In Manti Holdings, LLC, et al. v. The Carlyle Group, Inc., et al., C.A. No. 2020-0657-SG (Del. Ch. June 3, 2022), the Delaware Court of Chancery addressed fiduciary duty claims in the context of a conflicted controller transaction. The court found that the plaintiffs plead facts capable of showing that the controller competed with other shareholders for sale consideration in furtherance of a unique benefit. Lacking the approval of an independent and disinterested board, the court viewed the plaintiffs’ claims through an entire fairness lens, in which the allegations of the complaint withstood the defendants’ dispositive motion in large part.
Manti involved an action brought by shareholders of Authentix Acquisition Company, Inc., against the controlling shareholder, The Carlyle Group, Inc., and certain members of the board of directors concerning the sale of Authentix. In October 2015, Authentix explored offers to purchase the company from potential purchasers, but no sale was finalized. In 2017, members of the board of directors were “under pressure to sell Authentix…and it was time for [The Carlyle Group] to monetize and close [a] fund so the money could be returned to investors.” Ultimately, Blue Water Energy made an offer to purchase Authentix for $77.5 million. Authentix shareholders previously agreed to “consent to and raise no objections” to a sale, provided that the board of directors and the holder of a majority of the outstanding shares approved the transaction. Both conditions were satisfied with respect to Blue Water Energy’s offer, and under the terms of the sale, the preferred shareholders, comprised of The Carlyle Group and directors of Authentix, received the first $70 million. Holders of common shares were entitled to any proceeds in excess of that amount.
The plaintiffs filed suit against The Carlyle Group and certain members of the board of directors for breach of fiduciary duties, which the defendants sought to dismiss. The court found that the allegations of the complaint rebutted the application of the business judgment rule, thereby requiring the defendants to show that the underlying transaction was fair. The court based its determination on the allegations that the sale was a conflicted controller transaction that did not receive a stamp of approval from a disinterested and independent board of directors. Under Delaware law, there are two categories of conflicted controller transactions: (1) transactions in which the controller stands on both sides; and (2) transactions where the controller competes with the holders of common stock for sale consideration. A controller competes with common stockholders if the controller receives a greater share of the sale consideration, accepts a different form of sale consideration, or extracts something uniquely valuable. The complaint invoked the second category of conflicted transactions, in which the plaintiffs alleged that The Carlyle Group defendants received something uniquely valuable from the sale. Although the shareholders received the same form of consideration, the court found that it was reasonably conceivable to conclude that The Carlyle Group defendants received a unique benefit in the form of first priority to the sale proceeds and a timely opportunity to return money to its investors. While Delaware law presumes that shareholders have a financial incentive to seek the highest price for their shares, the first-priority status, along with statements from one of the defendants concerning the pressure to sell Authentix as soon as possible in order to close the fund, gave rise to a reasonable inference that The Carlyle Group defendants received a unique benefit. Accordingly, the court concluded that the entire fairness standard applied, in which the complaint plead facts to support the plaintiffs’ claims against the controlling shareholder.
Even though the court found that the claims against the controlling shareholder would be decided under the entire fairness standard, the court evaluated claims against directors on an individual basis. In this instance, the defendant directors sought protection from liability for violations of their duty of care under the exculpatory charter provision. Two of the director defendants held managerial roles with a number of The Carlyle Group defendants, and thus possessed a dual interest. Because the interests of their beneficiaries at Authentix and The Carlyle Group diverged, the court concluded that these defendants possessed an inherent conflict of interest. This inherent conflict required these director defendants to show that they acted in good faith and that the underlying transaction was inherently fair. The plaintiffs alleged that these director defendants were motivated by the need to close a sale of Authentix as soon as possible and that they excluded one director, who opposed the sale, from the negotiation. These allegations, in light of the sale consideration, allowed for a reasonable inference that the defendants acted disloyally.
Manti provides valuable insight concerning conflicted controller transactions under Delaware law. The allegations of the complaint rebutted the business judgment rule by pleading facts capable of showing that the controlling shareholder received a unique benefit. Had the sale been approved by a disinterested and independent board and/or a majority of disinterested shareholders, the court may have reached a different conclusion. However, on this record, the pleadings suggest that the controller’s presence was profound, such that the defendants must establish that the sale was entirely fair in order to defeat the plaintiffs’ claims.
*Rachel Santos, a summer associate at McCarter & English not yet admitted to the bar, contributed to this alert.