Mastering the Art of Unsolicited Takeovers

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takeover-11-25-15.pngAssume you sit on the board of a bank that has no present interest in being acquired. Without warning, you receive an unsolicited takeover offer. Much as you may find this an annoying distraction, you cannot dismiss the offer out-of-hand. Rather, you must ensure that the board respects the foundational principle that, as a body, it must make decisions that enhance shareholder value. It must accept its decision-making responsibility, and promptly undertake a financial analysis to determine whether the offer is one that could put the shareholders in a better position than maintaining the status quo. If the board concludes that the offer is legitimate and that, once accepted and consummated after negotiations, it could put the shareholders into a more favorable position than retaining their existing bank shares, then a decision is virtually unavoidable.

If You Are the Target
In most states, following their version of the business judgment rule will protect the board’s decision and courts are reluctant to second-guess that decision as long as:

  1. The board has adhered to the bank’s documented governance processes and recusal mechanisms that are consistent with peer institutions and designed to eliminate board member self-interest influences.
  2. The board relied in good faith upon non-conflicted expert advice.
  3. The board minutes establish that it conducted a thoughtful decision-making process. If the financial analysis makes the ultimate decision too close to call, thereby giving good reason to consider non-economic issues, and the bank’s by-laws permit the board to weigh non-economic factors, it is imperative that negotiations over non-economic concerns be carefully documented to mitigate litigation risk regardless of whether a transaction receives a green or red light.

If You Are the Acquirer
Now assume you are a board member of the acquiring bank. Knowing that your unsolicited offer will gain traction only if the target’s board finds the offer to be legitimate, your first concern should be to make certain that you have assembled a team with the necessary expertise willing to devote the resources to due diligence. The better the acquirer understands the target’s governance and attitude, as well as its customer demographics, competitive position and the potential for regulatory concern over market concentration, the more tailored the offer will be to the interests of the target and the more likely the offer will receive favorable consideration. If later challenged, the board’s due diligence will be judged by the investigative standard of reasonableness, where management decisions were ratified by the board only after independent inquiry. The board must uphold its duty of care, and that obligation will have been met if it has made reasonable examination of the totality of available information, including strategic, operational, management, timing and legal considerations.

Using Advisors
Whether you are on the board of the target or the acquirer, you will need to have a level of market, industry and technical expertise that requires engagement of outside advisors, with investment bankers often being the most prominent. The board will need to understand every advisor’s motive. It is essential that the advisors challenge your assumptions, and if their financial incentives depend on closing the deal, you must remain alert to that natural bias. The board must resist investment banker pressure to get a deal done, making sure that board agendas provide adequate time to study implementation progress, to anticipate and mitigate risks and to identify additional and alternative opportunities.

Clarity and open communication among members of the key leadership team and their advisors is imperative, especially with regard to keeping the transaction true to the board’s primary business goals.  These factors will drive contract negotiations, elevate the quality of the due diligence effort and ensure that the initiatives and business elements that create value are prioritized in the integration process.

For both acquirer and target, investment bankers in collaboration with legal counsel can be invaluable in guiding the boards towards successful completion of the transaction. Seasoned investment bankers can help set appropriate price terms and conditions and establish critical protocols for communicating with employees, the media, the market and investors. Experienced legal counsel can negotiate a transition services agreement governing consolidation and systems conversion and provide early, active and competent interaction with regulators to ensure unimpeded processing of all necessary filings and approvals.

Above all, it is vital to remember that failing to close the deal may ultimately be in the best interests of the enterprise. Ego, incentive compensation and deal momentum can all too easily distract the board from its paramount responsibility, namely, to constantly vet all pro forma assumptions of the deal.

Avoiding Pitfalls in Your Bank’s Data Processing Agreement

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vendor-management-9-23-15.pngA bank’s core processing agreement is often, by far, its most significant vendor agreement. These lengthy and complex agreements are commonly weighted heavily in favor of the vendor and can be rife with traps, such as steep change-in-control and early termination penalties. Nonetheless, many banks enter into core processing agreements without prior review by counsel, or even reading the agreement themselves. In the current regulatory environment, which stresses and scrutinizes vendor risk management and diligence, a bank’s failure to review and negotiate its core processing agreement could easily result in regulatory criticism, as well as unanticipated costs and potential liability.

In the past few years, the bank regulatory agencies have issued new or updated guidance related to vendor diligence and risk management. In those issuances, the regulators express concern that banks’ vendor risk management practices may be inadequate, citing instances in which management has failed to properly assess and understand the risks and costs of their vendor relationships. Regulators are concerned that banks may enter into agreements that are detrimental to the bank’s employees, customers or other stakeholders. Banks are expected to have risk management processes that correspond with the level of risk and complexity of their vendor relationships. Those processes include due diligence, careful vendor selection, contract negotiation, proper termination mechanisms and ensuring proper oversight. Regulators further expect banks to have more comprehensive and rigorous oversight of management of third-party relationships that involve critical activities, which may include significant bank functions, such as payments, clearing, settlements and custody, or significant shared services, such as information technology.

Regulators conducting bank examinations expect to see adequate risk management policies and procedures in place. Proper due diligence, negotiation, and oversight for data processing contracts should be integral to those procedures. Contrary to what many may think, the terms of data processing agreements are negotiable. Some of the most unfavorable terms may be eliminated simply by emphasizing the regulatory or business necessity for those changes during negotiations. Key terms to address in the negotiation process include termination provisions, regulatory provisions, audit rights and performance standards, among others.

A less obvious concern with core processing agreements arises in the context of a bank merger or acquisition. Steep termination fees in a data processing contract can change the economics of a bank acquisition transaction, making the selling bank a less attractive target and negatively impacting shareholder returns on the sale. It is typical for the initial proposal of a data processing agreement to include contract termination fees equal to roughly 80 percent of the remaining fees payable during the term of the contract. In most cases, these termination fees are negotiable, and data processing providers may be receptive to a graduated termination fee schedule, such that termination fees are less severe later in the term of the contract. In addition, termination fee calculations in core processing agreements are often complex. As such, it will be important for bank management to understand the practical implications of those calculations. Data processing providers will often attempt to recoup any past credits or rebates through the termination fee formula. Understanding and negotiating these termination provisions on the front end can save millions of dollars for the acquiring bank, and ultimately increase returns for the bank’s shareholders.

If your bank is considering a new data processing vendor, or reaching the expiration of your current term and considering renewing with your old vendor, you should work through your regulatory vendor risk management and due diligence checklists before entering into a new contract. We further encourage you to identify a dedicated team, with access to bank counsel, to review and negotiate any proposed agreement. If your institution is considering a future sale or other business combination transaction, then negotiating your data processing contract is of paramount concern. Ultimately, an ignored termination provision in your core processing agreement has the potential to undermine a potential merger or materially impair shareholder returns.