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Sunday, May, 2, 2010

Nancy H. Wojtas (Cooley Godward Kronish LLP) lists the top ten things companies considering a going private transaction should do when forming a Special Committee

PLI: When considering a going private transaction, what should a company do in forming the Special Committee of the Board?

NANCY H. WOJTAS: When a target company's board of directors has determined to form a special committee to negotiate and approve or disapprove a transaction between the target company and the majority or controlling stockholder in a going private transaction, there are a number of factors that must be considered by the board of directors. Since special committees serve an important function — determining that a negotiated conflict transaction is fair — it is extremely important that a properly formed and appropriately authorized special committee has been established.

Grant Adequate Authority to the Special Committee: A special committee formed to consider a conflict transaction must be granted adequate procedural and substantive authority. Each member of the committee also must understand the extent of that authority. Special attention should be paid to the enabling resolutions forming the special committee.
Size Matters: Ideally, a special committee should consist of at least three and not more than five directors. While a special committee of one independent director is permissible under Delaware law (but not under California law which requires two members), a committee of one will be subject to special scrutiny and should be avoided unless there is no alternative. Delaware law has long espoused the principle that "[I]f a single member committee is to be used, the member should, like Caesar's wife, be above reproach." Lewis v. Fuqua, 502 A. 2d 962, 967 (Del. Ch. 1985). Similarly, a special committee composed of two directors is not ideal because both directors will have to approve any action and if a court finds one director not independent, the remaining director will be subject to the special scrutiny reserved for the single-member committee. Special committees comprised of more than five members are more cumbersome to manage and create administrative issues such as difficulties in scheduling meetings.
Disinterested Directors Should Do the Selecting: The disinterested directors of the Board of Directors of the target company should select the directors to serve on the special committee, not members who are management or members with an interest in the transaction. At least one Delaware court has cited the involvement of interested directors in selecting the members of the special committee as a negative factor in evaluating the process followed by the special committee. See Fort Howard Corp., 1988 Del. Ch. LEXIS 110. A thorough interviewing process should be conducted to ensure that all disqualifying aspects of a director are discovered before any decisions regarding membership on the special committee are taken. It is far less embarrassing for a board member not to serve on the special committee than to have the disqualifying events discovered in the course of the litigation which will ensue after the conflict transaction is announced.
Members of the Special Committee Must Be Independent as Well as Disinterested: The directors selected to serve on the special committee must be "independent" under Delaware law — that is, his or her action is based "entirely on the corporate merits of the transaction and is not influenced by personal or extraneous considerations." Directors who have received significant payments for consulting or other services, including employment, from the company or other interested party, would not be considered independent. Unvested stock options in the target company should also be evaluated because they may create a financial incentive for directors to retain their positions as directors thereby making them "beholden" to the interested directors and therefore may not be independent. Social and personal relationships should be examined to determine whether a social or personal relationship is of a "bias-producing nature."

The directors selected to serve on the special committee also must be "disinterested" from the conflict transaction. A director is generally considered disinterested if he or she does not have a financial or other interest in the conflict transaction.
Consider the Intangibles: Since membership on a special committee requires a significant expenditure of time, a director, irrespective of how capable and competent he or she is, who cannot commit to spending the required time to committee business should not be chosen for membership on the committee. Members of the special committee will be required to attend frequent meetings, preferably face-to-face, with advisors and others, will spend significant amounts of time in preparation for meetings generally by reviewing extensive written materials, and will participate in potentially highly-charged negotiations of the conflict transaction. After the conflict transaction is announced, members of the special committee will spend significant amounts of time dealing with the litigation which will ensue. A potential member's schedule, personality, communication skills, intelligence, ability to make a decision, ability to work in a stressful situation and other strengths and weaknesses must be evaluated to ensure that each member of the special committee will assist in making the process a successful and defensible one.
Permit the Special Committee the Authority to Walk Away: In any litigation involving the conflict transaction, the courts will scrutinize the substantive authority of the special committee. In particular, it is essential that the special committee has the authority to "just say no." The enabling resolutions should address this issue and each committee member must understand the parameters of the authority granted to the special committee and be prepared to use the authority or the process will not be respected by the courts.
Retain Competent and Independent Advisors: The special committee must select its own advisors. Although it is permissible, and possibly helpful, for management, the general counsel or the outside corporate counsel of the target company to provide contact information for experienced and well-known counsel and other advisory firms to the special committee, there is a fine line between providing the information and making an affirmative recommendation. When interviewing potential advisors, the special committee must inquire as to the independence (and competence) of the advisors — whether the advisors previously worked for the company, management or the controlling stockholder involved in the conflict transaction. Interviewing more than one candidate should be done because it permits the special committee an opportunity to compare the credentials of the various advisors and it demonstrates the seriousness with which the special committee is viewing the engagement.
Optics Matter — Set Reasonable Compensation for Members of the Special Committee: While the members of the special committee should be compensated for the time spent serving on the committee, the board of directors must ensure that the fees paid to the members of the special committee are not excessive. Excessive compensation arrangements may result in questions about the independence of the members of the special committee. Although there is no general obligation to disclose the formation of a special committee or that the committee is evaluating a conflict transaction, events may occur (e.g., filing of a registration statement or periodic report) which may trigger disclosure under the federal securities laws and applicable stock exchange rules.

If new indemnification agreements are entered into with the members of the special committee, and such agreements do not fall within the exception contained in Instruction 1 of Item 1.01 of Form 8-K, the target company must determine whether such indemnification agreements are material and whether it is obligated to file a current report on Form 8-K with the SEC to report entering into such agreements. While the filing of the actual agreements may be deferred until the target company's next periodic report for the quarter in which the agreements were entered into by the parties, the disclosure that the target company entered into new indemnification agreements may tip the market that a transaction is being contemplated. The compensation arrangements for the members of the special committee do not trigger a mandatory filing of a current report on Form 8-K with the SEC. Counsel, however, must consider in connection with the target company's next periodic report whether the compensation arrangements, whether in the form of a written agreement or memorialized in the board minutes, must be attached as an exhibit to the periodic report. Item 601(b)(10)(ii)(A) of Regulation S-K under the Exchange Act provides that, except for contracts that are immaterial in amount or significance, any "contract to which directors, officers, promoters, voting trustees, security holders named in the registration statement or report, or underwriters are parties other than contracts involving only the purchase or sale of current assets having a determinable market price, at such market price."
Ensure that the Special Committee Receives the Most Recent and Best Information: All parties involved in the conflict transaction (i.e., the company, management and controlling stockholder and their advisors) must ensure that the special committee is provided all available and up-to-date financial information generated by the company so that the special committee can effectively perform its job. Failure to provide that information may undermine the entire committee process.
Respect the Special Committee's Process: The special committee must set its own agenda, including timing, scheduling of meetings and methods of communication with the interested party to the conflict transaction. While an interested party will be tempted to impose unreasonable time deadlines, such temptation should be ignored by the special committee. The courts may find that unreasonable time deadlines undermine the process since such deadlines do not provide the special committee an opportunity to consider the conflict transaction in a deliberate and thoughtful manner.

The Board of Directors: Although the special committee has a very important role in a conflict transaction, there are situations under Delaware law which require that the board of directors approve a transaction. In those situations, the special committee will make a recommendation to the board of directors and the board of directors will be required to act separately to approve (or disapprove) the transaction and satisfy its duty of care.

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