Global Courant
In September 2022, Jana Partners made an investment in Freshpet after the company’s stock fell about 74%. The company liked the company and its operations very much, but felt it was poorly managed and needed a reconstituted board to create more focus and management. responsibility. Because Freshpet had a staggered board – one in which some of the directors are up for election each year – Jana could only nominate four directors to the board last month to replace the four whose terms expire in 2023.
Jana made many good operational and capital allocation points in her advocacy for change that alone warranted the addition of one or two Jana representatives to the board. However, it is a big step from two new directors to four new directors. Replacing nearly 40% of the board is not something shareholders should do lightly, but it is necessary in situations where the poor performance is not just the problem, but a symptom of poor governance, and that couldn’t be more evident with Freshpet.
Forget about corporate governance violations like a staggered sign, which itself is a red flag. Freshpet had unique and somewhat unprecedented examples of at least board not holding management accountable, and at worst serious conflict.
In 2020, Scott Morris, president and chief operating officer of Freshpet co-founder of Hive Brands, a grocery and retail delivery service that focuses on the sustainability and environmental impact of the goods offered. Those commodities include premium pet food and treats that compete directly with Freshpet. I’m almost hesitant to make the point “direct competition” because it implies that this would be OK if Hive wasn’t Freshpet’s competitor. Obviously it wouldn’t be okay. Morris’ employment contract states, “During the term of employment, the Executive shall devote the full time and effort of the Executive to the Company’s business.” While it also states that “The Executive may participate in non-competitive business or charitable activities for a reasonable period of time each month so long as such activities do not interfere with the Executive’s responsibilities under this Employment Agreement”, I do not think that “activities” include participation in the launch of Hive, capital raises and management. In addition, by Freshpet’s own definition, Hive is a competitor to the company. The same employment contract defines a competitor in part as “(i) engaged in the manufacture, sale, or distribution of either (A) fresh, refrigerated, frozen, or raw pet food; or (B) dry pet food with more than 30% meat content.” But you don’t have to be a renowned law scholar Laurence Tribe to figure this out: it’s highly inappropriate for a senior executive of a publicly traded company to work for another company at the same time.
In addition, many standard employment contracts contain an invention assignment provision in which the employee agrees to transfer to the company property rights or other rights acquired through his work or services. Morris’ employment contract does not contain such a provision. But this seems not so much a mistake as an omission through negotiation. Section 7 of his employment contract governs non-competition and non-solicitation. Section 8 governs confidentiality and section 9 is where you normally see rights to inventions. However, there is no such Article 9. Instead, that article is a standard publicity stipulation. Moreover, in the original draft of the agreement, it did not appear to be so. Section 5(e) of Morris’s employment contract reads: “The obligations of confidentiality and rights to inventions set forth in Sections 8 and 9 of this Agreement shall survive termination of this Agreement pursuant to this Section.” Looks like someone missed removing a cross reference in the document.
Ultimately, Morris acquired a valuable interest by founding Hive at a time when he was serving as president and chief operating officer of Freshpet and being paid by Freshpet to “be involved in all aspects of the company’s development and day-to-day operations”. Between 2019 and 2021, Morris received $13.4 million in compensation from Freshpet while founding Hive. If the right to inventions clause remained in the agreement, the company would have a very credible claim to its interest in Hive.
To make matters worse, current Vice Chairman of Freshpet and former CFO Richard Kassar was simultaneously Vice Chairman of Freshpet and CFO of Hive until August 2022. He later took on the role of Freshpet’s interim Chief Financial Officer in September 2022, a position he held until December of that year. In addition, directors J. David Basto and Olu Beck have served as a director and formal advisor to Hive, respectively, according to Jana. Basto resigned from Freshpet’s boardeffective May 31, according to a filing with the Securities and Exchange Commission.
This situation appears to violate the company’s overall ethics policy, which states: “Team Members must not engage in outside work or conflicting outside activities that have or could have a material effect on the team member’s duties to the Company imply sponsorship or endorsement by the Company; negatively affect the Company’s reputation; or otherwise compete with the Company.”
Jana tried to address this by talking to Freshpet about improving corporate governance and adding new directors identified by Jana to the board. The company could have walked away with Jana’s offer to (i) replace any two of Freshpet’s directors with Jana’s directors, (ii) address ongoing conflict and governance issues (including the overlap of certain officers and directors with competitor Hive); and (iii) allow Jana to provide input and feedback on a potential future board chairperson. Jana even agreed to postpone (ii) above until after Jana’s appointed directors have joined the board.
The Freshpet board should have seen this as a godsend. Instead, the board went in the opposite direction, seemingly trying to create obstacles to fair elections, including expediting the annual meeting by moving it to July from that fall. This could be interpreted as an attempt to partially disenfranchise Jana and entrench incumbent administrators. Jana had to spend time and money filing a lawsuit in the Delaware Chancery Court, a move it made on June 1. Less than a week later, Freshpet returned the governance changes to state as they were before Jana’s involvement, including delaying the annual meeting to a date in October.
These types of tactics from Freshpet accomplish three things: (i) it causes both Jana and the company to spend unnecessary time and money; (ii) it creates self-inflicted distractions for management – the kind companies usually complain about when an activist starts a proxy fight – and (iii) it damages the board’s credibility with other shareholders and Institutional Shareholder Services. Shakespeare referred to unleashing “the dogs of war” as creating a force that – once unleashed – is very difficult to control. By making those ill-advised changes to entrenchment management, Freshpet has done just that, even though it has tried to undo it. The damage has already been done.
If this wasn’t a staggered board, I think Jana would have a good shot at getting a majority of the board seats given the company’s behavior and performance. Only because of Freshpet’s entrenchment device, Jana is limited to four nominees. If the company can settle for less than that, it should count its lucky stars, take the best settlement it can get, and start focusing on running Freshpet – and only Freshpet.
Ken Squire is the founder and chairman of 13D Monitor, an institutional research service on shareholder activism, and is the founder and portfolio manager of the 13D Activist Fund, an investment fund that invests in a portfolio of 13D activist investments. Freshpet is an interest in the fund. Squire is also the creator of the AESG asset class, an activist investment style aimed at improving portfolio companies’ ESG practices.
