Delaware Court Of Chancery Declines To Dismiss Claims That Officers Tilted Take‑Private Sale Process To Favored Buyer
On October 2, 2020, Vice Chancellor Kathaleen S. McCormick of the Delaware Court of Chancery denied a motion to dismiss breach of fiduciary duty claims brought by stockholders of Mindbody, Inc. (the “Company”) against two of its officers in connection with the Company’s $1.9 billion sale to a private equity firm. In Re Mindbody, Inc., Stockholders Litigation, C.A. No. 2019-0442-KSJM (Del. Ch. Oct. 2, 2020). Plaintiffs asserted that the Company’s founder-CEO/Chairman tilted the sale process toward the favored buyer, motivated by a need for liquidity and the prospect of post-merger employment with the firm. In particular, plaintiffs alleged that the CEO orchestrated (i) the provision of reduced diligence information in a less timely fashion to other potential bidders, and (ii) the lowering of earnings guidance to depress the stock price and make the Company a more attractive target to the favored firm while enhancing the premium apparent to stockholders. The Court found the allegations sufficient to support a “paradigmatic Revlon claim” and the determination at the pleading stage that the proxy was materially misleading such that the alleged breach was not cleansed under Corwin.
The Court explained that—as a cash-for-stock merger that was a final-stage transaction—the deal was presumptively subject to enhanced scrutiny under Revlon. The Court noted that the allegations tracked “the paradigmatic Revlon plotline,” which involves “a conflicted fiduciary … who tilts the sale process toward his own personal interests in ways inconsistent with maximizing stockholder value.”
Specifically, the Court found that the “liquidity-driven and prospective-employment” allegations “work[ed] in combination to land a powerful one-two punch” to “render it reasonably conceivable that [the CEO] subjectively harbored interests in conflict” with the Company. For example, the complaint detailed expenses that the CEO had incurred and alleged that he expressly acknowledged that his wealth was “locked inside” the Company and available only in “tiny bits” through his 10b5-1 plan, which he analogized to “sucking through a very small straw.” Likewise, the Court noted that it “need not infer” that the CEO desired employment with and compensation from the private equity firm, because “he said as much himself.”
As to the sale process, the Court highlighted allegations that the Company delayed its earnings call and sought a “creative way” to guide expectations down shortly after the CEO attended a “summit” for founder-CEOs of companies the private equity firm had acquired at which it “hyped … its history of generating enormous wealth” for them. The Court also outlined claims that the CEO had declined to share diligence information with other potential bidders, including during the go-shop period after the merger agreement was signed.
Significantly, the Court also found that the complaint adequately alleged that the CEO had failed to disclose material information about his alleged self-interest to the board. The Court noted that this was sufficient to sustain the breach of a duty of loyalty claim notwithstanding majority board approval of the deal. The Court also held that the Corwin presumption of the business judgment rule did not apply because the shareholder vote was not fully informed, as the proxy did not disclose the alleged conflicts of the CEO or correct the allegedly misleading earnings guidance.
The Court also denied the motion to dismiss by the Company’s CFO because the complaint sufficiently alleged gross negligence and, as an officer (as opposed to a director), he was not protected by the charter’s exculpatory provision. Specifically, the complaint alleged that he worked with the CEO throughout the flawed process and was also independently conflicted due to the prospect of future employment.
The Court, however, dismissed the claim against an outside director who was nominated to the board by a venture capital fund. The Court explained that the allegations that the fund had an “expiring investment horizon” and wanted to exit were insufficient to plead a conflict or that the outside director directed the process toward his personal interest.