The Rights and Obligations of Policyholders, Board of Directors, and Management
The Legal Duties of the Board of Directors
As a general rule, few state laws or court decisions specifically address the fiduciary duties owed by a mutual board. Nevertheless, it should be assumed that mutual boards owe duties to their company and members that are the same as the duties owed by directors of stock corporations to their companies and shareholders. In most states, these duties consist of the duty of care and the duty of loyalty.
Duty of Care
The fiduciary duty of care typically requires that directors, in the performance of their corporate responsibilities, exercise the care that an ordinary prudent person would exercise in the management of his or her own affairs under similar circumstances. Directors are required to make informed business decisions by considering all material information reasonably available to them, including adequate review of key transaction documents, either by reading it or having it explained by experts. Although directors are not required to possess any particular expertise, they should obtain the assistance of outside consultants if evaluation of a subject requires special expertise and knowledge that they do not possess.
Duty of Loyalty/Business Judgment Rule
The fiduciary duty of loyalty prohibits self-dealing by corporate directors. Their position of trust and confidence may not be used to further their own interests or to entrench themselves in management positions. Generally, absent a breach of these fiduciary duties, under the business judgment rule, a decision by a board will be respected by the courts of most jurisdictions and directors will be protected from liability for these decisions regardless of whether the decision is subsequently shown to be unwise. The business judgment rule is a presumption that in making business decisions, a board of directors is protected if it acts in good faith, on an informed basis, and in a manner reasonably believed to be in the best interests of the company.
Most states and state courts have applied the business judgment rule in the context of a takeover and have respected a board of directors' business decision, with two notable refinements. First, any action taken by a board of directors in anticipation of, or in response to, an unsolicited takeover threat is reviewed under an enhanced scrutiny standard (i.e., a stricter standard) first set forth in the Unocal case. According to the decision in Unocal, in order to receive the protection of the business judgment rule in connection with the adoption of anti-takeover measures in response to an unsolicited takeover threat, a board of directors must show that its decision-making process conformed to the standards of a good faith, reasonable investigation and that the defenses selected were reasonable in relation to the takeover threat.
Second, if the transaction being considered by the board of directors involves an inevitable change of control over or break-up of the company, in states that follow the majority Delaware line of cases, directors will have a fiduciary duty to maximize the value of the company by considering alternative transactions and selling to the bidder offering the greatest short-term value (the so-called "Revlon Duties"). Once the sale of control or break-up of the company is inevitable, the board should no longer consider long term benefits, since the shareholders or policyholders they represent do not have long term interests in the company. Instead it should become auctioneers trying to obtain the most value in the short term for the company. A mutual board should be aware that announcing almost any form of a restructuring transaction could lead to competing proposals from third parties. If a credible bidder offers policyholders more consideration and other rights compared to the internal restructuring, in practical, if not legal, terms, the board and management face difficult issues.
Mutual Restructuring Transactions
Traditional demutualizations, the formation of a mutual holding company or a mutual company merger generally are not considered a change of control. Therefore, directors are not obliged to auction off the company or otherwise maximize short term value to policyholders if they make a decision to go forward with such a transaction. They remain, however, subject to the usual standard of care and to the business judgment rule. In a traditional demutualization, policyholders become shareholders of a new stock company (alternatively, some may receive policy credits or cash) and retain their policy rights. The demutualization often includes or is followed by an initial public offering of stock of the new stock corporation. In most such cases, even where there is a public offering, as long as no one stockholder or group of stockholders will dominate the new stock company, a change of control will not have occurred since the mutual company has gone from being owned by one large, fluid body of persons (policyholders) to being owned by another large, fluid body of persons (stockholders). Similarly, the formation of a mutual holding company that would own at least a majority of the stock of a converted stock company insurer should not involve a change of control. In the mutual holding company formation, policyholder rights are bifurcated into a membership interest in the mutual holding company and policyholder rights issued by the stock insurer. The stock insurer may issue up to 49% of its stock to the public (directly or by means of an intermediate stock holding company). Again, there is arguably no change of control because the mutual holding company, by law, retains a majority interest in the insurer and is itself "owned" by the same members as the insurer was before the restructuring. A mutual merger, similar to a stock company merger, replaces one fluid body of owners with another and typically does not involve a change of control.
One form of restructuring that could clearly raise a control issue is a sponsored demutualization where all, or a control block, of the stock of a newly formed holding company is held by the sponsor and policyholders are given cash, or in some cases stock (and premium credits) in the sponsor, while retaining their policy rights.