Saturday, December 26, 2020
The backstory: In the wake of WeWork’s collapsed IPO, SoftBank – which was one of WeWork’s significant investors – agreed to buy additional equity from the company, to complete a tender offer for a large amount of WeWork’s outstanding equity, and to lend WeWork $5.05 billion. It ended up buying the equity and the debt, but the tender offer fell through. At that point, WeWork – on the authority of the 2-person Special Committee who had negotiated the SoftBank deal – filed suit against SoftBank for breaching its obligations under the contract. The Board of WeWork – by then consisting of 8 people: the 2 members of the Special Committee, 4 others designated by and obligated to Softbank, and 2 more with SoftBank affiliations – appointed two new, ostensibly independent directors to serve as a new committee to investigate the litigation. One of the Special Committee members objected to the appointment; the other abstained from the vote.
The new committee was charged with determining whether the Special Committee had authority to sue SoftBank. To the utter shock of absolutely no one, they concluded that, in fact, the Special Committee had no such authority, that the Special Committee could not continue the lawsuit due to certain conflicts, and that in any event continuing the lawsuit was not in the best interests of the company. Critically, one of the conclusions that the new committee reached was that WeWork – the company – had little to gain from the litigation because it was the tendering stockholders, and not the company, who would benefit from the completion of SoftBank’s tender offer. Thus, the new committee sought to terminate the litigation. Bouchard was therefore confronted with warring committees, and had to decide whether the litigation against SoftBank would continue.
Probably the least interesting aspect of Bouchard’s decision was his determination that the test of Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981) – originally developed to determine the propriety of allowing a special committee to terminate derivative litigation – would be used to evaluate the new committee’s decision here. That test requires that the court evaluate whether the new committee was independent acted in good faith, and conducted a reasonable investigation of the issues. Assuming it did so, the court must evaluate whether in its own “business judgment” the motion to terminate the litigation should be granted.
Here, Bouchard held that assuming the new committee was independent and acted in good faith, its investigation was not reasonable, because it ignored several facts that suggested the Special Committee had the authority to litigate against SoftBank and did not properly weigh the benefits against the burdens of completing the litigation. Bouchard also held that under Zapata’s second prong, in his judgment, the litigation should continue. Thus, he refused to allow the new committee to terminate the lawsuit.
In a companion opinion, he evaluated SoftBank’s motion to dismiss the WeWork/Special Committee complaint against it. Among other things, he held that WeWork had standing to sue over the failed tender offer, even though – as the new committee had also emphasized – the proceeds of the tender offer would go to tendering stockholders and not to the company itself.
What stands out here?
First, though Bouchard said he had “no reason to doubt” the good faith and independence of the new committee, I am not operating under such constraints. The 2-man committee was appointed for a two month term, for which each was paid $250K, and the expected outcome of their investigation was undoubtedly known to each of them. As Bouchard pointed out, they acted under significant constraints: not only were they on a clock, their limited mandate meant they could not, for example, take control of the litigation themselves and thus eliminate any purported conflicts under which the Special Committee acted. Truly independent directors, who were acting in good faith, might have refused such a charge, but these directors had no such qualms, and they reached exactly the conclusions that their patrons expected of them.
The entire circumstances of their appointment should, I would think, raise questions about their good faith and independence, and honestly, I wonder how often courts are willing to take at face value the conclusions of directors who are appointed for a particular purpose in the expectation they will reach a particular result. For example, I recall In re Oracle Corp. Derivative Litig., 824 A.2d 917 (Del. Ch. 2003), where two new ostensibly independent board members were appointed for the sole purpose of investigating claims against the incumbent board and concluded (again, shockingly) that the claims had no merit. The court decided – controversially – that the new board members were not independent, but did so because of preexisting ties to the company, and not because of the circumstances of their appointment.
There have previously been studies of how often board special committees conclude that derivative litigation against defendant board members has merit, and usually (but not always), they recommend dismissal. But what has not been studied, as far as I know, is how often new directors are appointed to create a special committee, whether they are more likely to recommend dismissal than incumbent directors, and whether courts are more or less likely to take their recommendations seriously. It’s possible sample sizes are just not big enough to draw conclusions, but I personally would be interested in an analysis of how new directors differ from incumbent directors in terms of their conclusions and/or the terms of their appointment.
I also note this: Delaware courts start with the presumption that corporate directors are so conscious of their fiduciary duties and so constrained by reputational concerns that they would not lightly betray their obligations for the crass material benefits that a board position can provide. But if that’s going to work, reputations have to mean something, and once damaged, they should not lightly be rehabilitated. Which is why I was so concerned by VC Zurn’s opinion in Rudd v. Brown. There, the plaintiffs alleged that an activist shareholder appointed a compliant director to a company’s board in order to force a merger. The plaintiffs claimed that this particular director lacked independence, because he had developed a sort of gun-for-hire reputation: activists had repeatedly appointed him, knowing he would champion acquisitions they favored. Zurn rejected the argument in a footnote:
Plaintiff also asserts in briefing that Brown had “a long history of being appointed to companies’ boards to push a merger or acquisition for short-term profit, including other companies that Engaged had targeted for a sale in the past.” Pl.’s Answering Br. at 37. Insofar as Plaintiff asserts that this gives rise to conflict, that assertion fails. Plaintiff provides no support for the proposition that a director is conflicted purely by virtue of his track record, and I am aware of none.
With this kind of precedent in hand, the newly-appointed WeWork directors had no worries that they were accepting a quarter-million dollars at the expense of their reputations with respect to future opportunities. But what if they had such concerns? What if appointing stockholders, as well, had to worry about directors’ past history of compliance? What if a past history of noncompliance helped burnish directors’ credentials as independent monitors? Wouldn’t that create a better system, where courts and minority stockholders had more faith in the special committee process?
Second, there’s the standing/harm issue. Both of Bouchard’s opinions – the one dealing with the new committee’s attempt at dismissal, and the one dealing with SoftBank’s dismissal motion – had to address the argument that WeWork the company was not harmed by SoftBank’s abandonment of the tender offer, since it was the individual stockholders, and not the company, who missed out. And this interests me because, in a roundabout way, it touches on the issue I raised a couple of weeks ago – namely, when a merger agreement falls through, is the harm to selling stockholders direct or is it derivative?
In this case, the new committee and SoftBank argued that the tendering stockholders did not have a direct claim against SoftBank for breach of contract because they were not parties to SoftBank’s contract with WeWork, and the contract itself specified there were no third party beneficiaries. They also argued that if the tendering stockholders had a problem with the termination of WeWork’s litigation, their remedy was a derivative action. See Op. at fn 253. And then they argued that WeWork was not in fact harmed by the termination of the tender offer because WeWork would not have collected the proceeds.
That is … quite the paradox.
Rather than fully engage this thorny question of who suffers a harm from a terminated stock sale, Bouchard concluded that WeWork as a company suffered a harm because if SoftBank increased its equity stake, it would have more of an interest in monitoring WeWork’s performance.
That is, I have to say, unsatisfying. I mean, by that logic, SoftBank would have the greatest interest in monitoring WeWork’s performance if it was planning to buy the whole company. But we know from Revlon that when there’s an offer to sell the whole company for cash, it’s an endgame transaction – we’re not worried about the company’s future after that point; instead, we’re worried about the selling stockholders.
Anyway, all of this just highlights to me that it’s a blip in the law, and perhaps unresolvable. At the end of the day, in a shareholder-wealth-maximization world, all harms to the company matter because they are harms to stockholders, and the direct/derivative distinction is not a fact of nature, but a policy judgment as to which types of claims should be handled by the board in the first instance and which should not. So it stands to reason there wouldn’t be complete doctrinal coherence for the edge cases.