Toys “R” Us – Revisiting a Board’s Duties in a Sale

C&G Review
Fall 2005

In denying a shareholder effort to halt a $6.6 billion buyout of Toys “R” Us, Inc., the Delaware Chancery Court recently provided a useful review of the fiduciary duties to which a board of directors will be held in a sale transaction. The court’s detailed review of the process makes clear the fact-intensive nature of the analysis of directors’ conduct. The decision should not be viewed as establishing a minimum standard; rather, Toys “R” Us should be studied for examples of conduct that will invite judicial deference to directors’ decisions, under the presumption afforded by the “business judgment rule.”

As described by the court, the Toys “R” Us board, facing economic challenges, began considering the sale of one of the company’s business units. After a public search, four bidders were chosen. When one bidder offered to purchase the entire company, however, the board sought similar bids from the other three finalists. The board finally decided to accept a bid for the entire company. The agreement reached with the winning bidder included several “deal protection measures” in favor of the buyer, including a breakup fee, a “no-shop” provision precluding the company from continuing its sale efforts, and a “matching right” allowing the bidder to match any rival bid that might be made on an unsolicited basis.

Certain shareholders sought an injunction to prevent the sale, complaining that the board breached its fiduciary duties by (1) failing to restart the sale process to seek new bids for the entire company (instead of seeking offers for the entire company only from the four final bidders for one of the business units) and (2) agreeing to the deal protection measures. Both sides cited the landmark Delaware Supreme Court Revlon decision, which affirmed that a board’s primary duty is to maximize shareholder value. Courts use a two-part test in evaluating claims that directors have breached the duties established in Revlon. Courts first determine the adequacy of the board’s decision-making process, including the information upon which decisions were based. Next, courts examine the reasonableness of the board’s actions in light of this information and the circumstances at the time. In applying Revlon, the Toys “R” Us court noted that its role is to examine whether the directors used reasonable efforts to find the best price and not to determine whether they performed flawlessly.

In its analysis of the board’s process and the reasonableness of its actions, the court noted that the board engaged in a publicly-disclosed 14-month process, holding 15 board meetings and 18 executive committee meetings. Further, nine of ten board members were independent. The court found that the Toys “R” Us directors took the time to educate themselves and made reasonable choices in confronting real world circumstances. The change from a sale of a single business unit to a sale of the entire company – a move that was central to the plaintiffs’ claim that fiduciary duties were breached – was applauded by the court as an example of a board’s supple willingness to change direction when in the stockholders’ best interest.

The actions taken by the Toys “R” Us board, regardless of the court’s approving analysis, should not be viewed as establishing a new minimum standard. As the court noted, there is no single blueprint for fulfilling the duty to maximize value. However, the actions and process viewed favorably by the court provide useful guidance for directors and their advisors faced with a sale transaction; in that regard, the following guidelines should be considered:

· Meet regularly even at the outset for updates on the information gathering process

· Keep a detailed record of the decision making process

· Retain experts to obtain and evaluate information and to evaluate alternatives

· Participate directly in the process instead of relying solely on the experts

· Have key decisions approved by a majority of independent directors

The court’s analysis of the deal protection measures accepted by the board also was made in context rather than in a vacuum: the deal protection measures are viewed from the board’s perspective at the time of the transaction and take into account the real world risks and prospects. Applying that standard, the court found that the deal protection measures accepted by the Toys “R” Us board were not inconsistent with those found in similar transactions nor inconsistent with those allowed in past judicial precedent. As a result, it was not unreasonable for the board to accept the protections negotiated by the successful bidder. Directors faced with an otherwise acceptable bid that includes deal protection measures should review the request in the same manner.

Although it has little in the way of new law, the Toys ”R” Us opinion contains a useful and detailed summary of a process that withstood court challenge, as well as commentary on some of the options (and challenges) raised in recent mergers and acquisitions, including so-called “staple” financing and “club” private equity deals. Directors facing a sale transaction would be well advised to review the Toys ”R” Us opinion.

For more information, please contact mstabile@cohenlaw.com