By Clifford S. Weber
Dodd-Frank Act compliance concerns, the uncertain financial environment, perceived economies of scale and institution-specific factors have spurred the consolidation of New York’s community banks. Since the summer of 2010, at least seven mergers have been announced or completed (see sidebar). Five of them have been interrupted by class action “investigations” or actual commenced litigation. Most of those litigations settled to avoid deal disruption. One of them ended in complete victory for the defendant banks and their directors. This is the story of that victory and its meaning for New York institutions.
Wilber National Bank was an Oneonta-based commercial bank with nearly $1 billion in assets that began serving its central New York market in 1874. In October 2010, The Wilber Corporation, a New York corporation and Wilber National Bank’s parent bank holding company, entered into a merger agreement with Community Bank System, Inc., the DeWitt, New York parent of Community Bank, a strong, profitable commercial bank. Each company’s board of directors approved the transaction unanimously. The deal, valued at $101.8 million, was structured so that Wilber shareholders received as aggregate consideration for their stock, 20 percent in cash and 80 percent in Community common stock, subject to adjustment based upon Community’s share price and Wilber’s asset quality. The Wilber Corporation was, and Community Bank System Inc. is, a public, exchange listed company.
The Class Action
Some law firms earn their living by representing shareholders in class action litigation. Typically, these self-described “shareholder rights” firms post on their websites “investigations” of the fairness of mergers and other deals shortly after they are announced and actively solicit shareholders to act as nominal plaintiffs. The “investigations” are often bereft of facts or evidence, but the threat of an injunction and delay of the deal frequently persuades companies to settle and pay attorneys’ fees (arguably the real purpose of the litigation).
Just days after Wilber and Community announced the signing of their merger agreement, and months before filing documents with the SEC, several law firms proclaimed the launch of investigations into possible breaches of fiduciary duty by the Wilber directors, and other unspecified violations of law. Two firms claiming to represent Wilber shareholders contacted Wilber and Community and tried to extract a settlement. The boards of directors of both companies refused to negotiate.
On Nov. 3, 2010, Wilber shareholders filed lawsuits in the New York Supreme Court in Otsego County. Both complaints sought class certification, named Wilber, Wilber’s directors, and Community Bank System as defendants and alleged that the director defendants breached their fiduciary duties by failing to maximize shareholder value in connection with the merger and that Community Bank System aided and abetted those alleged breaches of fiduciary duty. Specifically, the complaints alleged that the directors improperly favored Community Bank System and discouraged alternative bids by agreeing to the merger agreement’s non-solicitation provision and termination fee provision. Plaintiffs further alleged that pursuant to the merger agreement, Community Bank agreed to appoint two of Wilber’s directors to the boards of Community Bank System and to establish an advisory board of Community Bank, made up of the current directors of Wilber. The complaints also alleged that the directors and officers of Wilber entered into voting agreements to vote their shares of Wilber common stock in favor of the merger. In addition, the complaints alleged that the consideration to be received by Wilber’s common shareholders was inadequate and unfair. Plaintiffs sought an injunction stopping the merger and an award of attorneys’ fees.
The Business Judgment Rule
New York law vests a corporation’s board of directors with responsibility for direction of the corporate business. Directors may delegate day to day management to officers, but they cannot shed accountability for governance or their fiduciary duties of care, good faith and loyalty.
The business judgment rule is a judge-made rule that protects directors’ decisions from attack when the directors act consistently with their fiduciary duties. As the New York courts have stated:
“That doctrine bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes. ‘Questions of policy, of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to their honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.’”
The Delaware courts have said that under the business judgment rule, there is a “presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action was in the best interest of the company.” In other words, courts “will not invalidate a board’s decision or question its reasonableness so long as its decision can be attributed to a rational business purpose.” Under this rule, the directors’ decision is protected unless plaintiff can show that the board breached its duty of care or loyalty. Most recently, the Delaware Supreme Court noted that “[d]irectors’ decisions must be reasonable, not perfect.”
Community, Wilber and the Wilber directors answered the complaint and promptly moved for summary judgment. On March 28, 2011, the court granted the motion and dismissed both complaints. The merger closed as planned on April 8, 2011. The court based its decision on the following factors, all of which were described in the proxy statement/prospectus delivered to Wilber’s shareholders:
The court gave substantial weight to the process the Wilber board followed once it decided to sell the company. This included many meetings with its financial and legal advisers, solicitation of bids from nine potential acquirers, detailed analysis and comparison of the three bids it received, and comprehensive instruction on directors’ fiduciary duties when considering business combinations.
Wilber received a fairness opinion from a firm that was independent from the financial advisor that marketed the company and whose compensation was contingent on completion of the merger.
The Wilber directors discharged their fiduciary duty by acting with disinterested independence. Plaintiffs furnished no evidence of bad faith.
Wilber’s certificate of incorporation authorized the board to consider the factors enumerated in Business Corporation Law Section 717(b), including the long and short term interests of the company and its shareholders and the effects that the transaction may have on the growth, development, productivity and profitability of the company, its employees, customers, creditors and community.
New York caselaw upholds deal protection provisions such as voting (“lockup”) agreements, breakup fees and other contractual terms the plaintiffs alleged to be wrongful.
Guidance for Directors
The Internet enables aggressive lawyers to pounce on deal announcements, make flimsy allegations, troll cyberspace for potential plaintiffs and commence litigation to extract a settlement and attorneys’ fees. In this environment, the business judgment rule is a company’s and its directors’ best defense to any Monday morning attack on the board’s decision to enter into a change of control or other transaction with material economic consequences.
The defense boils down to this: if they properly discharge their duties, the business judgment rule protects from liability directors who are sued by shareholders alleging that they sold the company for an inadequate price (the typical claim) or that they benefited personally (another typical claim). To support invocation of the rule, evidence must exist that the directors upheld their duties. The evidence must show that the directors’ conduct was consistent with due care and loyalty. Documentation of the board’s deliberative process is the evidence that will support a successful business judgment defense in litigation seeking to second guess the board’s transactional decisions.
Practical tips for boards considering business combinations include:
Consider including provisions in the company’s certificate of incorporation that give the board flexibility when considering offers.
Evaluate the prepared marketing materials and expressions of interest from potential counterparties carefully and thoroughly. Ask questions and make certain that you understand the legal, accounting, financial and regulatory aspects of any proposed transaction. Educate yourselves to get the best-informed sense of market value.
Engage and utilize your retained experts, including lawyers, accountants and financial advisors.
Identify and disclose any conflicts of interest posed by a potential transaction. For example, if you lease property to a potential acquirer or own its securities, make certain that you disclose same and seek advice as to whether you should abstain from any vote on the deal.
Careful consideration of competing offers consumes time, which busy directors may not be able to devote. Consider appointing a special committee of the board to handle ongoing tasks, including narrowing the field of bidders to consider, filtering different kinds of offers and getting answers to routine questions from the company’s advisors.
Document the process in the minutes and through the adoption of appropriate resolutions at key junctures. Record dissenting votes.
Mergers and other major transactions place enormous stress on directors, officers and employees. Aggressors count on that and the fear of delay-by-injunction when they start hollow litigation. But as the Wilber-Community case shows, companies don’t have to cave in to a shakedown. The story can end well for boards that build a solid evidentiary record for the business judgment defense.■
Clifford Weber is a partner in the White Plains office of Hinman, Howard & Kattell, LLP. He represents community banks in regulatory, securities, corporate and transactional matters and represented The Wilber Corporation in the transaction discussed in this article.