings had viewed favorably.
In the case, In re TeleCommunications Inc. Shareholders Litigation, the court allowed a challenge to a 1998 merger between TCI and an AT&T subsidiary to go to trial, citing “genuine issues” about whether the transaction process and price were fair. Two bones of contention cited by the court:
That the investment bank that issued the fairness opinion to the special committee had a contingent fee agreement; the court said that fee created a “serious issue … as to whether [that adviser] could provide independent advice to the special committee”; and
The special committee’s use of bankers and legal counsel who had also worked for the corporation, a situation the court said “raises questions regarding the quality and independence of the counsel and advice received.”
Bernstein
Both points contradict some tried-and-true practices of merger planning, legal experts say. David Bernstein, a partner with Clifford Chance in New York, says the notion that an investment banker is tainted by a contingent fee “is a little surprising, or even disturbing.” According to Bernstein, several Delaware cases have said that an investment banker is not tainted by a contingency fee.
What’s more, he says, “it [wouldn’t] be smart to require that investment bankers who give fairness opinions get fixed fees… In the typical situation, you pay a small sum up front to the investment bank and the real money is paid when you do the deal. If you never do the deal, you don’t have to pay that big sum.”
Bernstein also says the special committee’s use of advisers who had worked for TCI was not an uncommon practice, and shouldn’t necessarily be seen as tainting the fairness opinion. “The company’s investment banker does a great deal of work and knows the company very well,” he notes.
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The plaintiffs in the Delaware case are shareholders of Series A common stock in TCI. They allege breaches of fiduciary duties by the directors of TCI in relation to its acquisition by a subsidiary of AT&T. According to the court, the persons most involved in the merger talks on TCI’s behalf were chief executive John Malone and chief operating officer Leo Hindery. Malone, they say, had insisted from the outset that Series B shareholders receive a 10 percent premium over the Series A holders.
TCI and AT&T announced the merger on June 24, 1998. If the transaction had been consummated on that day, the series A shareholders would have received a premium of 37 percent above the market price and the series B shareholders would have received a premium of 52 percent above its market price.
Had the Series A and Series B stock had been treated equally, the court noted, the special committee and board members would have received $220 million less in proceeds from the transaction; Malone alone stood to receive $130 million more because of the premium for Series B stock, and a majority of TCI’s board held Series B shares. The holders of Series A shares filed suit.
In a decision dated Dec. 21, 2005, Chancellor William Chandler refused to throw out the suit. In finding that questions existed about the fairness of the transactions, Chandler address numerous issues, including the contingent nature of the fee arrangement with the investment bankers who rendered an opinion to TCI’s special committee.
“A special committee does have an interest in bearing the upfront cost of an independent and objective financial adviser,” Chandler wrote. “A contingently paid and possibly interested financial adviser might be more convenient and cheaper absent a deal, but its potentially misguided recommendations could result in even higher costs to the special committee’s shareholder constituency in the event a deal was consummated.”
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Lipman
Frederick Lipman, a partner with Blank Rome in Philadelphia, says TCI appears to have made “a number of different mistakes” that caused the judge to let the case go to trial.
Although contingent agreements with investment bankers are “typical” in merger transactions, “courts are sensitive to the motivation that the investment banker might have to find a favorable opinion on fairness,” Lipman says. “A lot of us always thought that [this contingent arrangement] was material. The result of using a financial adviser who has a contingent compensation arrangement will always be suspect… If you had a non-contingent arrangement, the court might give the [adviser’s] opinion more respect.”
Using advisers who had worked for the corporation may have been “one of the things that broke the camel’s back,” Lipman says. “When you do special committee work, you’ve got to be extremely careful. This committee [allegedly] did a number of things wrong; this [selection of advisers] was just one thing. If the special committee had done everything else correctly and still used the company’s investment bankers, I’m not sure the court would have come out the same way.”
Duncan Grant, a partner with Pepper Hamilton in Philadelphia, says the legal standard applied by the court in the TCI case was, for the most part, “pretty routine.”
Grant
“Clearly you have directors [in this case], including two members of the special committee, on both sides of the transaction,” Grant notes. “The facts here don’t smell very good.”
As Grant sees it, the contingent nature of the investment bankers’ fee “wasn’t really what drove this decision. … I thought [the judge] was more concerned with the fact that the special committee did not have its own banker than with the contingent nature of the compensation.”
The “prevailing practice,” Grant says, is to “have a separate banking firm, and have separate legal advisers as well.” That the plaintiffs survived summary judgment “creates considerable settlement pressure,” he adds. “The plaintiffs now have tremendous leverage to try to get a settlement.”
Chandler also targeted the special committee for its failure to use independent advisers. “Rather than retain separate legal and financial advisers, the special committee chose to use the legal and financial advisers already advising TCI,” the chancellor wrote.
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