While regulators continue to probe investment banks’ role in matching up buyers and sellers of structured-finance products, two high-profile Delaware Chancery Court cases highlight merger and acquisition engagements as another area of potential conflicts of interest by banks.
In the two cases, In re Del Monte Foods Co. and In re Atheros Communications Inc., the Delaware court showed it “is prepared to raise the bar” regarding investment bankers’ actual or potential conflicts of interest that could threaten to compromise the integrity and fairness of an M&A transaction, according to a new paper by Gardner Davis and Tyler Parramore, attorneys at law firm Foley & Lardner. (The paper appeared in a recent issue of Securities Regulation & Law Report.)
Significantly, though, the Delaware court put the onus on boards of directors, not bankers, to prevent such situations. Failure to do so can result in breaches of fiduciary duty under the Revlon standard, which says directors must focus on securing a deal “that is the best value reasonably available for the shareholder” and “must exercise their fiduciary duties to further that end.”
The Del Monte case concerned the relationship between Kohlberg Kravis Roberts and Barclays Capital during the recent $5.3 billion acquisition of Del Monte Foods by a
KKR-led private-equity group. While Barclays came to advise the Del Monte board on the deal, it failed to disclose pre-engagement discussions with KKR on a Del Monte takeover and the fact that it was pursuing a role in the lucrative buy-side, or “staple,” financing that KKR would need to purchase Del Monte. According to the Delaware court decision, the Del Monte directors did not act reasonably “because they relied upon, and were deceived by, a conflicted financial advisor,” write Davis and Parramore.
The Del Monte ruling sends a strong message that CFOs and other board members need to have an honest, open conversation with their prospective bankers about conflicts of interest. If a board wants to avoid breaches of fiduciary duty, the “beauty contest” for selecting an investment banker or financial adviser now needs to include “blunt questions about [the bank's] potential conflicts of interest,” say Davis and Parramore.
That may require negotiation, because the first draft of engagement letters from investment-banking firms typically says the banker can and may represent other parties involved in the transaction and may in fact at the time of the auction sale be engaged by them, says Libby Kitslaar, a partner in the corporate practice at law firm Jones Day. Says Kitslaar: “As a client you need to go back and say, ‘Look, that’s really not acceptable. If you’re working for us as our banker in the sale, you cannot be compensated or be engaged by another party in this transaction. On this deal you’re our banker.’”
If a conflict arises in the middle of a sale, Kitslaar says the seller should engage a second investment banker to “do the backstop work on a fairness opinion” and perhaps evaluate competing bids. The selling company’s board could demand that the first bank split its fee with the second.