M&A Buyers Beware: Trend in Delaware Merits Heightened Attention by Acquirors

A trio of recent, high-profile M&A cases in the Delaware Court of Chancery merit special attention by M&A acquirors.  In each of these cases, the Court highlighted the liability of the third-party acquiror of a publicly listed target company for aiding and abetting breaches of fiduciary duties by the target board and executives.¹

Historically, successful “aiding and abetting” claims have been limited to the advisors of target companies and affiliates of a director.²  However, there are a number of reasons why asserting aiding and abetting claims against third-party buyers may now be attractive for plaintiffs in light of these recent cases:

• An aider and abettor will have joint and several liability for the underlying fiduciary duty breach by the target board or executive team in a sale process.  This means another deep pocket from which to obtain funds and have leverage in settlement discussions.  The Delaware Court of Chancery will often determine damages by looking to the difference between what the aggregate merger consideration would have been, but for the breach of duty, and the actual merger consideration.  Under this approach, the aggregate damages can be in the hundreds of millions of dollars and therefore having multiple deep pockets to draw from is of real value to the plaintiffs. 
• In the case of breaches of the duty of care (such as a shortfall in the performance of Revlon duties to obtain the best price reasonably available in a sale process), many claims for damages against target company directors and officers are nullified by the applicability of the right to exculpation as permitted by Section 102(b)(7) of the Delaware General Corporation Law.³  But claims against an aiding and abetting third-party buyer are not entitled to any such exculpation.
• As an aiding and abetting defendant, the acquiror becomes subject to potentially enhanced discovery of internal documents and depositions.  It is even possible that the acquiror’s own stockholders will start to pursue books and records demands and even derivative claims against the acquiror’s board relating to the aiding and abetting activity.  These risks provide further leverage for the plaintiffs to induce an early settlement payment directly from the acquiror.
• Troublingly, the standard insurance policies of many strategic acquirors—especially those that are publicly listed—may not currently cover these aiding and abetting liability risks.  This vulnerability may further induce these acquirors to settle quickly rather than fight an aiding and abetting claim.

How Does an Acquiror Become Liable for Aiding and Abetting a Target Board's Breach?

In the three recent cases, the Court identified what it considered to be a slew of missteps by target officers and directors in their sale processes that indicated questionable loyalties and indifference to the best interests of the stockholders.  But what turned this problematic conduct by target fiduciaries into “aiding and abetting” violations by the third-party acquirors were (i) the acquirors’ knowledge that these missteps by the personnel at the target companies constituted acts of disloyalty or at least deviations from practices designed to obtain the best price reasonably available, and (ii) despite this knowledge, the decision by the acquirors to participate in inducing and/or exploiting these missteps.  As the Court highlighted, a “potential acquirer’s right ‘to seek the lowest possible price through arms’ length negotiations with the target board’ is not unlimited.”⁴

Thus, for example in the Columbia Pipeline case, the Court found, after trial, that the two target company executives leading the sale process who breached their fiduciary duties:

• conveyed to the strategic acquiror that the target was eager to sell, 
• implied to the acquiror that they were personally seeking a quick sale to trigger their change in control benefits, 
• reassured the acquiror that the process would not be competitive, 
• never mentioned to the acquiror that the acquiror’s maneuvers to undermine the competitiveness of the process were in violation of the acquiror’s standstill undertakings, 
• provided the acquiror with due diligence access on an accelerated timeline not available to any other bidder, 
• were unduly receptive to proposals to decrease the proposed merger consideration, 
• extended the acquiror’s exclusivity despite the existence of competitive inbound inquiries, and 
• never countered a last-minute price drop.

The Court found further that the acquiror advocated for the target executives to take these actions while the acquiror understood that these actions would constitute deviations from these executives’ duties of loyalty and Revlon duties to obtain the best price reasonably available.  

The Court in Columbia Pipeline found additional violations of fiduciary duties by the target board arising from the failure to disclose these missteps properly in the “Background” section of the proxy statement.  The Court then examined these duty of disclosure violations on the part of the target board in the context of the acquiror’s knowledge of these omissions along with the merger agreement’s provision of a right for the acquiror to review and comment on the proxy statement.  The result was a Court finding that the faulty proxy statement disclosure constituted yet another basis for aiding and abetting liability on the part of the acquiror.

In the Presidio case, the Court denied a motion to dismiss aiding and abetting claims against a private equity acquiror because, according to the Court, the complaint portrayed a reasonable inference of (i) favoritism of the acquiror that would constitute breaches of fiduciary duties on the target side and (ii) the acquiror’s understanding that such favoritism constituted such a breach while nonetheless exploiting and attempting to keep secret its knowledge of this favoritism.  

In the Mindbody case, the Court did not formally find an aiding and abetting violation by the private equity acquiror due to a technical pleading shortfall by plaintiffs’ counsel, but dicta by the Court in Columbia Pipeline called out the finding of surreptitious communications between the target company CEO and the private equity acquiror in Mindbody as an instructive example of the components of an aiding and abetting violation by an acquiror—i.e., the Court focused on what it considered to be instances of (i) fiduciary duty missteps in the form of favoritism of a specific private equity bidder by a CEO “uniquely smitten” with this private equity bidder and (ii) exploitation by that private equity bidder of these missteps by the smitten target CEO in a manner that appeared to amount to the acquiror’s “participat[ing] knowingly in a sell-side breach.”⁵

Aiding and abetting a breach of a fiduciary duty is in fact a well-established doctrine in Delaware.  As a formal matter, it consists of two elements:  first, an underlying breach of fiduciary duty by a director or officer of the target company and second, knowing participation in such breach by the third-party acquiror.⁶

The second prong (knowing participation), which the Delaware Court of Chancery has noted as the “most critical element for an aiding-and-abetting claim,” consists of two further elements:  knowledge and culpable participation (in each case, of the underlying breach).⁷  Knowledge can be actual or constructive knowledge.  As explained by Vice Chancellor Laster in Columbia Pipeline, the plaintiff, to establish culpable participation, is required to show that the third-party buyer “create[d], exacerbate[d], or exploit[ed] the sell-side breach” of fiduciary duty.⁸

In sum, a plaintiff must show the following elements to succeed on an aiding and abetting claim against a third-party buyer:

1. Underlying breach of fiduciary duty on the sell-side,
2. The buyer had actual or constructive knowledge of the breach, and
3. The buyer created, exacerbated, or exploited the breach.

In contrast to these three recent cases, there are many more Delaware cases where the Court of Chancery dismissed aiding and abetting claims against third-party buyers and bidders.⁹  Indeed, Columbia Pipeline affirmed that aiding and abetting liability for a third-party buyer remains a very high bar—since knowing participation is difficult to plead, let alone prove.  Well-advised acquirors should be able to avoid aiding and abetting risks despite their attractiveness to plaintiffs.   

What Should Acquirors Do?

First, acquirors need to be on the lookout for acts of unwarranted favoritism or actions that are indicative of questionable loyalties on the part of the representatives of the target.  Questions that bidders and their advisors ought to be asking themselves regularly during sale processes include:

• Do we believe that we are receiving meaningfully preferential access to due diligence materials relative to the other bidders—either in the substance of the material or the timing of the access?  
• Are we receiving inside information about the sales process that would appear to undermine the competitiveness of the process and that we do not believe is being shared with the other bidders?
• Is the target looking the other way when we engage in repeated or blatant violations of our standstill or no-teaming undertakings?
• Are any executives from the target company engaging in discussions with us about plans for a post-closing role at the company or an individual side deal?
• Were we told that the sale process would abide by certain guidelines and protocols (such as prohibitions on unsupervised contacts with management) that are turning out not to be consistently followed?
• Are we receiving valuable information about how to prevail in the sale process through informal text messages and “offline calls” from target personnel rather than through formal sales process communications and channels?

The most effective way to ensure that these red flags do not give rise to aiding and abetting exposure (and, just as importantly, to mitigate the risk that consummation of the merger will result in the acquisition of a target rife with exposures for pre-closing fiduciary duty breaches) is for the bidder to insist on a quick, good faith confirmation that the target board is aware of and signed off on the developments in question combined with a sense check that business rationales exist for such developments.  After the bidder obtains this real-time, good faith confirmation, the bidder’s decision to exploit such developments shifts from potential fodder for an aiding and abetting claim to being a tactically smart move by the bidder.  

The beautiful characteristic of Revlon duties is that the sell-side “directors are generally free to select the path to value maximization, so long as they choose a reasonable route to get there.”¹⁰  As an outsider, no third-party bidder knows what actions would reasonably be in the best interests of the target stockholders.  Ignoring standstill violations may be a perfectly reasonable way for the target board to obtain the best value for stockholders in a sale process.  But when there are red flags that would make a sophisticated M&A player metaphorically scratch her head and question how that act could be linked to fulfilling Revlon, then it is best to find out first about where the target board stands before proceeding to exploit the questionable actions by the target company’s representatives. 

One practice note that comes out of the Columbia Pipeline opinion is the disdain that the Court has for one-on-one consultations with target directors, as opposed to an actual meeting of the board or a committee, for ensuring compliance with the duties of care and loyalty.  If a bidder wants to ensure that problematic activity by the target CEO is not problematic, then it is best not to settle for a message from a target executive along the lines of, “Oh, I spoke one-on-one with a couple of directors and they’re fine.”  Better to insist on confirmation that a board or committee meeting has determined that all’s in order.  In addition, although asking to see the target’s board minutes for the sale process is a step too far for a bidder, asking the target’s outside counsel to confirm that the target board’s understandings of certain elements of the sale process have been memorialized in the minutes (and that these minutes have been completed before the merger agreement is announced) is reasonable and advisable.  

Second, even if there were missteps leading up to the signing of the merger agreement, the Corwin doctrine provides one final opportunity for the parties to come clean and obtain “cleansing” through disclosure of material missteps.  A failure to take advantage of Corwin cleansing by having the “Background” section of the proxy statement disclose material missteps not only constitutes a missed opportunity to erase the fiduciary duty breaches, but such failure also may serve, as was the case in Columbia Pipeline, as another basis for an aiding and abetting claim.  In Columbia Pipeline, the Court viewed awareness by acquiror personnel of various omissions in the proxy statement as the basis for finding that the acquiror aided and abetted breaches of target’s duty of disclosure.  Best practice is to ensure that all representatives of the buyer who played a material role in the interactions with the target carefully review the “Background” section of the proxy statement and understand the costs for the acquiror of material omissions, even if the omitted disclosure may be awkward to insert into the “Background” section. 

Finally, acquiror deal teams in their internal post-transaction reviews should be circumspect about gloating about their successful navigation of the sale process.  Discussion of how personal relationships were leveraged and missteps by the target team were exploited can be turned by plaintiffs’ lawyers into foundations for aiding and abetting claims.  Indeed, the internal post-closing presentation by the acquiror team in Columbia Pipeline about the ways they were able to have such “strong success” in the sale process was repeatedly relied upon by the Court to support its finding of aiding and abetting liability on the part of the buyer.  

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1. In re Columbia Pipeline Gp., Inc., Merger Litig., 2023 WL 4307699 (Del. Ch. June 30, 2023); In re Mindbody, Inc., S’holder Litig., 2023 WL 2518149 (Del. Ch. Mar. 15, 2023); Firefighters’ Pension Sys. of Kans. City, Mo. Tr. v. Presidio, Inc., 251 A.3d 212, 286 (Del. Ch. 2021). 
2. See, e.g., New Enter. Assocs. 14, L.P. v. Rich, 295 A.3d 520 (Del. Ch. 2023); Morrison v. Berry, 2020 WL 2843514 (Del. Ch. June 1, 2020).
3. Breaches of the duty of loyalty are not entitled to exculpation.  See 8 Del. C. § 102(b)(7).
4. 2023 WL 4307699, at *64 (quoting In re Del Monte Foods Co. S’holders Litig., 25 A.3d 813, 837 (Del. Ch. 2011)).
5. Id. at *66.
6. Malpiede v. Townson, 780 A.2d 1075, 1096 (Del. 2001).
7. 2023 WL 4307699, at *62.
8. Id. at *68.
9. E.g., Jacobs v. Meghji, 2020 WL 5951410, at *8 (Del. Ch. Oct. 8, 2020); In re Xura, Inc. S’holder Litig., 2019 WL 3063599, at *3 (Del. Ch. July 12, 2019); In re Hansen Med., Inc. S’holders Litig., 2018 WL 3025525, at *12 (Del. Ch. June 18, 2018).
10. In re Answers Corp. S’holders Litig., 2011 WL 1366780, at *3 (Del. Ch. Apr. 11, 2011) (quoting In re Dollar Thrifty S’holder Litig., 2010 WL 5648895, at *17 (Del. Ch. Sept. 8, 2010)).