In re Zoox – Intermediate Scenarios in M&A

In the early stages of a company, sights are set high. Founders genuinely believe the company can be the next unicorn. Yet the reality is that most companies are either stunning failures (company goes to zero) or have intermediate success (exit for enough to pay preferred shareholders and very little for common shareholders). There are much fewer stunning winners (where all shareholders win).

The stunning failures, while heartbreaking, have an element of fairness to them. All lose. All share the pain. But it is the intermediate scenarios that provide the most tension between the interests of preferred shareholders and common shareholders. And it is the duty of the directors of the company to wisely navigate this tension and conflict.

It is this very intermediate scenario that Amazon’s acquisition of Zoox touches and led to a lawsuit by plaintiff former employee common shareholders. While the headline (a $1.3B deal in 2020) may seem impressive to some, given that the last valuation prior to that was at $3B, this scenario created predictable pain for the most diluted shareholders. While the case did not disclose the liquidation preferences of preferred shareholders, it appears that of the $1.3B cash offer, less than $100MM went to common shareholders; approximately $1.07B went preferred shareholders with liquidation preferences and the convertibles, and $200MM was a transaction bonus that went to a select group of top common shareholders. Given that Zoox raised approximately $1B from investors, it’s likely that preferred shareholders and convertibles received around their investment back – a non-participating 1X preference for preferred shareholders. Major common shareholders such as co-founders received the lions’ share of the remaining, with a bonus pool of cash and Amazon restricted shares for employees who stayed on. The former employees received 69 to 76 cents per share at closing, and they sued Amazon, Zoox executives, and Zoox directors, with only the former two claims remaining.

There is no one size fits all solution – but if the transaction is fair and the process is unconflicted, courts generally defer to negotiated terms. In intermediate cases, fiduciary duties protect against unfairness. Thus, when intermediate scenarios occur, directors must be careful to avoid being interested, lacking independence, or acting in bad faith.

Interested Directors

If a director receives a material economic benefit that makes it improbable that the director could have performed her fiduciary duties without being influenced by his personal interest, then that director is interested.

Lacking Independence

If a director is beholden to an extraneous influence, such as an interested director or other interested investor, rather than the corporate merits of the decision before the board, such that his discretion is sterilized, then the director lacks independence.

Bad Faith

If a director was motivated by actual intent to do harm, or with a conscious disregard of one’s duties, rather than the best interest of the corporation, then the director acted in bad faith.

In this case, the court found that at least half of the board was conflicted: These were 1) interested directors, the CEO and CTO management directors that qualified for a $200MM transaction bonus pool or restricted shares in Amazon,  and 2) Directors lacking independence, directors tied to Series A preferred shareholders who only stood to benefit if the sale was at least $1.0717B, and did not stand to benefit differently until the transaction exceed $2B, Series B preferred who did not receive any upside between $778.5MM and $2.9B, as well as the convertible noteholders. The court ordered for entire fairness review (the most strict standard of review of a transaction being entirely fair to both the corporation and the stockholders), since at least half of the board was conflicted. The merger had to be a product of both fair dealing and fair price. The case has yet to be decided.

However, boards in intermediate scenarios should form special committees or rely on truly disinterested and independent directors when making decisions, as well as obtain fairness opinions. That is the preferred path, pun intended.

Jerome Fogel is co-founder of Fogel & Potamianos LLP, a firm recognized by Chambers & Partners’ California Spotlight Guide for excellence in corporate law. A partner in the Corporate Practice Group and Chair of the Sports & Entertainment Group, he is known as an innovator and dealmaker in the legal community. He serves as an offsite general counsel to privately held companies, including representation in mergers and acquisitions and capital markets transactions. 

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