Previously this blog has discussed the importance of procedural compliance with various transaction structures when the transaction involves controlling or interested parties (see an example here). For instance, in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), the Delaware Supreme Court held that compliance with certain process elements enables deferential business judgment review of decisions regarding interested transactions with controlling parties (see here for a helpful discussion about MFW protections). Delaware courts have since expanded the role of MFW-like process protections in various contexts, thus demonstrating that adequate decisionmaking procedures are a central prerequisite to business judgment deference when controllers or interested parties are involved in contemplated transactions.
Vice Chancellor Laster’s recent decision in IBEW Local Union 481 Defined Contribution Plan & Trust v. Winborne, C.A. No. 2022-0497-JTL (Del. Ch. Aug. 24, 2023, corrected Sept. 7, 2023) (“GoDaddy”) is no exception. The decision reminds corporate boards, their consultants, and Delaware practitioners that, when contemplating, evaluating, and approving transactions that benefit corporate insiders, potentially at the expense of public stockholders, procedural compliance with MFW-like conditions matters.
In 2015, GoDaddy Inc., a web hosting and Internet technology company, completed an “Up-C IPO” (i.e., an umbrella partnership C corporation IPO), layering a parent-level corporation on top of a limited liability company that is treated as a partnership for tax purposes. This Up-C structure allowed preferential tax treatment for both pre-IPO investor insiders (“Founding Investors”) and for GoDaddy as a new, publicly traded corporation. Member interests in the partnership LLC were divided into units, adjusted to match the number of outstanding shares created by the offering. In the Up-C IPO, public investors received straight common stock in the form of Class A shares, and the Founding Investors received special Class B shares that carried voting rights only. The result was a hybrid entity that allowed public stockholders to participate both economically and in governance through their Class A shares, and Founding Investors to participate economically through their LLC units and in governance through their Class B shares.
Prior to the Up-C IPO, GoDaddy and the Founding Investors entered into tax receivable agreements (“TRAs”), which require GoDaddy to pay the Founding Investors 85% of any savings realized by the Company if and when it uses any tax asset generated by the Founding Investors to reduce the Company’s taxable income. GoDaddy was not obligated to make any payments to the Founding Investors unless and until the Company used those tax assets to generate savings.
By early 2019, several Founding Investors converted their Class B shares and LLC units into Class A shares, thus generating tax assets for the Company that totaled $2.2 billion and a commitment to pay the Founding Investors a nominal liability of $1.8 billion (85% of the tax asset benefit). However, because GoDaddy’s business model relied heavily on mergers and acquisitions that create tax benefits of their own, and because the Company intended to continue that growth strategy, the Company had little prospect of generating taxable income from the tax assets and thus little prospect of reducing the Company’s taxable income by utilizing such tax assets. In other words, it was unlikely for the Company to have to make TRA payments to the Founding Investors in the near future.
Nevertheless, in early 2020, GoDaddy’s General Counsel, who was also a Founding Investor standing to benefit financially from any TRA payments, asked the Company’s nine directors to establish a special committee (the “Special Committee”) to analyze and negotiate the terms of a potential TRA buyout. The Board adopted a written consent which stated that, during a prior Board meeting, the Board had discussed the possibility of a TRA buyout. The minutes of that prior meeting, however, did not reflect any such discussion, or the potential creation of the Special Committee, or who the members of that Committee might be.
The Board’s written consent further noted the Special Committee was being formed because certain members of the Board and of management “are affiliated with the holders of the TRAs or are party to the TRAs.” To that end, the Special Committee would “mitigate and address conflicts of interest” in connection with a potential TRA buyout. The Board’s empowering resolution delegated exclusive power and authority to the Special Committee to consider, evaluate, negotiate, and recommend a potential TRA buyout or any potential alternatives, and noted that the Board would not authorize or approve a TRA buyout without an affirmative recommendation from the Special Committee.
Five of the Company’s nine directors were neither affiliated with any Founding Investors nor members of Company management, but only two of those five directors had no apparent ties to the Founding Investors. The written consent named three directors to the Special Committee, but did not include either of the two directors who lacked any apparent Founding Investor ties.
Of the chosen directors, the first was a Founding Investor who renounced his rights under the TRAs so that he could serve on the Special Committee. That director, however, had been asked contemporaneously by a private equity firm holding Founding Investor rights to TRA payments to participate in a separate co-investment opportunity, and to serve on the co-investment target’s board. The second director chosen for the Special Committee also had ties to that same private equity firm; he had co-founded a vacation rental company in which the private equity firm had made a significant investment. The private equity firm also had two of its representatives on that company’s board. Finally, the third director chosen for the Special Committee also had overlapping connections with multiple private equity firms that likewise held Founding Investor rights to TRA payments.
Tasked with evaluating a potential TRA buyout, the Special Committee retained a financial consultant—one with concurrent representations of one of the Founding Investors—to provide value ranges for the potential buyout, but declined to request a fairness opinion from the consultant. The Special Committee also observed a projections presentation from the Company’s CFO, who for 11 years had been an executive of portfolio companies of a private equity firm that held Founding Investor rights to TRA payments (including approximately four years during which he worked for the Company). The Presentation assumed GoDaddy would begin to utilize the tax assets in 2022, and calculated a net present value of anticipated TRA payments of approximately $900 million. The Special Committee was aware that this presentation did not account for growth initiatives or future acquisitions, although such strategies were a significant part of GoDaddy’s business model and generated tax attributes that reduced the Company’s likelihood of utilizing the tax assets created by the Founding Investors. Nevertheless, the Special Committee discussed the anticipated timing of TRA buyout payments and the total amounts to be paid under the TRAs, “assuming all TRA attributes were utilized by the Company.”
The financial consultant retained by the Special Committee provided a present value range of the amounts due under the TRAs between $870 million and $1.2 billion. The Special Committee and management then discussed a strategy to negotiate with the Founding Investors. It was at this time that the Special Committee learned management had already begun to negotiate with one of the private equity firms holding rights to TRA payments, which was already in “alignment” with a buyout.
While the Special Committee was evaluating the potential buyout, the Company’s CFO led an effort to finalize the Company’s annual report. In November 2019—just before the Special Committee was formed—management informed the Audit Committee that it valued the TRA liability at roughly $175 million, because, in management’s view, the Company was unlikely to utilize all of the tax assets generated under the TRAs. Two of the Special Committee’s three directors also served on the Audit Committee, and thus knew of management’s estimated TRA liability valuation, and that management believed the Company was unlikely to utilize all of the tax assets generated by the Founding Investors. The annual report was filed in February 2020 and recorded a TRA liability of only $175.3 million, taking into account “limitations on our use of the favorable tax attributes due to limitations of taxable income”— the lynchpin for any near-future TRA payout obligations. Moreover, the Company’s audited financials did not project any TRA payments to the Founding Investors until 2023, at the earliest. This was in stark contrast to what the CFO had told the Special Committee: that the Company (i) likely would be able to utilize all of the tax assets subject to the TRAs, (ii) would be required to pay the $1.8 billion nominal liability of the TRAs in full, and (iii) would begin making payments under the TRAs in 2022.
Nevertheless, just days after the annual report was filed, the Special Committee authorized management to negotiate a TRA buyout up to $850 million. Management did just that, and at that price. Instead of evaluating the potential buyout and fashioning a recommendation to the full Board, however, the Special Committee “balked” and lateraled the issue back to the Board for its own consideration. In a subsequent Board meeting that lasted a total of 30 minutes, the voting members of the Board approved the buyout.
Following the Board’s recommendation, a stockholder pension fund sued derivatively in the Delaware Court of Chancery to challenge the TRA buyout, alleging among other things that (i) the Company’s CFO breached his fiduciary duties by providing materially false and incomplete information to the Board, the Special Committee, and the Company’s auditors; (ii) the Board breached its fiduciary duties by approving the TRA buyout and knowingly causing the Company to make substantial overpayments to the Founding Investors; and (iii) the TRA buyout constituted waste. The Board and CFO moved to dismiss.
Vice Chancellor Laster concluded that the plaintiff’s allegations supported a reasonable inference that the Board and CFO acted in bad faith and that the entire fairness standard applied to the events giving rise to the transaction. He further concluded that the plaintiff adequately alleged waste.
The Court opined that the “gulf” between the $850 million TRA buyout and the $175.3 million TRA liability valuation in the Company’s nearly contemporaneous annual report—prepared by management, audited by outside advisors, accepted by the Audit Committee, and approved by the Board—was alone sufficient to suggest bad faith. According to the Court, it was reasonable to infer that the Board approved paying $850 million for something the Board knew was worth only $175.3 million.
The Court also concluded the CFO’s conflicting representations to the Audit Committee and the Special Committee further supported a conceivable inference of bad faith. Specifically, the CFO informed the Audit Committee and outside advisors that the Company likely would not generate enough taxable income to utilize all of the tax assets created by the Founding Investors, but informed the Special Committee and later the Board that the Company likely would utilize all of the tax assets and have to pay the full $1.8 million nominal liability to the Founding Investors.
The Court further opined that the events surrounding the formation of the Special Committee, its work, and its decision to punt the TRA buyout assessment back to the Board, all contributed to an inference of bad faith under a holistic analysis of the pleaded allegations. The Court took occasion to note that GoDaddy’s General Counsel, “a Founding Investor in her own right,” began the process by circulating a request for a written consent to create the Special Committee. That consent noted that the Board had previously discussed the creation of a special committee for this purpose, but contemporaneous minutes of prior meetings contained no such references. The Special Committee (comprising directors with ties to Founding Investors) then hired a consultant (with ties to the Founding Investors itself) to conduct a valuation without a fairness opinion, relied heavily on projections from the Company’s CFO (with ties to the Founding Investors), which failed to account for the Company’s historical growth and acquisition strategies, and relied heavily on a TRA liability valuation significantly at odds with the TRA liability valuation described in the Company’s annual report and audited financials. Moreover, two members of the Special Committee also served on the Audit Committee, and therefore appreciated (or at least should have) the discrepancies between the competing TRA liability valuations presented to the Special Committee and the Audit Committee. Further, that the only two directors without any apparent ties to the Founding Investors were not chosen to serve on the Special Committee further gave rise to an inference of bad faith, as did the Special Committee’s election to lateral its evaluation of the buyout back to the full Board, which had created the Special Committee in the first instance to “mitigate and address conflicts of interest” regarding a potential TRA buyout.
The GoDaddy decision provides helpful reminders for corporate directors, their advisors, and Delaware practitioners contemplating transactions involving controlling or interested parties. Special committees can provide a host of legal benefits when implemented properly, and when such committees act independently and on informed bases. Their formation, structure, authority, and execution of objectives are integral in maximizing the ability to achieve corporate decision making deference.
In GoDaddy, the Delaware Court of Chancery reflected upon the way in which two members of management, both of whom either stood financially to gain if the contemplated transaction was consummated or had ties to those who would, “steered a process towards an outcome designed to favor” corporate insiders and sponsors. The Special Committee retained a financial consultant with undisclosed, concurrent representations of a counterparty to the contemplated transaction, and failed to require a fairness opinion regarding the contemplated transaction. The majority of its members also served on the Audit Committee, which had been provided information from management at odds with that which had been provided to the Special Committee, but failed sufficiently to consider those discrepancies.
Unlike in GoDaddy, where the Special Committee comprised the “three outside directors most likely to sign off on the deal,” corporate decisionmakers ought to ensure that those they select to serve on special committees to access sensitive transactions are independent and removed from the specter of conflict. Similarly, special committee members also must ensure they effectuate their prescribed authority sufficiently. It is paramount for directors charged to evaluate particular transactions to probe the independence of those they retain to facilitate their objectives, and to utilize all information available to them (be it through Special Committee meetings or otherwise) to render informed decisions.
Finally, GoDaddy serves as yet another reminder that company board and committee business ought to be memorialized in minutes that clearly reflect topics of discussion and the decision making process. Delaware jurisprudence consistently demonstrates that the adjudication of challenged corporate conduct so often turns on the sufficiency of compliance with procedural decision-making formalities.
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