In Re Netsmart Technologies, Inc. Shareholders Litigation
2007 Del. Ch. LEXIS 35, 2007 WL 1576151, 924 A.2d 171 (2007)
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Rule of Law:
When a board decides to sell a company for cash, its fiduciary duty requires it to have a reasonable, factual basis for its chosen sales process. Forgoing any exploration of strategic buyers in favor of a passive, post-signing market check may be an unreasonable sales method for a micro-cap company. Furthermore, the board must disclose all material information when seeking shareholder approval, including the financial projections used by its financial advisor in rendering a fairness opinion.
Facts:
- Netsmart Technologies, Inc., a leading supplier of software for behavioral health organizations, acquired its largest competitor, CMHC Systems, Inc., in October 2005.
- Following the acquisition, private equity firms, including Vista Equity Partners and Francisco Partners, expressed interest in acquiring Netsmart in late 2005 and early 2006.
- In May 2006, Netsmart's management, led by CEO James L. Conway, recommended that the board pursue a sale exclusively to a private equity firm.
- Management justified forgoing a search for strategic buyers by referencing sporadic, informal, and years-old contacts that had not resulted in serious interest.
- The board authorized a sale process focused solely on private equity buyers and, in July 2006, formed a Special Committee to oversee it.
- The Special Committee conducted a limited auction involving seven private equity firms, which management's continued employment and equity incentives were a component of.
- Ultimately, the board approved a merger agreement with Insight Venture Partners for $16.50 per share, which included a 'window shop' clause allowing consideration of unsolicited bids but no 'go-shop' provision for active marketing.
Procedural Posture:
- A group of shareholder plaintiffs filed several lawsuits against Netsmart Technologies, Inc. and its directors in the Delaware Court of Chancery.
- The court consolidated the lawsuits into a single action.
- The plaintiffs moved for a preliminary injunction to halt the consummation of the approved merger between Netsmart and private equity firms Insight Venture Partners and Bessemer Venture Partners.
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Issue:
Does a board of directors breach its fiduciary duties by forgoing any active search for strategic buyers and relying solely on a passive post-signing market check, and by failing to disclose to stockholders the financial projections underlying its financial advisor's fairness opinion when seeking approval for a cash-out merger?
Opinions:
Majority - Strine, Vice Chancellor.
Yes, the Netsmart board likely breached its fiduciary duties by employing a flawed sales process and by providing stockholders with materially incomplete disclosures. The board lacked a reasonable, factual basis for its decision to exclusively pursue a private equity buyer and forgo any exploration of interest from strategic buyers. The reliance on sporadic, informal, and temporally disparate contacts over the preceding decade was insufficient to conclude that strategic buyers would have no interest in Netsmart as it existed in 2006. Furthermore, the board's assumption that a passive, post-signing market check would be effective for a micro-cap company was unreasonable, as strategic buyers are unlikely to invest the resources to make a hostile topping bid for a small target without an active and targeted sales effort. The court also found the Proxy Statement was materially incomplete because it failed to disclose the full financial projections, including through the terminal year, that were prepared by management and used by the financial advisor, William Blair, in its discounted cash flow analysis supporting its fairness opinion. This information is highly material to stockholders who must decide whether to accept a one-time cash payment or retain their interest in the company's future prospects.
Analysis:
This decision clarifies that a board's Revlon duties are context-specific and that a sales process deemed reasonable for a large-cap company may be unreasonable for a micro-cap one. It establishes that a passive, post-signing market check is not a reliable substitute for an active canvass for a small, thinly-followed company, requiring boards to provide a compelling, fact-based reason for excluding an entire class of potential bidders. The opinion also strengthens shareholder rights by affirming that management-prepared financial projections used in a fairness opinion are highly material and must be disclosed in a cash-out merger context, as they represent the best insider view of a company's future value.
