Lessons from the Chancery Court Decision in P3 Health Group

Gail Weinstein is Senior Counsel, Steven J. Steinman and Brian T. Mangino are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Andrew J. Colosimo, Randi Lally, and Erica Jaffe and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? (discussed on the Forum here) by John C. Coates, Darius Palia, and Ge Wu; and The New Look of Deal Protection (discussed on the Forum here) by Fernán Restrepo and Guhan Subramanian.

In P3 Health Group, private equity firm Hudson Vegas Investments SVP LLC, which was the second-largest unitholder of P3 Health Group Holdings, LLC (the “Company”), challenged the Company’s de-SPAC merger. The Company’s sponsor, private equity firm Chicago Pacific Founders Fund, L.P., controlled the Company (a Delaware LLC) by virtue of its majority equity ownership, board designees, and contractual rights. Hudson claimed that the merger, which stripped it of $100 million of stock options and its contractual rights with respect to the Company and was effected over its objection, violated its contractual veto right over affiliated transactions.

The Delaware Court of Chancery recently issued five important decisions in the case (dated November 3, October 31, October 28, October 26, and September 12, 2022), rejecting dismissal of most of Hudson’s claims.

Background. Chicago Pacific provided the start-up capital for the Company and soon thereafter, Hudson invested $50 million in the Company. Soon thereafter, a de-SPAC merger was structured with Foresight Acquisition Corp. (a SPAC formed by an unaffiliated businessperson), which contemplated a three-way merger that included another Chicago Pacific portfolio company (known as “MyCare”). Hudson objected to the transaction. Chicago Pacific and the Company then restructured it to exclude MyCare (but allegedly contemplated including MyCare later in a follow-on transaction). Hudson unsuccessfully sued to enjoin the merger. Following the closing, Hudson asserted claims against Chicago Pacific and certain of its and the Company’s key managers and officers for their roles in arranging the merger. Hudson also added a claim that its initial investment in the Company was fraudulently induced. In a series of recent pleading-stage decisions, Vice Chancellor Laster rejected dismissal of most of the plaintiff’s claims.

Key Points

  • A private equity sponsor’s principal, without any formal role at a portfolio company that is a Delaware LLC, can face liability for actions as a de facto manager if the principal materially participated in the company’s management (generally or with respect to a specific transaction). In our view, in this case, it was the combination of actions taken that led to the court’s conclusion that the principal faced potential liability for his role in arranging the company’s de-SPAC merger.
  • Any person with a senior role at a Delaware LLC portfolio company now faces potential liability for their actions in that role. Based on this expanded interpretation by the court of its previous interpretation of the Delaware LLC Act, officers of Delaware LLCs should anticipate expanded potential for liability in connection with their roles. 
  • A sponsor’s principal who enters into a side deal with a personal benefit in the midst of a portfolio company’s deal process (and especially if without disclosure to the board) may face liability. The court rejected the defendants’ arguments that various standard provisions in the portfolio company’s LLC Agreement permitted them to enter into the side deals.
  • The sponsor’s post-merger designation of directors of the surviving company of a portfolio company’s merger may constitute an affiliated transaction under a company investor’s veto right for affiliated transactions. The court rejected the defendants’ argument that the consent right was inapplicable to a post-merger designation of directors.
  • A valuation of distributed SPAC shares at their nominal value may constitute a breach of waterfall provisions calling for valuation at fair market value. The court cited academic studies indicating that the value of SPAC shares at time of a de-SPAC merger are generally below the nominal value (and, in this case, the actual closing value just before the merger was below $10).
  • Depending on the circumstances, provision of a failed projection to a potential investor may support a reasonable inference of fraudulent inducement. The court found such an inference reasonable in this case, as the company was small and closely-held and the spread between the near-term projection and the actual result was very large.


 “SM,” a principal of Chicago Pacific, was an “acting manager” of the Company with respect to the merger and has potential liability for his actions in arranging the merger. SM was on the Chicago Pacific team with responsibility for overseeing the fund’s investment in the Company. He was not a named manager, director, officer or employee of the Company. The court explained that it may deem a person without any formal role at a Delaware LLC as an “acting manager” if the person “materially participates in the management of the company…[or, in other words,] makes decisions on behalf of the company.” We would observe that sponsors and their principals without official roles at portcos, in connection with monitoring and seeking to facilitate the success of portcos, often engage in the kinds of activities in which SM allegedly engaged in connection with the merger—such as attending meetings about strategic alternatives, reviewing documents and agreements, addressing funding issues and tax structuring, and so on. In our view, the court’s result flowed from the combination of the foregoing activities with the following: (i) SM, without authorization from Company management, allegedly “instructed” and “directed” the formal managers and outside advisors (including by insisting that the Company’s legal counsel not distribute any draft agreements without a prior sign-off from SM or Chicago Pacific’s board designee); (ii) SM stated in an email to the Company’s outside legal counsel that he and Chicago Pacific were “in charge” of the Company; and (iii) SM and Chicago Pacific allegedly had access to more information than the Company’s board did and “ke[pt] the [board] in the dark” about their decisions to proceed with the transaction following material developments (such as the SPAC’s significant lowering of its valuation of the Company in the midst of the process and significant negative developments with respect to the PIPE funding). In addition, the overall factual context of the case was seemingly very negative (as discussed below).

The Company’s General Counsel was an “acting manager,” with potential liability for her role in arranging the merger. In other cases, the court has established that the LLC Act confers personal jurisdiction (and thus potential liability) over a “president” of a Delaware LLC. In P3 Group, the court expanded this interpretation, holding that the Act confers personal jurisdiction over any person who “occupied a senior role in an LLC and performed functions constituent with that role.” The court held that it was not possible at the pleading stage to determine whether the Company’s General Counsel, as she contended, performed functions that were only “ministerial.” Further, according to the court, it appeared that the General Counsel had materially participated with respect to the merger, given her role in providing advice and materials to the board, preparing board minutes, and working with outside counsel to respond to Hudson’s concerns and minimize the provisions of information to Hudson’s board representatives.

Two Chicago Pacific principals may have violated their obligations by entering into a side deal that personally benefitted them. Allegedly, to “shore up Chicago Pacific’s commitment to the [de-SPAC] transaction” in the face of negative developments in the process, the person who formed the SPAC gave two Chicago Pacific principals, “GK” and “MT,” the opportunity to invest personally in another of his SPACs. Without any disclosure to the Company’s board, GK and MT invested $100,000 and $500,000, respectively, from which they allegedly “stood to reap” nearly $5 million and $9 million, respectively. GK, a director and officer of the Company, had fiduciary duties to the Company (as the LLC Agreement expressly preserved fiduciary duties of officers); while MT was a Company director (and the LLC agreement eliminated fiduciary duties for directors). The court found that, by making the investment in the midst of the transaction process and without disclosure to the board, GK may have breached his fiduciary duties, and that both GK and MT may have caused the Company to breach its contractual obligations to Hudson based on their personal interest in their side-deal investment. GK and MT argued that the LLC Agreement permitted them to make the investment as under standard provisions expressly providing that managers who were representatives of Chicago Pacific (a) could pursue other business interests even if they competed with the Company and (b) could consider “whatever interests they deemed fit…(consistent with the elimination of any and all fiduciary duties)” for directors. The court stated that these provisions are designed for other purposes—not to permit “an officer accepting a personal benefit [(a “bribe-like payment”)] from the company’s counterparty in an ongoing negotiation.” The court also rejected GK’s argument that he was exculpated from liability under the LLC Agreement as a director unless the alleged facts established that he was acting solely in his capacity as an officer. The court found that it was reasonably conceivable that GK “was acting as an officer when he was not attending board meetings or otherwise responding to requests for board action.”

 Chicago Pacific’s post-merger designation of directors to the board of the surviving company of the de-SPAC merger may have violated Hudson’s contractual right to consent to affiliated transactions. The court rejected the Company’s argument that, because the designation of directors came after the merger, the Company’s existence and the consent right had terminated. First, the court, citing what it called the “broad language” of the consent provision, found it reasonably conceivable that the designation of the directors (pursuant to which they would receive regular director compensation) was an affiliated transaction requiring Hudson’s consent—because the provision, by its terms, (a) applied not only to the merger itself but also to any “series of transactions” relating to it, and (b) covered not just an affiliated transaction but “entering into any agreement” involving an affiliated transaction. The court commented that Chicago Pacific’s “extract[ing] a non-ratable benefit for its principals…[was] precisely the type of transaction that the Affiliated Transactions Consent Provision allow[ed] Hudson to prevent”—and the fact that the benefit “came after the deal closed and from the surviving entity [did] not give Chicago Pacific a free pass.” Second, the court also found it reasonably conceivable that Hudson had a consent right because Chicago Pacific and the Company allegedly had continued to contemplate and “work on” a follow-on merger of MyCare for a month after the restructuring that excluded MyCare.

The Company may have breached Hudson’s contractual right to a priority distribution by valuing the distributed SPAC shares at their $10 per share nominal value when the actual value was lower. The LLC Agreement required that distributed shares be valued at their fair market value. The court pointed to academic work demonstrating that the value of SPAC shares when a de-SPAC merger takes place generally is “materially less” than the nominal $10 per share value. One study reported that “the mean and median SPACs in the cohort reviewed had just $4.10 and $5.70, respectively, in net cash per share outstanding at the time of their merger.” Further, in this case, the court noted, the actual closing price of the SPAC’s shares just two days before the merger was $8.87 per share.

Chicago Pacific and the Company may have fraudulently induced Hudson to make its initial investment in the Company. When Hudson was considering whether to invest in the Company, Hudson was provided with a projection reflecting 2020 EBITDA for the Company “north of $12.7 million.” Actual 2020 EBITDA turned out to be “negative $40 million.” The court held that, as the Company at that time “was a closely-held, relatively small LLC” (with just $14.5 million in assets and 52 full-time employees), the defendants likely would “have had a precise sense of [the Company’s] business and financials.” The court stated that while “the fact that a projection does not come to fruition, standing alone” generally is insufficient to state a cognizable claim for fraud, the court can consider “whether a sizeable miss on a near-term projection” indicates that the projection was knowingly false.

We would emphasize the seemingly very negative overall factual context of the case. As discussed, the merger allegedly was restructured to avoid Hudson’s veto right, with the defendants envisioning that they would accomplish the affiliated-transaction piece later; the Company ignored its financial advisor’s advice to negotiate with other bidders to create competition in the process; the acquiror, mid-transaction, lowered its valuation of the Company from $3.3 billion to about $1 billion and there were serious PIPE-related funding issues, but Chicago Pacific and the Company’s officers “moved forward at the lower valuation without discussing it with the full Board,” and “[t]o grease the skids,” the SPAC founder gave two Chicago Pacific principals “the lucrative opportunity” to participate in another of his SPACs; after Hudson objected to the merger, the Company’s board (including Hudson’s representatives) was “left in the dark” about the transaction; the merger was structured to permit Chicago Pacific (but no other member) to receive part of the consideration directly from the SPAC in a non-taxable exchange (although the court held that this was not an actionable claim); and Hudson’s initial investment in the Company allegedly was fraudulently induced.

Practice Points

  • Observing corporate formalities with respect to portcos. Broadly speaking, decisions for a portco typically should be made by the portco’s board and management. Generally, sponsors’ influence is best exercised through its equity ownership, board designees, and/or contractual rights. In this case, the sponsor principal’s articulating that he and the sponsor were “in charge” appeared to be a key factor in the court’s result.
  • Increased risk for potential liability of portco officers. Portcos and sponsors should review their exculpation, indemnification and advancement provisions and their D&O insurance coverage to ensure that they operate to provide appropriate protections. We note that the interplay among these sponsor and portco provisions and policies often is complex. In addition, directors who are also officers should keep in mind that, if the LLC operating agreement does not extinguish their fiduciary duties, they will not be exculpated as a director unless they were acting solely in their capacity as a director. When appropriate, director-officers may wish to create, to the extent possible, a record to support the capacity in which they were acting.
  • In the midst of a transaction process, directors and officers should inform the board of any “side deal” they intend to enter into that may provide them with a personal benefit. They also should consider whether any such side deal would violate any of their fiduciary or other obligations.
  • Emails, emails, emails. As so many Delaware cases highlight, directors, officers, controllers and others must exercise care with respect to their use of emails and other informal communications, as these often are used (and often prove to be critical) in litigation, particularly as evidence of intent or fraud, which otherwise may be difficult to prove.
  • Drafting LLC agreements:
    • Affiliated transaction consent rights. Consideration should be given to specifying whether the post-merger designation of directors to a surviving company’s board would, or would not, constitute an affiliated transaction for purposes of the consent right.
    • Waterfall distribution provisions. Consideration should be given to providing greater specificity as to the value to be ascribed to SPAC shares that are distributed.
    • Fiduciary duties. The agreement should clearly set forth the extent to which default fiduciary duties of managers and officers of LLCs are expressly preserved or eliminated. These provisions can be tailored, for example with specified types of transactions carved out from any fiduciary duties that are preserved.
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