Delaware Chancery Court Finds CEO Violated Revlon Duties by Tilting Sale Process to Preferred Bidder and That the Bidder Aided and Abetted Disclosure Breaches

In a recent post-trial decision, Delaware Chancellor Kathaleen St. J. McCormick found a CEO personally liable for breaching his fiduciary duties for tilting the company’s sale to his preferred acquiror.^[1] The court further held that the transaction was not cleansed by the shareholders’ vote approving the transaction because the proxy disclosures gave an incomplete and inaccurate “sterilized narrative” of the parties’ interactions. And based on the acquiror’s contractual obligation to review and supplement any inadequate disclosures, the court held the acquiror liable for aiding and abetting the disclosure violations. The case, although fact sensitive, provides a cautionary tale about pitfalls to avoid in a sales process.

Facts of the Case

The chancellor’s decision contains a detailed recitation of the facts she found. As set forth in the opinion, by summer 2018 Mindbody Inc.’s CEO, Richard Stollmeyer, had become anxious about his company’s future and frustrated about the inability to monetize his holdings of the company’s stock. Without the involvement or knowledge of the company’s board of directors, Stollmeyer attended a conference held by a private equity firm, Vista Equity, that touted the wealth that former CEOs of public companies had achieved by selling to and working under Vista ownership.

After the conference, Stollmeyer effectively “greased the wheels” for Vista. According to the court, Stollmeyer “did not adequately involve the Board or erect, much less adhere to, speed bumps to ensure a value-maximizing process.”^[2] Stollmeyer did not inform the board about Vista’s intentions until a week after Vista’s initial expression of interest. The board remained unaware of the full extent of Stollmeyer’s previous meetings with Vista. Even though a transaction committee instituted guidelines to cabin management communication with bidders, Stollmeyer tipped off Vista that a formal sales process was beginning. A banker friend of Stollmeyer’s who had originally introduced Stollmeyer to Vista told Vista Stollmeyer’s target price.

The court held that Vista had the inside track throughout the brief bidding process. After Vista submitted a firm offer, the board asked other bidders to respond promptly with their best offers. However, because other bidders were still in the early stages of their work and due diligence, they were not in a position to respond quickly enough. The board countered Vista’s original offer, and Vista raised its offer to $1 per share below where its team thought the final price would ultimately land. The board did not counteroffer and approved the sale to Vista.

Plaintiffs also contended that Stollmeyer breached his duty of disclosure to stockholders by not fully disclosing these pre-acquisition interactions with Vista. Additionally, plaintiffs claimed that Vista aided and abetted Stollmeyer’s disclosure violations. Stollmeyer had read the definitive proxy and supplemental disclosures before they were filed and he signed the proxy materials as CEO. The disclosures presented a narrative where Stollmeyer casually met with Vista and omitted certain facts that would have depicted Stollmeyer as favoring Vista. For its part, Vista had failed to correct the proxy and supplemental disclosures. According to the merger agreement, Mindbody could not file a proxy statement without first providing Vista with an opportunity to review it. Vista was also obligated to promptly notify Mindbody if it discovered any material omissions that could lead to a misleading disclosure. The court found that Vista personnel had reviewed the proxy materials and was aware of its own presale interactions with Stollmeyer but failed to correct material omissions.

Applicable Standards of Review and the Court’s Findings

Two Delaware Supreme Court cases provided the framework to analyze the defendants’ liability. Under Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.,^[3] in an all-cash merger context, the board has an enhanced fiduciary duty to determine, in good faith, the best interests of the corporation and its stockholders, including “the maximization of the value at a sale for the stockholders’ benefit.”^[4] Chancellor McCormick summarized the key features of this enhanced scrutiny test as requiring a judicial determination regarding (1) the adequacy of the decision-making process employed by the directors and (2) the reasonableness of the directors’ actions in light of the existing circumstances.^[5] In turn, under Corwin v. KKR Fin. Hldgs. LLC,^[6] defendant fiduciaries can nonetheless invoke the more favorable business judgment rule if the transaction was “approved by a fully informed, uncoerced majority of the disinterested stockholders.”^[7] Thus, sufficient and accurate disclosures and a stockholder vote will potentially cleanse an allegedly tainted deal. However, a single deficient disclosure may defeat Corwin cleansing. The plaintiff bears the initial burden of identifying disclosure problems, but the defendant bears the burden of proving that the stockholder vote was fully informed.

Here, the court concluded that the facts prohibited a finding that Stollmeyer had satisfied this enhanced duty under Revlon. He was a “conflicted fiduciary who [was] insufficiently checked by the board” and looked out for “his own personal interests in ways inconsistent with maximizing stockholder value.”^[8] Having proven Stollmeyer’s conflicts, plaintiffs had, according to the court, called “into question the reasonableness of the decision-making process employed and the reasonableness of the directors’ action in light of the circumstances then existing.”^[9] Further, “because the Board did not know about and could not disclose information about [Stollmeyer’s] machinations,” the defendants could not show that the stockholder vote was fully informed.^[10] Thus, they had failed to present a sufficient Corwin cleansing defense.

Additionally, plaintiffs showed that Vista had aided and abetted the disclosure breach against Vista. The key to that claim was proving “knowing participation” in the breach by Vista, which the court admitted was among the more difficult claims to prove.^[11] Chancellor McCormick, however, found that Vista knew that the proxy materials had omitted some of its presale interactions with Stollmeyer. It knew the significance of that omitted information. And it actively participated in the breach by failing to comply with its obligation to review and correct the proxy material. Thus, Vista had assisted in withholding information from the stockholders. Chancellor Chancellor McCormick indicated that she would likely have found Vista aided and abetted the substantive sale-process breach, but concluded that the claim had not been adequately pled and denied a motion to amend the complaint to conform to the trial evidence.

Result and Key Takeaways

Having held both Stollmeyer liable for sale-process breaches and Stollmeyer and Vista jointly and severally liable for the disclosure breaches, Chancellor McCormick awarded damages of $1 per share against Stollmeyer and Vista, given the evidence that Vista would have paid $1 more than what it actually paid.

While fact-specific, the case is a reminder of the board’s need to oversee a careful and diligent process that demonstrates the full board’s good faith. In a public company merger, the target’s proxy statement will generally include a detailed description of any of the relevant contacts between the bidder and the target or its representatives. The bidder itself is, by definition, aware of these communications and should take care that the proxy accurately describes such relevant contacts and that events that may seem less important in isolation are disclosed where their omission may render other statements misleading.

To the extent that management has conflicts, those conflicts should be openly identified and appropriately dealt with. Here too, it may behoove a bidder to make sure that “offline” communications are avoided and that the target’s representatives are aware of any direct contacts with management. In this case, as in others, some of the more unfavorable evidence consisted of informal text or similar communications that undercut the proxy narrative. Given that a bidder may inherit the target’s liabilities if it succeeds in the acquisition, and can itself have aiding and abetting liability, the bidder has a plain interest in ensuring that the target board’s process is reasonable and diligent.

^[1] _{In re Mindbody, Inc., Stockholder Litigation, No. 2019-0442-KSJM, 2023 WL 2518149 (Del. Ch. Mar. 15, 2023).}

^[2] _{Id. at *1.}

^[3] _{506 A.2d 173 (Del. 1986).}

^[4] _{Id. at 182.}

^[5] _{In re Mindbody, 2023 WL 2518149 at *32.}

^[6] _{125 A.3d 304 (Del. 2015).}

^[7] _{Id. at 305-06.}

^[8] _{In re Mindbody, Inc., 2023 WL 2518149 at *34.}

^[9] _Id.

^[10] _{Id. at *39.}

^[11] _{Id. at *43.}