Kelly and Hymes Discuss Lessons From the 'Mindbody' and 'Columbia Pipeline' Decisions
In two recent post-trial decisions, the Delaware Court of Chancery found that officers of a target company had breached their fiduciary duties in connection with a sale process by acting for personal gain, rather than to maximize stockholder value, that the target boards did not sufficiently manage the officers’ conflicts of interest that infected the sale process, and that the acquirors were liable for aiding and abetting certain of the sell-side fiduciary breaches.
In the first of the decisions, In re Mindbody Stockholder Litigation, C.A. No. 2019-0442-KSJM, 2023 WL 2518149 (Del. Ch. Mar. 15, 2023), the court found that the target company’s founder and CEO, due primarily to frustration from an inability to monetize his stock holdings, set a sale process in motion largely without the target board’s knowledge, then tilted that process toward a preferred bidder because he believed it offered him the best post-acquisition financial upside, and that the target board neither knew about the CEO’s conflicts nor managed them effectively. The court further found that the CEO breached his duty of disclosure by failing to disclose the full extent of his interactions with the acquiror, and that the acquiror aided and abetted this breach by failing to correct the material omissions in the target’s proxy materials, as required under the merger agreement. The court suggested that the acquiror may have been found liable for aiding and abetting the sell-side sale process breaches of fiduciary duty if not for a “procedural foot fault” by plaintiffs in not asserting such a claim until the close of trial.
In the latter decision, In re Columbia Pipeline Group, Merger Litigation, C.A. No. 2018-0484-JTL, 299 A.3d 393 (Del. Ch. 2023), the court found that the target company’s CEO and CFO took actions outside the range of reasonableness due to the desire to trigger their change-in-control benefits and retire early, that the target board breached its duty of care by failing to sufficiently monitor the officers’ conduct during the sale process, and that the acquiror aided and abetted the officers’ breaches by exploiting their conflicts of interest, reneging on an agreement in principle on the deal price and lowering the bid, and threatening to violate the standstill in the parties’ NDA if the reduced offer were not promptly accepted. The court also found a sell-side breach of the duty of disclosure, as the proxy statement omitted several interactions between the officers and the acquiror and failed to explain that those interactions were in violation of the standstill, and further found that the acquiror aided and abetted that breach by not fulfilling its obligation under the merger agreement to inform the target of those material omissions.
Below, we summarize the court’s findings in the Mindbody and Columbia Pipeline decisions and provide some of the key takeaways for target boards, officers, acquirors and counsel.
The Mindbody case stems from a 2019 acquisition of Mindbody by a private equity firm (PE buyer). See In re Mindbody Stockholder Litigation, C.A. No. 2019-0442-KSJM, 2023 WL 2518149, at *1 (Del. Ch. Mar. 15, 2023).
According to the court’s post-trial opinion, in 2018, Mindbody’s founder and CEO had grown frustrated by his inability to monetize his equity holdings in the company and desired a sale. The CEO initiated a sale process largely without the knowledge or involvement of the company’s board of directors (board), and met multiple times with PE buyer and told it of his desire to sell. Those interactions culminated in PE buyer expressing to the CEO its interest in acquiring Mindbody. The CEO informed his management team and the board designee of the venture capital firm that was the company’s largest stockholder (who also desired a sale) of PE buyer’s expression of interest, but did not inform the rest of the board until the following week (and did not disclose to the board the full extent of his interactions with PE buyer).
The court found that, thereafter, the CEO took steps to facilitate a near-term sale to PE buyer. The CEO asked the VC board designee to serve as chair of the transaction committee for the potential sale, and the board accepted him in that role without discussion. During the sale process, the CEO did not adequately involve the board or follow a process to extract the best sale price. Instead, according to the court, the CEO communicated with PE buyer before other bidders were involved, made an unauthorized call to PE buyer to tip it that a sale process was underway, and rejected other bidders for personal reasons; meanwhile, the company’s banker informed PE buyer of the CEO’s desired target price. The board did not know about PE buyer’s “huge head start,” and eventually accepted PE buyer’s second purchase offer of $36.50 per share while competing bidders were still far behind PE buyer in their diligence. Id., *26, *39.
Stockholders of Mindbody filed suit alleging, inter alia, that the CEO and the rest of the board breached their fiduciary duties and that PE Buyer aided and abetted those breaches. By trial, all defendants had either settled or been dismissed from the case except for CEO and PE buyer.
After trial, the court, applying enhanced scrutiny, found in favor of plaintiffs on their “paradigmatic Revlon claim,”—a situation where “a conflicted fiduciary who is insufficiently checked by the board tilts the sale process toward his own personal interests in ways inconsistent with maximizing stockholder value.” As to the sale process claim, the court concluded that the CEO breached his duty of loyalty because he “greased the wheels” for PE buyer and that the CEO suffered a disabling conflict because of his desire for liquidity and post-merger employment with the most financial upside. The court also found that the board did not know about and or manage the CEO’s conflict. The court determined, based on PE buyer’s internal communications, that PE buyer would have paid one dollar more per share, and that the CEO was liable for that amount. The court indicated that PE buyer may have been found to have aided and abetted the sale-process breach of fiduciary duty, had plaintiffs not failed to timely raise the claim.
As to the disclosure claim, the court found that the proxy did not adequately inform stockholders about, among other things, the CEO and PE buyer’s initial meetings and discussions or PE buyer’s expression of interest. The court found that the proxy presented a “false narrative” and, therefore, the Mindbody stockholders were not fully informed when they voted on the deal. The court also found that PE buyer aided and abetted the CEO’s disclosure breach because it did not correct the proxy disclosures about its involvement, as required under the merger agreement. On this point, the court noted that PE buyer took steps to hide information about the sale process from internal materials, reflecting its knowledge of the significance of the proxy’s omissions. In connection with the disclosure violations, the court ruled that the CEO and PE buyer were jointly and severally liable for nominal damages of one dollar per share. The court made clear that plaintiffs were entitled to only one recovery, stating that the damages awards were not cumulative.
The Columbia Pipeline case stems from a 2016 acquisition of Columbia Pipeline Group (Columbia) by another energy company (the acquiror). See In re Columbia Pipeline Group, Merger Litigation, 299 A.3d 393 (Del. Ch. 2023).
According to the court’s post-trial opinion, in connection with a 2015 spinoff, Columbia’s CEO and CFO (the officers) were granted change-in-control benefits that would result in significant payments if Columbia were thereafter acquired. With an eye toward retirement, these individuals desired a near-term sale. Outreach from potential buyers came soon after the spinoff was completed.
At the initial stages of the sale process, Columbia entered into non-disclosure agreements with multiple potential bidders. The NDAs contained “don’t-ask-don’t-waive” standstills that prohibited the bidder from seeking to buy Columbia without the permission of Columbia’s board of directors (the board), from contacting the company without invitation after termination of discussions, and from asking the company to waive the standstill. After receiving expressions of interest that it viewed as “too low to pursue,” the board ended the sale process. However, despite the standstill, a representative of the acquiror—who had previous ties to the CFO—promptly contacted the CFO to express acquiror’s continued interest. The CFO indicated that management continued to want to sell the company and expected to resume the process in a couple of months.
The court found that, thereafter, the officers “showed extraordinary solicitude toward” acquiror, which engaged in “a series of contacts” with the officers that “blatantly breached the standstill.” The officers, however, made “no effort to enforce” the standstill. It was not until after the acquiror made an oral expression of interest did the Officers finally go to the board to obtain permission to engage in exclusive negotiations. Subsequently, acquiror made an offer of $24 per share, below its indicative range, which offended the officers; the acquiror “immediately upped” its bid to $25.25, which the board rejected (on the officers’ recommendation). The officers then proposed to the acquiror a price of $26 per share, a price which the parties agreed on, and the sides believed they had reached an agreement in principle. After news of the deal talks broke in the press, the officers, believing they were close to signing up a deal with the acquiror, recommended to the Board that it renew the acquiror’s exclusivity, despite the fact that the company had been contacted by a potential second bidder. The acquiror then dropped its offer to $25.50 per share and threatened to publicly announce that negotiations had ceased if the offer were not accepted promptly. The board accepted the lowered offer at the officers’ recommendation.
The plaintiffs filed suit alleging that the officers and the board breached their fiduciary duties, and that the acquiror aided and abetted such breaches. The members of the board (other than the CEO) were dropped as defendants when the plaintiffs amended their complaint, and the officers settled before trial. Trial proceeded on the plaintiffs’ aiding and abetting claim against the acquiror.
After trial, the court held that the officers breached their duty of loyalty by prioritizing their own interests in a sale over the interests of the company’s stockholders, and that their desire to trigger their change-in-control benefits influenced them to take actions that were “outside the range of reasonableness.” According to the court, the officers, in pursuit of a deal, “behaved in ways that undercut Columbia’s negotiating leverage, led to lower offers from the acquiror, and resulted in the acquiror reneging on the $26 deal and ambushing” them with the lower offer.
The court next determined that the board inadvertently breached its duty of care by not sufficiently monitoring the officers or managing their conflicts.
The court also found that the officers and board breached their duty of disclosure because the proxy statement omitted or misleadingly portrayed the officers’ interactions with the acquiror, and failed to disclose the acquiror’s violations of the standstill, the parties’ agreement in principle, or that the acquiror reneged on that agreement.
The court then held that the acquiror aided and abetted the officers’ breach of the duty of loyalty by knowingly exploiting the Officers’ desire for a sale, explaining that the acquiror’s knowledge of the Officers’ conflicts emboldened the acquiror to renege on the parties’ agreement in principle, reduce the price, and threaten to publicly announce that the negotiations had concluded if the lowered offer was not accepted within three days. The court found the acquiror liable for damages of $1 per share—the difference between the merger price and the $26 price agreed to in principle, adjusting for increases in the equity component of the agreement in principle.
The court further held that the acquiror aided and abetted the disclosure breach by “choosing not to correct the material misstatements or omissions in” the Columbia proxy, in violation of the acquiror’s obligation to do so under the merger agreement. With regard to the claim of aiding and abetting the disclosure breach, the court awarded $0.50 per share as damages, but made clear (like in Mindbody) that damages for the two aiding and abetting claims were not cumulative.
- A board of directors should have an active and direct role in a sale process “from beginning to end.” (quoting Cede & Co. v. Technicolor, 634 A.2d 345, 368 (Del. 1993)). While senior officers often are involved in a sale process—indeed, management may be “most knowledgeable about the company, its value, and the industry in which it operates” (In re Ply Gem Industries Shareholders Litigation, 2001 WL 755133, at *10 (Del. Ch. June 26, 2001))—a board’s sole reliance on management may “taint the design and execution of the transaction.” See Mills Acquisition v. Macmillan, 559 A.2d 1261, 1281 (Del. 1989). As seen from the court’s findings in Mindbody and Columbia Pipeline, if a board is not vigilant, conflicted managers could commence (or resume) a sale process or steer it toward a preferred bidder.
- The board’s duty to oversee a sale process includes the need to identify and manage conflicts of interest on the part of directors, officers, or advisors, so that any such conflicts do not undermine the process. In both Mindbody and Columbia Pipeline, the court found that the board did not sufficiently monitor or manage corporate officers’ conflicts of interest, and that the conflicts led to a reduced transaction price. The court in Columbia Pipeline noted that, if the board had more information about management’s conflicts, “they would have realized that [the Officers] were not the right people to lead the sale process, and they could have shifted [the company’s bankers] into that role.”See In re Columbia Pipeline Group, Merger Litigation, 299 A.3d at 470.
- Officers have an obligation to provide the board with information needed to carry out its duties. Officers should, therefore, promptly report any merger-related communications with a potential buyer to the board. The court in each case discussed above found that management did not sufficiently inform the board regarding their interactions with the acquirors.
- Officers should follow any procedural guidelines established by the board or transaction committee regarding the sale process. Discussions regarding post-merger employment and compensation details should wait until the principal transaction terms have been agreed on, as stockholder-plaintiffs may attempt to portray such discussions as creating a possibility that management may have divergent interests from stockholders or may have steered the process toward a bidder with whom they engaged in such discussions.
- The court may scrutinize officers’ conduct in relation to the target company’s exercise of contractual rights, particularly where that conduct is alleged to be motivated by self-interested reasons. The court in Mindbody, for instance, found that the CEO—during the post-signing go-shop period—revealed to the acquiror that a potential interloper was trying to put together a bid, and when he went on vacation, instructed management to decline go-shop presentations in his absence, “signaling his lack of interest in a competing offer.” In re Mindbody Stockholder Litigation, 2023 WL 2518149, at *27. And, the court in Columbia Pipeline found that the target officers “did not care about” the standstill in the non-disclosure agreement between the target and the acquiror in the face of the acquiror’s breaches leading up to the parties’ entry into the merger agreement, and, in light of the record, seemed skeptical of the sell-side for extending the acquiror’s exclusivity “after a public leak about the deal talks and an inbound inquiry from [another] bidder.” In re Columbia Pipeline Group, Merger Litigation, 299 A.3d at 465, 468.
- There remains a high bar for holding third-party bidders liable for aiding and abetting a sell-side fiduciary sale process breach. Third-party bidders are, of course, permitted to negotiate at arm’s length with the target to seek to reduce the purchase price. As such, third-party acquirors rarely will face a viable aiding and abetting claim. However, where an acquiror “creates, exacerbates, or exploits” a sell-side fiduciary, the acquiror may face a possible aiding and abetting claim. The court in Columbia Pipeline emphasized that isolated foot faults would not have subjected the acquiror to aiding and abetting liability; rather, the acquiror “pushed on [target management] for months, inducing them to commit errors and give away points,” and even then, “would not [have been found] liable for aiding and abetting without the final act of reneging on the deal … , dropping the price …, and making a coercive threat …”
- An acquiror should utilize contractual rights to review the target’s proxy statement and should fulfill contractual obligations to correct material misstatements or omissions therein that relate to the acquiror’s interactions with the target. Failure to identify and correct material misstatements or omissions in the target’s proxy relating to the acquiror’s interactions may subject the acquiror to a claim of aiding and abetting a sell-side fiduciary breach of the duty of disclosure. Fully informed target stockholder approval, on the other hand, can “cleanse” any sale process flaws when the deal does not involve a conflicted controlling stockholder, and lead to pleading stage dismissal of claims for fiduciary breach and aiding and abetting.
- An acquiror should be on the lookout for favoritism from, or potential conflicts of interest on the part of, representatives of the target company. The two cases discussed above provide examples of such potential conflicts on the sell-side or preferential treatment provided to the acquiror. If an acquiror detects an apparent sell-side conflict of interest or suspects it may be receiving preferential treatment from the target, the acquiror should evaluate with its counsel how best to proceed with regard to participating in the process and negotiating with the target.
- Deal counsel should remind clients that, as noted above, fulsome and accurate disclosures in the transaction proxy, followed by stockholder approval of the deal, will (outside of a conflicted controller transaction) result in the application of the irrebuttable business judgment rule and cleanse the deal from fiduciary challenge under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015). See also Larkin v. Shah, 2016 WL 4485447 (Del. Ch. Aug. 25, 2016).
- In the event there were a materially misleading disclosure, however, in the Columbia Pipeline decision, the court introduced a new rebuttable presumption of stockholder reliance on a transaction proxy that contained the alleged disclosure violation. Stockholder class plaintiffs in the future may attempt to seek quasi-appraisal or rescissory damages stemming from the alleged disclosure breach as a result of the court’s ruling.
- Transactional counsel should emphasize to clients at the outset of a potential deal process to be mindful that their text messages, emails, and other forms of communications will be scrutinized by plaintiff’s lawyers if litigation is brought with regard to the transaction, and may factor into the court’s decision in determining whether defendants breached their fiduciary duties or aided and abetted in a fiduciary breach. In both Mindbody and Columbia Pipeline, the court quoted and relied on contemporaneous emails and text messages when reaching its holdings.
Reprinted with permission from the October 18, 2023 edition of the Delaware Business Court Insider © 2023 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.