Shareholder Litigation Involving M&A is on the Rise
About 96 percent of all mergers and acquisitions over $500 million in value last year resulted in shareholder lawsuits, about five per deal, according to Cornerstone Research. As bank mergers and acquisitions increase, is it possible that deal-related litigation could also increase? Absolutely, writes John Freechack, a bank attorney and chairman of the Barack Ferrazzano Financial Institutions Group based in Chicago. He responds to questions from Bank Director.
Who is filing these lawsuits?
Nationally, there are law firms that make a business out of M&A-related litigation. They often look for quick settlements, with a significant portion going to legal fees. In any event, you should proceed assuming that a lawsuit will be filed. There are also a lot of angry shareholders out there. Much value has been lost by holders of bank stock, many of whom are longtime investors. But not that many shareholders are willing to actually file a lawsuit. Many understand that the dismal economy may have played a larger role in the losses than management decisions. Some shareholders can be reasoned with and this is one reason that a solid continuing shareholder relations program, including giving shareholders periodic information about performance, is important for all financial institutions.
What are plaintiffs alleging in their complaints?
There generally are two allegations: inadequate deal consideration and that the board’s process was unfair or inadequate. Boards can document their pricing decisions and support them with documentation and assistance from a financial advisor. And remember that your board can control the process, which is extremely important to show that the directors fulfilled their fiduciary duties. The key for both buyers or sellers is preparation, and we emphasize that during our pre-transaction planning with our clients.
Is there other litigation related to deals that should concern banks?
We have been handling much more bank litigation generally the past few years. When you’re talking about litigation, you’re not only concerned with deal litigation. You should also be concerned with possible litigation that could occur based on discoveries or events that happen down the road, both before and after closing. First, due diligence is important. It’s not just obtaining a list of the seller’s outstanding litigation, but to uncover whether there are any practices or occurrences that could lead to future litigation after closing. This is generally accomplished through management interviews, compliance reviews, hard looks at loan files, stress testing, etc. It’s important that your due diligence findings are reported to the board and documented so that you can prove you took reasonable steps to discover any problems. Secondly, an acquirer needs to properly review and check the relevant language in the merger agreement, insurance policies, insurance tail coverage, the extent of indemnification provisions in articles and bylaws, etc. These provisions are critical in understanding the overall risks to the organization and the board moving forward.
You mentioned that internal investigations are on the rise.
That’s correct. There is more to be investigated after the carnage that has occurred in the industry the past few years. Some corners were cut. Some unfortunate decisions were made. It’s important to realize that not every questionable decision merits a formal investigation. But if there is an indication that something illegal or improper may have been done, it is imperative that the board evaluate whether it should conduct a more formal, internal investigation.
What is the most important aspect of internal investigations?
Consider the process, and make sure it is thorough and even-handed. Some investigations can be done quickly and internally. Some are serious enough to merit using outside advisors, attorneys or accountants. Be careful whom you choose. Investigations can spin out of control if not handled properly and can cause greater damages and expenses to the organization than what was originally alleged. Also, remember that the investigation process and results may likely be scrutinized by regulators, as well as by shareholders in litigation.
Any practical advice?
In today’s environment, it is more important than ever to document the process and document your actions. This includes board and committee minutes, emails, correspondence, loan files, etc. Anything in writing can be used to support your case or work against you. Establish a proper process with counsel, as well as to determine what is appropriate in minutes and other communications and do this before you get sued. Another thing to remember is that heightened deal risk and uncertainty dictates better risk management procedures. The board should evaluate the company’s risk appetite and should participate in determining the extent and timing of the board’s oversight of acquisition matters.
John Freechack is the chairman of the Financial Institutions Group at Barack Ferrazzano Kirschbaum & Nagelberg LLP.
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