Legal Update

April 2022

Two cases from Delaware and New York provide guidance to financial forensics and valuation professionals on the fiduciary duties that managers and directors owe to enterprises. The first case, In re: Multiplan Corp. Stockholders Litigation, is a class action arising from allegedly inadequate disclosure of a merger between a publicly traded special purpose acquisition company (SPAC) and a privately held operating company. The second case, The People of the State of New York v. The National Rifle Association, et al., is a civil action brought by the state attorney general against a nonprofit corporation and certain of its officers alleging personal enrichment at the nonprofit’s expense, and failure to comply with the fiduciary duties owed to the enterprise.

Two cases from Delaware and New York provide guidance to financial forensics and valuation professionals on the fiduciary duties that managers and directors owe to enterprises. The first case, In re: Multiplan Corp. Stockholders Litigation, C.A. No. 2021-0300-LWW (Del. Ch. January 3, 2022), is a class action arising from allegedly inadequate disclosure of a merger between a publicly traded special purpose acquisition company (SPAC) and a privately held operating company. The second case, The People of the State of New York v. The National Rifle Association, et al. No. 2022-22057 (N.Y.S. March 2, 2022), is a civil action brought by the state attorney general against a nonprofit corporation and certain of its officers alleging personal enrichment at the nonprofit’s expense, and failure to comply with the fiduciary duties owed to the enterprise.

Multiplan—A Failure to Disclose

The Facts

In October 2019, Michael Klein, through his privately owned Churchill Sponsor III, LLC (the “Sponsor”), formed Churchill Capital Corp. III (“Churchill”). Churchill was a SPAC, also known as a “blank check company.” The primary purpose of a SPAC is to find a privately owned company with which to merge, effectively taking the private company public without the need for a formal registration process. Mr. Klein unilaterally appointed himself and seven colleagues to the Churchill board of directors. Mr. Klein also served as Churchill’s Chief Executive Officer and named Jay Taragin as Churchill’s Chief Financial Officer (CFO).

On February 19, 2020, the Sponsor took Churchill public through an initial public offering (IPO) of 110,000,000 units at $10 per unit, raising $1.1 billion in proceeds. Each unit consisted of a share of Churchill Class A common stock. Churchill Class A stock represented 80% of the common stock. The remaining 20% was Class B “founder” shares that the Sponsor purchased for $25,000. The Sponsor distributed those Class B shares to Mr. Klein and five of the other Directors.

Under the terms of the deal, Churchill placed the IPO proceeds into a trust account. The company had 24 months to complete an acquisition. Class A shareholders would have the option to participate in the acquisition or not. Those who elected not to participate would receive the initial $10 per unit investment plus a pro rata portion of accumulated interest in the trust account. If Churchill was unable to complete an acquisition within that time frame, it was required to return the IPO proceeds, along with the accumulated interest, to the Class A shareholders and shut down. If Churchill failed to complete an acquisition, the Class B shares would become worthless.

A few months after the IPO, Churchill selected MultiPlan, Inc. (“MultiPlan”) as a potential acquisition target. Multiplan provided data analytics and cost management services to the healthcare industry. On July 12, 2020, less than five months after the IPO, the Churchill board approved a “de-SPAC” merger with MultiPlan. The merger agreement called for Churchill to pay approximately $5,700,000,000 in cash and stock to MultiPlan’s existing shareholders for 40% of the total capital. The combined entity would rename itself MultiPlan Corporation (“Public MultiPlan”). Along with approving the merger agreement, the Churchill Board also hired The Klein Group LLC, owned by Mark Klein, a Churchill board member and Michael Klein’s brother, as the financial advisor for the transaction. Churchill paid The Klein Group $30.5 million for these advisory services.

On September 18, 2020, Churchill issued a proxy statement to the Class A shareholders (the “Proxy”) seeking approval of the merger. The Proxy reminded the public shareholders that, if the transaction was approved, they could elect either to (a) participate in the merger in which case they would become shareholders in Public Multiplan or (b) redeem their shares out of the trust fund for approximately $10.04 as of the record date (approximately $0.05 less than the trading price at that time). According to the court:

The Proxy listed the “attractive valuation” and “opportunities for growth in revenues, adjusted EBITDA and free cash flow” as reasons that the Board was recommending the merger. It also described the “extensive due diligence” conducted by the Board and Churchill management, including communications with “senior leaders of several large customers of MultiPlan.”

The Proxy disclosed that MultiPlan was dependent on a its largest customer for 35% of its revenues. It did not identify the customer or reveal that the customer intended to create an in-house data analytics platform that would both cause the customer to drop MultiPlan as its vendor and compete with MultiPlan by the end of 2022. The unidentified customer had publicly declared that plan by June 2020.

While the sufficiency of Churchill’s due diligence is a matter for the fact finder, plaintiffs specifically alleged that the company did not obtain an independent, third-party valuation or fairness opinion to support the acquisition. Instead, it utilized the advisory services of Michael Klein’s brother and Michael Klein stood to make over $300 million if the deal closed and nothing if it did not. The court inferred from these facts that the due diligence may not have been quite so extensive.

The proposed merger was approved overwhelmingly, with fewer than 10% of Churchill’s public investors electing to redeem. Churchill completed the merger on October 8, 2020, and the market value of its stock closed at $11.09 per share.

Approximately one month later, a stock market analyst published a research report on Public MultiPlan that revealed publicly for the first time the identity of the company’s largest customer and the potential effect that its competing software would have on MultiPlan. The following day, Public Multiplan’s stock fell to $6.27 and never fully recovered.

The Law

The parties agreed that, as officers, directors, and (regarding Mr. Klein), a controlling shareholder of Churchill, the defendants owed fiduciary duties of care and loyalty to the Class A stockholders. “The duty of disclosure is an application of the fiduciary duties of care and loyalty implicated when fiduciaries communicate with stockholders.” The Proxy was a communication from the fiduciaries to the shareholders and, therefore, implicated the duties of care and loyalty. Delaware courts have established two modes for court review of alleged breaches of fiduciary duties: the business judgment rule and the entire fairness doctrine.

The business judgment rule is “Delaware’s default standard of review.” It reflects a “presumption that in making a business decision, the board of directors acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the company.” Absent specific allegations regarding conflict of interest, self-dealing or fraud by a majority of the directors participating in a decision, a court will assume that the board engaged in the appropriate deliberations and reached a conclusion based on the members’ experience and judgment. Sometimes those decisions turn out well; sometimes they do not. Under the business judgement rule, shareholder may not engage in “Monday morning quarterbacking” of board decisions, and the business judgment rule is nearly always fatal to a plaintiff’s claim.

On the other hand, if shareholders can properly allege that conflicts of interest, self-dealing or fraud existed for a majority of the directors, the standard of review will switch to the entire fairness doctrine, which places the burden on the defendants to prove that both the price of the transaction and the process by which it was approved were entirely fair to the company’s stockholders.

In the instant case, plaintiffs alleged two alternative theories in support of their contention that the entire fairness doctrine should apply: the de-SPAC merger was a “conflicted controller transaction” and most of the board were conflicted either through self-interest or lack of independence from Mr. Klein.

The Conflicted Controller Transaction

The parties agreed that Mr. Klein was the sole owner of the Sponsor, making him Churchill’s controlling shareholder. That, alone, is insufficient to trigger the onerous mandates of the entire fairness doctrine. For the entire fairness doctrine to apply, the “controller” must either stand on both sides of a transaction or compete with the common stockholders for consideration in the transaction. A controller can compete with the common stockholders for consideration if they:

• Receive more money per share in the transaction than the minority shareholders;
• Receive a different form of compensation than is available to the minority shareholders; or
• Receive a “unique benefit” from the transaction unavailable to the minority shareholders, even if the payment per share is the same.

While the defendants focused on the mechanics of the transaction (the Sponsor’s Class B shares would convert to Class A shares and be treated just like the public shareholders’ stock), the court focused on the “misalignment of interests during a prior step in the de-SPAC transaction process.” The Class B sponsor shares only had value if a de-SPAC merger was approved. Accordingly, the Sponsor’s holdings would be worth approximately $305 million if the transaction was approved and nothing if the transaction failed. Public shareholders, on the other hand, had redemption rights that made their shares worth $10.04 each if the transaction was not approved. “The potential conflict between Klein and public stockholders resulting from their different incentives in a bad deal versus no deal is sufficient to pass the ‘reasonably conceivable’ threshold.”

The Conflicted Board Allegations

A court can also review a transaction under the entire fairness doctrine when “there were not enough sufficiently informed, disinterested individuals who acted in good faith when taking the challenged actions to comprise a board majority.” MultiPlan plaintiffs alleged numerous examples of director self-interest and lack of independence:

• Like Mr. Klein, the five directors who received Class B stock from the Sponsor held shares that only had value if Churchill proceeded with a transaction. If the MultiPlan merger was approved, these individuals stood to make approximately $62.2 million, collectively. If the merger did not go through, their shares were worth nothing.
• Klein & Co., the consulting firm owned by Mr. Klein’s brother, received a $30.5 million fee for financial advisory services, including the only assessment of the transaction’s value. Churchill director Michael Eck, who received nearly 300,000 Class B shares, is also a “managing director” of M. Klein & Co. Jay Taragin, Churchill’s CFO, was also the CFO of M. Klein & Co.
• Five of the directors were on other SPAC boards that Mr. Klein organized and controlled and had reasonable expectations of being on more in the future if they did not cross Mr. Klein. Each of those board positions produced multi-million-dollar paydays. It is reasonable to assume that these financial incentives make most of the board members beholden to Mr. Klein.

Ultimately, the court recognized that plaintiffs’ allegations were sufficient, not just because the conflicts and self-interest existed, but “because the Complaint alleges that the director defendants failed, disloyally, to disclose information necessary for the plaintiffs to knowledgeably exercise their redemption rights.”

The Takeaways

In re: MultiPlan Corp. provides an interesting insight into the unique issues relating to SPACs. It highlights the exposure for directors and advisors of these entities that are, by design, intended to convert substantial economic resources quickly into wealth for the sponsor and their associates. While litigation typically highlights the minority of cases where the de-SPAC transaction fails, it is a lesson in the importance of independent financial advisors and valuation professionals as well as independent boards of directors.

NRA—Self-dealing and Mismanagement

The Facts

The National Rifle Association of America (the “NRA”) was organized in 1871 as a New York nonprofit corporation. The organization’s stated purpose was “the improvement of its members in marksmanship, and to promote the introduction of a system of army drill and rifle practice, … and for those purposes to provide a suitable range … in the vicinity of the City of New York.” In 1872, the NRA received $25,000 (equivalent to approximately $540,000 in 2022) to purchase land for a rifle range. Over the next 150 years, the organization grew to be one of the largest charitable organizations in the country. While it relocated its headquarters to Fairfax, Virginia, the organization remains a New York nonprofit subject to the oversight of the New York Attorney General (“NYAG”).

On August 6, 2020, following an “extensive investigation,” the NYAG filed a civil action against the organization; its Executive Vice President (and principal operating officer), Wayne LaPierre; its Secretary and General Counsel, John Frazer; its former Treasurer, Wilson Phillips; and its former chief compliance officer, Joshua Powell. The complaint set forth numerous examples of misconduct, self-dealing, and violations of the NRA’s own policies and procedures, including:

• Chartering private jets for personal travel;
• Chartering private planes for LaPierre family members when Mr. LaPierre was not a passenger;
• A vacation in the Bahamas on a yacht owned by the principal of several NRA vendors;
• The purchase of Christmas presents for Mr. LaPierre’s friends and NRA vendors; and
• NRA consulting contracts for NRA board members.

The NYAG’s civil action sought, among other claims, restitution for the misspent funds and dissolution of the organization.

On January 15, 2021, the NRA filed for Chapter 11 bankruptcy in the Northern District of Texas. Mr. LaPierre informed neither Mr. Frazer nor Mr. Phillips of the bankruptcy plan. Mr. Frazer only learned of the bankruptcy proceeding the day the petition was filed. As news of the bankruptcy filing spread, the NRA publicly disclosed that “it was not, in any conventional sense, bankrupt,” but was, rather, “in its strongest financial condition in years.” The bankruptcy filing, as the NRA explained, was part of a strategy for “dumping New York” and “reorganizing its legal and regulatory matters in an efficient[[1]] forum.” On May 11, 2021, the bankruptcy court dismissed the petition, finding that the NRA had not filed for bankruptcy in good faith and that it improperly sought to use the bankruptcy process to obtain a litigation advantage in the pending civil action in New York. The bankruptcy court found the circumstances surrounding the NRA “cringeworthy,” including both historic and ongoing financial improprieties.

Following the dismissal of the bankruptcy proceedings, the NYAG filed an amended complaint reflecting the additional misconduct revealed in the bankruptcy case. The NYAG’s amended complaint asserted two primary claims under the Not-For-Profit Corporations Law (N-PCL): restitution to the organization from the alleged financial abuses and breaches of fiduciary duties, and dissolution of the corporation. The NRA and Messrs. LaPierre and Frazer moved to dismiss.

The Law

Breach of Fiduciary Duties

As already noted, the NYAG alleged that Mr. LaPierre used “his powers as an officer and ex officio director of the NRA to obtain illegal compensation and benefits, to convert NRA funds for his own benefit, and to dominate, control, and direct the NRA to obtain private benefit for himself, his family members, and for certain other insiders, including [former NRA officers] Phillips and Powell in contravention of NRA bylaws, policies and procedures, and applicable laws” of the state of New York. Similarly, the NYAG alleged that Mr. Frazer failed to meet the duties an attorney owes to their client in failing (a) to act with reasonable diligence, (b) to make sufficient inquiry into and analysis of the factual and legal problems under his responsibility, and (c) to use methods and procedures meeting the standards of competent practitioners. These failures, according to the NYAG, violated the N-PCL.

The court found the NYAG more than adequately pleaded the claims under the N-PCL. “In several hundred paragraphs of specific factual allegations, the Amended Complaint describes, in meticulous detail, LaPierre’s exploitation of the NRA for his financial benefit, his abuse of power, and his general disregard for corporate governance.” The court similarly found ample allegations related to Mr. Frazer’s failures. “[T]en paragraphs of the Amended Complaint are spent describing his allegedly incompetent supervision of the NRA’s compliance with New York law, and his failure to ensure the accuracy of the NRA’s annual filings with the Attorney General. Frazer’s alleged misconduct regarding supervision of the NRA’s conflict-of-interest and related party transaction policies, his failure to appropriately handle related party transactions, and his failure to follow proper procedures regarding procurement, are also detailed in the Complaint.” (Internal citations omitted.)

Dissolution

The court devoted substantially more space to its analysis of the NYAG’s claims seeking dissolution of the organization. While there was no question that the state, which authorized the existence of the corporation, can also take that existence away, “[c]orporate death, in the form of judicial dissolution, represents the extreme rigor of the law.” (Internal citations and quotation marks omitted.)

The N-PCL provides two bases for the attorney general to dissolve a corporate entity:

• Where the corporation “carried on, conducted or transacted its business in a persistently fraudulent or illegal manner, or by the abuse of its powers contrary to public policy of the state;” and
• Where the “directors or members in control of the corporation have looted or wasted the corporate assets, have perpetuated the corporation solely for their personal benefit, or have otherwise acted in an illegal, oppressive or fraudulent manner.” (Internal citations omitted.)

Judicial review of these provisions has refined the analysis so that not any allegation of material misconduct is sufficient to warrant the corporate death penalty. “Over time, judicial dissolution at the hands of the State has been a remedy reserved for corporate misconduct that ‘has produced, or tends to produce, injury to the public’.” Injury to the public warranting dissolution has included trade associations that operated price fixing conspiracies,[2] engaged in deceptive advertising,[3] and served as a cover for illegal conduct.[4]

The instant case, the court concluded, failed to establish such a widespread harm to the public. The NYAG was simultaneously characterizing the NRA as a victim of the individual defendants’ predations and, at the same time, seeking to punish the corporation as a perpetrator of public harm. The court, on the other hand, concluded that the individual defendants harmed the corporation and its members, not the general public. The individual defendants’ actions deprived the organization of resources that it could have used to pursue its mission.

The court granted defendants’ motions to dismiss the NYAG’s claims for dissolution and the common law claims for unjust enrichment and prudent management but denied the motions regarding all of the other claims.

The Takeaways

People v. The Nat’l Rifle Ass’n is a stark reminder of the authority that the state attorney general wields over nonprofit corporations licensed in their state. Valuation and financial forensics professionals should keep in mind that while they usually deal with managers of nonprofit entities, they ultimately answer to the attorney general. Similarly, while nominally responsible for guiding the nonprofit, boards of directors can be subject to the influence of charismatic managers and many times rely exclusively on the officers for guidance rather than providing guidance to the officers.

In their role as the ultimate authority for nonprofits, state attorneys general can, and do, seek recovery for wasted and/or misappropriated resources of the organization. While the ultimate penalty, dissolution, is limited to situations of grave public harm, the abuses by management should be a factor in nonprofit related engagements.

[1]  Meaning friendly.

[2]  N. River Sugar and People v. Milk Exchange, 133 NY 565 (1892) involving commodity price fixing conspiracies.

[3]  People v. Abbott Maintenance Corp., 11 A.D.2d 136 (1st Dept 1960) which involved luring people and small businesses into high-cost equipment leases using illusory promises of potential sales.

[4]  People v. Zymugy, Inc., et al., 233 A.D.2d 178 (1st Dept 1996) which involved a company acting as a front for a pedophilia ring.

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Michael J. Molder applies 30 years of experience as a Certified Public Accountant and litigator to help investigate and analyze cases with complex financial and economic implications. He has acted as both counsel and accounting expert in pending and threatened litigation as well as participating in internal investigations of financial misconduct. As a litigator, Mr. Molder helped co-counsel understand complex financial and accounting issues in dozens of cases. In 2006, Mr. Molder returned to public accounting applying his unique skills to forensic engagements. He has also performed valuations of business interests in a wide variety of industries.

Mr. Molder has served as valuation expert for both plaintiffs and defendants in commercial litigation matters and owner and non-owner spouses in matrimonial dissolutions. He has participated in the valuations of businesses in a wide variety of industries, including: food service, wholesale and retail distribution, literary development and production, healthcare, manufacturing, and real estate development.

Mr. Molder has also investigated and valued damages in a wide variety of litigation contexts ranging from breach of contract claims to personal injury cases, and from employment disputes to civil fraud. He has consulted on many matters which have not involved the issuance of a report for litigation or resulted in deposition or trial testimony. Accordingly, the identity of these matters is protected by attorney client privilege.

Mr. Molder has also lectured widely on a variety of accounting and litigation related topics including business valuation, financial investigations in divorce proceedings, accountant ethics, financial statement manipulation and “earnings management.”