June 6, 2022

PE Sponsor’s Desire to Close-Out Fund Results in Entire Fairness Review

Delaware courts acknowledge that controlling stockholders generally have an incentive to maximize stockholder value in a third-party sale, but will apply the entire fairness standard to such a transaction in certain situations. In a recent decision, the Chancery Court held that one of those situations is when a sale of a portfolio company is motivated by the sponsor’s desire to close out the private equity fund that invested in that company.

In Manti Holdings v. The Carlyle Group, (Del. Ch.; 6/22), the plaintiffs alleged that the PE sponsor and its representatives on the target’s board were under pressure to sell the target in order to enable it to close out the fund that had invested in the target, and that this created a conflict justifying application of the entire fairness standard.  The defendants argued that the Chancery Court had consistently refused to accept the theory that a controller’s need for liquidity represented a disabling conflict and emphasized that the controlling stockholder had every incentive to maximize the consideration received in the deal.  Vice Chancellor Glasscock rejected those arguments:

I agree with the Defendants that Delaware law generally presumes that stockholders “have an incentive to seek the highest price for their shares,” and that as a result, “liquidity-driven theories of conflicts can be difficult to plead.” But as this Court has recognized, “the reality is that rational economic actors sometimes do place greater value on being able to access their wealth than on accumulating their wealth.”

Steve Bailey’s statement that he was under pressure from Carlyle to close the Sale quickly so that Carlyle could close its applicable fund, together with the nonratable benefit Carlyle received from its preferred stock holdings, and the Director Defendants’ decision to cut the lone dissenting stockholder, Barberito, out of the deliberations, gives rise to a reasonable inference that Carlyle derived a unique benefit from the timing of the Sale not shared with other common stockholders, rendering it conflicted.

Not surprisingly, the Court also refused to dismiss fiduciary duty claims against directors affiliated with the PE sponsor.  It said that these directors were “dual fiduciaries,” and observed that “when directors of a Delaware corporation are on both sides of a transaction, they are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.”

John Jenkins