In a rare finding of Revlon liability, the Delaware Court of Chancery recently sided with the plaintiffs and awarded damages post-trial in In re Mindbody, Inc., Stockholder Litigation, C.A. No. 2019-0442-KSJM.
The landmark 1986 Delaware Supreme Court opinion Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. found that boards of directors must satisfy an enhanced level of scrutiny and make a reasonable attempt to maximize stockholder value if a company is up for sale. In the 2015 decision Corwin v. KKR Financial Holdings LLC, the Delaware Court of Chancery found that board decisions should be granted the deference of the business judgment rule (rather than the enhanced scrutiny required by Revlon) as long as the stockholder vote approving the transaction was approved by a “fully informed, uncoerced majority of the disinterested stockholders.”
The recent case revolves around the 2019 sale of Mindbody, Inc. The plaintiffs, which collectively owned the second-largest block of the acquired company, alleged that the company’s CEO breached his fiduciary obligations by tilting the sale process toward the acquirer and by failing to disclose all information that was material to the acquisition. The plaintiffs also alleged that the acquirer aided and abetted the disclosure breaches in the process.
Three standards of review are used for transactions in Delaware law: business judgment, enhanced scrutiny and entire fairness. Chancellor Kathaleen McCormick noted that in all-cash mergers and acquisitions such as the one in this case, enhanced scrutiny is the default standard. Enhanced scrutiny is advantageous to plaintiffs, as it shifts the burden of proof to defendants to show that there were no material disclosure breaches. When the enhanced scrutiny standard is used under a Revlon claim, such as the one in this case, however, defendants can invoke the ruling in Corwin. Under Corwin, the standard of proof can be lowered to the more deferential business judgment rule, which would shift the initial burden of proof to the plaintiffs to show any disclosure breaches or other breaches of duty; hence, the difficulty for stockholders in successfully litigating Revlon claims since Corwin.
In the recent Mindbody case, McCormick evaluated the plaintiff’s Revlon claims and then assessed the viability of using Corwin to review the decision under the business judgment rule rather than enhanced scrutiny. McCormick found that because the vote of the disinterested stockholders was not fully informed, the defendants’ attempt at using Corwin failed, and the burden of proof was shifted back to the board and the other defendants under enhanced scrutiny.
McCormick found that the plaintiffs proved the company’s CEO had ample reason to tilt the sale to the acquirer due to disabling personal conflicts. McCormick cited statements the CEO made in his book and in a podcast, which discredited his testimony regarding these conflicts and his state of mind pre-acquisition. Specifically, the CEO stated that he needed liquidity to meet increasing financial burdens and that he had a desire to step down as CEO in two to three years. Additionally, McCormick noted his incentive to sell the company before the sunset clause on his super-voting Class B shares came into effect in three years’ time. Once enacted, the sunset clause would substantially limit his influence by reducing his voting share of the company from 19.8% to under 4%. Furthermore, McCormick found that the plaintiffs proved that the CEO preferred the acquirer to all other suitors because of his belief they would be able to consummate the transaction quickly and provide post-closing employment by allowing him to stay on as CEO. McCormick noted that the acquirer advocated speed of acquisition as a business model, which is not in and of itself a problem, but that the defendants still needed to ensure an appropriate sale process.
McCormick found that the plaintiffs proved that the CEO acted on these biases and tilted the sale process by “strategically driving down Mindbody’s stock price and providing [the acquirer] with informational and timing advantages during the due-diligence and go-shop periods.” McCormick found that the company’s board failed to adequately oversee the CEO because board members were left in the dark about his conflicts and his actions in tilting the sale process, which resulted in material omissions in the proxy materials. Furthermore, McCormick found that the plaintiffs proved that the acquirer was liable on the claim that it aided and abetted the disclosure breaches by failing to correct the material omissions it was aware of in the proxy materials. McCormick awarded $1 per share plus interest in damages to the plaintiffs based on evidence that the acquirer would have been willing to pay that price in its closing offer.
The case shows that Revlon claims can still be successfully litigated in the aftermath of Corwin and that parties involved in mergers and acquisitions are advised to use caution in both their public comments and in private communications throughout the dealmaking process. Lastly, extensive evaluation of proxy statements by the parties is encouraged to ensure all material information and communications are disclosed, no matter their implications, to limit post-closing litigation and potential liability.
Authors would like to thank case assistant Colin Hopkins for his assistance in drafting this article.