March 2011 Private Equity Alert

Private equity sponsors should beware of actual or potential conflicts Conflicts of of interest by target management or a sell-side financial advisor in Interest Beware connection with a sale process, particularly a sale process involving a public company. Such conflicts of interest can lead to monetary liability By Joshua Peck for the sponsor and can jeopardize the enforceability of deal protections on which the sponsor is relying. Recent examples of this were the take- privates of J. Crew and Del Monte, each of which was challenged by target company stockholders due to alleged conflicts of interest. In J. Crew, the allegedly self-interested actions by its CEO contributed to a settlement of stockholder lawsuits, which set aside heavily-negotiated deal protections for the sponsors. In Del Monte, the Delaware chancery court found, based on a preliminary record, that the allegedly self- interested actions of its sell-side financial advisor tainted the sale process and the judge temporarily enjoined the transaction and certain of the negotiated deal protections for the sponsors. The Court also found, on a preliminary record, that the plaintiffs established a reasonable likelihood of success on the merits of their claim that a sponsor “aided and abetted” the target board’s breach of its fiduciary duties. The “critical element” of an aiding and abetting claim is “knowing participation” by the sponsor. As a result, sponsors need to beware any time it seems like target management or a sell-side financial advisor has a potential conflict of interest and the sponsor could be viewed as participating in that conflict. For example, the Court in Del Monte found, on a preliminary record, that the sponsor “knowingly participated” in the financial advisor’s attempt to put together a club deal without the board’s authorization or approval and in violation of the anti-teaming provision in the confidentiality agreements. An aiding and abetting claim brings significant potential exposure to a sponsor. Statutory director exculpation and protection provisions (e.g., Sections 102(b)(7) and 141(e) of the Delaware General Corporation Law) “do not protect aiders and abetters, and disgorgement of transaction-related profits may be available as an alternative remedy”. The sponsor’s exposure is not limited to monetary liability; important deal protections negotiated by the sponsor can also be lost. As part of the settlement of the stockholder lawsuits challenging the J. Crew transaction (which settlement the plaintiffs’ counsel subsequently attempted to repudiate), the following key amendments were made to the merger agreement: the extension of the go-shop period to almost three months, the expansion of what constitutes an “Excluded Party” (i.e., a party that made an offer during the go-shop period), the reduction in the break-up fee, limitations to the sponsors’ matching rights if the company receives a “Superior Proposal” above a certain per share price, the reimbursement of up to $3 million of the fees of any bidder

Weil, Gotshal & Manges LLP Private Equity Alert

Weil News that submits a bid between created a conflict of interest that certain per share prices but fails merited injunctive relief,” and n Weil advised Advent to consummate a transaction applied these principles to Del International in connection with due to a subsequent Superior Monte. The Court found that the its £925 million acquisition of Proposal, the elimination of financial advisor in this case went Priory Group, an operator of the sponsors’ right to receive “far beyond what took place in addiction clinics and mental information regarding the results Toys “R” Us.” For example, the health facilities in the UK of the go-shop period until after Del Monte board permitted the n Weil advised the Macquarie the expiration of the go-shop use of stapled financing before Group Limited in connection period and a closing condition a definitive agreement on the with its acquisition (together that a majority of the unaffiliated transaction had been reached, with The Carlyle Group) of stockholders approve the including price and legal terms, Australia-based Redflex deal. In connection with these there was no “deal-related Holdings Limited, the owner and amendments to the merger reason” to use stapled financing, operator of the largest network agreement, J. Crew’s CEO agreed there was not a “justification of digital vehicular speed and to a two-year non-compete if any reasonably related to advancing red-light cameras in the world third party bidder (x) acquires the stockholder interests”, it did not company, (y) offers him terms generate a higher price for the n Weil advised Grohe Group (a portfolio company of TPG that are the same or better than company and it was not necessary Capital and DLJ Merchant those offered by the sponsors, to secure sufficient financing for Bank) in connection with its and (z) he does not enter into an the transaction. Furthermore, the tender offer for all of the shares employment agreement with such financial advisor was permitted to of Joyou, the China-based third party bidder. provide stapled financing and run the go-shop solicitation process at manufacturer of bathroom, In Del Monte, the Court the same time. kitchen and other faucets preliminarily enjoined the n Weil advised AIRCOM stockholder vote on the merger for Unfortunately, the Del Monte International (a portfolio a period of 20 days and enjoined, decision does not provide clear company of Advent pending the stockholder vote, the guidance to target boards as to International), a telecom non-solicitation and matching the circumstances in which they network management rights provisions in the merger can prudently authorize their consultancy firm, in connection agreement and the termination financial advisor to participate with its sale to HIG Europe fee of up to $120 million payable in, or to lead, the financing for a to the sponsors in the event of a bidder. Hopefully, future court n Weil advised SiTel topping bid. decisions will provide more clarity Semiconductor (an HGCapital on these issues. portfolio company), the Del Monte may also discourage Netherlands-based producer target boards from authorizing In light of the J. Crew settlement of home wireless, voice and its financial advisor to provide and the Del Monte decision, data application products, in stapled financing due to the sponsors should be aware of connection with its sale to risk that such authorization and should carefully consider Dialog Semiconductor could be second-guessed by their actions when dealing with plaintiffs’ lawyers and the courts target management and sell-side n Weil advised General Catalyst as an unjustifiable conflict of financial advisors who may have Partners in connection with the interest by the financial advisor. an actual or potential conflict of recapitalization of CLEARest In evaluating the use of stapled interest in connection with the Consulting financing, the Court discussed the sale process. The active or tacit n Weil advised The Gores Group in Toys “R” Us, case, in which “Vice participation by a sponsor in connection with the formation Chancellor Strine considered conduct by target management of their $2 billion Gores Capital whether an investment banker’s or the sell-side financial advisor, Partners III, L.P. role in providing stapled financing which raises a conflict of interest,

Weil, Gotshal & Manges LLP March 2011 2 Private Equity Alert

may imperil the enforceability management or the financial company has in the litigation. of important deal protections. advisor. Even if the sponsor does All good reasons for sponsors to It potentially could also lead to not have direct monetary liability beware of any conflicts of interest monetary liability for aiding and for its own actions, it will also on the sell-side. abetting breaches of duties by inherit any liability the target

Private Equity Alert is published by the Private Equity Group of Weil, Gotshal & Manges LLP, 767 Fifth Avenue, New York, NY 10153, +1 212 310 8000, http://www.weil.com.

The Private Equity Group’s practice includes the formation of private equity funds and the execution of domestic and cross-border acquisition and investment transactions. Our fund formation practice includes the representation of private equity fund sponsors in organizing a wide variety of private equity funds, including buyout, venture capital, distressed debt and real estate opportunity funds, and the representation of large institutional investors making investments in those funds. Our transaction execution practice includes the representation of private equity fund sponsors and their portfolio companies in a broad range of transactions, including leveraged buyouts, merger and acquisition transactions, strategic investments, recapitalizations, minority equity investments, distressed investments, venture capital investments and restructurings.

Editors: Doug Warner (founding editor) ([email protected]) + 1 212 310 8751 Michael Weisser ([email protected]) + 1 212 310 8249

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