Boards and Special Committees: the role of Special Committees in dealing with the "entire fairness standard".

• Author: D'Cunha, Karl

Any corporate transaction involving an existing or potential conflict of interest may become the subject of litigation initiated by minority shareholders. In such cases, directors may be called upon to prove that all aspects of the transaction were fair to the corporation and its shareholders. Directors may, however, be able to shift this burden of proof away from themselves and to the minority shareholders/plaintiffs if they have taken certain steps to ensure the fairness of the transaction. One important step is the establishment and use of a properly functioning Special Committee comprising independent and disinterested Board members empowered to negotiate the transaction.

A basic principle of corporate law is that the business and affairs of a corporation are managed by its board of directors. Courts have recognized that directors, acting on behalf of a corporation, have certain fiduciary duties to the corporation and its shareholders, including a duty of care and a duty of loyalty. In fulfilling these duties, directors must act "on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company." Where directors have done so, a court will not question the business judgment of the directors or otherwise second-guess the transaction. This is known as the business judgment rule, or the business judgment standard.

One exception to this standard occurs where the interests of the directors or a controlling shareholder conflict with those of the corporation or its minority shareholders. In that case, courts subject the transaction to a stricter standard. This stricter standard is known as the entire fairness standard and is best explained as follows:

Entire fairness

The concept of fairness has two basic aspects: fair dealing and fair price. The former embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and stockholders were obtained. The latter aspect of fairness relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock. However, the test for fairness is not a bifurcated one between fair dealing and fair price. All aspects of the issue must be examined as a whole since the question is...