1) KIRKLAND & ELLIS
KIRKLAND M&A UPDATE
February 8, 2016
Constituency Directors – Controlling the
Information Flow
With the increasing
prevalence of directors designated by
specific stockholders
being added to
boards (and the possibility of even more
if proxy access
regimes take hold),
companies must find
the right balance of
rights and restrictions to address the
access that a director
designee and the designating stockholder
have to company
information.
A growing number of public companies have recently added directors who are designees of activist hedge
funds or other financial investors, often following a proxy contest or as a result of the settlement of a threatened or pending contest. These companies are now facing difficult questions about the flow of confidential
information to and through these “constituency” directors, complicated by the perception or reality that these
designees may be acting on behalf of or favoring the interests of their sponsors. A number of recent Delaware
decisions have addressed this information flow and highlight two key questions that companies must grapple
with:
(1) To what extent are directors, regardless of provenance, entitled to full and equal access to corporate
information?
(2) Are directors designated by investment funds or other sponsors permitted to share information
received in that capacity with their sponsors?
In the recent NavLink decision, VC Noble addressed statutory demands by two directors under §220 of the
Delaware corporation law for access to emails and documents of the company that they believed had been
unfairly withheld from them while being shared with other directors. The court, citing Delaware precedent,
stated that a “director who has a proper purpose…has ‘virtually unfettered’ rights to inspect books and records
… at least equal to that of the remainder of the board. Management cannot ‘pick and choose’ the specific
information each director receives.” The court described this access right as concomitant with the directors’
fiduciary duties and ability to fulfill those obligations. It is not limited to communications in a formal board
setting and includes fair opportunity to participate in all board meetings and reasonable and timely access to
employees and information. However, the right is not unrestricted, with any demand needing to be reasonably
related to the director’s role. Applying these principles, the court ordered the company to share with these
directors communications between the board secretary and other directors regarding board meeting minutes,
between the company and a contract counterparty about key agreements being considered by the board, and
between management and outside counsel relating to scheduling the annual meeting, but denied the directors’
request for broad access to all communications among board members and between the other board members
and management (sought to prove that the other board members were colluding, including by holding secret
pre-meetings, to exclude them from board business and discussions) and open-ended access to all communications relating to the company’s operating plan.
While the right to information for directors may be broad, the director’s fiduciary duties include an obligation
to maintain the confidentiality of any information received in the director capacity. A breach of this confidentiality obligation exposes a director to a fiduciary duty claim, one that may not be eligible for exculpation or
indemnification.
This simple proposition gets complicated where a director is designated for board nomination by a stockholder. Perhaps surprisingly to some, Delaware law seems to set a default principle that, absent prohibitions to the
contrary, such a director may be permitted to share information with the fund that designated or nominated
her. In Kalisman, VC Laster held that a principal of a hedge fund that served as a director of a public company
in which the fund owned 14% could not be denied access to company information (including attorney-client
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privileged material) based on a fear that he would
convey the information to the fund. The court noted
in dicta that, “When a director serves as the designee
of a stockholder … and when it is understood that
the director acts as the stockholder’s representative,
then the stockholder is generally entitled to the same
information as the director.” Of note, the case-law
does not provide clear guidance as to when a director
is deemed to act as the “stockholder’s representative”
(e.g., how to treat a nominally independent director
identified by an activist investor for nomination?) and
leaves open the possibility that a company may deem
it appropriate to prohibit such a transmission of some
or all confidential information (e.g., a company could
choose to allow sharing of business and financial
information for purposes of analysis by the shareholder, but not information about board deliberations or
decisions). Of course, a stockholder who receives
information from a director is not free to share the
information with others and is exposed to insider
trading risk if it trades while in possession of material
non-public information received through its director.
Facing these realities and uncertainties, companies
with constituency directors may want to consider
combinations of policies and agreements applicable to
the director and/or her sponsor to supplement basic
fiduciary duties in order to manage confidentiality,
information use and insider trading concerns that
arise from the broad access rights of the director and,
by extension, the sponsor. Whether these policies or
agreements can be imposed, as opposed to agreed
upon, may be a function of the specific circumstances
such as a legitimate concern about a conflict (see, e.g.,
Universal American where the court held the company could insist that a designee director sign a confidentiality agreement as a condition to being seated
because the nominating stockholder was engaged in
litigation with the company). In certain circumstances, such as an issue of direct adversity between
the company and the nominating stockholder, a
withholding of limited information or use of a special
committee may be permissible to limit or delay information flow to the designee director on the specific
issue of adversity.
****
With the increasing prevalence of directors designated
by specific stockholders being added to boards (and
the possibility of even more if proxy access regimes
take hold), companies must find the right balance of
rights and restrictions to address the access that a
director designee and the designating stockholder
have to company information. Even if the company
or the rest of the board perceives the designee as
being “hostile” or not aligned with the other directors
and the company’s other stockholders, the ability to
restrict access must take account of the Delaware
principle that favors director rights to review the
company’s books and records. A full understanding of
the director’s legal rights, and the various techniques
that can be used to mitigate resulting risks, is an
important element of the onboarding process for
these constituency directors.
If you have any questions about the matters addressed in this M&A Update, please contact
the following Kirkland author or your regular Kirkland contact.
Daniel E. Wolf
Kirkland & Ellis LLP
601 Lexington Avenue
New York, NY 10022
http://www.kirkland.com/dwolf
+1 212 446 4884
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