I was recently asked by a reporter to discuss the lawyers role in advising an acquiring company's board of directors in acquisition transactions. The conversation induced me to add a section on the topic to the forthcoming fourth edition of my Mergers and Acquisitions treatise. Herewith some thoughts derived therefrom:
Many corporate acquisitions turn out badly for the acquirer and its shareholders. A 1989 study concluded that although target shareholders experienced positive returns from takeovers, “since 1975, takeover bidders have earned at best a zero, and perhaps a slightly negative, net-of-market return.”[1] More recent studies confirm that acquirer shareholders frequently experience significant losses.[2] Many acquirers either overpay or botch the post-acquisition process of integrating the two companies.
Despite the substantial risk that acquiring company management and directors will make poor acquisition decisions, there is a critical difference between the liability risk exposure of a target and an acquirer board in acquisitions. As Judge Henry Friendly observed, “a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death.”[3] Although the target board thus faces a classic final period problem, the acquirer’s board remains in a repeat relationship with its shareholders. As a result, any conflict of interest on the part of the acquiring company’s managers and boards is tempered by market forces. Not surprisingly, acquiring company directors are rarely sued and face a very low risk of liability.[4]
Acquiring company shareholders face two significant hurdles in challenging a board decision to approve an acquisition. First, cases brought against acquirer boards typically must be brought as derivative suits.[5] The procedural rules governing derivative litigation impose substantial obstacles for shareholder plaintiffs.[6] Second, assuming that the case reaches the merits, the shareholder plaintiff typically must overcome the business judgment rule.[7]
Ideally, despite their resulting low liability risk, the acquiring board should nevertheless be actively engaged in making important acquisition decisions and, perhaps even more importantly, supervising post-acquisition integration of the two firms. In particular, the acquirer’s board should seek advice from outside legal and financial advisors. Just as with a target board, the acquiring company’s best defense is evidence that they made an informed decision.
[1] Bernard S. Black, Bidder Overpayment in Takeovers, 41 Stan. L. Rev. 597, 601-04 (1989).
[2] See Afra Afsharipour, A Shareholders' Put Option: Counteracting the Acquirer Overpayment Problem, 96 Minn. L. Rev. 1018, 1032 (2012) (reviewing studies).
[3] SEC v. Geon Industries, Inc., 531 F.2d 39, 47–48 (1976).
[4] See Afra Afsharipour, A Shareholders' Put Option: Counteracting the Acquirer Overpayment Problem, 96 Minn. L. Rev. 1018, 1055 (2012) (“The few cases addressing acquirer boards' duties make clear that the risk of liability for violation of the board's duties is extremely limited.”).
[5] See id. at 1051-52 (stating that “given *1052 that in acquisition transactions the acquirer's shareholders are not losing their status as shareholders, they are generally limited to bringing derivative lawsuits on behalf of the corporation when alleging that directors have violated their fiduciary duties to the corporation”).
[6] See Stephen M. Bainbridge, Corporate Law 241-56 (4th ed. 2020) (discussing procedural aspects of derivative litigation).
[7] See Samuel C. Thompson, Jr., The Merger and Acquisition Provisions of the ALI Corporate Governance Project as Applied to the Three Steps in the Time-Warner Acquisition, 1996 Colum. Bus. L. Rev. 145, 166 (1996) (stating “that it will . . . be a rare situation in which the business judgment rule will not protect the directors of an acquiring corporation in deciding to make, or not to make, an acquisition of a target”).
