Litigation Coverage: Chewy Shareholder Sues BC Partners, Management

Relevant Document:
Complaint

On Nov. 20 a Chewy Inc. shareholder filed a derivative class action in Delaware Chancery Court against controlling shareholder BC Partners and directors and officers, alleging that BC caused Chewy to take on substantial tax and other contingent liabilities attributable to BC’s September 2023 sale of a portion of its holdings in former Chewy parent PetSmart to Apollo.

According to the plaintiff, BC and the directors approved an October 2023 downstream merger of the BC sellers into Chewy that left Chewy on the hook for a $1.9 billion tax bill and other liabilities related to the sale, without securing any value for minority shareholders or sufficient indemnification in exchange. The plaintiff claims that the D&O defendants breached their fiduciary duties to Chewy by acceding to a merger that exclusively benefited BC despite having substantial leverage to extract value from the controlling shareholder, which needed to undertake the sale to close out one of its funds.

The plaintiff notes that as part of the merger BC left behind $1.9 billion in cash “to pay for any liability arising from the PetSmart Sale,” but Chewy bears the risk that cash “would not satisfy the actual final obligations.” BC agreed to indemnify Chewy for any shortfall, the plaintiff adds, but its indemnification obligations were capped at $246 million (including $196 million for tax indemnification) and are nonrecourse – they can only be satisfied through a sale of escrowed Chewy shares, which could depress the market price of the shares held by the minority.

In addition to failing to secure adequate indemnification, “Chewy and its public stockholders were not adequately compensated for the significant benefits BC Partners received from the Merger,” the plaintiff contends. According to the plaintiff, the special Chewy board committee formed to evaluate the merger originally proposed a “substantial” cash payment to compensate minority Class A shareholders for the risks Chewy assumed, but the special committee “readily abandoned” this demand when BC refused.

Instead of pushing back and utilizing their leverage with BC, the plaintiff says, the special committee accepted a “paltry consolation prize.” According to the plaintiff, Chewy received an assignment of PetSmart’s pharmacy business with “nebulous” value, worthless governance concessions, an illusory collapsing of the Class A and Class B share structure and the potential for a cash payment to shareholders if Chewy’s volume-weighted average stock price for the 15 days before the closing exceeded $50 per share. Chewy’s stock was trading at about $18 per share at the time of the merger, so the conditional payment was never made, the plaintiff says.

The plaintiff argues that the three-member special committee that approved the merger failed to push for more consideration from BC because they were not truly independent. Specifically, committee member Martin Nesbitt had “a longstanding relationship” with BC-affiliated director and defendant Raymond Svider going back to their attendance at the University of Chicago Booth School of Business in the late 1980s, the plaintiff says. In 2018 Svider made a donation to a museum where Nesbitt’s wife is a trustee, and Svider hired Nesbitt’s son to work at BC Partners in 2019, the plaintiff adds.

The plaintiff also says that company counsel Kirkland & Ellis was conflicted when it determined the independence of the special committee because it also represents BC in numerous transactions. Special committee counsel Cleary Gottlieb also represented BC in five transactions, the plaintiff adds.

LionTree Advisors, the special committee’s financial advisor, had a substantial relationship with Apollo, the plaintiff notes, including representing the board of directors of Apollo portfolio company Presidio Inc. in connection with BC Partners’ 2019 acquisition. According to the plaintiff, the Delaware Chancery Court found in litigation following the Presidio acquisition that “LionTree tipped BC Partners about the price of a competing bid and hid that from Presidio’s board of directors.”

As a result of these conflicts, the plaintiff asserts, the special committee “failed to appropriately leverage the substantial negotiating power it held in light of the significant benefits BC Partners would reap by passing its liabilities onto Chewy.” “Chewy could have sought fair terms that would have adequately compensated it and/or its minority stockholders, but nevertheless failed to do so,” the plaintiff concludes.