Misconduct by Financial Advisor Tainted Company’s Sale Process
On the eve of the shareholder vote to approve the $5.3 billion leveraged buyout of Del Monte Foods, Vice Chancellor Travis Laster of the Delaware Court of Chancery last night issued a preliminary injunction delaying the vote for 20 days and enjoining Del Monte's private equity buyers from enforcing the merger agreement’s deal protections pending the vote.
The purpose of the injunction is to give other potential bidders an opportunity to top the $19 per share merger price, which, based on a preliminary discovery record, the Court found was likely obtained through a flawed sale process tainted by misconduct by Del Monte’s financial advisor (which also served as a source of buy-side financing) and collusion on the part of the buyers with this financial advisor.
Despite finding that the Del Monte board of directors appeared to have sought in good faith to fulfill their fiduciary duties, Vice Chancellor Laster concluded that the shareholder-plaintiffs had established a reasonable probability of success on the merits of a claim for breach of fiduciary duty against the directors because of their failure properly to oversee the company’s financial advisor. “Although the blame for what took place appears at this preliminary stage to lie with [the financial advisor], the buck stops with the Board. Delaware law requires that the board take an ‘active and direct role in the sale process.’”
Prior to discovery, the plaintiffs alleged, among other things, that Del Monte’s sale process was flawed insofar as its financial advisor was conflicted due to the sizeable fees the advisor stood to receive as a source of buy-side financing. However, discovery in connection with plaintiffs’ application for a preliminary injunction brought to light additional alleged misconduct on the part of the financial advisor, which was then disclosed by the company in an extensive proxy supplement approximately 10 days prior to the scheduled shareholder vote. Among other things, the preliminary record suggests that the financial advisor (i) concealed from the company that its coverage officer had engaged in unauthorized conversations that put Del Monte in play; (ii) manipulated the sales process in order to engineer a transaction with financial buyers that would maximize its opportunity to obtain lucrative buy-side financing fees; (iii) encouraged a violation of the “No Teaming” provisions of the bidders’ confidentiality agreements by brokering a collaboration among two of the highest financial buyers; and (iv) intentionally concealed the pairing of the bidders from the company. During the preliminary injunction hearing, plaintiffs’ counsel informed the Court that they intend to file an amended complaint that will include aiding and abetting claims against Del Monte’s financial advisor.
Although Vice Chancellor Laster noted that Del Monte’s board was misled and deceived by its financial advisor and therefore is unlikely to face any meaningful threat of monetary liability (given the company’s exculpation of its directors under Section 102(b)(7) and the directors’ good faith reliance on its advisors), he criticized the board’s decision to allow its financial advisor to participate in the acquisition financing while it was still negotiating the merger price with the buyout group. Moreover, Laster chastised the board for allowing the financial advisor to run the post-signing go-shop process despite its inherent conflict, particularly when other investment banks were available and familiar with the company. Despite finding no specific fault in the actual running of the go-shop, Vice Chancellor Laster emphasized that “the ‘who’ is as important as the ‘what,’” and the financial advisor’s “body language” may have tainted the go-shop process.
Unlike other preliminary injunctions of merger votes, the purpose of the 20 day injunction in this case is not to require corrective disclosure on the part of the company, but rather to permit a topping period during which the deal is stripped of its protective provisions (non-solicitation, matching-rights and termination fees relating to topping bids and changes of recommendation) in an effort by the Court to recreate a pre-contract environment to best approximate an untainted process. In one sense, the remedy sounds a cautionary note to directors, buyers and their advisors, as it deprives the merger parties of certain carefully negotiated contractual provisions and subjects a premium transaction to market risk in order to create an opportunity for another bidder, despite the Court’s conclusion that it appeared that the company already was actively shopped during the go-shop period. But the Court’s remedy is heavily shaped by the combination of misconduct by Del Monte’s financial advisor, a fiduciary breach by an independent board that, in the Court’s view, failed adequately to supervise the financial advisor, and inducement or collusion by the buyer in the financial advisor’s misconduct.
While much of the Court’s willingness to upend negotiated deal protections here is attributable to the particularly egregious facts suggested by the preliminary record, Vice Chancellor Laster’s decision underscores the Court’s heightened sensitivity to potential conflicts of interest on the part of financial advisors more generally. Since Vice Chancellor Strine’s 2005 comments in Toys “R” Us that stapled financing by sell-side advisors “tends to raise eyebrows by creating the appearance of impropriety,” practitioners have proceeded on the assumption that sell-side advisory work will be scrutinized more stringently if financing is also being provided (although Vice Chancellor Strine’s comments at a subsequent symposium and in more recent decisions recognized that, in some situations, the availability of such financing, with the proper controls, could be process-enhancing). In the current case, Vice Chancellor Laster found that the activities of Del Monte’s financial advisor “went far beyond what took place in Toys,” and that but for those actions the Del Monte process would have played out differently. In all events, the case illustrates the pressures that may be placed on the conduct of a sale process when the sell-side advisor is also a participant in the buy-side financing, and the need for boards of directors and their advisors to consider the need for an active second financial advisor when such multiple roles are contemplated.
Click here for a copy of In re Del Monte Foods Company Shareholders Litigation, Consol. C.A. No. 6027-VCL (Del. Ch. February 14, 2011).