The deal was not received well, particularly by a Block pension fund shareholder who launched a derivative class action against Block’s directors.
Fortunately for Block, a Delaware judge dismissed the lawsuit in May because the plaintiffs failed to plead demand futility; this was despite the other details of the case that showed it was, in fact, a terrible deal.
A Brief Background on the TIDAL Acquisition
Shawn Carter, aka Jay-Z, acquired a Norwegian-based music-streaming company in 2015 and rebranded it as TIDAL, with the goal to introduce a more artist-friendly streaming platform.
However, by 2020, the company was failing, having logged multimillion-dollar losses for 10 quarters straight.
The company had other woes, too, like blowing through five different CEOs, unpaid liabilities to music labels, and an ongoing criminal investigation in Norway for artificially inflating streaming numbers, to name a few.
Despite the company’s failings, someone might still want to acquire it. Enter Jack Dorsey.
Why would Dorsey, the CEO of Block (a financial technology company), want to acquire the music-streaming platform—especially since, according to court documents, Block had “never ventured into the music-streaming industry and, at the time it acquired TIDAL, had no plans to do so.”
Of course, many great business deals come out of collaborations between friends. But there are plenty of details around this particular case that show it was a bad move, leaving people to wonder why Dorsey was so eager to push ahead.
Details of the case reveal that:
- Dorsey proposed the acquisition during a video conference with the company board while he was in the Hamptons vacationing with the Carters.
- Block’s Transaction Committee’s first meeting only lasted 35 minutes.
- Block management highlighted the potential risks of the deal to the Transaction Committee, including the fact that TIDAL only had a paltry 2.1 million subscribers and it would be difficult to grow that number with competitors like Spotify (which, by contrast, had 138 million subscribers) and others. Other risks included the criminal investigation, the company losses, a federal lawsuit, expired contracts, bad relationships with musical artists, and more.
- Existing artists with TIDAL would have no legal obligation to Block after the merger.
- There were no plans to integrate the company into Block, and the Transaction Committee was aware that the lack of a clear operational/strategic lead was one of the greatest risks of the deal.
- Block management estimated that the acquisition would generate a negative EBITDA for Block of $68.3 million by 2023.
- Dorsey was the only executive who was strongly advocating moving forward with the deal, and there was already substantial pushback from senior executives.
On this last point, it has to be said: Dorsey has an impressive track record as a business visionary given that he’s a co-founder of both Twitter and Block. This would not have been the first time he was a strong “yes” in the face of a lot of naysayers.
In any case, Block completed the acquisition on April 30, 2021. After the deal closed, Carter joined the Block board of directors as its 12th member.
The Court’s Decision
Given the facts of the situation, it is unsurprising that shareholders brought suit alleging that Dorsey and the board had breached their fiduciary duties. Perhaps plaintiffs thought the facts were so egregious they had a slam dunk case.
The court, however, was not impressed by the plaintiff’s failure to allege demand futility. As a result, notwithstanding the facts of the situation, Block won its motion to dismiss in May 2023.
The demand requirement is a prerequisite for bringing a derivative suit under Delaware law and states that before bringing suit, the stockholder must demand that the board look into a shareholder’s allegations.
Demand is excused, however, if it is futile, meaning that the board lacks the ability to look at the allegations objectively as independent directors are required to do.
When the plaintiff filed their complaint, the board was composed of 12 members—Dorsey, Carter, the four Transaction Committee members, and six other board members.
In her decision, Delaware Judge Cathleen McCormick referred to a previous Delaware case in United Food and Commercial Workers Union v. Zuckerberg stating that in order for the plaintiff to prove that the Block board was not impartial, it would need to show that at least six of the 12 directors were not able to make an independent decision.
This would require that the court consider the following:
- Did the director receive a “material personal benefit” from the alleged misconduct;
- Does the director “face a substantial likelihood of liability” on any of the plaintiff’s claims; and
- Does the director have a relationship with someone who could be described by the first two items listed?
Given the relationship between Dorsey and Carter, Dorsey clearly lacked the ability to be impartial.
Of course, the plaintiffs were betting on the lack of impartiality of Dorsey and Carter as board members—but what about the rest of the board?
Ultimately, Judge McCormick held that the plaintiff had failed to meet its burden relating to the other 10 board members.
Did Block Directors Act in Bad Faith?
Since the other directors did not have a relationship-independence issue, under Zuckerberg, the demand would only be futile if a majority of board members faced a substantial likelihood of liability.
Block, however, has director exculpation provisions in its certificate of incorporation. As a result, the directors would only face liability if they acted in bad faith during the deal.
After a lengthy analysis, Judge McCormick found that the board did, in fact, do the work necessary during the deal. She noted that the board formed an independent Transaction Committee that received reports and asked numerous questions.
In her words, while the facts of the case “do not generate tremendous confidence in the transaction committee’s process, they fall short of supporting an inference of bad faith.”
As to the involvement of board members not on the Transaction Committee, the plaintiff’s arguments fell flat overall. The plaintiff argued that the remaining defendants merely failed to meaningfully supervise the Transaction Committee’s process and should have intervened to stop the TIDAL acquisition.
However, the court noted that because the plaintiff had not “adequately alleged that the Transaction Committee’s approval of the TIDAL acquisition rose to the level of bad faith, it is difficult to imagine how the Board’s lack of ‘supervision’ of that process did so.”
In other words, if the Transaction Committee did not act in bad faith, the other directors’ alleged lack of supervision does not come into play.
Ultimately, Judge McCormick granted Block’s motion to dismiss, concluding that “because Plaintiff failed to adequately allege with particularity facts giving rise to a reasonable doubt that a majority of the Board was disinterested or lacked independence with respect to the TIDAL acquisition, Plaintiff failed to plead that demand was futile.”
Takeaways
No director wants to be pulled into a bad M&A deal. Bad deals destroy shareholder value and certainly do not enhance the reputations of the directors involved.
That said, as the court in the Block case so succinctly notes: “Under Delaware law … a board comprised of a majority of disinterested and independent directors is free to make a terrible business decision without any meaningful threat of liability, so long as the directors approve the action in good faith.”
While that sentiment seems extreme, it underscores Delaware’s respect for boardroom processes when those processes are conducted by independent directors in good faith.
This case highlights the fact that yes, you can make a terrible deal, but if directors have done all the right things during the M&A process, they can reduce their risk.
Of course, in a world where even good deals are challenged by plaintiffs, directors should certainly expect to be sued if they approve a controversial deal.
This is why, if there is even a hint of social connections in the mix, forming an M&A transaction committee is an excellent defensive move.
Also, in addition to documenting a robust and independent process, directors will want to make sure they have an updated personal indemnification agreement and the best possible D&O insurance in place.
