This article was prepared by Frank Reynolds, who has been following Delaware corporate law and writing about it in various publications for more than 35 years
The Delaware Court of Chancery has allowed GoDaddy Inc. shareholders to continue their suit that claims their directors exhibited bad faith by disloyally rubber-stamping the under-valued buyout of a tax asset business that allegedly cost the web hosting company $850 million, in IBEW Local Union 481 Defined Contribution Plan and Trust v. Winborne, et al., C.A. No. 2022-0497-JTL (opinion issued) (Del. Ch. Aug. 24, 2023).
Vice Chancellor Travis Laster’s August 31 opinion refused to dismiss a pension fund’s derivative breach of duty and waste of assets charges, finding that, viewed as a whole, the suit contained enough particularized allegations supporting multiple reasons to believe the directors’ actions were not entitled to the protection of the business judgment rule or exculpation—due to indications of bad faith conduct.
The process by which the court made that determination should be of interest to corporate law practitioners. The vice chancellor said one way to determine bad faith in this context is, if it appears that the transaction was “authorized for some purpose other than a genuine attempt to advance corporate welfare or is known to constitute a violation of positive law,” then a court can find bad faith. Even if the defendants argue that the extreme transaction had a legitimate purpose, “if the decision is sufficiently extreme, then the court can still infer bad faith, but the decision must be so extreme that it could not be rationally explained on another basis” he said, citing. In re Orchard Enters., Inc. S’holder Litig., 88 A.3d 1, 34 (Del. Ch. 2014).
In fact, he explained, that type of pleading matches the standard for a claim for waste, defined as a decision “so egregious or irrational that it could not have been based on a valid assessment of the corporation’s best interests.” White v. Panic, 783 A.2d 543, 554 n.36 (Del. 2001). The vice chancellor said that at the pleading stage, the test for bad faith is “whether the complaint alleges a constellation of particularized facts which, when viewed holistically, support a reasonably conceivable inference that an improper purpose sufficiently infected a director’s decision to such a degree that the director could be found to have acted in bad faith.”
Vice Chancellor Laster said that inference of bad faith was enough, for the purposes of the dismissal motion, to find that pre-suit demand is satisfied under Rule 23.1 because a majority of the defendants’ actions are not the type of breach of duty that can be exculpated.
The source of the litigation began in 2015, when GoDaddy completed an Up-C IPO, a structure which the court said, “layers a parent- level corporation on top of a limited liability company that is treated as a partnership for tax purposes” and has a member interest in the LLC divided into a number of units – some of which are owned by GoDaddy and some by public and private equity investors.
The opinion said the litigation arose from a complex transaction involving the buyout of the tax assets generated. The complaint charged GoDaddy CFO Raymond Winborne significantly misstated the value of the tax asset, causing a multimillion liability payment that hurt GoDaddy’s value. Windborne knew the value he stated was incorrect and so did the directors who voted for the tax asset scheme, the complaint by a union pension fund claims;
A holistic approach
In this case, the court said it “adopted a ‘holistic’ approach, compiling a “constellation” of various factors from the complaint’s allegations that together provide reason to doubt that the voting directors acted in good faith. The court listed those factors:
The first indicative factor is the stark contrast between the valuation of $175.3 million for the TRA Liability in GoDaddy’s audited financial statements and the $850 million payment in the TRA Buyout. The contrast between those figures is so glaring as to support a claim of waste and hence an inference of bad faith on that basis alone.
The second indicator of bad faith is the conflict between Winborne’s representations to the Audit Committee and Ernst & Young and his representations to the Special Committee and the Voting Directors. For Winborne to have said one thing to the Audit Committee and Ernst & Young then said the opposite to the Special Committee and the Voting Directors supports an inference of bad faith.
In addition, there were no questions or objections from the directors regarding that wide discrepancy, the courts noted. Indeed, such an exchange “is so one-sided that no businessperson of ordinary, sound judgment could conclude that the corporation has received adequate consideration.” the court said.
A third indicative factor is that that Winborne’s projections and analysis excluded any consideration of GoDaddy’s M&A-based business model and its effect on GoDaddy’s ability to use the Tax Asset. One of the main reasons why GoDaddy had not made any payments under the Tax Agreements and kept putting off when they would begin was because the Company engaged in M&A. The pleading-stage record supports an inference that the members of the Special Committee knew that Winborne’s projections rested on unrealistic assumptions.
It’s all how you look at it
In summary, the vice chancellor ruled that, at most, a claim for breach of the duty of care does not give rise to liability for pre-suit demand purposes but, “When viewed holistically, the complaint’s allegations support an inference of bad faith.” Two members of management steered a process towards an outcome designed to favor the Founding Investors, aided by a Special Committee populated with the three outside directors most likely to sign off on the deal.
“Since the standard under Rule 12(b)(6) is less stringent than the standard under Rule 23.1, a complaint that survives a Rule 23.1 motion to dismiss generally will also survive Rule 23.1” he said.