Revlon Revived: Former Executive and Private Equity Acquiror Both Held Liable for Tainted Sale Process That Failed to Maximize Stockholder Benefits
In a recent post-trial opinion in In Re Mindbody, Inc., Stockholder Litigation, Chancellor Kathaleen McCormick of the Delaware Chancery Court gave new life to the Revlon enhanced scrutiny standard of review when she held that the former CEO of Mindbody, Inc. and its private equity acquiror were liable for orchestrating and failing to fully disclose what the court found to be a sweetheart deal that deprived stockholders of the benefit of a maximized purchase price.
In 2019, a software-focused private equity firm acquired Mindbody for $1.9 billion. As early as February 2018, the CEO’s external communications revealed frustration from the pressures of running a public company and a need for liquidity due to substantial financial commitments. After the CEO was introduced to the private equity firm’s executives by a banker, he “quickly came to believe that selling to [that firm] gave him the unique opportunity to both gain liquidity and remain as CEO in pursuit of post-acquisition equity-based upside.” The CEO notified management of the private equity firm’s interest and began socializing the idea of a sale with the board, but he never disclosed his need for liquidity or strong desire for a quick sale to that firm in particular. Two weeks later, unaware of the full extent of the CEO’s early discussions with the private equity firm, the board formed a transaction committee to consider running a sale process. The CEO asked a director who represented Mindbody’s largest stockholder, an entity that was also interested in a near-term exit, to chair the transaction committee. Upon that chair’s recommendation, the transaction committee hired the same banker who had introduced the CEO to the private equity firm. Disregarding the transaction committee’s guidelines on management communications with potential bidders, the CEO tipped off the private equity firm that the company was commencing a formal sale process and the banker gave the firm a preview of the CEO’s target price. The CEO also provided inside information to the private equity firm, including his plans to resign within two to three years, that was not shared with other bidders. These issues were compounded by the omission of material information about the CEO’s dealings with the private equity firm from Mindbody’s proxy disclosures to stockholders.
Luxor Capital Partners, L.P. and affiliates, collectively the second largest stockholder of Mindbody stock, sued both the CEO and the private equity acquiror for fiduciary duty breaches arising from the sale process that furthered the CEO’s personal interests at the expense of stockholders and the failure to disclose material information about the sale process in Mindbody’s proxy statement.
The court first addressed Luxor’s claim that the CEO breached his fiduciary duties by tilting the sale process in favor of the private equity firm that he preferred. The court determined that Luxor’s claim fit within the Revlon framework because the CEO had a disabling conflict from his personal desire to gain liquidity from a fast sale and expectation of post-merger employment and equity-based incentives. Infected by the conflict, the court found that the CEO tilted the sale process by intentionally depressing Mindbody’s stock price to make a deal more attractive to the private equity firm and giving that firm informational and timing advantages during the due diligence and go-shop periods. The court also concluded that Corwin cleansing was unavailable because the material omissions in the merger proxy materials meant the stockholder vote was not fully informed.
Second, the court addressed Luxor’s claim that the CEO, aided and abetted by the private equity acquiror, committed disclosure violations by omitting key facts regarding the sale process in the proxy materials sent to stockholders. The court found that, taken together, the partial and complete omissions from the proxy disclosures, including sterilized descriptions of the scope of interactions between the CEO and the private equity firm, altered the total mix of information available to Mindbody stockholders such that the CEO breached his duty of disclosure. The court further found that the private equity firm had aided and abetted the CEO’s disclosure-based breach because it knew that the pre-sale discussions with the CEO had not been disclosed in the merger proxy materials and failed to correct the material omissions, despite contractual obligations in the merger agreement to do so.
The Mindbody decision serves as a reminder that conflicts that have the potential to infect a sale process must be fully disclosed and carefully managed from the perspective of both the buyer and the seller. On the seller’s side, directors and executive officers must fully disclose their conflicts — to the board and to stockholders — to ensure that any sale process is transparent and fair, and results in a deal that maximizes stockholder value. As the court noted, “[d]irectors can manage conflicts if they are aware of them,” but the board is crippled in its ability to manage conflicts if it does not even know they exist. For private equity buyers, Mindbody cautions that initial engagement with founders or executives who express a strong interest in doing a deal should be undertaken carefully, to ensure that both the sale process and the final deal serve the interests of the stockholders in the target company as well as the executive presenting the deal.
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