When the Negotiator of Deal Terms Is Negotiating Personal Compensation: Lessons for Board Members

The business judgment rule is a standard of judicial review that gives deference to corporate decision-making by protecting “well-meaning directors who are misinformed, misguided and honestly mistaken” from judicial second guessing. (See FDIC v. Castetter, 184 F.3d 1040 (9th Cir. 1999), Aronson v. Lewis, 473 A.2d 805 (Del. 1984).) Entire fairness is a heightened standard of review that applies in certain instances where one or more directors has an interest in a transaction different from the corporation’s stockholders generally. Under this standard, a defendant—here, the CEO and chairman of Towers—must prove that the transaction was entirely fair to the corporation with respect to both price and process.²

Directors, officers and dealmakers alike should pay attention to this reversal. The entire fairness standard of review is a difficult burden to overcome for a defendant and can lead to a costly trial. If a defendant is found to have breached the duty of loyalty, the defendant will not be entitled to the exculpation protection provided in the corporation’s governing documents, and may not be entitled to the indemnification, resulting in substantial personal liability.

The Allegations of the Complaint
In June 2016, Towers, a Delaware corporation and publicly traded professional services firm, and Willis, a publicly traded global advisory corporation chartered in Ireland, agreed to merge. After Towers’ board and both companies’ stockholders approved the merger, the plaintiffs sued, alleging that neither the approval of the Towers’ board nor that of its stockholders was adequately informed.

According to the plaintiffs, Willis’ second largest shareholder, ValueAct Capital Management, L.P., and ValueAct’s CIO, Jeffrey Ubben, urged Willis to explore strategic alternatives, including a potential business combination with Towers. Late in 2014, the CEO of Willis, Dominic Casserley, and the CEO and chairman of Towers, John J. Haley, began discussions, signed non-disclosure agreements, and retained financial advisors. For the first five months, only one Towers board member, Linda D. Rabbitt, knew of their discussions. In May 2015, Haley finally disclosed the discussions to the entire Towers board.

The Towers board formed a special committee but disbanded it after 11 days. During that time, (i) Haley met with Casserley and Willis’ chairman, James McCann, to discuss terms, including Haley’s proposal that Towers own the larger stake of the post-merger company, and (ii) Rabbitt contacted McCann to propose that Haley serve as CEO of the post-merger entity. Following the disbanding of the special committee, the board delegated the negotiations to Haley. Shortly thereafter, McCann agreed to make Haley CEO of the combined company.

According to the plaintiffs, Haley then conceded his previous position that Towers own a majority of the combined company and agreed that Willis would own 50.1% of the combined company and Towers’ stockholders would receive a $4.87 per share special dividend before the merger closed. Haley purportedly agreed to these concessions without the approval of the Towers board and without the assistance of its financial advisor.

At the end of June 2015, Towers’ financial advisor presented its fairness opinion to the Towers board, which then unanimously approved the Merger Agreement. The Merger Agreement provided that the parties would take actions to ensure that Haley would serve as CEO of the combined company.

On news of the merger, Towers’ stock price dropped nearly nine percent. Analysts criticized the merger terms for Towers’ stockholders but praised Haley’s track record regarding prior deals. In early September 2015, ValueAct’s Ubben reached out to Haley and made an executive compensation proposal offering Haley over five times his current compensation (“Compensation Proposal”). Meanwhile, a Towers stockholder, Driehaus Capital Management LLC, began an activist campaign opposing the merger—asking, in an opposition letter to the SEC, whether “Towers management has skin in the game? Are incentives aligned?”

The proxy statement, issued in October 2015, contained the Towers’ board recommendation of the merger but was silent on the Compensation Proposal, post-merger management compensation or ValueAct’s role in the merger. Following a disappointing third-quarter earnings announcement for Willis, ISS and Glass Lewis recommended that Towers’ stockholders vote against the merger.

Doubting whether Towers’ stockholders would approve the deal, Haley and ValueAct’s CIO, Ubben, agreed to increase the price of the special dividend to $10 per share, resulting in consideration per share that was still at a seven percent discount to Towers’ unaffected share price prior to announcement of the merger. The plaintiff stockholders claimed that Haley viewed this dividend as the “the minimum amount necessary to secure the Stockholder Approval [Haley] needed to push the merger through so that he could secure the massive [Compensation] Proposal Ubben had promised him.”

In November 2015, the Towers board met for the first time since they had approved the merger in June. Haley still did not disclose his compensation discussions with Ubben—information that at least one Towers director testified he wished he had known. The board approved the increased special dividend, and other revised terms, including an increased termination fee for Towers. Towers updated its proxy, which continued to lack any disclosure of the Compensation Proposal or ValueAct’s role in the merger negotiations.

Analysts and Driehaus remained highly critical of the transaction. Nevertheless, 62 percent of Towers’ stockholders approved the transaction, which closed in January 2016. Haley became CEO of Willis Towers and received a compensation package closely resembling that proposed by ValueAct.

The Court of Chancery’s Grounds for Dismissing the Complaint
The Court of Chancery held that the failure to disclose the Compensation Proposal failed to rebut the business judgment rule because “(1) the Board already knew the combined entity would be larger and would generate a larger salary for Haley; (2) Haley kept the Towers Board generally apprised of the negotiations; and (3) the [Compensation] Proposal was merely a proposal.” For these reasons, the Court of Chancery held that plaintiffs had “failed to establish that a reasonable director would have considered the Compensation Proposal to be significant when evaluating the merger.”

The Supreme Court’s Reversal
The Delaware Supreme Court reversed, concluding that, as pled, the following allegations were sufficient to rebut the presumption of the business judgment rule and invoke the entire fairness standard of review: (i) Haley’s interest in the Compensation Proposal “rendered him materially interested in the transaction,” (ii) Haley failed to inform the Towers board of the Compensation Proposal and his discussion with ValueAct and Ubben, and (iii) the Towers board “would have found it material that its lead negotiator had been presented with [the Compensation Proposal] during an atmosphere of deal uncertainty and before they authorized him to renegotiate the merger consideration.”

Importantly, the Delaware Supreme Court did not agree that the nonbinding nature of the Compensation Proposal rendered it immaterial. The facts pled raised a reasonable inference that Haley’s conflicting interest in obtaining a significantly enhanced compensation package for himself caused Haley not to seek the best possible merger terms for Tower stockholders. The plaintiffs adequately pled that Haley subjectively believed the increase in compensation set forth in the Compensation Proposal was attainable, and that is what mattered.

Related Federal Litigation
The merger also led to federal securities litigation claiming that the failure to disclose Haley’s conflict of interest rendered the proxy statement false or misleading in violation of Section 14(a) of the Securities Exchange Act of 1934.

The District Court dismissed the case for failure to allege a material non-disclosure. The Fourth Circuit reversed, holding that a jury could reasonably conclude that disclosing this information would have changed the ‘total mix’ of information available to stockholders, “especially if the conflict caused Haley not to seek the best possible merger terms” for the Tower stockholders. (See In re Willis Towers Watson PLC Proxy Litig., 937 F.3d 297, 304 (4th Cir. 2019).)

Key Takeaways and Best Practices
This case serves as a reminder of important best practices in corporate governance and transaction processes:

• The board of directors should affirmatively question the directors and officers involved in the transaction about conflicts of interest rather than relying on the fiduciary duty of persons involved to disclose conflicts—i.e., boards should not assume that directors and officers will always recognize when they should disclose information that affects the transaction process.
• Offers that affect a fiduciary’s personal financial interest are potentially material and should be disclosed, whether or not they are accepted and lead to a binding agreement.
• Discussions with deal negotiators of their post-closing compensation should be avoided until the terms of the transaction are truly final. A director or officer should work closely with a legal advisor to ensure that these discussions are handled appropriately and at the right time.
• Sellers should consider including in any non-disclosure agreement with a potential bidder a provision in which the bidder agrees to refrain from any such compensation-related discussions with directors and officers without the prior approval of the target’s board of directors.

^{1 The plaintiffs also alleged that the second largest stockholder of Willis and the stockholder’s CIO aided and abetted the Towers CEO’s breach of fiduciary duty when they proposed a post-merger compensation package to the Towers CEO before the Towers stockholders approved the transaction and before the terms of the merger were finalized. The plaintiffs claimed that the Willis stockholder and its CIO induced the Towers CEO to breach his fiduciary duties by pressuring reluctant Towers stockholders to vote for the merger and favoring Willis when renegotiating the merger terms. Because the Court of Chancery had dismissed the aiding and abetting claim solely because it was dismissing the underlying breach of fiduciary claim, the Delaware Supreme Court remanded the aiding and abetting claim to the Court of Chancery for further consideration in light of its reversal; the Supreme Court itself did not determine whether the aiding and abetting allegations otherwise sufficed.}

^{2 As the plaintiffs’ claims were based on the conduct of a single director, the plaintiffs had to (and adequately did) allege facts that met a three-prong test, namely: (i) the Towers’ CEO was “materially self-interested” in the transaction, (ii) the Towers’ CEO failed to disclose his “interest in the transaction” to the Towers board, and (iii) “a reasonable board member would have regarded the existence of the Towers’ CEO’s material interest as a significant fact in the evaluation of the proposed transaction.”}