Promer Materials 34

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Published on January 13, 2008

Author: Carmela

Source: authorstream.com

Ethical Dilemmas Facing Private Equity Managers :  Ethical Dilemmas Facing Private Equity Managers Presented by: Alan C. Promer Hangley Aronchick Segal & Pudlin Materials by: Alan C. Promer and John J. Kenney, Jr. Hangley Aronchick Segal & Pudlin OVERVIEW:  OVERVIEW Directors’ fiduciary duties Range of liability Statutory and other protections THE “TRIAD” OF DUTIES:  THE “TRIAD” OF DUTIES Loyalty Care Good Faith Emerald Partners v. Berlin, 787 A.2d 85, 90 (Del. 2001) DUTY OF LOYALTY:  DUTY OF LOYALTY Obligation to make decisions based on the best interests of the portfolio company, and not on any personal interest (including the interest of the private equity company) DUTY OF LOYALTY:  DUTY OF LOYALTY Corporate Opportunity Doctrine DUTY OF LOYALTY:  DUTY OF LOYALTY Corporate Opportunity Doctrine Potential liability if director becomes aware of an opportunity for the portfolio company that is not presented to the portfolio company before the director pursues opportunity for himself or the private equity fund DUTY OF LOYALTY:  DUTY OF LOYALTY Corporate Opportunity Doctrine Guidelines and Factors Could the company undertake or exploit the opportunity Access to cash Line of business Current activities Activities consistent with company’s reasonable needs/aspirations Interest or expectancy (including legal or structural obstacles) Guth v. Loft, Inc., 5 A.2d 503 (Del. Ch. 1939) DUTY OF LOYALTY:  DUTY OF LOYALTY Corporate Opportunity Doctrine “Safe harbor” Presentation of the opportunity to the board avoids the possibility that an error in the fiduciary's assessment of the situation will create future liability for breach of fiduciary duty. Rejection of opportunity creates safe harbor. Broz v. Cellular Information Systems, Inc., 673 A.2d 148, 157 (Del. 1995) Delaware General Corporation Law, Section 122(17) DUTY OF LOYALTY:  DUTY OF LOYALTY Serving on Multiple Boards Potential Issues (Mis)use of Confidential Information Negotiations between the two companies Pursuit of same opportunities and business relationships Recruiting key employees Recusal from decisions DUTY OF CARE:  DUTY OF CARE “The fiduciary duty of due care requires that directors of a Delaware corporation use that amount of care which ordinarily careful and prudent men would use in similar circumstances, and consider all material information reasonably available in making business decisions, and that deficiencies in the directors' process are actionable only if the directors' actions are grossly negligent.” In re Walt Disney Co. Derivative Litigation (Disney I), 907 A.2d 693, 749 (Del. Ch. 2005) (internal quotations omitted). DUTY OF CARE:  DUTY OF CARE The process of making decisions: Informed Diligent Consider all material information reasonably available DUTY OF CARE:  DUTY OF CARE How to “be careful” Attend board meetings Document the decision-making process Options considered Outside advice considered Disclosure of conflicts/recusals Obtain approval of disinterested directors (and if necessary shareholders) BUSINESS JUDGMENT RULE:  BUSINESS JUDGMENT RULE “The business judgment rule 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 taken was in the best interests of the company [and its shareholders]. . . . [T]he business judgment presumption is a rule of evidence that places the initial burden of proof on the plaintiff. To rebut the presumptive applicability of the business judgment rule, a shareholder plaintiff has the burden of proving that the board of directors, in reaching its challenged decision, violated any one of its triad of fiduciary duties: due care, loyalty, or good faith.” Emerald Partners v. Berlin, 787 A.2d 85, 90-91 (Del. 2001) (footnotes and internal quotations and citations omitted). BUSINESS JUDGMENT RULE:  BUSINESS JUDGMENT RULE Entire Fairness If a director is on both sides of a transaction, commits fraud, or personally benefits from a transaction, there is a presumption of unfairness in the director’s act, and the director has to prove fair dealing and that the price was fair to the company. Fair dealing Timing of transaction Initiation of transaction, negotiations, structuring Circumstances of approval of transaction Fair price Economic analysis Fairness opinions, third party valuations DUTY OF GOOD FAITH:  DUTY OF GOOD FAITH DUTY OF GOOD FAITH:  DUTY OF GOOD FAITH “Bad Faith” is “authorizing a transaction for some purpose other than a genuine attempt to advance corporate welfare or [when the transaction] is known to constitute a violation of applicable positive law. In other words, an action taken with the intent to harm the corporation is a disloyal act in bad faith. . . . Bad faith (or lack of good faith) is when a director acts in a manner unrelated to a pursuit of the corporation's best interests. It makes no difference the reason why the director intentionally fails to pursue the best interests of the corporation.” Disney I, 907 A.2d at 753-54 (footnotes and internal quotations omitted). See also In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 66-67 (Del. 2006) (“Disney II”) (describing the standard as “intentional dereliction of duty”). Difficult to distinguish from other duties. RANGE OF LIABILITY:  RANGE OF LIABILITY Stretching obligations of persons who might not appear at first glance to owe a duty to the plaintiff Potential for indirect breaches of duty by aiding and abetting those who violate their duties RANGE OF LIABILITY:  RANGE OF LIABILITY Fiduciary duty on part of directors of corporate general partner to limited partners: In re USACafes, L.P., 600 A.2d 43 (Del. Ch. 1991) If anything, trend seems to be to extend the level of fiduciary duties to the directors of the corporate general partner and this trend could extend further upstream in the organizational structure RANGE OF LIABILITY:  RANGE OF LIABILITY Possible Fiduciary duty on part of controlling shareholders of corporate general partner to limited partners: In re Integrated Resources, 1990 WL 325414 (Bankr. S.D.N.Y. Oct. 22, 1990) Duty to investigate RANGE OF LIABILITY:  RANGE OF LIABILITY Controlling shareholder has duty to shareholders: Thorpe v. CERBCO, Inc., 676 A.2d 436 (Del. 1996) Kennedy v. Venrock Assocs., 348 F.3d 584 (7th Cir. 2003) (no control = no duties) RANGE OF LIABILITY:  RANGE OF LIABILITY Aiding and Abetting Breach of Duty Venture capital company unable to dismiss claim that it aided and abetted possible breaches of duty by board of portfolio company, where managing partner/general partner of venture capital company was on board of portfolio company. Khanna v. McMinn, 2006 WL 1388744 (Del.Ch. May 9, 2006) RANGE OF LIABILITY:  RANGE OF LIABILITY Aiding and Abetting Breach of Duty Cast of Characters Covad: Portfolio Company of Crosspoint Crosspoint: Venture capital company Shapero: Managing partner/general partner of Crosspoint and Covad Board Member. Also a BlueStar board member. McMinn: Founder of Covad, and of Certive, and on board of Blue Star and Covad Knowling: CEO of Covad and on board of Covad Certive: Competing company formed by McMinn and in which Crosspoint invested BlueStar: Crosspoint portfolio company, Shapero and McMinn on board Khanna v. McMinn, 2006 WL 1388744 (Del.Ch. May 9, 2006) RANGE OF LIABILITY:  RANGE OF LIABILITY Aiding and Abetting Breach of Duty Aiding and Abetting Elements (1) existence of a fiduciary relationship (2) breach of fiduciary duty (3) knowing participation in that breach by the defendant (4) proximate causation of damages Khanna v. McMinn, 2006 WL 1388744 (Del.Ch. May 9, 2006) RANGE OF LIABILITY:  RANGE OF LIABILITY Aiding and Abetting Breach of Duty Misuse of confidential information and competing: CCBN.com v. Thomson Financial, Inc., 270 F.Supp.2d 146 (D. Mass July 2, 2003) (applying Delaware law). LIMITING LIABILITY:  LIMITING LIABILITY LIMITING LIABILITY:  LIMITING LIABILITY A company can include in its partnership agreement, operating agreement, or certificate of incorporation a provision purporting to limit or eliminate the liability of the directors and general partners for breaches of (some) fiduciary duties. LIMITING LIABILITY:  LIMITING LIABILITY Exculpatory Charter Provisions Section 102(b)(7) of the Delaware General Corporation Law, 8 Del. C. § 102(b)(7): Certificate of incorporation may: Eliminate or limit the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director for: breach of the director's duty of loyalty to the corporation or its stockholders; acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law. LIMITING LIABILITY:  LIMITING LIABILITY Exculpatory Charter Provisions Section 122(17) of the Delaware General Corporation Law, 8 Del. C. §122(17): [A corporation has the power to] (17) Renounce, in its certificate of incorporation or by action of its board of directors, any interest or expectancy of the corporation in, or being offered an opportunity to participate in, specified business opportunities or specified classes or categories of business opportunities that are presented to the corporation or 1 or more of its officers, directors or stockholders. LIMITING LIABILITY:  LIMITING LIABILITY Partnerships and LLCs Partnerships and Limited Liability Companies can similarly modify partnership or fiduciary duties. See Delaware Revised Uniform Limited Partnership Act Section 17-1101, 6 Del.C. § 17-1101: Partnership agreement may expand, restrict or eliminate a partner’s duties and liabilities and protect a partner from liabilities for actions taken in good faith reliance on the partnership agreement provisions. Partnership agreement cannot eliminate the implied contractual covenant of good faith and fair dealing See 6 Del. C. § 18-1101(c)(2) (as to Limited Liability Company) LIMITING LIABILITY:  LIMITING LIABILITY Partnerships and LLCs Miller v. American Real Estate Partners, L.P., 2001 WL 1045643 (Del. Ch. 2001). Draft such provisions carefully. THE PRIVATE EQUITY FUND:  THE PRIVATE EQUITY FUND Fund formation documents can and should: Allow fund managers to comply with duties to portfolio company even if it conflicts with duties to fund Take advantage of statutory sections mentioned above CONCLUDING THOUGHTS :  CONCLUDING THOUGHTS Condition closings on amendment of portfolio company’s charter, articles, bylaws to provide for statutory protections of Sections 102 and 122 Get consent to invest in/sit on boards of competing companies Indemnification of directors by portfolio company in bylaws and in indemnification agreement D&O insurance Private equity firm should have its own D&O policy Drafting board minutes Alternatives considered Time spent at meetings THE END:  THE END

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