Judge Rakoff: Directors Sometimes at Risk When Multistep M&A Transactions Lead to Insolvency
Updated: Jan 25, 2021
These are interesting times with respect to corporate transactions related to alleged or actual fraudulent conveyances, whether arising through private equity deals or efforts to limit the costs of legacy liabilities arising from "mass torts." A much publicized, recent opinion by Judge Rakoff, In re Nine W. LBO Sec. Litit., __ F. Supp. 3d __, 2020 WL 7090277 (S.D.N.Y. Dec. 4, 2020), adds new grist to consider, as exemplified by online news articles in financially focused news media and memos from a host of national law firms. The financial media attention include a December 11, 2020 article at Deal Lawyers, and a December 14, 2020 article from the Financial Times titled: "Dealmakers warn of chilling effect on buyouts from US court ruling."
Law firm commentaries include the following, among many:
Warning to Directors of Selling Companies: Breach of Fiduciary Duty Liability May Exist for Failure to Investigate and Ensure Solvency of Company Post-Closing and Propriety and Effect of All Related Transactions (But You Can Protect Yourself)(Weil)("A recent ruling from the United States District Court for the Southern District of New York sent shock waves through the legal and financial community, with some shouting that this “could be a gamestopper for the private equity business.”)
SDNY Denies Motion to Dismiss Breach of Fiduciary Duty Claims Against Former Directors Based on Allegations That Approval of Leveraged Buyout Was Reckless (Gibson Dunn)("The Court allowed the claims to proceed, finding that the directors, by their own admission, failed to conduct a reasonable investigation into whether the transaction as a whole was beneficial to the company or would render the company insolvent. The directors were not entitled to the protections of the business judgment rule because they expressly avoided any investigation regarding two key steps in the transaction; they allegedly turned a blind eye to the intention to complete those steps after the initial merger.")
Lessons Learned and Best Practices in LBO Transactions Following the Nine West Decision (Cleary Gottlieb)("While the business judgment rule applied, it did not insulate the directors from liability where they acted recklessly by failing to make an adequate investigation into the surviving company’s solvency.")
Caveat Venditor: Sellers (and their Directors) Beware Nine West Has an Important Message for Boards Considering an Exit (Ropes & Gray)(“Nine West holds that directors approving the sale of a company as part of a leveraged buyout can be liable for breach of fiduciary duties in the seller’s subsequent, post-sale bankruptcy where those directors failed to adequately assess the seller’s post-sale solvency.”)