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Delaware Court of Chancery Declines to Dismiss Claims against Conflicted CEO
December 14, 2018 Download PDF
Recently in In re Xura, Inc. Stockholder Litigation, the Delaware Court of Chancery denied a motion to dismiss fiduciary duty claims against the CEO of Xura, Inc. for his actions in negotiating a sale of the company. The court, in an opinion by Vice Chancellor Slights, concluded that business judgment review did not apply under Corwin v. KKR Financial Holdings LLC because shareholders were not fully informed about aspects of the negotiations when they approved the deal. Moreover, the court held that plaintiff pled a viable claim that, in negotiating the transaction, the CEO favored his own interests—which included securing continued employment—over those of the shareholders and may therefore be personally liable for an unexculpated breach of his duty of loyalty. The case reminds executives and boards about the dos and don’ts of how to conduct an appropriate sale process under Delaware law.
In August 2016, an affiliate of Siris Capital Group, LLC and two co-investors acquired Xura for $25 per share in a transaction that was approved by Xura’s shareholders. Despite the board forming a strategic committee to evaluate and negotiate the deal, Xura’s CEO oversaw negotiations almost exclusively. The CEO did not keep the Xura board or the company’s financial advisor fully informed regarding developments (despite repeated requests from the financial advisor to do so) and defied the board’s requested negotiating strategy on at least one occasion. The nondisclosure agreement executed between Xura and Siris required Siris to communicate through the CEO and to obtain his permission before communicating with others, and the board reaffirmed this authorization. Siris did communicate almost exclusively through the CEO, even though Xura’s financial advisor made requests to Siris that communications go through the advisor.
The circumstances also suggested that the CEO tipped off one potential bidder regarding Siris’ offer for the company, leading the potential bidder not to make its own offer to acquire Xura, but instead to co-invest with Siris. Throughout the process, the CEO faced job uncertainty, with the board considering management changes if there was no deal and major shareholders openly questioning his performance. Siris, however, indicated its willingness to work with existing management (including the CEO). Further, after closing, the CEO negotiated a $25 million long-term incentive, although he never realized on this plan because he was terminated before its implementation. None of these issues surrounding the negotiations process was disclosed to shareholders voting on the transaction.
In denying a motion to dismiss a fiduciary duty claim brought against the CEO, the Court of Chancery concluded that business judgment review was not applicable to the CEO’s actions under Corwin because the shareholders were not fully informed regarding key aspects of the negotiations. These included, among other things, that the CEO privately negotiated with Siris, including on price, without the board’s knowledge or approval. Additionally, the court concluded that plaintiff pled a viable claim against the CEO based on allegations that in negotiating the transaction, the CEO favored his own interests in securing continued employment over the best interests of shareholders.
Xura offers several helpful reminders for executives and boards negotiating sale transactions:
- The board or a special committee should remain engaged in the sale process, and designated negotiators should keep the board or special committee informed of their discussions. While it is common for a board or special committee to designate a primary negotiator or contact person during a sale process, they should not abdicate their oversight responsibilities to that individual, especially when he or she may have special self-interests in the outcome of the transaction. Ultimately, the board of directors is responsible for the strategic decisions of the company. Therefore, even where CEOs and other officers are authorized to negotiate on behalf of the company, they should keep the board fully informed of negotiations, and the board should be proactive in resolving any breakdowns in communications.
- Boards and executives should be mindful of possible conflicts (including any appearance of conflicts) and implement procedures to mitigate them. To lessen the inference of potential conflicts in the sale process, CEOs and other negotiators should delay discussing post-closing employment or other opportunities arising from the transaction with potential acquirers until after a specific acquirer is selected and the principal deal terms are finalized. The Xura court stated that “[c]ontinued employment in itself is a material interest,” resulting in a pleading stage inference that officers facing job uncertainty acted to secure their future employment prospects rather than protecting shareholder interests. Such conflicts could potentially subject the officers to non-exculpated personal liability.
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