Limiting director liability in mergers, demergers and spin-offs: boards need to carefully consider whether shareholders will be damaged after transforming a conglomerate into multiple stand-alone businesses.

• Author: Bartell, Robert A.

At the corporate board level, directors are working with management teams to create shareholder value in this era of economic uncertainty and anemic growth. The strategies and tactics to do so may include a merger, spin-off (demerger) and/or a special dividend or share repurchase--each of which requires thorough information gathering and solid decision-making.

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After the financial failure of firms like Enron, Lehman Brothers and Madoff, many boards of directors have been more cautious and thoughtful about confirming the data and analyses provided by company management and outside parties, such as lenders and investment banks. Boards have been strongly encouraged to embrace a strong oversight process, rigorous internal debate and constant analyses of downside scenarios.

Whether companies should increase in size, diversity of products and geographic markets or stick to a highly specialized and narrow approach is an ongoing debate for many organizations. In the current cycle of mergers and acquisitions activity, many companies are contemplating demergers or spin-offs of unrelated business units. A spin-off often creates value, as research analysts understand the resulting companies better and management teams can grow their business through specialization.

However, boards need to carefully consider whether shareholders will be damaged after transforming a conglomerate into multiple standalone businesses. They should also think carefully about solvency and ask themselves if the stand-alone businesses have adequate capital and liquidity. One helpful technique for thinking through these issues is to study the potential valuation, solvency, and profitability of the independent entities and compare them to the pre-transaction conglomerate.

Contingent Fees Under Scrutiny

The high-profile Kraft/Cadbury merger brought to light many of these considerations. The Association of British Insurers said that listed companies and shareholders need to scrutinize advisory arrangements between companies and their investment banks. There is a renewed concern by some institutional investors that incentive fees and success fees may "tilt the market in favor of one transaction versus another" and compromise "objective, independent advice." Boards need to be prepared to address concerned shareholders, who in some cases worry that the contingent fees paid to investment banks compromise the financial institutions' independence and objectivity.

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