Anyone considering a private-equity buyout should study a trio of recent Delaware decisions by Vice Chancellor Leo Strine. Each of the three decisions – Netsmart[1], Topps[2], and Lear[3]– is a fact-intensive analysis of whether directors selling a public company in a private-equity buyout met their duty to seek the “best value reasonably attainable” for shareholders as required by the Delaware supreme court’s 1985 Revlon opinion and subsequent cases.[4]

In Netsmart, Strine found directors had breached Revlon duties by limiting an auction to financial bidders without a reasonable basis for excluding strategic bidders. He reasoned that sporadic past contacts between Netsmart’s investment banker and potential strategic bidders were not a sufficient basis for excluding them from an auction because of changes in Netsmart and market conditions.

Strine found a post-signing “window shop” provision was not a substitute for adequate shopping before signing due to the thin market for this micro-cap’s stock. His decision was also influenced by late formation of the special committee – after management (counting on remaining after a private-equity buyout) had driven the decision to exclude strategic buyers – and by the special committee’s decision to hire the company’s long-time investment banker as its financial adviser.

Proving adequacy of the deliberative process was made difficult by poor minute keeping. Minutes for the 10 meetings at which Netsmart directors formally considered the transaction over a period of four months were not approved until after shareholders filed litigation. And, the meeting at which they claimed to have actually decided to sell was “informal” and never memorialized in minutes.

Despite these flaws, Vice Chancellor Strine permitted Netsmart shareholders to decide their fate, enjoining the vote only until additional information (including a copy of his lengthy decision) could be provided to shareholders.

In Topps, Strine found that the process leading up to signing a buyout agreement between the venerable baseball-card company and a private-equity group led by Michael Eisner was adequate under Revlon. The Vice Chancellor also commented favorably on a liberal “go-shop” provision in the Eisner agreement that permitted the Topps board to “shop like Paris Hilton” for 40 days. However, Strine found that Topps directors had likely later failed in their duties by holding a competing bidder at bay with a standstill agreement. Strine enjoined the Eisner deal until additional disclosure was circulated to Topps shareholders and the standstill agreement waived to permit a competing tender offer.

In Lear, Strine found serious Revlon issues when the special committee of this Fortune 200 company permitted the CEO to continue leading negotiations for a buyout by Carl Icahn, despite the CEO’s conflicts of interest. Again, the Vice Chancellor enjoined a vote on the Icahn deal only until additional information concerning the CEO’s conflicts could be distributed to shareholders.

These cases make a number of important points about Revlon duties in private-equity buyouts:

  • Process is everything. It must be deliberate, informed and controlled by the board, not the CEO.
  • Boards must understand and properly deal with conflicts inherent in any buyout where management has a continuing role. Shortcuts linked to management conflicts of interest inevitably lead to problems.
  • The special committee should be formed early – before decisions on scope of an auction or other shopping strategies are made. The special committee should hire independent advisers except in extraordinary circumstances.
  • To get the most mileage out of good deliberative process, minutes must be prepared in a timely, accurate and thoughtful manner. Boards must make full disclosure of material information, including management conflicts, when seeking shareholder approval of a going-private deal.

The duty under Revlon to seek the best value reasonably attainable is a very serious fiduciary responsibility. But recent Delaware case law makes it clear that a reasonable process will suffice – even in the challenging context of a private-equity buyout.