The special committee should be special: it takes a full and proper deliberative process to address conflicts in conflict of interest transactions.

• Author: Raymond, Doug
• Position: LEGAL BRIEF

RECENTLY, we have seen renewed criticism of "going private" transactions. Whenever stockholders are bought out or a company engages in a transaction with insiders, conflicts of interest must be addressed. When such transactions are challenged, the Delaware courts, among others, use an "entire fairness" standard, which focuses both on fair dealing and fair price.

In general, most companies try to satisfy the entire fairness standard through a special committee consisting of disinterested directors who evaluate the transaction on behalf of all of the corporation's constituencies. Not any special committee will do--it must be properly constituted, created, and functioning.

Delaware case law provides examples of how--and how not--to approach the special committee process. The 2006 case of Gesoff v. IIC Industries, et al., provides an illustration of a failure of the special committee process.

In Gesoff, the controlling stockholder sought to squeeze out the minority stockholders and set up a special committee to satisfy the Delaware entire fairness standard. Unfortunately, the special committee consisted of only one member, the only available independent director. (There was one other independent director at the outset, who died.) Initially, the special committee was charged with evaluating a proposed tender offer, which, it was anticipated, would be followed by a short-form merger. Ultimately, the tender offer fell short. Forced to shift strategy, the board chose to complete the process with a statutory long-form merger, at the same price as the failed tender offer. However, the special committee sought no additional information and performed no new analysis regarding this unexpected shift in transaction form.

The flaws in this committee process arose even before the special committee was appointed. One flaw was that the special committee's legal and financial advisers were essentially chosen by the controlling stockholder. For the parent company, this arrangement ensured that its planned bid and counter-bid strategy, which had been agreed upon within a predetermined price range, would be followed. Other problems: Not only was the special committee's lawyer chosen by the parent, but also he was the lawyer to both the subsidiary and the parent on the merger transaction, thus placing (in the court's words) "[their] own outside counsel directly in the opposition camp"; and the financial adviser was recommended by counsel and, as the court noted in...