Another development in the Bill Ackman / Herbalife Ltd. (NYSE:HLF) kerfuffle. In a politely-worded letter that is ostensibly a friendly bit of advice, Ackman warns the board of directors that they may be personally on the hook for the results of their share repurchase program if the company is indeed found to be an illegal pyramid scheme.
Ackman’s letter to Herbalife: full text
November 1, 2013
Board of Directors
P.O. Box 309GT
Ugland House, South Church Street
Grand Cayman, Cayman Islands
Re: Director Liability Resulting from Share Repurchases
To the Board of Directors of Herbalife Ltd.:
On the second and third quarter earnings calls, your CFO hinted that, after the auditors complete their re-audit of Herbalife Ltd. (NYSE:HLF)’s financial statements, the company would consider a leveraged share buyback. We are writing to suggest that you consider the propriety of any share repurchases in light of contingent exposures that could undermine Herbalife’s solvency, particularly because under Cayman law each of you may become subject to massive personal liability if you are found to have gone over the line.
Cayman law limits repurchases to the company’s capital, share premium and profit accounts, and in any event permits a repurchase only if, after giving effect to the repurchase, the company remains solvent (i.e., remains able to pay its debts as they fall due in the ordinary course of business). Moreover, Cayman law imposes on directors an affirmative fiduciary duty to carefully consider the present and future solvency of the company before approving a share repurchase. In considering solvency, directors have a duty to take into account contingent exposures. The larger the repurchase, and the larger the contingent exposure, the more cautious directors should be. It would be particularly dangerous for a board to approve a large repurchase despite a large contingent exposure, especially given that a court evaluating your decision would have the benefit of hindsight if the contingent exposure comes to pass.
If a director is found to have breached his or her fiduciary duties, that can result in enormous personal liability. For example, in Weavering Macro Fixed Income Fund Limited (in liquidation) v. Stefan Peterson and Hans Ekstrom (2011), two directors of a Cayman company were found personally liable for losses of $111 million each for failure to discharge their fiduciary duties.
As you know, we believe Herbalife will eventually be found to be an illegal pyramid scheme and will be shut down (in which case the company will no longer be able to pay its debts as they come due). If that were to happen, a court with the benefit of hindsight may well conclude that your belief in the solvency of the company when it repurchased its own shares was not reasonable (especially given your access to all the facts). In that case, the court, acting for the benefit of victims of the scheme and other creditors, could require you to make the company whole out of your own pockets for the cash wrongly used in share repurchases.
Very truly yours,
PERSHING SQUARE CAPITAL
By: PS Management GP, LLC, its General Partner
Name: William A. Ackman
Title: Managing Member
cc: Brett R. Chapman
(Chief Legal Officer and Corporate Secretary)
Also see another recent letter to Herbalife which we have uploaded as a pdf here- 213635162-Letter-to-Herbalife-Board-of-Directors