Manti Holdings, LLC v. Carlyle Group Inc., C.A. No. 2020-0657-SG (Del. Ch. June 3, 2022) (Glasscock, V.C.)
In this memorandum opinion, the Court of Chancery denied a motion to dismiss claims for breach of fiduciary duty and unjust enrichment arising from the sale of Authentix Acquisition Company, Inc. (“Authentix”). Plaintiffs asserted claims for breach of fiduciary duty against three Authentix directors and Authentix’s controlling stockholder Carlyle U.S. Growth Fund III Authentix Holdings, L.P. and certain of its affiliates (collectively, “Carlyle”) and claims for unjust enrichment against Carlyle and Authentix’s CEO. The Court granted, however, a motion to dismiss claims for aiding and abetting and civil conspiracy. The Court held the entire fairness standard of review applied to the sale, and that plaintiffs pled sufficient facts at this stage to support a claim of unfair price and unfair process.
Authentix, a Delaware corporation, maintained a capital structure consisting of common and preferred stock, both controlled by Carlyle. All Authentix stockholders were parties to a stockholders agreement containing drag-along rights requiring all non-Carlyle stockholders to consent to any sale of Authentix approved by the company’s board and a majority of Authentix stockholders (i.e., Carlyle). Additionally, preferred stockholders, including Carlyle, were entitled to the first $70 million of any sale consideration.
In October 2015, Authentix began exploring a potential sale of the company. The process, however, was complicated by the fact that Authentix’s customer base was consolidated, creating a risk that one or more of its customers might cancel or fail to renew their contracts with the company. While director Lee Barberito, a designee of Authentix stockholder Manti Holdings, LLC, favored delaying the sale process until the company had received further clarity from its customers, Authentix CEO and director Bernard Bailey allegedly was under pressure from Carlyle to sell the company as soon as possible so that it could monetize its investment in Authentix and return that money to its investors.
To that end, on July 22, 2017, Blue Water Energy submitted a $105 million all-cash offer for Authentix, $77.5 million of which was guaranteed and $27.5 million of which was contingent. After Barberito urged the board to withdraw from the sale process, the other directors stopped providing him with status updates and pushed forward with the sale. About a month later, two of Authentix’s major customers renewed their contracts with the company and Authentix earned a new contract with the U.S. Federal Reserve Bank. Instead of seeking to renegotiate the deal, on September 12, the Authentix board voted 4-1, over Barberito’s lone objection, to consummate the sale, and Carlyle executed a written consent. No further stockholder vote was needed pursuant to the terms of the stockholders agreement, and the sale closed. Since Carlyle held a majority of Authentix preferred stock, it received the bulk of the $77.5 million in guaranteed sale consideration, resulting in a profit on its investment.
The Court first held that Carlyle, a controlling stockholder of Authentix, was conflicted because it received a unique benefit from closing the sale on its preferred timing (i.e., by September 2017). Thus, because Carlyle was a conflicted controller, the Court held that entire fairness was the applicable standard of review. While the defendants argued that Corwin cleansed the transaction, the Court rejected that argument, explaining that Corwin does not apply to conflicted controller transactions and that the deal was not approved by a majority of Authentix’s independent stockholders. The Court went on to hold that, because the complaint alleged that Authentix’s value was depressed because of contract uncertainties, and because the sale was not approved by an independent special committee, plaintiffs had met their burden to show that it was reasonably conceivable that the sale was not entirely fair.
Similarly, the Court held the complaint sufficiently stated claims against the three director defendants. Two of those defendants served as dual fiduciaries of Authentix and Carlyle. The Court held that, because the interests of these two entities diverged, the fiduciaries faced inherent conflicts of interest which were not cleansed by the formation of a special committee, and both participated in the sale process throughout. The Court held that these allegations gave rise to a reasonable inference that both directors acted disloyally in connection with the sale.
Regarding the remaining director defendant, who also served as Authentix’s CEO, the Court relied on long-standing Delaware precedent to hold that senior corporate officers generally lack independence in connection with matters involving the interests of a controlling stockholder. This presumption was further supported by allegations that the CEO had stated during sale negotiations that he “worked for Carlyle” and “had been told to sell the company.” As such, the Court held the complaint sufficiently plead factual allegations that this director breached his fiduciary duties.
The Court also denied the motion to dismiss the unjust enrichment claims against Carlyle and Authentix’s CEO. While Carlyle argued that any sale at an unfair price would have impoverished Carlyle because of its ownership of common stock, the Court rejected this argument, finding that the complaint sufficiently alleged that Carlyle desired an immediate sale, which it received, and which worked a benefit or enrichment on Carlyle. The Court likewise rejected an argument that the unjust enrichment claim against Carlyle was duplicative of the fiduciary duty claim. The Court also maintained the unjust enrichment claim against Authentix’s CEO, holding that the claim was properly asserted as a direct claim because it was plausible that the $3 million bonus paid to Bailey in connection with the sale was a transaction expense paid out of the sale consideration, thus diverting the consideration that otherwise would have gone to stockholders.
Finally, the Court dismissed claims for aiding and abetting and civil conspiracy, holding that the complaint failed to establish knowing participation by a non-fiduciary defendant, since both Carlyle and the director defendants owed fiduciary duties to Authentix and its minority stockholders.