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Court Considers Fiduciary Duties in Merger under Minnesota Law

by   |   August 8, 2017

The United States District Court for the District of Minnesota considered the application of the fiduciary duties of directors in the context of a merger under the Minnesota Business Corporation Act. The case, Lusk et al v. Akradi et al, involved the acquisition of Life Time Fitness, Inc. by a group of private equity firms, referred to as the Buyout Group.

Life Time initially considered the benefits of conversion to a REIT. Thereafter, an unsolicited offer was received, and the Board determined to solicit other bids. A special committee was formed consisting of independent and disinterested directors. The special committee permitted Bahram Akradi, Lifetime’s Chairman of the Board, President and CEO, to solicit bids. The special committee “discussed their beliefs that potential bidders were more likely to submit the highest bids possible if they were permitted to discuss potential arrangements with senior members of Life Time’s management team and that such discussions could be helpful in connection with arranging financing for a transaction.” The Special Committee allegedly “permitted Akradi to negotiate the terms of a rollover investment and his continued employment at the surviving company with potential buyers.”

In the final negotiations, Party A delivered a revised proposal with an offer of $72.00 per share, but did not provide a rollover investment or continued employment for Akradi. The Buyout Group also submitted a bid of $72.10 per share and requested Akradi roll over $125 million in equity. The Special Committee and the Board both unanimously approved the merger with the Buyout Group.

Claims against the Board

Life Time’s articles of incorporation exculpated its directors to the fullest extent permissible under Minnesota law. Accordingly, any breach of fiduciary claim against the Defendants sounding in “negligence or even gross negligence” arising from the merger would fail as a matter of law because “such allegations would constitute only a breach of the exculpated duty of care.” Plaintiffs argued they pleaded non-exculpated breach of loyalty and good faith claims against the Board and Akradi.

Plaintiff’s sole allegation that members of the Board, other than Akradi, violated the duty of loyalty was the acceleration of director equity awards as a result of the merger. The Court rejected this claim, noting that the acceleration aligned the directors’ interest with Life Time’s shareholders, as the Board was entitled to merger consideration with the “same terms and conditions as applied to holders of Life Time common stock.” The Court noted that Delaware courts repeatedly hold that vesting of stock options during a merger is not a breach of the directors’ duty of loyalty.  The Court held the Board had an incentive by virtue of their stock options to obtain the maximum merger consideration. Such an incentive aligns the Board with the shareholder interests.

As to the good faith claim, Plaintiffs alleged that the Board acted inappropriately by: failing to allow a bidding war between Party A and the Buyout Group; failing to consider REIT analyses; abdicating the sales process to Akradi; and agreeing to deal protection devices with the Buyout Group.

With respect to Plaintiffs’ allegations that the Board failed to allow a bidding war or consider REIT analyses, the Court noted the law is clear that the Board is not liable for failing to carry out a perfect process, which would at most lead to an exculpated duty of care claim. Life Time’s proxy statement disclosed that the Board sought highest and best offers from Party A and the Buyout Group, Party A indicated that its best and final offer was $72.00 per share, and the Board relied on financial analyses that indicated $72.10 was fair merger consideration. The Court noted Plaintiffs’ allegation that the Board ignored the value of Life Time’s real estate conflicted with the proxy statement’s disclosure that the Board met with the financial advisors to discuss the two merger proposals as well as a REIT conversion, and considered the REIT analyses as well as the “uncertainties and risks associated” with a REIT conversion.

The Court also found the Board did not breach the duty of good faith by allowing Akradi to privately negotiate terms with bidders. According to the Court, “it is appropriate for a board to enlist the efforts of management in negotiating a sale of control,” and “[i]t is well within the business judgment of the Board to determine how merger negotiations will be conducted.”

Finally, Plaintiffs asserted that the Defendants improperly adopted deal protection devices such as a no-solicitation provision, a matching rights provision, and a termination fee. The Court described the devices as routine that may sometimes be necessary to secure a strong bid.  The Court held adopting deal protection devices alone is not enough to rise to a level of “sustained or systematic failure of the board to exercise oversight” to satisfy a breach of good faith claim.

Claims against Akradi

Plaintiffs alleged Akradi had a conflict of interest with Life Time’s shareholders because, instead of pursuing a REIT transaction, Akradi forced an undervalued sale to his favored bidder to ensure his continuing interest in the surviving company.

The Court found that, pursuant to Minn. Stat. § 302A.255, the disinterested Life Time shareholders ratified the transaction, precluding a breach of loyalty claim against Akradi. Minnesota Statute § 302A.255, subd. 1, provides that “[a] contract . . . between a corporation and an organization in or of which one or more of its directors . . . have a material financial interest, is not void or voidable because the director or directors or the other organizations are parties” if the “material facts” of the transaction and the director’s interest are “fully disclosed” and the transaction is approved by an affirmative vote by two-thirds of disinterested shareholders entitled to vote.  It was not disputed that that the disinterested Life Time shareholders – excluding Akradi’s and the Board’s shares – approved the transaction, with 81.65% voting in favor.

The Court observed that although Minn. Stat. § 302A.255 does not define or explain what it means to fully disclose a material fact for purposes of shareholder ratification, Minnesota courts addressing materiality for breach of fiduciary duty claims have turned to federal law. In a ruling earlier in the case, the Court had already addressed and dismissed Plaintiffs’ federal securities law claim that the proxy statement allegedly omitted the full terms of Akradi’s rollover agreement. The Court found that the “[s]hareholders had substantial information about Akradi’s Rollover Agreement . . . and the proxy painted a ‘sufficiently accurate picture so as not to mislead.'” Thus, paralleling federal securities law, the Court found that by virtue of the proxy statement, the shareholders were duly informed about Akradi’s conflict of interest for purposes of Minn. Stat. § 302A.255.