In these difficult economic times, financial sponsors often find themselves holding their investments longer than they initially intended. Liquidity and exit opportunities are not easy to come by and are often fleeting when they present themselves. Nevertheless, a recent Delaware Chancery Court case reminds us that a board of directors must satisfy its fiduciary duties to all stockholders in a change of control transaction, despite pressures from financial sponsors or other major investors to “get the deal done.” In re Answers Corp. Shareholders Litigation, Consolidated C.A. No. 6170-VCN, 2012 BL 92475 (Del. Ch. Apr. 11, 2012).
The case involves the merger of Answers Corporation (Answers) with AFCV Holdings, LLC (AFCV), a portfolio company of Summit Partners, L.P. Answers was a publicly traded company, and Redpoint Ventures (Redpoint) was a 30 percent shareholder of Answers. In early 2010, Redpoint decided that it wanted to sell its interest in Answers. Answers‟ stock was thinly traded, however, and Redpoint allegedly could only exit its investment through a sale of the entire company. As a result of the merger transaction, the plaintiffs filed a lawsuit alleging that the Answers board of directors (the Board) breached its fiduciary duty to its shareholders and that the buyer group aided and abetted the Board in that breach. The defendants then filed a motion to dismiss such claims. Vice Chancellor Noble denied the defendants‟ motion to dismiss the claims of breach of fiduciary duty against the Board and concluded that the facts alleged were sufficient to support a claim that the Board members were interested in the transaction and had acted in bad faith. He also denied the motion to dismiss a claim of aiding and abetting against the buyer group, as discussed below.
Under Delaware law, once a board has decided to sell its company, it has a fiduciary duty to seek the highest value reasonably available for its shareholders. Here, the plaintiffs claimed that the Board ran a “fatally flawed” sales process “not aimed at getting, for shareholders of Answers, the best price reasonably available for their shares.” Plaintiffs alleged that three conflicted Answers directors co-opted the sales process and the remaining four directors abdicated their fiduciary duties. Plaintiffs alleged that at the urging of the three interested directors, the Board agreed to complete the sales process with the buyout group quickly, without completing a true market check and before Answers‟ trading price had the opportunity to rise above the buyer‟s offer price upon the disclosure of Answers‟ improved operating and financial performance.
In order to be “interested,” the directors of the Board must receive a personal financial benefit from the sale of Answers that is not equally shared by all of Answers‟ stockholders. It was determined that Answers had three interested directors: Robert S. Rosenschein, W. Allen Beasley and Thomas Dyal. Rosenschein, the Chairman of the Board and the CEO, was deemed to be interested because Redpoint had told the Board that if the company could not be sold in the near future, then the entire management team, including Rosenschein, would be replaced. The Vice Chancellor noted that in the past he had questioned the theory that managers should be deemed interested just because they would continue to manage the company after the transaction, but here, the allegation was that the CEO would lose his job if Answers did not engage in a change of control transaction. Furthermore, the CEO‟s desire to keep his job was allegedly what caused him to seek and approve this sale. The Vice Chancellor held that these were sufficient allegations to suggest an interest in the transaction that was different from the interests of the public shareholders.
Beasley and Dyal were deemed to be interested because, as directors appointed by Redpoint, they wanted to engage in a sale of Answers to gain liquidity for Redpoint. As Vice Chancellor Noble noted, “[l]iquidity has been recognized as a benefit that may lead directors to breach their fiduciary duties.” Even though all of the stockholders, including Redpoint, were to receive cash in the transaction, Answers‟ public stockholders already had liquidity, as they could sell their stock in the open market. Redpoint, however, gained liquidity only on the sale of the entire company. The complaint alleged that this desire for liquidity caused Beasley and Dyal to manipulate the sales process, and the court held that these allegations were sufficient to establish that these directors were interested.
As to the four remaining directors, the court held that the complaint adequately alleged that they acted in bad faith. In order to have acted in bad faith, the Board members must have intentionally failed to act in the face of a known duty to act. The known duty to act in this case was the duty under Delaware law to seek the highest value reasonably available for the company‟s shareholders once the Board had initiated the sales process. The plaintiffs alleged that these four directors knew that the three interested directors wanted to end the sales process quickly and thus “agreed to manipulate the sales process to enable the Board to enter quickly into the Merger Agreement before Answers‟ public shareholders appreciated the Company‟s favorable prospects.” Thus, the court concluded that this was a well-pled allegation and that one could infer that the four Board members “consciously disregarded their duty to seek the highest value reasonably available for Answers‟ shareholders.”
Aiding and Abetting Claim
The court also allowed the aiding and abetting claim to survive a motion to dismiss. The court noted that the four requirements for an aiding and abetting claim for breach of fiduciary duty are: (1) the existence of a fiduciary relationship, (2) a breach of the fiduciary‟s duty, (3) a knowing participation in that breach by the aider and abettor, and (4) damages proximately caused by the breach. The plaintiffs had alleged that the directors were in a fiduciary relationship with Answers‟ shareholders and that the breach was the result of a flawed sales process that deprived the shareholders of the best value for their shares. Those facts satisfied all the elements of the aiding and abetting claim except for the “knowing participation” element. The court then explained that the plaintiffs had alleged that the buyout group received confidential information about Answers‟ operating and financial performance, that this information showed that Answers‟ performance was increasing, that Answers‟ stock price would likely have risen upon the release of this information to the public and that the buyout group had pushed the target to do a quick market check to finish the process before this information was released to the market. These facts were sufficient to have adequately pled the “knowing participation” element of the aiding and abetting claim for purposes of surviving the motion to dismiss.
The plaintiffs alleged a variety of potential missteps by the Answers Board. For example, the Board allegedly permitted Redpoint to threaten the replacement of the entire management team if the company was not sold in the near future. Vice Chancellor Noble notes that Redpoint‟s alleged actions created an interest in the transaction for the Answers CEO that was not equally shared by all stockholders. Of course, the transaction may have otherwise created a personal interest for the CEO due to a change of control or employment contract, but Redpoint‟s alleged threats focused attention on Redpoint‟s apparent demand for liquidity. Indeed, the facts alleged suggested that Redpoint‟s liquidity became the key driving factor in the Board‟s decision-making. If Redpoint‟s liquidity was not a paramount concern, then the management team responsible for improving results presumably would not have been told that they would not have jobs if they could not sell the company. These facts serve to focus more scrutiny on the Board‟s performance of its duty to obtain the best value for stockholders.
Another set of issues arose in the sales process after both the buyer and the Board learned about Answers‟ improving financial results. The banker, UBS, allegedly told the Board that a two-week market check in the last two weeks of December was not a “real” market check. The Board, however, authorized a two-week market check that coincided with the holidays. Allegedly, the buyer was pressing the target to move quickly. It is possible, of course, that the speed of the market check could be explained by the Board‟s reasonable concern regarding losing the proverbial “bird in the hand.” When a target board decides to take an action which could be construed as contrary to its financial advisor‟s advice, it should do so only if it can reasonably contend that the action is value-enhancing.
Perhaps the most serious factual allegations in this case surround the Board‟s decision to move forward with the merger despite improved results for Answers, which allegedly would have likely resulted in an increase in the trading price of Answers‟ stock. A well-advised board would consider these facts in context and would be able to articulate the reasons why the deal at hand made more sense than waiting for a potential increase in the stock price. Again, we are at an early stage of this case, and one can imagine, for example, that the Board‟s decision was driven by an impatient buyer with a clear limit on its price range, a concern that the results, while good, were not sustainable, a management team unwilling to revise its forecast upward, and a lack of other interested buyers. Answers entered into the merger agreement with the buyer while in possession of positive financial information not yet released to the market. Interested directors were allegedly involved in that decision, and in such cases, it is important that a target board be able to explain how the actions it took satisfied its duty to seek the highest value reasonably available for its stockholders.
It is worth noting that the buyer, who was allegedly pushing for this quick transaction before information could be released to the market, might have had concerns about the impact of these undisclosed improved results on the Board‟s duties. The buyer never has perfect information about the target and may not have appreciated the alleged conflicts of interest in this case. The buyer‟s alleged role here in pushing for a quick deal could be found to be a result of the buyer‟s lack of information as to the target directors‟ motivations and faith in the Board‟s supervision of the sales process. Buyers should keep in mind that where a target board or management has conflicts of interest, an independent claim may be lodged directly against the buyer, if the buyer is viewed as aiding the conflicted party.
Finally, it also seems, based on the allegations, that the Board did not necessarily recognize that Redpoint‟s particular interest in liquidity caused a conflict of interest for Redpoint and its directors. It is of course possible that the Board will be able to show that it recognized the interest of the Redpoint directors, or that there was no actual conflict, and that disinterested directors determined that the merger was in the best interests of stockholders. This case is, however, an important reminder that the duty of loyalty is critical, and that directors must be scrupulous in spotting and evaluating potential conflicts of interest.
In re Answers Corporation Shareholders Litigation provides us with timely reminders about the importance of having disinterested directors approve a change of control transaction and with examples of certain factual situations that should trigger scrutiny by a board during a sales process. Vice Chancellor Noble‟s opinion also reminds us of the need for the target board in a merger transaction to evaluate critically conflicts of interest in order to limit opportunities for plaintiffs to allege that the board acted in bad faith or that the directors breached their duty of loyalty. Finally, it provides a good reminder that the ultimate duty of a target board is to maximize value for all stockholders in the event of a sale of the company.