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Delaware Case Highlights Enhanced Revlon Duties of Directors Are Alive and Well

In a decision rendered on March 15, 2023, the Delaware Court of Chancery, in the case In Re Mindbody, Inc. Stockholder Litigation,¹ held Richard Stollmeyer (the CEO), the chief executive officer and a director of Mindbody, Inc. (the Company), a public company incorporated under the laws of Delaware, liable for breaches of the fiduciary duties of care and loyalty to the Company and its stockholders in a transaction involving the sale of the Company via merger to Vista Equity Partners Management, LLC (Vista). The Court also held Vista liable for aiding and abetting such breaches.

The plaintiffs claimed that the CEO breached his fiduciary duties by tilting the sale process in favor of Vista and committed disclosure violations by failing to disclose facts about the sale process and that Vista aided and abetted such breaches.

Sale Process Claims
Under Delaware law, in the context of a sale of control of a Delaware corporation, directors are required to focus on one primary objective, securing the transaction which offers the best value reasonably available to the stockholders. This means that directors, in exercising their fiduciary duties, must seek a deal that offers the best price and other terms reasonably available under the circumstances. Directors must prioritize Revlon duties over other long-term corporate and financial objectives. Where a stockholder challenges a change-of-control transaction, enhanced scrutiny, as set forth in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.² is the presumptive standard of review.

Under Revlon, the directors have the burden of demonstrating both (i) the reasonableness of the decision-making process employed by the directors, including the information on which the directors based their decision and (ii) the reasonableness of the directors’ action in light of the circumstances then existing. The business judgment rule, under which there otherwise would be a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interest of the Company, does not apply except where the transaction is approved by a “cleansing vote” of a fully informed, uncoerced majority of the disinterested stockholders. In deciding whether the business judgment rule standard could be restored in the case at hand by such a cleansing vote, the Court found that the stockholder vote was flawed because the stockholders were not made aware of the CEO’s conflicts or the way in which the sale process favored Vista as described below, and therefore, the transaction was not approved by a fully informed, uncoerced majority of the disinterested stockholders. Accordingly, the Court found that enhanced scrutiny was the appropriate standard of review.

In holding the CEO liable, the Court found that the conduct leading to the merger fell outside the range of reasonableness. The following summarizes certain findings of the Court as set forth in its opinion.

The CEO was subjectively motivated in large part by his need for liquidity. He had substantial financial commitments; approximately 98% of his net worth was in stock of the Company and he was substantially limited in the amount of stock he could sell from time to time. This created a disabling conflict.

The CEO set the sale process in motion largely without the involvement or knowledge of the Board of Directors. Without informing the board and prior to the commencement of a formal sale process by the board, the CEO met with a banker who introduced him to Vista, and the CEO had initial meetings with Vista. The CEO attended a Vista summit for chief executive officers of ex-public companies that Vista had acquired, at which Vista made presentations advertising the immense wealth that the chief executive officers had achieved by selling to and working for Vista. After the summit, the CEO believed that selling to Vista gave him the opportunity to both gain liquidity and remain as chief executive officer in pursuit of post-acquisition equity-based upside. The CEO became focused on a sale to Vista and wanted to sell to Vista.

The CEO held shares of a super-voting class of stock, which provided control of approximately 19.8% of the Company’s voting power. The super-voting stock was set to automatically convert to common stock in approximately three years, which would carry less than 4% of the Company’s fully diluted voting power. Tactically, it was best for the CEO to take action quickly on a sale before the super-voting class of shares converted to common and his voting power was diluted.

The CEO did not inform the full board of directors immediately upon receipt of an expression of interest from Vista to acquire the Company. Rather, the CEO had a lengthy discussion with the director, who was the director designee of the Company’s largest shareholder, whom the CEO knew also wanted a near-term exit from its investment in the Company. It was not until approximately a week later that the CEO informed the full board of Vista’s expression of interest. However, the full board was not made aware of the full extent of the discussions that the CEO had with Vista, and the board did not form a transaction committee to consider running a sale process until approximately two weeks thereafter.

The CEO knew that Vista might attempt to move fast to gain a competitive advantage over other bidders. While the transaction committee formed by the board of directors established certain guidelines to cabin management’s communication with potential bidders, the CEO ignored them and, among other things, tipped Vista that a formal sale process was beginning. However, the CEO did not tip other potential bidders of the sale process. By causing a delay in providing information to the board and tipping Vista on the sale process, the CEO gave Vista a huge head start. When Vista was ready to make a firm offer, the other bidders (seven other parties signed non-disclosure agreements and were given access to the data room) were still in the early stages of their due diligence review of the Company and were largely unable to respond within the timeframe requested to make best and final offers. After Vista made a firm offer, the investment committee countered and Vista raised its final bid to $1 per share below where its deal team thought that the deal price would land. That offer was ultimately accepted by the Company. The evidence shows that Vista could and would have gone higher if it had been pressured to do so.

The plaintiffs also argued and presented evidence that the CEO lowered earnings guidance to depress the Company’s stock price and make a deal seem more attractive.

The Board of Directors was kept in the dark and did not know of the conflicts involving the CEO that infected the sale process. Among other things, the board did know about the CEO’s need for liquidity, the Company’s largest stockholder’s desire for a near-term exit, the details of certain meetings that the CEO had with Vista or information the CEO communicated to Vista regarding his desire to find a home for his Company or that he had tipped Vista about the start of the formal sale process giving Vista a huge head start. The CEO’s actions deprived the board of information needed to employ a reasonable decision-making process.

Ultimately, the Court found that the CEO did not strive in good faith to pursue the best transaction reasonably available. He instead pursued a fast sale to Vista to further his personal interests. Because he tilted the sale process in Vista’s favor for personal reasons, the process did not achieve a result that fell within the range of reasonableness.

Vista prevailed against the plaintiffs and was not held liable for the plaintiffs’ sale-process claims on procedural grounds because the plaintiffs failed to assert a claim against Vista for aiding and abetting in the sale-process breaches until trial. However, as noted below, the plaintiffs prevailed against Vista on aiding and abetting disclosure violations.

Disclosure Violations
With regard to the claims that the CEO committed disclosure violations by failing to disclose facts about the sale process, the Court held that the CEO breached his duty of disclosure and Vista aided and abetted such breach. The Court found that the CEO failed to disclose the full extent of his involvement with Vista in the proxy materials delivered to the stockholders, which was a material omission, and that Vista aided and abetted the CEO’s breach by failing to correct the proxy materials to include a full and fair description of its own interactions with him. Under the merger agreement between the Company and Vista, Vista was contractually obligated to review the proxy materials and inform the Company if there were material omissions from the proxy materials. The record shows that Vista personnel who interacted with the CEO reviewed the proxy materials; Vista knew about its own interactions; it was evident that they were not disclosed and Vista knowingly participated in the breach by not speaking up.

This case reinforces that in running any sale process, it is important for the board to be proactive in managing the sale process in a reasonable manner and to uncover any conflicts of interest or interference in the process by particular individuals. As is often the case, continuing management may be key to the sale and will have both an interest in the transaction terms and influence over the potential buyers and process. Beyond the issues in this case, boards need to be cognizant that in deals involving conflicts of interest (i.e., where a majority of the directors approving the transaction were interested or where a majority stockholder stands on both sides of the transaction), an even higher standard of entire fairness could be applicable. As a result, it is important to run a process that will withstand scrutiny not only under the Revlon standard but also as to overall fairness to all stockholders. The Board of Directors or a special committee formed to manage the process can weigh various factors, including the feasibility of closing the transaction (e.g., availability of financing), any regulatory approval hurdles, the identity of the bidder and the bidder’s plans for the Company and other reasonable factors but must ensure that the overall process is fair and free of conflicts of interest that impact obtaining the best result for the stockholders. The board must also ensure that in seeking any cleansing vote of the disinterested stockholders, all disclosures are complete, accurate and do not omit any material information that is necessary for stockholders to make a fully informed decision.

¹ 2023 WL 2518149 (Del. Ch. March 15. 2023)

² 606 A.2d 173 (Del. 1986)

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