Tuesday, July 07, 2020

CEO sold out shareholders for higher post-merger comp, plaintiffs alleged

By Anne Sherry, J.D.

Investors in Towers Watson & Co. rebutted the business judgment presumption by adequately pleading that the Towers CEO negotiated an unfavorable merger in exchange for a lucrative compensation package with the post-merger company. Reversing the chancery court, a majority of the Delaware Supreme Court determined that the CEO’s conflict would have been material to the Towers board. One justice dissented on the basis that the board already knew the CEO would likely get a pay raise and the details of a secret presentation about the pay proposal did not add anything material (City of Fort Myers General Employees’ Pension Fund v. Haley, June 30, 2020, Valihura, K.).

The lawsuit centers around the 2016 merger of equals between Towers and Willis Group Holdings to form Willis Towers Watson. Unbeknownst to Towers stockholders or the board, their CEO, while he was leading the merger talks on behalf of Towers, had been discussing post-merger compensation with the CIO of ValueAct, a critical institutional stockholder of Willis. This CIO proposed a compensation plan with the post-merger entity that could increase the Towers CEO’s pay fivefold. When the merger was announced, analysts and others criticized it as a bad deal for Towers; both ISS and Glass Lewis recommended that Towers stockholders vote no and hold out for a better price. Towers’s CEO renegotiated the transaction terms to increase the special dividend, and although the proxy advisors still cautioned that the merger consideration fell short, 62 percent of Towers stockholders voted for the deal.

Among the lawsuits to emerge from the deal was the plaintiffs’ breach-of-duty suit in the Delaware Court of Chancery. The plaintiffs alleged that Towers’s CEO, due to a material conflict, negotiated to give Towers stockholders the minimum consideration that they would accept. The chancery court dismissed this complaint on the basis that the plaintiffs failed to rebut the business judgment rule. In the trial court’s reasoning, the Towers board already knew that their CEO would also run the company post-merger and that his compensation would increase because the post-merger company would be so much larger. Even knowing this conflict, the Towers board appointed the CEO as lead negotiator and kept apprised of negotiations. The court also reasoned that ValueAct’s proposal was nonbinding and reflected an upside potential based on "pie-in-the-sky" outcomes.

Reversal. On de novo review, however, the Delaware Supreme Court found that the chancery court erred in dismissing the breach-of-duty claim against the CEO. The business judgment presumption did apply because there was no change of control involved in the merger between widely held public companies. However, the plaintiffs rebutted the presumption by adequately alleging that the ValueAct proposal, made during an atmosphere of deal uncertainty, would have been material to the board. The fact that the proposal was nonbinding did not sway the high court from its conclusion that the CEO should have disclosed the proposal to the board.

Furthermore, even if the Towers CEO kept the board generally apprised of the merger negotiations, the plaintiffs alleged that he did not disclose that he had discussed his compensation with ValueAct. Towers’s compensation committee chair testified in an appraisal proceeding that he would have wanted to know about those discussions and the magnitude of the pay increase. The plaintiffs adequately pleaded that a reasonable board member would have found the CEO’s interest in the proposal to be a significant fact in evaluating the merger. The high court accordingly reversed chancery’s dismissal and remanded the plaintiffs’ claims that ValueAct and its CIO aided and abetted the Towers CEO’s breach of fiduciary duty.

Dissent. Justice Vaughn dissented from the opinion. Although he agreed with the majority’s legal analysis, he came to a different conclusion after applying the legal principles to the facts as pleaded. In his view, the conflict of interest was obvious, and the Towers board was aware that the CEO was materially self-interested. Once the Towers board proposed that the CEO continue serving in that role at the combined company, everyone concerned knew that he stood to receive a substantial pay raise. The ValueAct presentation did not alter or add anything material to the nature of the conflict. Justice Vaughn was unswayed by the testimony of the compensation committee chair, noting that the "isolated answer" in the context of the appraisal proceeding did not amount to a well-pleaded allegation or an allegation that he would have considered the presentation significant to deciding whether to approve the merger agreement.

The case is No. 368, 2019.