New Trends In M&A Transactions: To Disclose or Not To Disclose?

Any corporate finance deal always carries a set of required disclosures. Target companies want to know as much as possible about the plans and financial capabilities of prospective acquirers and buyers want to make sure there are no undisclosed skeletons in the target company’s closet. This broad disclosure is also essential, in particular, for the protection of shareholders: on the one hand, if a transaction goes smoothly, the shareholders are the ultimate beneficiaries; on the other hand, if there are adverse consequences to the transaction, the shareholders are often the ultimate victims.

Nowadays, attention is also focused on financial advisors. Whether at banking institutions or private investment firms, the role of these advisors has evolved, as they may play a part in the financing of the deal, or provide services at each end of the transaction.

Recent decisions of the Delaware Chancery Court evidences a new trend towards greater disclosure as to financial advisors’ potential conflicts, with an emphasis on situations where an advisor receives a contingency fee for the successful closing of the transaction.

The best illustration of this trend is the case In re Del Monte Foods Company Shareholders Litigation. In November 2010, the directors of Del Monte agreed to a merger with a pool of three private equity firms led by KKR. Before completion of the deal, the shareholders sought injunctive relief to postpone their vote on the merger. The Delaware Chancery Court granted the shareholders’ injunction, on the grounds that Del Monte’s financial advisor, Barclays, failed to disclose that it was also providing deal financing to the buyers. The Court found that, on the one hand, Barclays had a strong interest in ensuring that a private equity firm acquired Del Monte. On the other hand, the Court noted that Barclays had a “keen desire” to see the deal close with the aforementioned buyer, as evidenced by the substantial success fee it had negotiated. The Court therefore came to the conclusion that Barclays had “secretly and selfishly manipulated the sale process.”

In light of this case, financial advisors are now incentivized to play the transparency card. Nevertheless, all information is not necessarily worth disclosing. The following outlines which particular conflicts mandate disclosure, and how to efficiently disclose them.

Which conflicts to disclose?

The first conflict category covers the relationships between an advisor and potential bidders and the target company. In practice, such conflicts are likely to crystallize when the advisor has already represented one of the counterparties in a previous deal.

A second type of conflict can arise when the advisor provides services to a company, whether on the buy or sell side, in which it has an equity stake. In such case, the advisor would have a direct interest in the transaction, and all parties involved need to be made aware.

A third type of conflict may occur when financial advisors offer financing to potential bidders while counselling the target company. This particular issue has been a major focus in recent Delaware caselaw, and financial advisors are more likely to be named as defendants rather than third party witnesses in subsequent litigations.

How and when to disclose potential conflicts?

In the first two instances, the earlier the disclosure, the better. A statement in the engagement letter is generally satisfactory disclosure. In addition, the financial advisor has an ongoing duty to disclose any new conflict which arise.

In the third instance, disclosure in the engagement letter is often not possible, as an offer of financing usually occur at a later stage of the transaction process. In this case, the financial advisor should raise the issue with the target board as soon as it arises, and be prepared to discuss the costs and benefits to the target of its financing role.

Communicating with shareholders

The bulk of financial advisors’ communications are directed at the board of directors. Nonetheless, advisors are sometimes required, or specifically instructed by the board, to communicate with the shareholders.

Before communicating any information to the target’s shareholders, financial advisors should conduct due diligence on certain areas of focus. These areas include historical financials, forecasts, business plans, budgets, risks and liability.

Although financial advisors are not required to conduct a full independent verification of these areas of focus, they are required to discuss them with auditors and management separately.

Once due diligence is complete, financial advisors may communicate with the shareholders, and must make clear that they were appointed by the board to represent the company, and not the shareholders. Financial advisors must also refrain from communicating any material information that is not public.