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A Shareholder Duel For FanDuel
With its unique placement in Scotland, MBM’s team of US-qualified attorneys often work within the intersection of UK and US law across M&A transactions. The high-profile merger of Scottish betting company, FanDuel Ltd., with American betting company, Paddy Power Betfair, is an example of the importance of choice of law in acquisition agreements and shows that, though the UK and US may be seen as different nations that share a “common language”, there is not always harmonious protection under the law for the parties involved.
In 2020, the founder and employees of FanDuel, along with early investor shareholders, filed a claim against private equity firm Shamrock Capital Advisors LLC alleging that the value of FanDuel was intentionally understated to benefit only preferred shareholders during the 2018 merger. At the time of the merger, FanDuel’s share capital comprised preference and ordinary shares. In the event of an exit or merger of the company, preferred shareholders had priority over deal proceeds valued at the original subscription price of their shares, as well as “drag-along” rights that entitled them to compel other shareholders to approve and participate in a proposed acquisition or merger. When the merger occurred, FanDuel was valued at $559 million, which was the calculated subscription price of only the preference shares, leaving no transaction proceeds available for the holders of ordinary shares. The plaintiffs filed a claim against holders of 36% of FanDuel’s preference shares (including Shamrock and another investor) claiming that the defendant shareholders had purposely undervalued FanDuel’s assets, which led them to lose approximately $120 million in transaction proceeds as a result. Two years after the merger, the defendant shareholders sold the stake they had acquired in the newly-formed, PandaCo, for approximately $4.2 billion, highlighting the immense discrepancy between the true value of FanDuel and the valuation ascribed to it in the merger.
Choice of Law & Venue Issues
The claim was originally brought under New York law, alleging breaches of fiduciary duties against the directors and certain preferred shareholders of FanDuel. However, before the New York Supreme Court (NYSC), the defendants argued that Scots law applied under the “internal affairs doctrine” which holds that the laws of a company’s place of incorporation govern that company’s internal affairs. In applying Scots law, the defendant appealed for the case to be dismissed, arguing that there was no basis available under Scots law for claims alleging duties owed by directors to shareholders or by shareholders to other shareholders. To the contrary, the NYSC held that the application of New York law was appropriate because FanDuel maintained its principal office in New York, held board meetings in the state and negotiated the merger transaction in the state, and found that the plaintiffs had adequately brought their claim for breach of fiduciary duties which is a recognisable cause of action under New York law. The defendants then appealed to the New York Appellate Division, asserting that the transaction and claim were both governed by Scots law, and the Appellate Division held that, under Scots law, no fiduciary duty was owed to the shareholders. The plaintiffs later appealed to the NY Court of Appeals which found that Scots law did apply, and that the director defendants did owe limited fiduciary duties to the plaintiffs. In assessing how that duty was breached, the courts pointed to the waterfall mechanism in the transaction documents and Shamrock’s drag-along rights. After two years of appeals, the case will now go on to be adjudicated.
Merits of the Claim
In August 2024, the plaintiffs filed an expanded claim that alleged that a number of illegal actions were taken by the defendants in addition to the purposeful undervaluing of FanDuel’s assets, including collusion by shareholders and acting within conflicted situations to the benefit of certain shareholders and the detriment of other shareholders and the company. In light of these new claims, we have highlighted various risks which may arise when a company takes on investor shareholders as well as strategies to mitigate these risks in future M&A transactions:
I. Articles of Association
“Drag Along” Rights: In the FanDuel merger, the ordinary shareholders were disadvantaged by the “drag along” rights held by the preferred shareholders, which allowed the defendants to compel the ordinary shareholders to participate in the merger. Companies who are taking in early-stage investments should be aware that investors who seek preference shares will often require “drag along” rights. It is important to consider how the makeup of share capital and amendments to a company’s articles could affect the other shareholders in future transactions and consider negotiation of these rights where possible.
Waterfall Dynamics: FanDuel’s articles were not specific on the way in which the share-for-share consideration and proceeds from an M&A transaction would be allocated amongst the holders of preference and ordinary shares. In their claim, the FanDuel plaintiffs allege that the waterfall was specifically triggered at a premature point in the transaction negotiations so as to allow the preferred shareholders to benefit from a lower theoretical valuation of PandaCo, though a higher valuation would have been certain if determined at a later three- or five-year mark. It can be helpful to leave flexibility in the articles for determining the distribution waterfall during the negotiation of a transaction; however, this should be a key consideration for the Board and shareholders during term sheet negotiations to ensure alignment of interests amongst selling shareholders as early as possible.
Director Conflicts of Interest: Where a company has investor-designated directors, it is important that the articles limit potential conflicts that may arise between such directors and their shareholder appointors, as well as limit the ability for principals, partners, managers, officers, directors or employees of shareholders from having a material relationship with any other shareholder. In FanDuel, the plaintiffs allege that although the articles had mechanisms for avoiding conflicts of interest, necessary steps were not taken where conflicts existed, which led to collusive behaviours and disadvantages in information sharing between interested shareholders in the transaction. Specifically, in FanDuel, it is alleged that preferred shareholders were given access to information about the merger negotiations through their personal relationships with the investment bankers involved as well as their relationships with their designated directors. For example, KKR and Shamrock received advanced copies of the term sheet proposals ahead of other preferred shareholders and FanDuel’s Board. It is important to ensure that key information and a line of communication is open to all shareholders (including minority sellers) so as to ensure all interests in the transaction are aligned at the earliest stage, which will allow the timeline to move smoothly and pre-empt any issues that individual shareholders may have with deal terms, as well as avoiding alleged conflicts of interest.
The extensive proceedings in the FanDuel case over the past two years highlight the impact of choice of governing law in M&A transactions as well as the intricacies involved in shareholder and investor dynamics that need to be managed as companies view an exit. While the final judgment in FanDuel is still to be determined, it will be interesting to observe how a New York court applies Scots law to the claims, and the proceedings and outcome will certainly be a cautionary tale for investors and sellers alike in future cross-border M&A transactions.
