Conflicts of Interest and Special Committees Revisited: Has Kahn V. Tremont Corp. Permanently Changed the Landscape, or Merely Slyghtly Altered It?

A. CONFLICTS OF INTEREST AND THE USE OF SPECIAL COMMITTEES

It is axiomatic that corporate directors owe a duty of care and a duty of loyalty to the corporations that they serve. Although the duty of care is a concept that most corporate directors can grasp easily, the duty of loyalty, while an easy concept to grasp intellectually, can often prove to be a troubling concept when a corporation undertakes certain types of transactions. The duty of loyalty requires that the best interests of the corporation and its shareholders take precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the shareholders generally. Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993). Conflict of interest transactions implicate the duty of loyalty because of the possibility that when a director of one corporation does a transaction with another corporation in which he has an interest, such director may be inclined to favor one corporation over the other.

Virtually every state has a statute governing conflict of interest transactions. See, e.g., Cal. Corp. Code § 310; Del. Code Ann. Tit. 8, § 144. Generally, these statutes set forth a procedure that provides, if the statutory requirements are followed, that a contract or transaction between a director and his corporation will not be voidable. One of the procedures frequently proscribed under these statutes, and perhaps the procedure most frequently employed in practice, is the appointment of a special committee of disinterested directors, which committee will be charged with reviewing and negotiating the relevant transaction. Under these statutes, if there is disclosure and shareholder or disinterested director approval in accordance with the statutory requirements, the transactions will not be voidable solely because of the director's interest in the subject transaction. The failure to obtain disinterested director or shareholder approval does not mean, however, that a transaction will be found automatically voidable. Under the Delaware statute, if "a contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee or the shareholders," the contract or transaction shall not be void or voidable solely because a director has an interest in such contract or transaction. Del. Code Ann. Tit. 8, § 144(a)(3).

The full text of the Delaware statute governing conflicts of interest is set forth below:

Del. Code Ann. Tit. 8, § 144.

In theory, the Delaware conflicts statute is straightforward and easy to follow, and one might be tempted to think that the procedures in subsections (a)(1) and (a)(2) of the statute would be followed in virtually all interested director transactions in order to "insulate" the transaction from a conflict of interest charge. In practice, however, the effect of compliance with subsections (a)(1) and (a)(2), by procuring disinterested director or shareholder approval, is unclear because many conflict of interest statutes (like Delaware's) do not expressly set forth the consequences of obtaining such approval. And, in fact, as will be seen below, Delaware courts may often apply the entire fairness standard (discussed infra) to such transactions notwithstanding such attempted compliance. At a minimum, compliance with subsections (a)(1) and (a)(2) of the Delaware statute by a completely independent and well functioning board or special committee acting in good faith should have the effect of shifting the burden on the entire fairness issue to the plaintiff.

Until recently, it was assumed by some that disinterested director or shareholder approval in accordance with the relevant statute would remove the taint of a director's self-interest in a transaction and thereby relieve the interested director of the burden of proving the fairness of the transaction. Cede & Co. v. Technicolor, Inc., 634 A.2d at 365. The recent Delaware Supreme Court case of Kahn v. Tremont Corp., 694 A.2d 422 (Del. 1997), has perhaps brought the accuracy of such statement into question, and has forced many practitioners to re-examine the procedures used in conflict situations. Moreover, the Tremont case, with its critical examination of the workings of the special committee employed in that case, may have serious implications for the Silicon Valley attorney, venture capitalist and entrepreneur, particularly in merger and acquisition transactions. The Tremont case is also useful in that it provides a brief treatise and current restatement of the Delaware Supreme Court's view of the law concerning transactions between a corporation and interested parties. Accordingly, these materials will provide an in-depth review of the Tremont case, and will try to determine if the case will have any lasting significance beyond its facts.

2. THE TREMONT CASE

In Tremont, plaintiff-shareholder Kahn appealed a decision of the Delaware Court of Chancery (Judge Allen) that approved the purchase by Tremont Corporation ("Tremont") of 7.8 million shares of the common stock of NL Industries, Inc. ("NL"). The block of NL shares, which represented 15% of NL's outstanding stock, was purchased by Tremont from Valhi, Inc. ("Valhi"). Valhi owned a majority (62.5%) of NL's outstanding stock immediately prior to the time of the transaction. A trust for the family of Harold C. Simmons (through the trust's ownership of 100% of the stock of Contran Corporation) owned 90% of the stock of Valhi. Valhi also owned 44.4% of Tremont's outstanding shares of stock (Tremont's largest shareholder) and was deemed to control Tremont. The relationship among these companies is set forth graphically below:

Kahn alleged that Simmons effectively controlled each of Valhi, NL and Tremont, and through his influence, structured the purchase of NL shares by Tremont in a manner which benefited Valhi (and Simmons) at the expense of Tremont. Simmons was the chairman of the board of Valhi and NL, and served on the board of Tremont. The Chancery Court concluded that due to Simmons' status as a controlling shareholder, the transaction must be evaluated under the entire fairness standard of review (and not the more deferential business judgment rule). Notwithstanding this more exacting standard of review, the Chancery Court found that Tremont's utilization of a special committee of disinterested directors was sufficient to shift the burden on the entire fairness issue to Kahn. With the burden on Kahn, the Chancery Court concluded that both the price and the process employed were fair to Tremont.

Kahn appealed, alleging that the Chancery Court had erred in its burden of proof allocation regarding the entire fairness of the transaction. The Delaware Supreme Court agreed, concluding that under the circumstances the Tremont Special Committee did not operate in an independent or informed manner and therefore, the Chancery Court erred in shifting the burden of persuasion to Kahn. Accordingly, the Delaware Supreme Court reversed the judgment of the Chancery Court and remanded the case for a new fairness determination with the burden of proof upon the defendant directors.

1. Facts of Tremont.

In late 1990, NL's board believed that the current market price of NL's stock ($10-$11 per share) was significantly undervalued. Accordingly, over the course of 1990 and 1991, NL took certain steps to repurchase its shares. First, NL implemented an open market repurchase program. Second, NL implemented a "Dutch auction" to repurchase up to 11.3 million of its shares.

Valhi, which prior to the time of the Dutch auction, owned 68% of NL's outstanding shares, tendered all of its NL shares (Valhi recognized it would sell at most 11.3 million NL shares). On September 12, 1991, 11,268,024 shares were accepted for purchase by NL in the Dutch auction. Of these shares, 10,928,750 shares were purchased from Valhi. Due to the share repurchase, Valhi's ownership of NL decreased to 62%. After the close of the Dutch auction, NL's stock price fell from approximately $16 to around $13.50.

After selling 10.9 million NL shares in the Dutch auction, Valhi became aware that it could obtain two significant benefits if it could reduce its holdings of NL stock below 50%. First, Valhi could save approximately $11.8 million in taxes on its proceeds from the Dutch auction. Second, Valhi would be able to deconsolidate NL from Valhi's financial statements, thereby improving Valhi's access to capital markets. Valhi began to explore the possibility of selling a block of 7.8 million NL shares (15% of outstanding NL shares).

Michael Snetzer, the President of Valhi (and a director of both Tremont and NL), initially contacted two potential purchasers. Both potential purchasers declined. Snetzer also contacted Salomon Brothers about selling the shares. Salomon Brothers advised Snetzer that in order to sell a block of 7.8 million shares in a series of privately negotiated transactions, Valhi would have to sell the shares at a discount of 20% or more to NL's then market price because of the illiquidity discount that would be requested by such purchaser to buy unregistered stock in a series of private transactions. Snetzer did not employ Salomon on behalf of Valhi to sell the block of NL shares. In Snetzer's view, Valhi simply would not sell the NL shares at that price.

Snetzer decided to approach Tremont, which had $100 million in excess liquidity and was in need of productive investment options. Snetzer thought that because Valhi also owned 44% of Tremont, any appropriate discount from market might be more acceptable to Valhi, and, from Tremont's perspective, a lower discount than what otherwise might be required might be more acceptable to Tremont because Tremont's management would have better information about NL and its business than any unrelated buyers that Salomon Brothers was considering. Further, Snetzer reasoned, Tremont would not be exposed to the same risk assessment in purchasing the NL shares as a third party would, and might therefore rationally be willing to purchase the NL shares at a price closer to the market price of such shares.

Since November 1990 Tremont had been holding approximately $100 million in capital for acquisition purposes. Tremont had also disclosed to its stockholders that Tremont intended to attempt acquisitions in other areas of business and that such acquisition might include "participation in the acquisition activities conducted by NL, Valhi and other companies that may be deemed to be controlled by Harold C. Simmons" and could involve the acquisition by Tremont "of securities or other assets from such related parties."

On September 18, 1991, Valhi communicated an invitation to Tremont asking Tremont to consider the purchase of 7.8 million NL shares from Valhi. J. Landis Martin, President, CEO and a director of Tremont (Martin also served as President and CEO of NL), in his capacity as CEO of Tremont, then wrote to Tremont's three outside directors, Richard Boushka, Thomas Stafford and Avy Stein, asking the three directors to consider what Tremont's response to Valhi should be. These three individuals were thereafter designated by the Tremont Board as a Special Committee for the purpose of considering the Valhi proposal and recommending a course of action with respect to the proposal. Although the three directors were deemed "independent" by Tremont for purposes of this transaction, all three had significant prior business relationships with Simmons or Simmons controlled companies.

Stein, a lawyer, was, prior to 1984, affiliated with a law firm which had represented Simmons on several of his corporate takeovers and had worked closely with Martin. In 1984, Stein left this law firm to organize and promote various business ventures. Over the next five years, Martin invested in projects promoted by Stein despite such projects' poor performance. In October 1988, Stein's business ventures had largely ceased when Martin, then at NL, offered Stein a consulting position with NL at $10,000 per month, plus bonuses to be paid at Martin's discretion. Stein remained in this consulting position for one year, earning bonuses totaling $325,000, before taking a position with two subsidiaries of Continental Bank.

Stafford had been employed by NL in connection with Simmons' proxy contest to acquire control of Lockheed and received $300,000 in fees for such service. Boushka was initially named to Simmons' slate of directors in connection with the Lockheed proxy contest and was paid a fee of $20,000.

Of the three Tremont Special Committee members, Stein was the most closely connected to Tremont management. Nonetheless, Stein assumed the role of chairman of the Special Committee and directed its operations, including the selection of legal and financial advisors.

The Special Committee's first action was to select financial and legal advisors. The Special Committee considered several investment banking firms before Stein recommended Continental Partners, a subsidiary of Continental Bank, with whom Stein was affiliated (at the relevant time, Stein was working for subsidiaries of Continental Bank). Continental Bank had earned significant fee income in prior years from Simmons related companies (e.g., in 1990 and 1991, Continental Bank received approximately $400,000 from Simmons related companies). The Special Committee decided to retain Continental Partners.

The Special Committee chose the Dallas firm of Thompson & Knight as the Committee's legal advisors and C. Neel Lemon of that firm as the Committee's attorney. Mr. Lemon and his firm were recommended by David Garten, general counsel for both Tremont and NL. In addition, Garten assumed the responsibility for performing the conflicts check. Lemon had had two prior connections with Simmons companies in 1990. First, Lemon represented the underwriter for a proposed convertible debt offering by Valhi. Lemon had also been hired by a special committee of NL to represent that special committee in considering a proposed merger between NL and Valhi.

On October 8, 1991, Boushka and Stein, along with their legal and financial advisors, met with representatives of NL to receive a presentation on the business, operating results and prospects of NL. On October 9, 1991, this same group from Tremont met with representatives of Valhi for a presentation of the business purposes of Valhi's proposal (the tax benefits to Valhi). Both presentations were conducted in the morning, and in each case an afternoon meeting was held in order for the legal and financial advisors to analyze the respective morning presentations.

Stafford did not attend any of these meetings because he was in Europe on other business. Stafford was informed of what had transpired at the meetings via telephone. Boushka attended the two morning presentations but did not attend the afternoon sessions with the advisors. Thus, of the three directors on the Tremont Special Committee, only Stein, the Chairman of the Special Committee, was present at the afternoon sessions with the advisors. In addition to periodic telephone discussions, the entire Special Committee (all members present) met two more times (October 21 and October 30) to consider the Valhi proposal before the final negotiations took place.

NL provided the Tremont Special Committee and its advisors with financial information, including the regularly prepared projections of NL's management regarding NL's future earnings, on October 8, 1991. The Special Committee also directed Continental Partners to independently assess the reasonableness of NL's projections. Continental Partners, at the request of Boushka, obtained advice from an independent consultant regarding certain parts of NL's projections. Ultimately, Continental Partners concluded that NL's projections were reliable and the best basis on which to construct a discounted cash flow analysis. Continental Partners utilized five different methodologies, including discounted cash flow, to determine the "intrinsic value" of NL shares. These methodologies led Continental Partners to ultimately conclude, at the completion of its analysis, that the intrinsic value of NL shares was between $13 and $20 per share.

Valhi's initial proposal (on October 9, 1991) was to sell Valhi's NL shares to Tremont at $14.50 per share, with no registration rights or other provisions to enhance the liquidity of the NL shares. NL stock had closed at $13 the previous day. By the October 21, 1991 meeting of the Tremont Special Committee, Continental Partners had developed a preliminary indication of intrinsic value (between $12.50 and $23 per share). On October 21, 1991, Stein called Valhi's President Snetzer, telling Snetzer that some provision to afford liquidity to Tremont of the unregistered NL shares would be necessary (the shares were being sold by an affiliate of NL, Valhi, so the shares would be restricted securities in the hands of Tremont). Stein also told Snetzer that a $14.50 price per NL share was too high. Snetzer replied that Valhi may be able to go below $14 into the high $13s. The NL stock closed at $13.125 on October 21, 1991.

After the Tremont Special Committee conferred, Stein and Snetzer met to negotiate some of the non-price terms. Stein did not make any price proposals or discuss a liquidity discount, but did tell Snetzer that he would be surprised if Tremont would be willing to do a deal near the range Snetzer was then talking about (the low or mid $13s).

At its October 30, 1991 meeting, the Tremont Special Committee determined that Tremont would seek a transaction at $12.625 or below. Continental Partners stated that it would be willing to deliver a fairness opinion at $12.625. Stein then met with Snetzer and offered to do a deal at $11.25 per NL share. Stein and Snetzer eventually agreed on a price of $11.75 per NL share. In addition, Tremont was to receive the registration rights and co-sale rights that Stein had sought as protection to the limited liquidity of the investment in NL shares. NL stock closed at $12.75 that day.

After Stein and Snetzer agreed on a price of $11.75 per share, the Tremont Special Committee met on October 30, 1991 and agreed to and did recommend the purchase of the 7.8 million NL shares at such price to the entire Tremont Board. The Tremont Board as a whole met and considered and approved the recommendation of the Special Committee, with the three most interested Tremont Board members (Harold Simmons, Glenn Simmons (vice chairman of the Valhi Board), and Snetzer) abstaining and the two other members (Martin and Susan Alderton, Vice President and Treasurer of both Tremont and NL) voting with the Tremont Special Committee to provide a quorum.

2. The Delaware Supreme Court's Decision

Ordinarily in a challenged transaction involving self-dealing by a controlling shareholder, the substantive legal standard is that of entire fairness, with the burden of persuasion resting upon the defendant shareholders or directors. Tremont, 694 A.2d at 428, citing Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983). This burden, however, may be shifted from the defendants to the plaintiff shareholder through the use of a well functioning committee of independent directors. Tremont, 694 A.2d at 428, citing Kahn v. Lynch Communication Systems, Inc., 638 A.2d 1110, 1117 (Del. 1994). Regardless of where the burden lies, when a controlling shareholder stands on both sides of a transaction, the conduct of the parties will be viewed under the more exacting standard of entire fairness as opposed to the more deferential business judgment standard. Tremont, 694 A.2d at 428, citing Lynch Communication Systems, Inc., 638 A.2d at 1116.

The entire fairness standard "remains applicable even when an independent committee is utilized because the underlying factors which raise the specter of impropriety can never be completely eradicated and still require careful judicial scrutiny." Tremont, 694 A.2d at 428. This policy reflects the reality that in a transaction such as the case at hand, the controlling shareholder will continue to dominate the corporation regardless of the outcome of the transaction. Id. Cognizant of these factors, the Delaware Supreme Court has chosen to apply the entire fairness standard to "interested transactions" in order to ensure that all parties to the transaction have fulfilled their fiduciary duties to the corporation and all of its shareholders. Id. at 428-29.

To obtain the benefit of a shift of the burden of unfairness to the plaintiff, a "controlling shareholder must do more than establish a perfunctory special committee of outside directors." Id. at 429. Rather, the "[special] committee must function in a manner which indicates that the controlling shareholder did not dictate the terms of the transaction and that the [special] committee exercised real bargaining power 'at an arms-length.'" Id.

In the case at hand, Tremont, "with Valhi's approval", established a Special Committee consisting of three outside directors. The Delaware Supreme Court noted the Chancery Court's reservations about the establishment of the Special Committee and the selection of its financial and legal advisors. First, Stein was the dominant member of the Special Committee and played a key role in the negotiations with Valhi. Stein "had a long and personally beneficial relationship with Mr. Martin [and Simmons' controlled companies]." Id. Further, "the selection of professional advisors for the Special Committee does not give comfort; it raises questions." Id. Specifically, Tremont's General Counsel suggested the name of an appropriate legal counsel to the Special Committee, and that individual was promptly retained. Id. Moreover, "the Special Committee chose as its financial advisor a bank which had lucrative past dealings with Simmons-related companies and had been affiliated with Stein through his employment with a connected bank." Id.

Accordingly, the Delaware Supreme Court held that the Chancery Court's determination that the Tremont Special Committee was fully informed, active and appropriately simulated an arms-length transaction was not supported by the record:

Id. at 429-30.

The Delaware Supreme Court noted that it had in the past defined director independence as "the care, attention and sense of individual responsibility to the performance of one's duties . . . that generally touches on independence." Id. at 430, quoting Aronson v. Lewis, 473 A.2d 805, 816 (Del. 1984). Continuing, the Delaware Supreme Court stated that the record amply demonstrated that neither Stafford nor Boushka possessed the "care, attention and sense of responsibility" necessary to afford them the status of independent directors. Id. at 430. Further:

Id.

The Delaware Supreme Court's decision required that the case be remanded for an entire fairness determination by the Chancery Court with the burden of persuasion on the directors. However, the Delaware Supreme Court addressed certain aspects of the plaintiff's claims of "unfair dealing" for the guidance of the Chancery Court.

In Weinberger, the Delaware Supreme Court stated that the test of entire fairness has two aspects, fair price and fair dealing. Id., citing Weinberger, 457 A.2d at 711. The fair dealing element focuses upon the conduct of the corporate fiduciaries in effectuating the transaction, including how the purchase was initiated, negotiated, structured and the manner in which director approval was obtained. Id. at 430-31, citing Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1280 (Del. 1988). The fair price element relates to the economic and financial considerations relied upon when valuing the proposed purchase including assets, market values, future prospects, earnings, and other factors which affect the intrinsic value of the transaction. Id. at 431, citing Weinberger, 457 A.2d at 711. Delaware courts have historically applied this heightened standard to ensure that individuals who purport to act as fiduciaries in the face of conflicting loyalties exercise their authority in light of what is best for all entities. Id.

With respect to fair dealing, the Tremont court noted that initiation by the seller, standing alone, is not incompatible with the concept of fair dealing so long as the controlling shareholder does not gain financial advantage at the expense of the controlled company. Id. at 431. With respect to the disclosure issues raised by the plaintiff, the Tremont court noted that the disinterest of the two previously contacted third parties (to purchase the NL shares) was "clearly not the type of information required to be disclosed." Id. at 432. Further, the Tremont court found that Valhi had no duty to disclose to Tremont that Salomon Brothers had advised Valhi concerning an appropriate illiquidity discount, noting:

Id.

The Delaware Supreme Court noted that although arguably, as the Chancery Court found, the resulting price paid for NL shares by Tremont might be deemed to be at the lowest level in a broad range of fairness, this did not satisfy the Weinberger test for entire fairness:

Id. (citations omitted).

3. LESSONS FROM TREMONT FOR SILICON VALLEY

At first blush, the Tremont case seems particularly troubling for Silicon Valley professionals. Perhaps more than any other part of the United States, portfolio companies, venture capitalists, investment banks and law firms in Silicon Valley are intertwined. A venture capitalist might serve on the board of one portfolio company, and own a considerable portion of the equity of such portfolio company, and then might wish to acquire all or a part of another portfolio company in which his venture capital firm has an interest. Similarly, an entrepreneur CEO and Chairman of the Board of a startup company may be asked to serve as a director of another corporation in a related industry. Moreover, it is not at all uncommon for a Silicon Valley law firm to have represented, in different matters at different times, both parties to a transaction.

While the ethical rules regarding such relationships are fairly simple to address through disclosure, consent and written waivers, the fiduciary duties owed to shareholders required by corporate law cannot be waived. More importantly, Tremont now requires that such relationships among directors (and their legal and financial advisors) should be examined closely before a special committee is formed. Simply appointing all non-officer directors as the special committee in such a context, as may be the current practice for some companies, may prove to be an unwise move if such directors are later found to be beholden to a person or party on the other side of the transaction. Indeed, as Tremont makes clear, even if directors do not have a direct interest in the matter before the special committee, if such directors could be viewed as beholden to a controlling shareholder (or in the context of a management buyout, management), such directors' service on a special committee may not satisfy the entire fairness test.

Similarly, Tremont requires that the special committee, rather than management or the interested board members, should select the legal and financial advisors to the special committee. Further, care should be taken to ensure that such legal and financial advisors are not similarly "beholden" to parties on the other side of the transaction. Having their ability to provide "non-biased" advice called into question may disturb some legal and financial advisors. The Tremont court made clear, however, that the court did not approve of the job done by the advisors, noting, "the circumstances surrounding the retaining of the Special Committee's advisors, as well as the advice given, cast serious doubt on the effectiveness of the Special Committee." Id. at 429. Whether the Tremont court believed that the problems with the advisors' recommendations grew out of a lack of independence, or rather was a product of the flawed selection process and the inability of the Tremont Special Committee members to attend meetings with the advisors is debatable. At a minimum, a thorough examination by the special committee (not management) of work done in the past for the opposing party in a transaction by potential advisors prior to appointment of such advisors by the special committee is warranted.

Ultimately, Tremont is probably not a case that potentially expands liability for special committee members. Rather, Tremont is a case where the members of the Tremont Special Committee, in a situation where there was already a large amount of outside influence on such individuals because of the controlling shareholder Simmons, thereby raising the "specter of impropriety," failed to convince the Delaware Supreme Court that the Special Committee deserved to have the benefit of the burden of proof on the entire fairness issue shifted to the plaintiff because the Special Committee's actions (and inactions), taken as a whole, were not sufficient to evidence such independence.

One member of the Tremont Special Committee never attended a meeting with the Special Committee' outside legal and financial advisors. Another member only attended approximately half the meetings. Both of these members effectively abdicated their role as Special Committee members. The third member, Stein, was employed at the time by affiliate companies of the Special Committee's financial advisors. The Delaware Supreme Court said it succinctly, "the result was that Stein, arguably the least detached member of the Special Committee, became, de facto, a single member committee - a tenuous role." Id. at 430.

Furthermore, it is not entirely clear that the Tremont rule will be applied as harshly outside of the controlling shareholder context. The holding in Tremont was fairly narrow, and stressed that challenged transaction was a "controlled transaction." Tremont, 694 A.2d at 430. It is entirely likely that outside of the controlling shareholder context (e.g., a common director on both sides of a transaction, common minority shareholders on both sides of a transaction), similar facts to Tremont would meet the entire fairness standard. In fact, given the Delaware Supreme Court's narrow holding and as explained below, it is possible that the Tremont directors will ultimately be found to have met the entire fairness standard. In our view, if (i) all of the members of the Special Committee had attended all of the Special Committee's meetings and (ii) the Special Committee had not chosen as its financial advisor Continental Partners (which was an affiliate of Stein's employers), it would be more likely that the Tremont Board of Directors would have had the benefit of the burden of proof on the entire fairness issue shifted to the plaintiff.

On remand in Tremont, the Delaware Chancery Court (Judge Lamb) noted that given the Delaware Supreme Court's placement of the burden of proof on the issue of entire fairness on the defendant directors, any remaining "fair dealing" issues had been resolved by the Delaware Supreme Court's opinion, and thus, only "fair price" issues remained. Kahn v. Tremont Corp., 1997 WL 689488 at *1 (Del. Ch. Ct. Oct. 28, 1997). As for the fair price issue, the Chancery Court explained:

I do not understand . . . the Supreme Court's decision to preclude a finding that the $11.75 per share price paid in the transaction was adequate to support a finding of entire fairness. Rather, I understand it to mean that Chancellor Allen's conclusion in this regard must be revisited in light of the Supreme Court's assignment of the burden of proof to the defendants and its finding that the Special Committee process was fundamentally flawed. Thus, the question to be addressed is whether the $11.75 price is sufficient to support a conclusion of entire fairness where it is found to be the product of a negotiating process lacking in independence.

Id. at *2. Instead of ruling on the fair price issue, the Chancery Court granted the parties' motions for the need to hear additional evidence on the fair price issue.

At the time these materials went to print, no further rulings had been issued by the Chancery Court in the Tremont case.

As stated above, the Tremont case, while providing some important lessons, should not be taken too far. Indeed, the Delaware Supreme Court itself has noted that "a finding of perfection is not a sine qua non in an entire fairness analysis." Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1179 (Del. 1995). The standard is not a bright line test, rather, it is a standard by which a court "must carefully analyze the factual circumstances, apply a disciplined balancing test to its findings, and articulate the bases upon which it decides the ultimate question of entire fairness." Id. Indeed, the Delaware Supreme Court's affirmance in Technicolor of the Chancery Court finding of entire fairness (on remand), and, accordingly, no director liability, notwithstanding that the Delaware Supreme Court had previously found (in a prior opinion of the Delaware Supreme Court in this litigation) that the Technicolor directors were grossly negligent in failing to provide for a market test, proves that the absence of certain aspects of fair dealing does not prevent a finding that a challenged transaction as a whole is otherwise fair to shareholders. Id. at 1179-80.

3. RECOMMENDATIONS FOR SILICON VALLEY PROFESSIONALS

1. To help prevent or identify potential conflicts of interest with corporate officers or directors, companies may want to circulate conflicts questionnaires to such individuals on a periodic basis. This could be done as part of the annual questionnaire sent out to directors for proxy statement purposes. However, given Tremont, the questions may have to go beyond those required by Item 404 of Regulation S-K
2. Whenever possible, any decisions in connection with a proposed transaction should be made by independent or disinterested directors in accordance with the applicable corporate statute. Although the appointment of a special committee is not absolutely required, it is difficult to imagine a good argument, from a risk management standpoint, militating against the formation of a special committee.
3. If a disinterested special committee of the board of directors is formed, the members of the committee (not management) should select outside legal and financial advisors. Care should be taken to ensure that the selected advisors do not have (or have had in the past) a relationship with the opposing party in the proposed transaction that could cause such advisors to be deemed "not independent." In fact, interested parties (like the opposing party in the transaction and its advisors) should now avoid recommending advisors to the other party.
4. If, after full disclosure by a director to the board, a conflict of interest is found to exist for a director, the interested director should refrain from voting on the transaction. It is also appropriate for such director to excuse himself from any meetings (or portions thereof) where such transaction is discussed.
5. Although an obvious point, as Tremont stresses, members of special committees should attend all, or nearly all, meetings of such special committee (including participating telephonically if necessary). While attendance is more of a duty of care issue, Tremont indicates that such an element of the duty of care can factor into the entire fairness test (traditionally a corollary of the duty of loyalty).
6. Recognize that when a controlling shareholder stands on both sides of a transaction, in litigation the directors' conduct probably will be viewed under the entire fairness test. Accordingly, taking sufficient steps to shift the burden of persuasion from the directors to challenging shareholders, including specifically the use of a well functioning committee of independent directors, may be critical to the outcome of any litigation. In fact, our experience is that in any conflict transaction which involves a value of more than approximately $50 million, the plaintiffs' lawyers will sue to test the transaction, get a price adjustment and collect attorneys' fees to settle the suit. The greater the non-compliance with the Tremont standard, the greater the settlement value.
7. Similarly, records of special committee meetings should reflect thoughtful and informed consideration of the relevant issues by the special committee. Legal counsel is critical to this issue, and such counsel should be sure to help draft the agenda, review the reports (written and oral) of the financial advisors and others and review or help draft the minutes of such meetings.
8. An independent special committee should be allowed to negotiate the terms of the transaction on the board's behalf and should not be limited in its access to information and resources.
9. Keep an eye on the changing structure of the transaction. A transaction that may start out as a merger with an outside third party (generally not implicating conflict of interest analysis) may devolve into a management buyout, or a transaction where management's interest in the company post-consummation is considerably higher. In either case, if management has a significant interest in the consummation of a particular transaction at the expense of an alternative transaction, the need for an independent special committee is triggered.
10. Consider obtaining shareholder approval of a transaction after full disclosure (perhaps even where not required by statute) to provide the highest level of comfort to the board of directors.