Two private equity firms may have controlled shares in a public company, they each may have had an agreement to hold a majority on that company’s board, and they each may have blessed deals from which they each profited – but that doesn’t mean they were a control group, a Delaware judge has ruled.

Vice-chancellor Morgan Zurn dismissed a shareholders’ derivative suit against Apollo Global Management, Riverstone Holdings and their principals because lead plaintiff Vrajeshkumar Patel couldn’t prove that the fund advisers had an explicit agreement to help each other out through a publicly traded oil-and-gas company they co-ran.

That oil-and-gas company, Talos Energy, bought a series of portfolio companies affiliated with Riverstone last year. Patel claims that the purchase price was an outrage, based on a flawed analysis by an investment adviser. He also says the overpay was a form of payback from Apollo, which had been rescued by a Talos investment two years before.

Zurn ruled that while Riverstone controlled 27.5 percent of Talos’ shares and Apollo more than 35 percent, and while they each signed what they called a “control agreement” to divide Talos’ board seats among them (with the sixth seat given to Talos’ CEO), Patel hadn’t proven they acted as a control group.

Zurn said that Patel “falls short of alleging any agreement between the sponsors that would support such a finding, or any other indication of a transaction-specific connection. In short, despite relying on a purported wink-and-nod agreement between the private equity sponsors, the stockholder alleges neither a wink nor a nod.”

Banner weeks

Zurn’s decision caps a banner couple of weeks for private fund advisers in one of capitalism’s most important jurisdictions. On September 20, the Delaware Supreme Court reversed itself on a 15-year-old decision to dismiss a shareholders’ suit against Brookfield Asset Management. Shareholders can no longer file dilution suits directly against controlling shareholders, the court ruled, and will have to rely on the more complicated derivative lawsuits.

Three days later, that same court then made it even harder to fight a derivatives lawsuit when it ruled for Facebook and its founder, Mark Zuckerberg, in a suit brought by a union pension fund. The union had argued that Zuckerberg loyalists on the board formed a control group that prevented meaningful review of Zuckerberg’s command.

In a unanimous decision, the Delaware justices held that derivative suits from now on must pass a three-pronged test. To succeed, plaintiffs in Delaware now must prove a company director:

  • Benefited personally from the alleged misconduct;
  • Is at risk for his or her own shareholders’ actions stemming from the alleged misconduct; or
  • Depends on someone who benefited personally from the alleged misconduct.

If the majority of a board checks “yes” on these questions, a suit can proceed. Zurn’s decision in the Patel case is the second since the Supreme Court delivered its opinion in Zuckerberg. She says Patel didn’t pass that test, either.

‘Nearly whole’

In late 2019, Talos announced that it was buying oil-and-gas rights and rigs in the Gulf of Mexico from a series of Riverstone companies. Patel says that “an extensive valuation analysis” helped him determine that Talos “had grossly overpaid” for the assets. Even worse, that over-payment was payback for Talos having “bailed Apollo out of a disastrous investment” two years before.

In 2013-14, Apollo had loaned Whistler Energy $135 million. The firm suffered what Zurn calls “operational issues” and went into bankruptcy. By the time Whistler emerged from bankruptcy in March 2018, Apollo had recovered only $35 million on its loans. But it had obtained new membership interests in Whistler that gave Apollo all distributions of its loans, interests, and fees, Zurn said.

Late that summer, Talos bought Whistler, “making Apollo nearly whole” on its investment, Zurn says. “But this came at a price: according to the complaint, ‘[m]aking Apollo whole required Talos to greatly overpay for Whistler,” at a premium of between 61 percent and 66 percent over a fair price,’” Patel alleged.

“Having agreed to let Talos bail out Apollo from the Whistler debacle,” Patel claims, “Riverstone was rewarded with its own sweetheart deal in the Controllers’ next interested-party transaction.”

Among his suit’s problems, Zurn ruled, Patel “offers no other allegations that Riverstone was involved in the Whistler transaction, or that it struck any agreement with Apollo to support the Whistler deal in exchange for a future favor.”