Changing Its Mind: A Board's Prerogative?

Under Delaware law, the board of directors of each company executing a merger agreement is required to adopt a resolution approving the merger agreement and declaring its advisability,1 although Delaware law also provides that a company may "agree to submit a matter to a vote of its stockholders whether or not the board of directors determines at any time subsequent to approving such matter that such matter is no longer advisable and recommends that the stockholders reject or vote against the matter."2 Further, under the Securities Exchange Act of 1934, for transactions involving a tender offer or exchange offer, the target is required to file a Tender Offer Solicitation/Recommendation Statement on Schedule 14D-9, disclosing the target board's position as to whether its stockholders should accept or reject the tender offer or defer making a determination regarding such offer.3

The terms of public company merger agreements typically require the target's board of directors to recommend that its stockholders either vote in favor of the proposed merger or tender their shares into the tender offer or exchange offer, as applicable, and contain limitations on the target board's ability to subsequently withdraw or qualify its recommendation. The merger agreement will, however, typically have exceptions, referred to as "fiduciary outs," that permit the board to change its recommendation in certain circumstances. Although market practice, as well as Delaware case law, supports the view that some restrictions on a target board's ability to change its recommendation are consistent with directors' discharge of their fiduciary duties—including the board's disclosure obligations under Delaware's duty of candor— the scope of those permissible restrictions will depend on the particular terms (and other relevant facts and circumstances) of each transaction. Market practice in this regard has also evolved over the last several years, particularly with respect to the introduction, and then increasing use, of a so-called "intervening event" (discussed below) as a trigger for a board's ability to change its recommendation.

Delaware courts have not expressly stated whether a board's recommendation to its stockholders is, in itself, a fact that falls within the requirements of the duty of candor, although evolving Delaware case law suggests that restrictions on a board's ability to change its recommendation could implicate that duty. As described in Lynch v. Vickers Energy Corp.,4 the duty of candor (also referred to as the duty of disclosure) is a fiduciary duty owed by a board to its stockholders requiring '' 'complete candor' in disclosing fully 'all the facts and circumstances surrounding the' transaction," though later, in Stroud v. Grace,5 the Delaware Supreme Court clarified that the board's disclosure obligations are limited to...