Defending board members against M&A lawsuits by investors

Fairness and solvency opinions provided by independent experts are the more effective and preferred tool in defending boards of directors from growing transaction-related litigation, according to survey results released last week by FTI Consulting. Since the financial crisis in 2008, the number of transaction-related lawsuits has increased annually, making boards of directors who approve M&A deals and other financial moves subject to higher levels of regulatory scrutiny and shareholder backlash.

In March, Cornerstone Research reported that 94 percent of the 612 mergers and acquisitions valued at more than $100 million in 2013 were met with shareholder lawsuits. By contrast, lawsuits were filed in only 44 percent of deals valued over $100 million in 2007. This was the fourth consecutive year in which shareholders filed lawsuits in at least 90 percent of M&A deals valued over $100 million.

Cornerstone also reported that last year an average of five lawsuits were filed for each deal valued at more than $100 million and an average of 6.2 for each transaction valued at $1 billion or more. These lawsuits typically questioned whether the deals represented fair valued for investors and often targeted individual board members for not protecting shareholder interests.

While not required by law, fairness and solvency opinions are part of the due diligence process in complex mergers, acquisitions and other financial transactions and provide directors, trustees and managers with a legally defensible basis for setting the price of a deal. Investment banks involved in the deals and other outside consulting firms provide these opinion reports to help boards decide whether they are making the best possible deal for all parties involved.

FTI surveyed more than 150 lawyers, senior corporate executives and private equity and hedge fund practitioners and found:

• The majority of respondents say fairness and solvency opinions were frequently or occasionally used to defend boards of directors in a wide variety of transactions.

• More than seven times as many respondents believe that independent fairness opinions are more effective in defending board decisions in subsequent litigation than fairness opinions provided by investment banks involved in the underlying transaction.

• More than 60 percent of respondents say there has been an increased preference for independent fairness opinions since 2008. However, a previous FTI study of 50 large mergers and acquisitions between 2009 and 2012 showed that independent fairness opinions were provided in just 9 percent of those cases while 91 percent were provided by investment banks involved in the deals.

• More than 85 percent of respondents believe that fairness and solvency opinions are more defensible when opinions are rendered by providers possessing strong industry experience.

• The majority of respondents believe that fairness opinions (73 percent) and solvency opinions (90 percent) are more effective in defending boards when opinion providers are hired before forecasts and deal terms are finalized.

Perhaps one of the biggest issues the report reveals is the conflict between accepting fairness opinions from investment banks that also have a stake in the deals being negotiated. The reality is that although board members may want to have an independent opinion in these matters, sometimes they cannot afford to pay the fees to bring in an outside firm. Roy Salter, senior managing director in FTI Consulting’s corporate finance/restructuring segment, says having independent opinions can add value by proving that the company did its best to make sure the deal was the best possible solution, and it demonstrates that unbiased expertise was sought in making the decision in cases where a lawsuit is filed.

In many cases, ‘The problem is that a less than optimal deal may have been negotiated,’ Salter explains. ‘For example, instead of it being an outright sale for cash, might an alternative have been considered?

‘The deal makers might consider asking What are the other choices available to the minority shareholder? Or might there be an opportunity for the minority owners to be given the opportunity to join forces with the new buying group so that they can continue to enjoy the same benefits that they’ve enjoyed up to now?’

The survey findings should also help companies realize that the current regulatory environment allows the entire board to be sued for doing nothing wrong except making a business decision, so the process that went into making that decision must be defensible in court. Paying for an independent fairness opinion may save the company and individual board members from costly lawsuits after the deal’s completion. Salter estimates that independent opinions can cost $750,000 or more but says much more than money is at stake.

The cost is not so prohibitive as to make an independent opinion not worth using for the sake of the board’s defense, he says. ‘And remember, the board are the caretakers as fiduciary of the shareholders; they are meant to be the voice of the people who have no voice – the minority shareholders and creditors.’

With the study showing that 90 percent of the fairness opinions of deals are rendered by conflicted parties and 90 percent of those surveyed believe an independent opinion is a better way of defending the board, perhaps there will be an increase in the number of independent fairness opinions used in financial transactions going forward. And once that occurs, perhaps the litigation tied to financial transactions will begin to decline.