Peter S. Kaufman, President & Henry F. Owsley, CEO of Gordian Group Co- Author Article on Liability Warnings on the Sell Side for Harvard Law School Forum on Corporate Governance
Warnings Persist for Corporate Directors Evaluating LBO and Other Multi-Step Transactions – Published on July 21, 2021
I. Executive Summary.
As the year 2020 was coming to a close, District Judge Rakoff issued a decision in In re Nine W. LBO Sec. Litig., No. 20 MD. 2941 (JSR), 2020 WL 7090277 (S.D.N.Y. Dec. 4, 2020) (“Nine West”) that sent some shockwaves through the M&A community with respect to the future of corporate governance in the context of director duties relating to the sale of a plainly solvent company.
As the second quarter of 2021 comes to a close, the implications and potential for far-reaching consequences of Judge Rakoff’s decision continues to draw fascinating intellectual debate amongst legal and financial advisors and corporate professionals alike, as reasonable minds differ as to whether Judge Rakoff’s decision also marked a new beginning—as with much else in 2020—for directors in their execution of applicable state-mandated duties. Indeed, the New York Times recently published an article  discussing Judge Rakoff’s decision and querying whether the private equity party that Wall Street has been embracing for years might be coming to an end as “[w]hat had for decades been considered a virtue—selling a company for a market-clearing price to the benefit of existing shareholders—might have become a vice.”
While Judge Rakoff’s decision was in the context of a motion to dismiss (which requires a court to draw all reasonable inferences in the plaintiff’s favor) and the claims at issue against the JG Directors (as hereinafter defined) were subsequently settled among the parties, it nonetheless may have moved the needle as to the potential risk directors may face and the considerations they should be factoring when transacting to sell companies.  And—again, as with many things in 2020—industry professionals are questioning whether this development has saddled directors with new and moving boundaries and constituents, and in so doing added (perhaps materially) to their risk for no greater reward. While hindsight offers 20/20 perspective, are directors now charged with having a lens into the future, even—perhaps especially—over matters that fall under the purview of the acquiror’s own subsequent post-transaction directors?
Prior to Nine West, it has been axiomatic that, when selling a solvent company, the directors are tasked with obtaining the highest price for the selling shareholders. What happens to the business in new hands has not been the concern of selling shareholders, and all the more so when sophisticated lenders are financing the acquisition and sophisticated investors are contributing new equity to the transaction.
But now: if something goes awry or differently than as may have been hoped at the time of the transaction, as is often the unfortunate case in corporate transactions, are former directors now effectively charged with being guarantors of the company’s future success under new directorship— lest they face liability? Is the state of the law now that if a corporate transaction goes south, the legal blame can be placed on the doorstep of the selling directors, as opposed to (or perhaps in addition to) the actions of the subsequent directors in the post-transaction period?
Said differently, once a solvent company changes ownership, why would the selling directors not be able to put the transaction, and future success or failure of the company, completely in their rear-view mirror absent fraud in connection with the sale?
Where the line—the new line—may ultimately get drawn in terms of the where, when, and to whom a director owes its duties remains to be seen, but, for now, Nine West’s implications for director liability have many on high alert as to whether existing practices amongst directors requires reformation.
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