This post was prepared by Frank Reynolds, who has been following Delaware law and writing about it in various publications for over 30 years.
The Chancery Court recently required Authentix Holdings L.P. directors who were also employees of the brand protection services company’s controlling stockholder, private equity giant The Carlyle Group, to show that Authentix’s sale to Carlyle-connected Blue Water Energy met Delaware’s exacting entire fairness standard, in Manti Holdings LLC et al. v. The Carlyle Group Inc., et. al., No. 2020-0657-SG, opinion issued (June 3, 2022).
In a June 3 opinion, Vice Chancellor Sam Glasscock declined to dismiss investor charges that three Authentix directors and controller Carlyle disloyally shortchanged Authentix’s common shareholders by ramming through an inadequately priced deal and falsely claiming a “drag-along” provision in the company charter barred them from challenging it. The decision allows the plaintiff investors to proceed with most of their breach of duty and unjust enrichment charges, but dismisses some aiding and abetting charges against the same defendants as duplicative.
The ruling is noteworthy for corporate transaction specialists because it found that even though Carlyle got no more than other preferred shareholders, the defendants were not shielded by Delaware law’s deferential business judgment rule or an exculpatory clause in the by-laws that exempts directors from monetary liability for breaches of fiduciary duty-of-care under 8 Del. C. § 102(b)(7).
Importantly, the vice chancellor said there are two reasons a deal can be tainted by a conflicted controller:
(a) where the controller stands on both sides; or
(b) where the controller competes with the common stockholders for consideration.
And a controller violates that second category where it:
- “receives greater monetary consideration for its shares than the minority”
- “takes a different form of consideration than the minority stockholders”, or
- extracts “‘something uniquely valuable to the controller, even if the controller nominally receives the same consideration as all other stockholders.’”
“I find it reasonably conceivable that Carlyle received a unique benefit from closing the sale by September 2017 that rendered it conflicted,” the Vice Chancellor explained, noting allegations that a majority of Carlyle-affiliated directors misused their control to force an early sale to their preferred buyer and to “monetize and close that fund so the money could be returned to investors.” He said that disloyalty charge, if proven would not be exempted under 8 Del. C. § 102(b)(7).
Authentix agreed to try to attract big capital investments by adopting a so-called “drag-along” clause that barred shareholder challenges to any deal approved by a majority of the Authentix stock. That persuaded Carlyle to buy a majority of Authentix stock – which in turn enabled Carlyle to place three directors on the five-member board.
But according to the complaint the Carlyle-affiliated directors were directed to sell Authentix as soon as possible in order to pay off the Carlyle investors who had funded the acquisition of a controlling interest in Authentix. In addition, a stockholder agreement allowed the preferred shareholder to take the first $70 million from any sale of the company with the common shareholders getting most of what was left.
And the Sept. 13, 2017 sale price that the Carlyle-majority of directors negotiated with Blue Energy was $77.5 million, with a possibility of additional funds if certain conditions were met later, according to the complaint filed by lead plaintiff Manti Holdings on behalf of other Authentix common shareholders. There was no independent review or shareholder vote on the deal because none was called for under the consent agreement.
Must take entire fairness test
In his June opinion, Vice Chancellor Glasscock found the deal must be reviewed under the entire fairness standard because it was “reasonably conceivable” that:
(i) The Sale was an alleged conflicted controller transaction and
(ii) The Sale was not approved by an independent and disinterested Board.
He found that even though Carlyle did not stand of both sides of the transaction it was nevertheless conflicted because this was a deal “where the controller competes with the common stockholders for consideration.” And although there was no extra money, the benefit Carlyle received was “something uniquely valuable” from the Sale because it had a unique desire to close its investment in Authentix by September 2017.”
He noted that “the Director Defendants’ decision to cut the lone dissenting stockholder, Barberito, out of the deliberations gives rise to a reasonable inference that Carlyle derived a unique benefit from the timing of the Sale.”
No exculpatory shield
The two Carlyle-affiliated director defendants here are protected by an exculpatory charter provision pursuant to 8 Del. C. § 102(b)(7), which normally insulates them from liability for duty of care claims, but here there are allegations that their loyalty was conflicted by their roles as officers of various Carlyle entities. The court said. “If the interests of the beneficiaries to whom the dual fiduciary owes duties are aligned, then there is no conflict. But if the interests of the beneficiaries diverge, the fiduciary faces an inherent conflict of interest,” the vice chancellor explained.
However, he had already found that Carlyle’s interests diverged from the common stockholders with respect to the Sale and “There is no ‘safe harbor’ for such divided loyalties in Delaware.”
The Authentix CEO – who was also a member of the board is also conflicted for purposes of this motion because he “allegedly stated during Sale negotiations that he “worked for Carlyle” and “had been told to sell the company,” the court said.
The court dismissed alternate aiding and abetting claims against all defendants since they already face similar claims based on their fiduciary duty.