The "Buyout Boom" and D & O Claims

The D & O Diary has previously noted (most recently here) the problems that can arise in connection with “going private” transactions in which management teams up with outside investors to buy out public shareholders’ interests. The latest example may be Clear Channel Communications’ November 16, 2006 announcement (here) that a group led by Thomas H. Lee Partners and Bain Capital Partners will acquire the company for $26.7 billion (including $8 billion of debt assumption).

Early press reports of the proposed transaction were critical of the deal; for example, the Wall Street Journal’s November 14, 2006 article “Clear Channel Buyout Talks Fuel Concern of Management Conflicts” (here, subscription required) commented that the deal was the latest transaction raising concerns that “corporate executives may be pushing transactions that are ideal for themselves but might not be optimum for shareholders.” Among other things, the Journal commented on the “lightning-fast auction” process that produced the two competing bids for the company, and on the close ties between the company’s founders and managers, the Mays family, and the company’s board. The article also raised the question whether the company adequately considered bids from groups less friendly to the Mays family or considered whether a break-up would raise more money than selling the company as one piece. According to other news reports (here), other shareholders have publicly questioned the transaction, including the benefits to the Mays family and the fact that the acquirors plan to sell off assets to finance the transaction.

The Company’s November 16, 2006 8-K (here) describing the transaction reports some details of the deal that may also raise concerns. For example, the company has only until December 7, 2006 to consider any competing bids, and the company would, if it accepting a competing bid, it would have to pay the currently proposed acquirers a break up fee of $500 million. Past going private transactions have been criticized for similarly short “go shop” periods and for break up fees so large that potential competing bidders would be discouraged.

The 8-K also discloses that if following the completion of the transaction, either the company’s CEO, Mark Mays, or its CFO, Randall Mays, have their employment terminated under change of control provisions, they would each receive cash payments equal to the sum of one year’s base salary, bonus and accrued vacation pay, plus 2.99 times the sum of each executive’s annual salary and bonus, as well as three years continued benefits. (The 8-K does note that the executives did at least give up the right to a state and federal tax “gross up” as well as the right to received 1 million options upon termination.) According to news reports (here), these provisions for payment to the Mays family member represent a "significant reduction" from the amounts originally under discussion -- but are still substantial, and are still the subject of sharholder objections, according to othere news reports (here). According to a shareholder quoted in these reports, "This is an extremely one sided deal."

Transactions involving these kinds of potential conflicts of interest create circumstances where accusations of wrongdoing can more easily arise. It is almost to be expected that the Clear Channel transaction is the subject of a purported shareholder class action. On November 16, 2006, the law firm of Wechsler Harwood filed a lawsuit (here) in Texas state court, accusing Clear Channel and its directors of breach of fiduciary duty. The lawsuit alleges that the “going private” transaction is for the benefit of insiders, particularly the Mays family, but to the detriment of the company’s public shareholders. The lawsuit seeks an injunction against the transaction, or, should the transaction be completed, damages on behalf of Clear Channel’s shareholders.

A cynical view of these kinds of lawsuits is that they represent no more than an attempt by plaintiffs’ lawyers to extract a toll from the parties to the transaction. But at least in cases where the allegations of conflicts of interest are substantial, these kinds of claims may present a threat of more than just a cost of doing business.

The Clear Channel transaction is just the latest in a series of huge “going private” transactions. These mega-deals and the accompanying risk of D & O claims are likely to continue into the foreseeable future. As the Wall Street Journal noted in its October 26, 2006 article entitled “Growing Funds Fuel Buyout Boom” (here, registration required), private equity firms have raised buyout funds of as large as $20 billion. According to the article, fifteen of the top 20 buyouts ever have taken place in the last 18 months, and larger buyouts may lie ahead as private equity funds “eye takeover targets with stock market values of $50 billion or more.” (The largest buyout ever is KKR’s $25.1 billion takeover of RJR Nabisco.) The article quotes a leading M & A attorney as saying “We are seeing a significant privatization of corporate America.”

The massive amounts of money involved in these "going private" transactions create enormous opportunities for conflicts of interest to arise, particularly where incumbent management has the potential to benefit if a particular party’s proposed transaction succeeds. These circumstances present a serious potential risk of claims against directors and officers of the target companies.

As The D & O Diary has previously noted, private equity funds themselves are drawing scrutiny; according to media reports (here), the Department of Justice has begun an investigation whether private equity funds’ “club deals” violate antitrust laws by artificially limiting the amount shareholders realize when companies are acquired.

The WSJ.com has an interesting “Who’s Who in Private Equity,” with a listing and description of the leading private equity firms here. Bain Capital, one of the successful bidders for Clear Channel, was founded by the current Republican Governor of Massachusetts, Mitt Romney.

A Rolling Stone magazine profile of Clear Channel and its influence on American radio and popular culture can be found here. Salon.com has an index of its articles about Clear Channel here.

Update: The private equity "buyout boom" continues. On November 20, 2006, the private equity firm the Blackstone Group announced (here) a $19 billion buyout of Equity Office Properties Trust.