Funko Inc.‘s leaders and private equity backers lost their bid Monday to end litigation over claims they’re abusing the toymaker’s corporate structure to double-dip in profits by blocking cash distributions destined for public investors.
A Delaware judge let the case move forward with allegations that Funko board members deliberately “trapped cash” with the company by exploiting its up-C status—a complex arrangement involving a publicly traded parent and an operating subsidiary that’s partly owned by corporate insiders holding separate equity units.
Vice Chancellor Nathan A. Cook said it’s plausible ex-CEO Brian Mariotti schemed with Acon Investments LLC and Fundamental Capital LLC—through an investment agreement and veto rights they held—to manipulate the ratio between the direct equity units and the public shares by adopting a “no cash dividend” policy.
The allegations make it “reasonably conceivable that the individual defendants used their positions of trust to divert value to the alleged control group—and indeed themselves—away from the public stockholders,” Cook said in a bench ruling for Delaware’s Chancery Court, the leading US forum for high-stakes business disputes.
The judge placed “considerable emphasis” on the “limited record” and early stage of the case, saying the Funko insiders could still prevail at the end of the day. “This seems like a somewhat novel action derived from a somewhat unique and arguably emerging corporate structure,” he said during a nearly 90-minute hearing.
Up-C Cases
The proposed class action, filed in early 2022, is part of a wave of lawsuits over the idiosyncrasies of up-Cs, or umbrella partnership corporations, which have multiple class of stock: ordinary common shares, equity units in an operating subsidiary, and preferred shares with voting rights pegged to the economic value of those units.
The other up-C disputes generally challenge the terms of nine-figure payouts given to founders, major investors, and other insiders in connection with reorganizations aimed at streamlining a corporation’s capital structure on terms that offered tax benefits to the company itself.
Firms facing those cases include affiliates of Apollo Global Management Inc., Carlyle Group Inc., GoDaddy Inc., KKR & Co., and others.
The lawsuit against Funko differs slightly. It involves a continuing up-C, rather than a corporate transformation, and allegations that insiders took unfair advantage of the process letting them trade in their pre-IPO equity in the toymaking subsidiary—and their voting-only class B shares—for ordinary stock.
Cook said Monday that it’s conceivable “what the defendants refer to as a ‘cash management’ decision”—the policy against giving investors a dividend from the cash distributed upstream to the publicly held parent company—worked “to increase the amount the alleged control group and pre-IPO owners are able to capture.”
The judge also shot down the argument that company leaders had no duty to maintain the equivalence. The obligation is backed up by internal documents, regulatory filings, common sense, academic articles, and the fact that they actually did return about $74 million to public investors after the litigation began, he said.
That transaction didn’t necessarily render the case moot, however, given the complexity of the dynamics, according to Cook. “I, for one, am not an investment banker,” he said. “But even if I were, I am not sure that the record defendants have presented at this stage would be sufficient.”
For the same reason, it wouldn’t make sense to award interim legal fees to counsel for the Funko investor leading the case with so many unanswered questions about the lawsuit’s value, the judge said. “This is essentially just application of the goose-gander rule,” he said.
Friedlander & Gorris PA, Robbins Geller Rudman & Dowd LLP, Shobe & Shobe LLP, and Morris Kandinov LLP are counsel for the shareholder, Leo Shumacher.
Funko and its leadership are represented by Richards, Layton & Finger PA and Latham & Watkins LLP. Acon is represented by Connolly Gallagher LLP and Aegis Law Group LLP. Fundamental is represented by Reed Smith LLP.
The case is Shumacher v. Mariotti, Del. Ch., No. 2022-0051, motion to dismiss denied 12/18/23.