Delaware Court Of Chancery Reinforces High Bar To Plead Existence Of A Control Group And Dismisses Action Challenging Take-private Acquisition

The Delaware Court of Chancery, in Le Clair v. KnowBe4, Inc., issued a decision dismissing a putative class action challenging Vista Equity Partners’ (“Vista”) take-private acquisition of KnowBe4, Inc. (“KnowBe4” or the “Company”). Specifically, former stockholders of KnowBe4 alleged that two institutional investors and KnowBe4’s CEO had formed a unified “control group” that forced through a conflicted buyout and that the directors who approved the acquisition breached their fiduciary duties. At the pleading stage, the Court found that Plaintiffs failed to adequately allege a control group. The Court then held that, assuming director-level conflicts, a fully informed, uncoerced stockholder vote cleansed the transaction.

This decision is notable for its stringent application of the control-group pleading standard and its application of amended Section 144 of the Delaware General Corporation Law. The Court noted, where entire fairness applies because of director-level conflicts, “either a fully empowered, independent special committee or a fully informed, uncoerced stockholder vote can cleanse the transaction.” Le Clair also highlights the value of robust deal protections in analogous M&A transactions featuring director-level conflicts of interest, including an empowered Special Committee and/or a majority-of-the-minority stockholder vote.

Background

KnowBe4 is a Delaware corporation that provides cybersecurity awareness training. Sjoerd Sjouwerman, who founded KnowBe4 and served as its CEO, held 4.2% of the voting power as of the record date. Affiliate vehicles of KKR & Co. Inc. (“KKR”) and Elephant Partners (“Elephant”) invested in KnowBe4 through several financing rounds. KKR held 26.4% of KnowBe4’s voting power and Elephant held 37.5%. Each had its own board designee.

Vista Equity Partners Management LLC (“Vista”), a private equity sponsor, bought preferred shares from KKR, Elephant, and another institutional investor for $300 million, which gave Vista 12.4% of KnowBe4’s Class A shares—constituting 2.8% of KnowBe4’s voting power. KnowBe4 completed an IPO and established a dual-class share structure: Class A shares (one vote per share) and Class B shares (ten votes per share).

Vista met with KKR’s board designee, Elephant’s board designee, and Sjouwerman to discuss a potential transaction. The Board subsequently met to discuss those conversations; Elephant’s and KKR’s board designees disclosed that their firms might not sell all of their holdings. Sjouwerman likewise disclosed that he and management might retain a portion of their equity. Before substantive price negotiations began, the Board formed a three-member Special Committee, not including either of Sjouwerman or the Elephant or KKR board designees. The Board later executed a Unanimous Written Consent formally establishing the Special Committee and defining the scope of its authority. The Unanimous Written Consent authorized the Special Committee to consider, reject, or approve any potential transaction and conditioned any transaction on dual Kahn v. M&F Worldwide Corp. protections: approval by (1) the Special Committee and (2) a majority-of-the-minority vote of KnowBe4’s disinterested stockholders.

The Special Committee supervised a sales process and retained its own financial advisor, Morgan Stanley, to conduct outreach. Morgan Stanley contacted more than a dozen parties, but only Vista submitted a bid. The Special Committee limited Elephant’s and KKR’s involvement in the negotiation process and instructed that neither KKR nor its designee would participate in discussions with Vista.

The parties ultimately agreed on a price of $24.90 per share, valuing the Company at over $4 billion. Vista conditioned the merger on KKR, Elephant, and Sjouwerman collectively rolling over equity worth $682 million (i.e., exchanging their existing shares for equity in the post-merger company rather than receiving the per-share cash merger consideration). The rollover stockholders also gave up their voting power by down-converting their Class B shares before the record date. The stockholders overwhelmingly approved the merger, which was a cash-out transaction for non-rolling stockholders and returned KnowBe4 to private ownership.

Roughly two years after the merger closed in February 2023, former stockholders of KnowBe4 brought a putative class action alleging three counts: (1) KKR, Elephant, and Sjouwerman acted as a unified control group to push through the conflicted take-private acquisition and breached their fiduciary duties (Count I); (2) the director defendants breached their fiduciary duty of loyalty by approving the merger while allegedly conflicted (Count II); and (3) KnowBe4 breached an equal-treatment provision in its incorporation documents requiring that Class A and Class B shares be treated equally in any merger (Count III). The defendants moved to dismiss under Court of Chancery Rule 12(b)(6).

The Delaware Court of Chancery’s decision

At the pleading stage, the Court of Chancery (Hon. Kathaleen McCormick) dismissed the two fiduciary-duty claims for separate reasons. It dismissed Count I because the Amended Complaint failed to adequately allege a control group. After rejecting that theory, the Court dismissed Count II after assuming that entire fairness applied based on alleged director-level conflicts and holding that the fully informed, uncoerced stockholder vote cleansed the transaction. The Court dismissed Count III separately because Plaintiffs did not advance it in briefing.

Control Group Allegations. As to the control group allegations,¹ the Court applied the “legally significant connection” standard for pleading the existence of a control group outlined in Sheldon v. Pinto Technology Ventures, L.P. To meet this standard, Plaintiffs’ Amended Complaint must “‘give rise to a reasonably conceivable inference’ that an alleged control group struck an ‘actual agreement to work together in connection with’ a challenged transaction.” Absent a formal or written agreement demonstrating that connection, as was the case here, Plaintiffs must plead an “array of plus factors,” such as historical ties and transaction-specific connections. The Court held that Plaintiffs failed to plead meaningful historical ties or transaction-specific connections among the purported control group members sufficient to support a reasonable inference of an actual agreement to work together. In particular, the purported control group members lacked the kind of “long, well-documented history of coordinated investments” that Delaware courts expect to show that the parties “operated in tandem” as a control group. Here, Elephant was a “nascent” firm and the firms made their investments in KnowBe4 years apart. With respect to the transaction-specific facts, the Court described the rollover decision as a “quintessential example of parallel economic interests.” Thus, the Court rejected contentions that equity rollovers, meetings with Vista, separate support agreements (i.e., agreements that completed the rollovers), and the Board’s adoption of MFW deal protections constituted a legally significant connection. As a result, the Court dismissed Count I because Plaintiffs failed to adequately allege at the pleading stage that Sjouwerman and the two rollover investors had formed a control group.

Director Breach of Fiduciary Duty Claims. The Court next addressed Count II, the director defendants’ fiduciary duty claim. It assumed that entire fairness applied based on alleged director-level conflicts: Sjouwerman rolled over his shares, and three other directors were alleged to be dual fiduciaries for the rollover stockholders. The Court rejected the alleged control-group theory at the pleading stage before turning to the director-level conflicts; its vote-cleansing analysis therefore did not address a controlling stockholder conflict. Instead, where entire fairness applied because of director-level conflicts, the Court held that a fully informed, uncoerced stockholder vote could cleanse the transaction. If the transaction was cleansed, business judgment review applied under Corwin v. KKR Financial Holdings LLC. Because the defendants relied on the stockholder vote, Plaintiffs bore the burden of alleging a material disclosure deficiency that would render the vote uninformed or coerced. The Court rejected each of the alleged disclosure deficiencies concerning (1) the Special Committee’s conflicts, (2) Morgan Stanley’s conflicts, (3) KKR’s rollover participation, (4) a support agreement with Sjouwerman’s friend and former director, and (5) the Special Committee’s alleged favoritism toward Vista. Consequently, the Court determined that the stockholder vote was uncoerced and fully informed and that the business judgment standard applied. Because Plaintiffs conceded that their claim could not proceed under the business judgment standard, the Court dismissed Count II.

Takeaways & practice points 

• This case underscores the high pleading burden that courts impose on plaintiffs who seek to allege a control group. Rollovers and voting commitments, without more, do not adequately allege a control group; aligned or parallel economic interests are expected in a take-private merger. The Court observed that the “concurrent” timing of the rollover decision is “typically driven by the deal itself, not the group members,” and that documents incorporated by reference demonstrated different approaches. For example, Elephant maintained a fixed sale percentage, while KKR varied its rollover amount.
• Merely adopting MFW-style deal protections does not, standing alone, support an inference that a control group exists. Boards can implement prophylactic safeguards under the MFW framework without conceding that a conflicted controller or control group exists. The Court reasoned that MFW incentivizes boards to adopt procedural protections when negotiating transactions that may involve controller conflicts and that “[d]eeming the decision to adopt [such] protections as a concession concerning the existence of a conflicted controller would disincentivize their use.”
• This decision is a good example of the importance of adopting procedural deal protections. The transaction featured several protections that, collectively, formed a robust defense: (1) an independent Special Committee was empowered to evaluate the transaction; (2) the Special Committee hired counsel and retained its own financial advisor, Morgan Stanley; (3) the conflicted stockholders were separated from the sales process; (4) the Special Committee surveyed the market and contacted more than a dozen parties; (5) the deal was subject to several stockholder votes, including a majority-of-the-minority vote; and (6) the rollover stockholders relinquished their voting power by down-converting their Class B shares before the record date.
• A Special Committee’s process is especially important at the pleading stage. Here, the Special Committee’s decision to quarantine KKR, Elephant, and their designees from participating in its discussions with Vista was central to the Court’s analysis. The Court rejected the alleged Morgan Stanley disclosure deficiency in part because KKR “did not participate in the Special Committee process[.]” Although Plaintiffs argued that the proxy statement should have disclosed Morgan Stanley’s alleged holdings of approximately $200 million in KKR & Co. stock and $350 million in KKR portfolio companies, the Court concluded that KKR’s exclusion from the process limited the significance of those relationships for disclosure purposes. The upshot is that excluding conflicted stockholders from the Special Committee process can limit the disclosure obligations associated with a financial advisor’s professional relationships.
• As to what must be disclosed in proxy statements for a take-private merger, this decision illustrates that companies need not include every internal board deliberation that did not materialize into a bid. Once a defendant relies on a stockholder vote, a plaintiff must plead a material omission or other disclosure deficiency. Here, KnowBe4’s disclosures did not need to include preliminary expressions of interest that never materialized into bids. In the Court’s words: “Delaware law ‘does not require a play-by-play description of every consideration or action taken by a Board[.]”

Footnote

1. When a Delaware court finds a control group, it accords the group members controlling stockholder status and subjects them to fiduciary duties. See, e.g., Dubroff v. Wren Holdings, LLC, 2009 WL 1478697, at *3 (Del. Ch. 2009) (“[T]he control group is accorded controlling shareholder status, and, therefore, its members owe fiduciary duties to their fellow shareholders.”).