Plaintiffs’ lawyers will apply greater scrutiny to financial projections and earnings guidance prepared during buyout talks as a result of a recent court case involving Dole Foods’ freeze-out merger. In light of the decision, CFOs must anticipate that their projections and guidance will be twisted or taken out of context to support allegations that management intentionally misled independent directors or stockholders about the desirability of a deal.
In a scathing decision detailing the misdeeds of Dole’s president and its controlling stockholder, a Delaware Chancery Court held the pair personally liable for $148 million for breach of duty in connection with the freeze-out of minority stockholders. Given the plaintiffs’ payday, other lawyers will assuredly try to mimic the claim in future lawsuits challenging merger and acquisition transactions.
(A freeze-out merger is any corporate transaction whereby two entities are merged into a single entity, and the minority shareholders are “frozen out” of the decision-making process and forced to sell their stock for cash.)
The court found that, in service of controlling stockholder David Murdock’s secret plan to take the company private, Dole’s president issued a series of press releases designed to depress the shares. In one release, Dole announced that its “current expectation” for adjusted EBITDA would be at the low end of the previous guidance range. In addition, the press release predicted the sale of a business unit would result in $20 million of cost savings, down from the $50 million the company had previously said it would save. Dole’s stock price dropped 13% on the news.
Dole then issued a press release announcing that a stock repurchase plan had been “suspended indefinitely” because of the company’s need to use the funds for capital projects. After that announcement, Dole stock price tumbled another 10%.
In fact, according to the Delaware court, Dole’s president, Michael Carter, still believed the actual cost savings from the divestiture would be $50 million, and he used the spending on capital projects as a pretext to suspend the share buyback. His misdirection was aimed at driving down the share price in advance of controlling shareholder Murdock’s buy-out proposal.
And after the stock market had absorbed the false news, the court said, Murdock made his move, proposing to take the company private through a freeze-out merger. In response, the Dole board appointed a special transaction committee. The committee engaged an investment banker, who asked for updated financial projections that reflected Dole management’s current best views about the prospects of the business.
The president himself took charge of creating new projections. Rather than generating a complete set of projections with supporting profit-and-loss statements prepared by division heads — the company’s past methodology — the president created only high-case and low-case forecasts. He told the division heads to reverse engineer the supporting budgets, the court said, after setting his desired results.
Dole’s revised projections were significantly lower than prior internal projections, with a projected EBITDA reduced by more than 20%.
Two aspects of the revised projections caught the court’s attention. First, the projections accounted for only $20 million of the projected $50 million in cost savings. In addition, the projections did not forecast any additional income from future purchase of farms as part of Dole’s planned vertical integration effort. The court found that both of these actions constituted fraud.
Meanwhile, the president provided more positive information to the controlling stockholders’ bankers when he met with them separately the next day. In addition, the president provided the more optimistic projections to debt-ratings agencies and to Dole’s lenders after the merger agreement had been negotiated.
While the behavior described in the Dole Foods case may seem anomalous, allegations of conflicts of interest, bad faith, and even fraud are standard practice in shareholder lawsuits challenging M&A transactions. The case provides a handful of lessons for financial executives:
- Updated projections should follow a company’s customary budgeting process, including re-creation of supporting profit-and-loss statements. Never start with the desired result and work backwards.
- Updated projections should identify and explain all deviations and changes from prior projections.
- Assumptions and judgment calls should be carefully noted so that readers may draw their own conclusions and independently adjust the outcome based on any differences of opinion.
- The transaction committee and its investment banker should have the opportunity to meet face-to-face with the entire budget team to discuss the basis for the revised projections and the judgment calls involved.
- No projections or earning guidance should be provided to third parties, including the potential acquirer and its bankers, without the specific prior authorization of the transaction committee.
- Legal counsel should review the projections and accompanying discussion of assumptions with an eye toward potential future allegations that management intended to mislead or deceive.
- Extreme caution should be used when updated earnings guidance or financial projections are lower than previous projections and the “bad news” furthers the personal objectives of management or the controlling stockholder.
- Never provide information orally to bankers or ratings agencies which is inconsistent with the updated financial projections.
- Never, never, ever simultaneously provide two different sets of projections.
Gardner Davis is a partner and corporate lawyer with Foley & Lardner LLP. He regularly counsels companies and their boards of directors in M&A transactions and corporate governance matters. Davis can be reached at [email protected].