Highlights:
The Delaware Court of Chancery’s recent Mindbody decision[1] held a corporate officer and Private Equity (“PE”) Sponsor liable for tilting the sale process in favor of the PE Sponsor in order to advance the officer’s personal financial interests. Mindbody applied Revlon enhanced scrutiny to hold a CEO liable as a disloyal fiduciary, insufficiently checked by the company’s board, who tilted the sales process to favor his personal interests instead of maximizing the deal price. Mindbody is significant, because Revlon claims have rarely succeeded – and here they succeeded against a CEO and the PE Sponsor, which aided and abetted the CEO’s disclosure violations. The Mindbody case is an important weapon for stockholders to recover damages from an unfair merger price – and a cautionary tale for PE Sponsors to avoid involvement in a fiduciary’s misconduct.
First, the Mindbody Court found the CEO liable for a Revlon violation because he had a disabling conflict of interest based on his personal interests in “near-term liquidity” from his locked-up company stock and in lucrative post-merger employment and equity incentives from the Private Equity Sponsor (“Vista”). The CEO held “98%” of his net worth “locked inside” Mindbody stock, which he could only sell pre-acquisition in “tiny bits” through a 10b5-1 Plan, which he described as “like sucking through a very small straw.” Further, the CEO wanted post-merger employment and significant equity-based incentives from Vista, by running Mindbody as a Vista portfolio company. The CEO had attended a Vista “CXO Summit” for CEOs of companies that Vista had acquired, and called it “mind blowing” in describing how post-acquisition he could “keep his position as CEO, reload with equity, and participate in a follow-on sale.” [2]
Second, the Mindbody Court found significant evidence of the CEO tilting the sale process in favor of Vista, the Private Equity Sponsor. He met twice with Vista to discuss a merger before getting Board authorization to explore a sale – including the Vista CXO Summit, at which he pitched Vista to acquire Mindbody. He delayed informing the full board about Vista’s initial expression of interest for over a week to give Vista a head start in the sale process. This put Vista in position to make a firm offer several weeks before other bidders – and when Vista made its final bid, the other main contender complained that it needed more time. And the CEO tipped Vista that Mindbody would be commencing a formal sale process, and attended a Vista-sponsored charity event during the sale process. The CEO did not inform Mindbody’s board of this favoritism. As a result, Vista ended up paying only $36.50 per share to acquire Mindbody, even though it had authority to bid up to $40 per share if a bidding war emerged.
Third, the Mindbody Court found liability – even though the deal was approved by a majority of disinterested stockholders under Corwin v. KKR[3]– since there was no disclosure to stockholders of the CEO’s conflicts of interest or about the CEO tilting the sale process in favor of Vista. The disclosures to stockholders omitted that before the sale process began, the CEO pitched Vista for a deal and that the CEO had an interest in post-Merger employment and compensation from Vista. Further, the disclosures to stockholders omitted that the CEO tipped Vista that Mindbody would be running a formal sale process or that one of Mindbody’s bankers tipped Vista about the CEO’s desired sale price.
Fourth, the Court held Vista, the PE sponsor, liable because it knew about the misleading deal proxy statements, yet declined to correct those statements despite a contractual obligation to do so. Vista knew the proxy statements were misleading, because it was involved in the omitted misconduct. For example, Vista knew that the deal proxy omitted the extent of its deal discussions with the CEO before the sale process began (the CXO Summit and a prior conversation). Vista also knew that the CEO had tipped them about Mindbody beginning a formal sale process; that a banker tipped them about the CEO’s $40 per share price minimum target; and that it had invited the CEO to a charity event. But Vista declined to correct the deal proxy misstatements and omissions, even though it reviewed them several times, and had a contractual obligation under the merger agreement to correct any false statements.[4]
Finally, the Court awarded Revlon duties damages “based on the last transaction price,” i.e., the higher price at which the Company could have been sold to the same or a different acquirer through a proper sales process. The Court analyzed Vista’s pre-deal internal estimates of where they expected a deal to be struck. The pre-deal consensus among Vista’s internal team was that a deal would be made at $37.50. Thus, the Court held that the damages were $1 per share, based on Vista’s internal estimate of $37.50 per share, compared to the actual deal price of $36.50.
The Mindbody case is a lesson that corporate officers and Private Equity sponsors can be held liable even under Revlon enhanced scrutiny when they tilt the merger process to benefit themselves at the expense of stockholders. For stockholders and other plaintiffs, Mindbody is an important weapon for recovering damages from an unfair merger price. Where a merger or acquisition resulted from a tainted process where an insider or controlling stockholder dominated or significantly favored one bidder, stockholders can recover significant damages. Courts will even go as far as imposing liability on Private Equity Sponsors for participating with a disloyal corporate officer or director in rigging the sales process to sell the company at a low price.
If you have any questions about this article, the Mindbody decision, or about a potential case involving alleged misconduct by an officer, director, or other fiduciary in a merger or similar context, please contact Sam Lieberman at (212) 573-8164 or SLieberman@Sadis.com.
[1] In re Mindbody, Inc. Stockholder Litigation, 2023 WL 2518149 (Del. Ch. March 15, 2023).
[2] Slip Op. at 9, 90.
[3] See W. Savitt, “Delaware’s Prudent Approach to the Cleansing Effect of Stockholder Approval (Harv. Forum on Corp. Gov., Jan. 16, 2018), available at https://corpgov.law.harvard.edu/2018/01/16/delawares-prudent-approach-to-the-cleansing-effect-of-stockholder-approval/
[4] The Private Equity Sponsor could also have been held liable for the Sales Process violations, because it appeared to knowingly participate in the CEO’s conduct. But Plaintiffs failed to timely amend their complaint to add this claim.