Delaware court decision to enjoin merger vote emphasises fiduciary duties that also apply to Swedish boards of directors

In November 2010, Del Monte Foods Company (“Del Monte”) announced that it had reached an agreement on a USD 5.3 billion buyout with Blue Merger Sub, Inc., an entity ultimately owned by a consortium of private equity funds affiliated with Kohlberg Kravis Roberts & Co. L.P. (“KKR”), Vestar Capital Partners and Centerview Partners. 

However, the shareholders’ vote on the proposed buyout, which was required in order to implement it, was postponed by the Delaware chancery court so that Del Monte could seek other potential buyers in an additional “go shop”-period. The reason for the postponement of the decision to approve the buyout and the approval by the court of a new go-shop period, which was in addition to a go-shop period in the merger agreement, was that the court found there was reasonable probability that the Del Monte board had breached its fiduciary duties, which in turn was caused partly by actions by Del Monte’s financial advisor.

In short, the background was that the financial advisor had represented both Del Monte and KKR without informing Del Monte. The financial advisor’s incentive to do so was that by representing both sides of the transaction it would be able to generate additional fees by providing financing to the buyer side. It was noted by the court that the financial advisor, among other things, had failed to inform Del Monte of its dual loyalties and also that it had directly assisted in breaches of confidentiality agreements entered into. The buyout was subsequently approved and successfully implemented.

This is essentially old news unrelated to the Swedish market, but the underlying principles involved are still of interest. One should bear in mind that, while the US and the Swedish legal systems are very different, the concept of fiduciary duties exists in both systems.

What, then, were the reasons for the court’s decision to postpone the merger, i.e. what specific actions and omissions constituted breaches of the board’s fiduciary duties?

One of the main omissions by the board was that it made insufficient efforts to follow up on its advisor’s actions. The financial advisor was working for both sides of the transaction and this was not questioned by the board even when it became apparent. The board should have done more to protect the company and its shareholders from the negative aspects of conflicts of interest on the part of the financial advisor.

Second, when one of the lead private equity firms wanted permission to “team up” with a private equity firm that had previously shown significant interest in Del Monte, this was approved by the board, thereby limiting the competition. In view of the interests of the company’s shareholders, some compensation, such as a higher price, should have been sought by the board in order for such a concession to be made. Alternatively, the board could have asked the private equity firms involved to team up differently in order to preserve or increase competition among them.

Third, the board acted unreasonably when it approved its financial advisor’s request to be allowed to provide buyerside financing. At this time, the board appeared not to have considered at all if this was to the benefit of shareholders, i.e. if it increased the likelihood of a successful transaction or a higher price. As no such considerations appear to have been made, the shareholders were instead left with the key drawback: as Del Monte’s financial advisor was also providing financing to the buyer, the financial advisor had an obvious conflict of interest. If the buyer over-paid this could by extension lead to substantial credit losses for the financial advisor. 

Even though the Del Monte case includes many aspects specific to the US, we note that the issues relating to conflicts of interest are also highly relevant in Sweden. Although there is a general absence of case law on the fiduciary duties of Swedish boards of directors, we find that at least some of the shortcomings highlighted by the Delaware court could be viable as grounds for litigation against a Swedish board of directors.

If it finds itself in a situation similar to that of the Del Monte board, a board of directors should ask itself at all times: are we doing our best to protect the interests of the company and its shareholders? If the answer to this question is yes, this would reasonably also mean that the board is taking steps to ensure that its advisors do not have a conflict of the interest from the outset and that the board is taking reasonable measures to ensure that its advisors remain unconflicted by monitoring their conduct. Furthermore, if an advisor makes a specific request to assist another party in addition to the company, e.g. for it to be able to also assist a counter-party in a transaction, such a request should only be approved if there is a significant advantage to the company and its shareholders and if such advantage outweighs the risks involved. In addition, the board should note that while many of the questions relating to conflicts of interest raised could be addressed in an agreement when its advisor is retained, the board’s responsibility does not end there. Only by making sure that its advisors stay unconflicted can the board
of directors be sure that it is observing its fiduciary duties.