Delaware Court Faults Sale to Buyout Firms

In a ruling that could have broader effects on the booming buyout business, a Delaware judge faulted Netsmart Technologies for excluding strategic buyers from its sale process and ordered the company to delay a vote on its proposal to be acquired by two private equity firms. In a memo to clients, law firm Wachtell, Lipton, Rosen & Katz called the decision, issued late Wednesday by Vice Chancellor Leo E. Strine Jr. of Chancery Court, a “major opinion” on a deal that, although small, had many of the same elements as large private-equity transaction.
The ruling comes as some shareholders are growing concerned that their companies are not being adequately shopped around before agreeing to a buyout. For example, shareholders of Adesa are suing that company in Delaware Chancery Court over its agreement to sell itself to a group of private equity firms for $2.5 billion. Among other things, the lawsuit alleges that Adesa’s investment bankers urged Adesa’s board only to consider transactions with private equity firms, which the plaintiffs say depressed the price that Adesa was able to fetch at auction.
Some deal-makers have also been suggesting that courts in Delaware, where many companies are incorporated, has been issuing decisions that are less friendly toward corporations.
In this week’s opinion, Chancellor Strine was critical of what he termed Netsmart’s “sporadic” efforts to find a strategic buyer that might offer more for the company than private equity investors. He has barred Netsmart from polling shareholders on a $115 million offer to sell out to Insight Venture Partners and Bessemer Venture Partners until it tells investors more about how the software company was shopped. The vote had been scheduled for April 5.
By looking only at private equity buyers, Netsmart’s board may have failed to find a better deal among strategic buyers, companies that might be interested in adding Netsmart’s software for the mental health industry to their own portfolio of offerings, the judge suggested.
In his opinion, Chanceller Strine found that “the [Netsmart] board’s failure to engage in any logical efforts to examine the universe of possible strategic buyers and to identify a select group for targeted sales overtures was unreasonable and a breach of their Revlon duties.”
Netsmart’s sale process had many features common to much larger buyout deals: It was an auction involving private equity firms, and the deal was approved by a special committee of Netsmart’s independent directors. There was also a so-called “go shop” provision, allowing the company to seek out better offers after the deal was signed.
Despite these elements, which are ostensibly intended to insure that shareholders get the best deal, the Delaware court found the Netsmart auction was flawed.
Wachtell Lipton, a firm that is involved in many large takeover deals, said in a memo that the decision is a reminder that Delaware courts “will be skeptical of arguments that deal-structuring and deal-protection decisions are proper because they are common or have been approved in other contexts.”
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