Conflicts of Interest in LBOs -- a Case Study
Vice Chancellor J. Travis Laster, a member of the Delaware Chancery Court, handed down a recent decision highlighting the substantial conflicts of interest that bedevil the investment banking industry in leveraged buyout transactions, and how one board of directors mishandled these conflicts. Steven Davidoff in his NY Times DealBook blog gives a fine account of the matter.
The case concerns the buyout of Del Monte by PE firms Kohlberg Kravis Roberts, Centerview Partners and Vestar Capital Partners, for $5.3 billion including debt.
Barclays Capital was hired by Del Monte to run a sale process for the company. Barclays made sure that its long time client, KKR, would be the winner of the bid, subject to a “go shop” provision. In return, Barclays received a commitment from KKR that it would represent KKR and the other buyers in placing the debt financing for the deal. Vice Chancellor Laster excoriates the Del Monte board for letting this conflict of interest play out under its nose. He painstakingly laid out the time table and steps taken by Barclays to put together a deal that served the interests of KKR and Barclays.
From the court’s opinion:
“Barclays secretly and selfishly manipulated the sale process to engineer a transaction that would permit Barclays to obtain lucrative buy-side financing fees. On multiple occasions, Barclays protected its own interests by withholding information from the Board that could have led Del Monte to retain a different bank, pursue a different alternative, or deny Barclays a buy-side role. Barclays did not disclose the behind-the-scenes efforts of its Del Monte coverage officer to put Del Monte into play. Barclays did not disclose its explicit goal, harbored from the outset, of providing buy-side financing to the acquirer. Barclays did not disclose that in September 2010, without Del Monte’s authorization or approval, Barclays steered Vestar into a club bid with KKR, the potential bidder with whom Barclays had the strongest relationship, in violation of confidentiality agreements that prohibited Vestar and KKR from discussing a joint bid without written permission from Del Monte.”
After months of behind the scenes steps, Barclays finally informed Del Monte’s board that Barclays also planed to be a major participant in the distribution of debt securities for the buying group. It was a tricky moment because the board was relying on Barclays’ opinion saying that the KKR bid is fair from a financial standpoint. How could that opinion be trusted when the giver of the opinion had lined up a lucrative engagement to distribute debt securities for the buyers? In fact, the fees Barclays would earn on the debt distribution were higher than the fees it would earn from representing Del Monte in the sale. The solution was pretty simple. Barclays had the board hire a second firm -- Perella Weinberg -- to give a second investment banking fairness opinion. The fee for that opinion - $3 million – was paid by Del Monte with the approval of its board.
Adding to the intrigue, in an earlier round of bidding, Vestar Capital Partners, a PE firm with loads of experience in the canned food business, made the highest offer. In the second round, Barclays paired Vestar with KKR, in violation of the “no teaming” provisions of earlier agreements the firms had entered into with Del Monte, and had them submit a joint bid. Problem was, Barclays didn’t let the Del Monte board know it had taken this step, leading the board to believe that Vestar had dropped out. Vice Chancellor Laster found that this shady business alone “materially reduced the prospect of price competition for Del Monte”.
Here is a copy of the opinion.
One reason for the board’s inertia may have to do with the fact that the CEO of Del Monte presented the board with little option but to sell the company. Despite being pressed by the board for a succession plan to deal with his planned retirement in 2012, the CEO dallied, and in the end recommended a sale of the company. Personally, he stood to gain $24 million if Del Monte were sold before his retirement in 2012.
The initial proxy materials filed by Del Monte omitted to describe the true story behind Barclays’ activities. In response to this litigation, an extensive proxy supplement was mailed to shareholders describing all the goings on. The mailing of those materials eliminated one of the two remedies sought in the litigation. The other remedy -- to delay the meeting and give Del Monte time to solicit other offers – was granted by the court.
Of course, due to the ironclad protections under Delaware law absolving board members from financial liability where they have acted “reasonably”, this injunctive relief was the only remedy against directors available to the plaintiffs. From the court’s opinion:
“Unless further discovery reveals different facts, the one-two punch of exculpation under Section 102(b)(7) and full protection under Section 141(e) makes the chances of a judgment for money damages vanishingly small.”
