New Risks For Special Board Committees
from
May/June 2006
by Julie Connelly
Say you’re a director of a company that is merging with a
very blue-chip outfit. Most of your shareholders have A shares,
entitled to one vote per share, but five board members—including your
chairman and CEO—have B shares as well, entitled to 10 votes per share.
The CEO controls 47% of the votes, consisting of 52 million B shares
and 1.3 million A, and he and the president are negotiating this
transaction. Your leader has made it clear that unless the B holders
receive a 10% premium over whatever is paid to the A’s, there will be
no deal. What do you do to see that the transaction price is fair to
the A holders?
You probably form a special committee right quick, which is exactly what the directors of Tele-Communications Inc. did in June 1998 after the board was informed that merger negotiations were under way with AT&T. The special committee held four meetings in a week to deliberate, ultimately recommending the merger with the premium to the B holders that chairman and CEO John Malone had demanded. “I didn’t care if the special committee came back and said, ‘It’s grossly unfair,’” Malone said in a deposition. “I would have just said, ‘That’s how life is. You want the deal, you pay the 10%.’”
As surely as night follows day, a shareholder suit alleging breaches of fiduciary duty by TCI’s directors followed a shareholder vote in favor of the merger. This January, Chancellor William B. Chandler of the Delaware Court of Chancery denied the TCI directors’ motion for summary judgment of the suit, noting in his opinion that “at this stage, certain factors appear in the record suggesting that the special-committee process was flawed, providing an inhospitable clime for arm’s-length bargaining to blossom.”
If you have just been asked to join a special committee, how much are you going to be affected by this case? David Bernstein, a partner at the Clifford Chance law firm in New York City who is a specialist in mergers and acquisitions and has advised special committees, says that Chandler’s opinion raises a number of issues for those committees. The first, he says, is “the role the special committee has to play in the negotiation of a transaction. The other issue is the ability of a special committee to rely on the financial adviser to the company,” particularly when that adviser’s pay is contingent on there being a deal.
Even though TCI’s financial adviser, the investment bank Donaldson Lufkin & Jenrette, had been hired by Malone, the special committee decided to use the same firm. DLJ gave the committee a fairness opinion, though Chandler noted that the firm did not appear to consider whether the premium paid to the B holders, which was going to mean less money on the table for the A’s, was fair to the A’s. Says Bernstein: “Where the investment banker is told the issue is deal or no deal, the contingent nature of the fee begins to rise and become more important, because it is critical to the investment banker that there be a deal. So Malone’s throwing down the gauntlet and saying ‘If I don’t get my 10%, I vote against’ actually does taint the contingent-fee issue.”
What should special committees do in such circumstances? Historically, says Bernstein, these committees have relied on the company’s financial adviser, and there is no requirement that they get separate advice. But in cases where there is a conflict, such as TCI’s, Bernstein has a suggestion. A committee that he was advising about a transaction it was contemplating decided to go with the opinion of the company’s adviser, which had just done an exhaustive analysis for the company. But the committee then hired another financial advisory firm—and paid it a flat fee—to help the committee analyze the opinion the company’s adviser had rendered. That way, Bernstein says, “the committee would have a sanity check, if you like, on what was received.”
Should the special committee have negotiated the deal on behalf of the A shareholders? Not necessarily, says Bernstein. The transaction had two components: how high a price TCI could extract from AT&T, and subsequently, how that price was to be allocated among the A and B shareholders. Where getting the best price was concerned, he says, there was no conflict between the A’s and the B’s—everyone wanted the highest price possible. “There is every reason why Malone should have conducted these negotiations,” says Bernstein. “He is a skilled negotiator. He knows the company, and he has more personally at stake than anybody else.” But later, if the committee didn’t think the premium was fair to the shareholders it was supposed to be protecting, it should have been able to say no. “The Delaware Supreme Court has said that it’s essential that the special committee have the power to say no,” Bernstein notes. “The special committee doesn’t have to negotiate the deal, but they do have to be able to turn it down if they don’t like it.”
TCI’s committee may have been constrained by two developments: the influence of the controlling shareholder—Malone—and the way in which the two directors on the special committee, John W. Gallivan and Paul A. Gould, were compensated. When the committee was formed, “Malone recommended that Gould and Gallivan be reasonably compensated for their efforts in connection with the transaction, though no action was taken with respect to their compensation at this time,” Chandler wrote in his opinion. The day the shareholders voted to approve the merger, the board voted to pay Gallivan and Gould $1 million each for their services on the special committee. Chandler’s opinion noted tartly, “I pass over, for the moment, how one might rationally consider a $1 million payment for four meetings over a one-week period to be ‘reasonable’ compensation.” Then he wondered how special-committee members might act if they suspected that their potential compensation could hinge on the decision they reached. Says Bernstein: “Special-committee fees that I see usually run in the $50,000 range. That’s why the million-dollar fee was so extraordinary.”
So the case appears headed for trial, and Bernstein has some tips for special committees: Fix your fees in advance, identify the constituency you are there to protect, consider the questions you ought to be asking about your ultimate decision—and get answers to them.
