Much ado about … not much?
While not a major paradigm shift in the fiduciary duty standard applicable to directors considering corporate change-of-control transactions, the decision in In re Nine West LBO Securities Litigation adds nuances to directors’ duties in the context of a multistage corporate change-of-control transaction.
In In re Nine West LBO Securities Litigation, Case No. 20-2941 (S.D.N.Y. Dec. 4, 2020), the U.S. District Court for the Southern District of New York denied a motion by the defendant directors’ former directors of Jones Group, Inc., to dismiss breach of fiduciary duty and aiding and abetting breach of fiduciary duty claims brought by the liquidating trustee for Nine West, Jones Group’s successor. The trustee brought these claims after Nine West filed for bankruptcy in 2018 and the trustee originally included several fraudulent conveyance claims that the court dismissed earlier in 2020 pursuant to a unique bankruptcy defense. Ultimately, the claims related to the 2014 acquisition of Jones Group by private equity sponsor Sycamore Partners Management, L.P.
The merger agreement contemplated a multistage transaction. Its terms included the following:
- An affiliate of Sycamore merged with Jones Group, which had been a publicly traded company prior to the transaction, and Jones Group, the survivor, was renamed Nine West Holdings, Inc.
- Sycamore and another firm contributed $120 million in equity to Nine West (though the merger agreement originally contemplated a contribution of at least $395 million).
- Nine West assumed additional debt in the amount of $1.55 billion (though the merger agreement originally contemplated additional debt of $1.2 billion).
- Jones Group shareholders were cashed out at $15 per share, for a total of approximately $1.2 billion.
- Certain brands, notably the Stuart Weitzman and Kurt Geiger brands, which had been among Jones Group’s strongest performing, and other assets of Nine West were carved out and sold to affiliates of Sycamore (the carve-out businesses) as a separate transaction from the merger.
The merger agreement included a “fiduciary out” clause giving the Jones Group directors the option to withdraw their recommendation in favor of the transaction if they determined that the directors’ fiduciary duties could require withdrawal; namely, if they received an alternative superior bid.
The trustee argued, and in denying the motion to dismiss the court agreed that the trustee had adequately pleaded, that the Jones Group directors violated their fiduciary duties. Applying Pennsylvania law, the court held that, while the business judgment rule applied, assuming all of the allegations in the complaint were true, it would not shield the Jones Group directors from liability because the trustee had adequately asserted that the directors had failed to adequately investigate the transactions. The court reasoned that the Jones Group directors were alleged to have acted recklessly by expressly excluding the post-closing transactions from the board’s deliberations and failing to consider the solvency of the surviving company. It noted that, though the Jones Group directors did not approve the post-closing sale of the carve-out businesses or the new debt assumed by Nine West (each of which had been approved by the new board of Nine West, composed of two principals from Sycamore), because the merger agreement contemplated these post-closing transactions, the merger and the post-closing transactions could be treated as one integrated transaction.
The court also identified a number of “red flags” suggesting that the multistage transaction, when considered as a whole, would be reasonably likely to result in the insolvency of the surviving company. Specifically, the court noted that, as alleged: (1) the estimated valuation of the company after the merger and the spinoff of the carve-out businesses was less than the amount of Nine West’s total post-transaction debt ($1.4 billion, compared to $1.55 billion); (2) the projected adjusted debt to EBITDA multiple (6.6x, as calculated by Sycamore, or 7.8x, as calculated by Jones Group’s management) was considerably higher than the multiple that Jones Group’s advisers had reported that the company could support (5.1x); and (3) Sycamore was using “‘unreasonable and unjustified’” EBITDA projections to obtain a solvency opinion in connection with the sale of the carve-out businesses. The court reasoned that the trustee had adequately pleaded that the defendant directors acted recklessly by allegedly ignoring these red flags and approving the merger agreement.
With respect to the claim that the Jones Group directors had aided and abetted breaches of fiduciary duty by the new Nine West board, the court concluded that the trustee had adequately pleaded that the defendant directors had “actual or constructive knowledge that [the new board] would carry out the contemplated Carve-Out Transactions and that such actions would leave the Company insolvent.” The court therefore held that the allegations were sufficient to state a claim that the directors had “knowingly participated” in the alleged breach of fiduciary duty by the Nine West board, despite the fact that the actions by the Sycamore principals, who would become the Nine West directors, giving rise to the aiding and abetting claim occurred before those Sycamore principals joined the board and related to the post-merger transactions that occurred after the defendant Jones Group directors left the board.
Though the claims that survived the motion to dismiss must still be tried, the court’s decision in In re Nine West LBO Securities Litigation provides some useful guidance for boards considering a leveraged buyout and spinoff or other multistage transactions. First, boards should analyze and consider multistage transactions as a singular integrated transaction. The court’s opinion demonstrates that transition off of the board in conjunction with an early phase of a multistage transaction may not insulate directors from liability arising from actions taken by the board in subsequent phases. To ensure that directors will not be liable for subsequent transactions considered by a court to be integrated into a single transaction, directors should ensure that any meaningful changes to significant deal terms, like the amount of debt being assumed by the company after a merger, cannot occur without the board’s approval until some time has lapsed after closing.
Additionally, boards should be mindful of a transaction’s impact on a company’s post-closing solvency. When the board has access to information concerning the impact of a transaction on the solvency of the company after closing, it should take that information into account when evaluating the relative merits and risks of a proposed transaction. Boards should also consider proactive steps to document that the board has taken the post-closing solvency of the company into account in its deliberations.
One simple solution might be a solvency opinion. While Sycamore did procure an opinion addressing the solvency of Nine West after the sale of the carve-out businesses, the court saw fit to disregard the solvency opinion on a motion-to-dismiss basis because, as noted above, the trustee alleged that the EBITDA projections Sycamore provided to the adviser rendering the opinion were “‘unreasonable and unjustified.’” A solvency opinion that considered the transaction taken as a whole — including the merger, the sale of the carve-out businesses and the assumption of debt post-closing — and, more importantly, that was based on reasonable and realistic projections, may have been better received by the court. Such an opinion would seemingly have evidenced that the Jones Group directors placed an emphasis on the company’s post-closing solvency when considering the transaction and may have ultimately shielded them from the trustee’s claims.
As noted above, In re Nine West LBO Securities Litigation seems unlikely to represent a significant or far-reaching shift away from the traditional requirement that boards focus on maximizing immediate shareholder value in the corporate change transaction context. Instead, it merely suggests that in certain specific contexts — such as leveraged buyout, spinoff and other multistage transactions — the post-closing solvency of the company should be one factor that the board takes into account when evaluating a proposed deal.
For additional guidance on the information in this alert, please contact any of the authors, any member of McGuireWoods’ securities compliance team or your primary McGuireWoods contact.
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