Saturday, December 18, 2021
Today I’m posting to call everyone’s attention to In re Kraft-Heinz Co. Derivative Litigation, decided by Vice Chancellor Will earlier this week.
This is a demand excusal case and there may be a lot that’s interesting about it but I’m focusing on one specific aspect.
Kraft-Heinz was 27% owned by Berkshire Hathaway, 24% owned by 3G (which had operational control), and 49% owned by public shareholders. Berkshire and 3G each got to nominate 3 members of the 11 member board, and they had a shareholder agreement whereby they promised to vote for each other’s designees, and not take action to “to effect, encourage, or facilitate” the removal of the other’s designees.
Kraft-Heinz started to perform poorly and 3G sold 7% of its stake just before a disappointing earnings announcement. Shareholders filed a derivative lawsuit alleging that 3G traded on nonpublic information, naming 3G and its board designees as defendants, and the critical question was whether the 11-person board was majority disinterested for demand purposes. That question, in turn, turned on whether Berkshire’s nominees – one of whom was a Berkshire director, one of whom was a director of several Berkshire subsidiaries and the CEO of one – could objectively consider whether to bring a lawsuit against 3G.
The plaintiffs alleged that Berkshire and 3G together formed a control group, but the court did not consider that relevant one way or another; i.e, whether they were or they weren’t, the critical question was the disinterestedness/independence of Berkshire’s board nominees vis a vis 3G, and that question did not turn on their control group status.
The court said the Berkshire members were disinterested and independent, notwithstanding the shareholder agreement. Per the court, the agreement did not bind Berkshire not to sue 3G and its board nominees – only to refrain from removing them – and the Berkshire nominees were not themselves parties to that agreement anyway. Plus, Berkshire Hathaway does not exactly need to rely on 3G to have access to investment opportunities.
Okay, so why is this interesting?
Conceptually, it’s not dissimilar from the problem that faced the court in Patel v. Duncan, which I blogged about here. That case also involved a publicly traded company controlled by two private equity firms that had a shareholder agreement to select 60% of the board nominees. One of the firms engaged in an interested transaction with the company, and the way the case was framed, the critical question was whether the firms jointly consisted a control group such that the transaction could only be cleansed via MFW procedures, but substantively what it came down to was whether the court believed that the first PE firm could be objective about transactions in which the second firm had a financial interest. The court believed objectivity was possible, and though the plaintiff argued that the two firms had a tacit quid pro quo – where each would approve the other’s interested transactions – the court found no evidence of such an agreement other than the existence of an interested transaction with the first firm, approved a year earlier, and dismissed the case.
As I blogged at the time, shareholder agreements in publicly-traded firms are increasingly common, and one very popular structure involves agreements among PE firms with respect to a company that they take public but retain continuing control over. Which means we can expect to see more questions arise concerning how disinterested one firm can truly be when it comes to matters involving its co-venturer.
I mean, sure, in one sense, each firm may have an incentive to police the behavior of the other (unless, as alleged in Patel, they have a joint agreement to loot the company), but if we take the more nuanced approach to dependence that the Delaware Supreme Court has recently pursued, it seems much more likely that one firm will try, within at least some limits, to placate the other rather than allow disagreements to spill into litigation and boardroom friction, especially if they expect to do future deals together.
Vice Chancellor Will believed that Berkshire didn’t need 3G to do future deals – and so that would not be a factor in assessing Berkshire’s objectivity – but Berkshire’s brand is being a nondisruptive shareholder; the last thing it wants to do is get a reputation for public squabbles with co-investors. Plus, 3G had substantive control of the company; Berkshire may have worried about its ability to find a replacement with whom it could also partner if 3G’s malfeasance were established. And that doesn’t even get into the question whether VC Will correctly evaluated the effect of the shareholder agreement on the behavior of the Berkshire nominees (at least one of whom, as a Berkshire subsidiary CEO, is functionally a Berkshire employee).
Anyway, this is a problem that’s going to recur, which means Delaware needs to offer more considered guidance about the appearance of bias that may stem from shareholder agreements, and the legal consequences that follow.