Overview of Fiduciary Duties

Directors of a target company facing a potential takeover must make important
decisions quickly. In Canada, the provincial or federal corporate laws under
which the target is incorporated or organized will govern the board’s conduct.
In addition, securities regulators have adopted a national policy on defensive
tactics that encourages unrestricted auctions for the benefit of shareholders. The
fiduciary duties of a U.S. target’s directors are governed by the state corporate
laws where the target is incorporated or organized. In discussing the U.S.
requirements, this part focuses on the laws of Delaware because it is the most
common state of incorporation for publicly traded U.S. companies, and the laws of
many other U.S. states are similar to Delaware’s laws.

Regardless of where a target is organized, the general rule is that directors
facing a change of control must exercise due care and act honestly and in good
faith with a view to the best interests of the corporation. The board’s decisionmaking
process must be reasonable under the circumstances and must enable, and
be seen to enable, informed decision making by the directors. By exercising their
fiduciary duties diligently, a target’s directors will help protect the company and
themselves against litigation.

In discharging their duties, directors of a target company must be sensitive to
conflicts of interest they may have. Conflicts arise because of the role played by a
takeover as a mechanism to displace management and directors. Outside directors
are in a conflict position that is perhaps different in degree − but not in kind −
from the position of inside directors. Both share responsibility for the conduct of
the business and affairs of the company.
The courts, while accepting that even outside directors may not be totally
free from the inherent conflict of inside directors, have recognized the crucial
function that outside directors perform during the negotiation and approval of
extraordinary corporate transactions that involve real conflict of interest for
management and inside directors. In these situations, outside directors can play
an important role by providing a more independent review.

To enhance the decision-making process, a target board should consider
whether it would be appropriate to establish a special committee made up of
independent directors to consider takeover bid responses. A special committee
is desirable, for example, when the target company has a controlling shareholder
whose objectives may differ from those of other securityholders or when
members of management are hostile to a bid. There are, however, no hard and fast
rules as to when a special committee should be constituted; that decision should
be made by the board, taking all the circumstances into account.

Provided that directors act without conflict of interest and with due care in
what they honestly believe to be the best interests of the corporation, courts will
defer to their business judgment. This is referred to as the “business judgment
rule.” Courts will generally defer to many of the decisions that directors face in
corporate control situations, such as whether to solicit alternative proposals or
put a company up for auction. The use of a special committee of independent
directors can be an important element in obtaining the benefit of the business
judgment rule.

A target’s board in Canada or the United States should keep the following
principles in mind when deciding whether to conduct a broad public auction:
• A public auction may often be advisable but is not required by law.
• Although price is persuasive, the highest bid is not automatically the best
bid – the surrounding facts and circumstances must be taken into account.
• Market checks on the value of a target are extremely valuable, but a market
check may sometimes be achieved in ways other than via a public auction