Joseph Horne Company, a Pittsburgh department store chain, was the target of a management leveraged buyout in 1986 and was suffering with the resultant $160 million in debt. Horne executives were relieved when, in 1988, Dillard Department Stores, Inc, and mall developer Edward J. DeBartolo agreed to buy Horne's stock for $74 million and to assume the 1986 buyout debt. As part of the deal,

Question

Dillard's installed data lines and computers in Horne's fourteen stores to prepare for the consolidation. With the stores hooked into its Little Rock, Arkansas, headquarters, Dillard's assumed control of Horne's merchandise purchasing. Dillard's executives wanted financial and purchasing control because the contract price was contingent upon a finding that Horne's financial statements were accurate. Horne's CEO, Robert A. O'Connell, voiced his concerns to E. Ray Kemp, Dillard's vice chairman, about the extent and speed of Dillard's assumption of control. Kemp told O'Connell, "Trust me, it would take an act of God for this deal not to go through.". Dillard's had been acquiring department stores like Horne's all over the country, adding 196 stores in five years. From 1987-1991 Dillard's earnings had gained 20 percent through its strategy of taking over financially troubled firms. In 1990, however, Dillard's deal with Horne's fell through, and Horne sued Dillard's and DeBartolo for breach of contract and fraud. Horne's suit alleged that Dillard's plan in taking over the buying and data was to decrease the value of Horne's to get a bargain price. Experts in the industry indicate that Horne demonstrated inexperience by allowing Dillard's rapid infiltration. The contract provided that Horne could veto any proposal for Dillard activity in Horne's business. Between the time the contract was negotiated and Dillard's cancellation of the agreement, Dillard's executives found that some Horne accounting practices were questionable. But some industry experts and Horne executives said Dillard's often "nickels and dimes" sellers to bring down the price. Horne's suit also alleged that Dillard's told 500 employees that their jobs would be gone after the takeover. Thirty percent of those employees quit before Dillard's and DeBartolo withdrew. Because Dillard's took over merchandise buying, Horne maintained, merchandise deliveries were late and the wrong merchandise was ordered for critical periods, such as the holiday season. A Pittsburgh National Bank officer testified in his deposition in the suit that a Dillard's executive told him in 1988 that Dillard's might wait until Horne's bankruptcy to buy the company. Dillard's denies the statement and the plan. Dillard's and Horne's settled the suit in 1992.
a. Were the damages Horne's experienced just a consequence of a failed business deal?
b. Did Dillard's take advantage of a debt-ridden company?
c. What financial-disclosure obligations do takeover targets have?
d. Did Dillard's have any special obligations because of its access to Horne's data and buying power?
e. Is it unethical to take advantage of a naive party in a commercial transaction?

Answer 1

a. Horne's damages were something more than a failed takeover. Horne's, perhaps naively, allowed too much infiltration of its organization and experienced too much loss of authority along with too poor management of its orders and merchandise. Dillard's perhaps because of its experience, may have gone too far in conducting its due diligence and may have become too involved in Horne's operations.

b. Dillard's is a large company with extensive experience in takeovers. Horne's is a local company with no experience in takeovers. Dillard's was able to take over the books as part of its due diligence examination, but was also able to assume a management role prior to the actual takeover. Horne's was probably naive in terms of the extent to which Dillard's could take over in performing its due diligence. Horne's was anxious to have the takeover and may have been willing to do more than it was required to do with respect to the books, records and management control.

c. Horne's did have to surrender access to its books and records, but did not have to surrender management control of purchasing and other functions. The due diligence portion of a takeover is a means by which the offeror (Dillard's) can examine the books and records to verify the financial information furnished by the takeover target (Horne's).

d. Dillard's had a duty of trust imposed by its experience and the tentative nature of the takeover. It was not proper to take over the functioning of Horne's nor interfere with its management structure until the deal was completed. Due diligence does not authorize assumption of responsibility for management of the firm. While Horne's could have objected to Dillard's conduct at any time, it apparently was not experienced enough to know that such conduct was unusual prior to closure.

e. Many business people argue that they hire experts: lawyers, accountants, to do just that – find the technicalities to minimize cost and maximize returns. From an ethical perspective, the long-term views should be: how long do I want this relationship to last? What will my reputation in the industry be?