In a recent M&A decision following trial, the Delaware Chancery Court held the former CEO of a public company personally liable for breaches of fiduciary duty in a sale of the company (In Re Mindbody, Inc. Stockholder Litigation (Del. Ch. March 15, 2023)). The court found that:
- The CEO violated his fiduciary duty under Revlon to obtain the best possible transaction under the circumstances by tilting the sale process in favor of the acquirer.
- The CEO was personally liable for inadequate disclosures in the merger proxy statement.
- The acquirer—a leading private equity firm—failed to ensure disclosure of material facts in the merger proxy statement despite a contractual obligation to do so, and therefore was jointly and severally liable for aiding and abetting the CEO’s disclosure violations.
- The plaintiffs could recover $1 per share in damages from the CEO and the acquirer PE firm (amounting to $44 million plus interest and costs). In determining the award, the court concluded, relying on internal text messages and other communications, that the acquirer PE firm was willing to pay an extra $1 per share.
Delaware law allows an unconflicted CEO wide latitude to lead an exploration of the sale of a company provided that the board of directors or a committee of the board supervises the process and that steps in the process fall within a range of reasonableness. In Mindbody, the court found that the sale process did not meet these standards due to the CEO’s “disabling conflicts[s]” and extreme favoritism for the acquirer PE firm.
The facts in Mindbody are a tutorial on how not to sell a public company. Although the particular facts in Mindbody are unique, the underlying dynamics and pressures can arise in almost any significant M&A transaction. Among the “bad” facts recited by the court, the CEO:
- Was highly conflicted due to his desire for near-term liquidity, a “fast” sale of the company, and post-transaction employment which promised substantial equity and wealth upside. The CEO’s stock ownership did not mitigate these conflicts.
- Gave the acquirer PE firm substantial timing and informational advantages by:
- Failing to disclose to the company’s board of directors his motivations and interactions with the acquirer PE firm.
- Suggesting to the acquirer PE firm that the company was open to a sale and pitching the merits of an acquisition.
- Failing to disclose to the board for a week receipt of an indication of interest from the acquirer PE firm.
- Tipping off the acquirer PE firm that the company would commence a formal sale process (and later tipping the acquirer PE firm to the identities of bidders in a post-signing “go shop” process).
- Failed to disclose to the board that a director associated with a major VC investor in the company confided in him that his VC fund desired a near term exit; the board later appointed that director to chair a transaction committee that oversaw the sale process.
- Ignored communication requirements to refrain from contacting the acquirer PE firm and attended every meeting of the transaction committee.
- Talked down the company’s Q4 forecast during an earnings call, prompting analysts to adjust their company price targets downward, a development that encouraged the acquirer PE firm to pursue its bid.
As a result of the CEO’s conduct, the court said the company board and the transaction committee utterly failed to effectively oversee the sale process.
The court also said that the M&A financial advisor retained by the transaction committee tipped the acquirer PE firm as to the CEO’s target purchase price for the company. In addition, the stockholder vote was not fully informed—for one thing, the merger proxy statement did not mention several material facts, including a number of pre-sale process meetings and communications between the CEO and the acquirer PE firm and positive 4th quarter financial results.
- The board of directors has ultimate responsibility for designing and implementing a process for selling the company. A CEO who receives an inquiry he or she believes should be explored should promptly alert the board.
- Authorization to explore a sale of the company rests with the board. Putting the company “in play” by signaling that it is for sale or intends to undertake a sale process is a decision for the board—not the CEO or the company’s investment banker, unless authorized by the board.
- Directors and officers should recognize and disclose conflicts to the board. They each have a duty to do so to ensure that the board is able to properly discharge its duties, should the board pursue a sale of the company.
- The board should identify, examine and neutralize potential conflicts, including removing the CEO from the sale process if the officer appears hampered by material conflicts.
- Acquirers—PE firms and strategics alike—should understand and embrace the importance of a sound target board sale process and M&A disclosure requirements under Delaware law. They should pay attention to red flags—such as a CEO inexperienced in selling a public company, a CEO acting without apparent board oversight or approval, or apparent material omissions from a draft merger proxy statement.
- The target board should consult legal and financial advisors as early as possible after receiving an unsolicited acquisition proposal. Frequently, experienced advisors can address “foot faults” so they do not undermine the sale process.
- Parties should not assume that text messages will remain private. The plaintiffs were able to obtain text messages relating to the transaction through records requests and the court relied on text messages to make factual determinations.
* * * * *
If you have any questions regarding the Mindbody case, please contact one of the listed authors or your regular Orrick contact.