Explore a case study involving a furniture company’s M&A journey and learn valuable lessons in due diligence for directors and officers. Discover the importance of thorough research and risk mitigation in the world of mergers and acquisitions.
M&A Stories
September 21, 2023
Introduction:
In the world of mergers and acquisitions (M&A), making informed decisions is paramount. Directors and officers of Delaware limited liability companies, much like their counterparts in corporations, are obligated to exercise due care when considering an acquisition. While they are not guaranteeing the success of the deal, they must act with prudence to minimize risks. Failure to do so can result in personal liability, in cases of gross negligence.
The Background:
Let’s dive into a case from 2016 involving a furniture company established in 1984. This company, primarily operating furniture factory outlet stores in the South and Midwest, was known for its high-quality furniture brands. In 2016, a private equity firm acquired this company at an enterprise value of $34 million.
In 2018, the company made a strategic move by purchasing a bedding and home furniture retailer in Kentucky for over $7 million, aiming to expand its presence in that region. Unfortunately, this acquisition did not yield the desired results, and the subsequent pandemic pushed the company into bankruptcy. It was eventually sold out of bankruptcy for approximately $14 million, with certain liabilities assumed.
At its peak, the company boasted annual revenues of around $143 million, ran 68 locations, and employed about 675 people. However, by the time of the 2020 bankruptcy filing, it had downsized to 31 retail locations, a bedding manufacturing facility, a distribution facility, and roughly 270 employees.
Legal Proceedings:
In the aftermath of the bankruptcy, the company’s trustee filed a lawsuit against the officers and directors, alleging breach of their duty of care because of gross negligence in the Kentucky acquisition. The trustee argued that the due diligence process had failed to explore significant cultural and operational differences between the acquiring company and the Kentucky target.
According to the trustee, the decision-makers focused too narrowly on historical data from the Kentucky target and made flawed assumptions about future performance. They neglected key market trends, such as the shift to e-commerce and declining in-store foot traffic. Moreover, they failed to consider the economic challenges in the industry, including a softening mattress market that led to aggressive pricing strategies and bankruptcies among major mattress firms. Lastly, the trustee emphasized the failure to address substantial cultural differences, which hindered the integration of the acquired business.
In response, the directors and officers attempted to have the trustee’s complaint dismissed.
Outcome:
The bankruptcy judge determined that if the allegations were true, they could constitute gross negligence. Consequently, the motion to dismiss was denied.
Comment:
It’s worth noting that courts are generally hesitant to find breaches of the duty of. Additionally, Delaware corporations and LLCs have mechanisms, such as exculpatory clauses in their governing documents, that can shield directors, officers, and LLC managers from personal liability for breaches of their duty of care.
Case Reference:
See In Re Furniture Factory Ultimate Holding, LP, Case No. 20-12816 (JKS), Adv. Pro. No. 22-50390 (JKS), United States Bankruptcy Court, D. Delaware (August 31, 2023).
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
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