In September 2022, Jana Partners invested in Freshpet after the company’s stock fell by about 74%. The firm liked the company and its business, but felt it was mismanaged and needed a restructured board to create more focus and governance. accountability. Because Freshpet has a staggered board — some of which are elected annually — Jana was only able to appoint four directors last month to replace the four whose terms expire in 2023.
Jana has made many good operating and capital allocation points in its case for change that justify adding a Jana representative or two to the board. However, adding two new directors to the four new directors is a big step. Replacing nearly 40% of the Board is not something shareholders should do lightly, but it is necessary in situations where poor performance is not only a problem, but also a sign of poor management, and is no more evident at Freshpet.
Forget corporate governance violations like the stair plate, which itself is a red flag. Freshpet had unique and somewhat unprecedented examples of, at least, failure of the board to hold management accountable and, at worst, serious conflicts.
In 2020, Freshpet President and COO Scott Morris co-founded Hive Brands, a grocery and retail delivery service that focuses on the sustainability and environmental impact of its offerings. These products include high quality pet food and treats in direct competition with Freshpet. I almost hesitate to mention the “direct competition” point because it implies that Hive Freshpet would be fine if it wasn’t a competitor. Obviously, that wouldn’t be good. “During the Term of Employment, the Executive will devote the full time and efforts of the Executive to the Company’s business,” Morris’ employment agreement states. Although it also states that “the Board of Directors may engage in non-competing business or charitable activities for a reasonable period of time each month, provided that such activities do not interfere with the Executive’s obligations under this Employment Agreement,” I believe that “activities” ” Hive- including participation in the launch, capital raising, and management of Hive Freshpet. Moreover, Hive Freshpet is a competitor of the Company by its own definition. The same employment contract competitor is, in part, engaged in “(i) or (A) the manufacture, sale and supply of fresh, chilled, frozen, or raw pet food; or (or) or (B) defined as dry animal feed that is more than 30% meat content.” But you don’t need to be the famous legal scholar Laurence Tribe to figure it out: It is very inappropriate for a senior executive of a public company to work for another firm at the same time.
In addition, many standard employment contracts contain an assignment of inventions clause in which the employee agrees to assign to the company any proprietary or other rights acquired through his work or services. There is no such provision in Morris’ employment contract. However, this does not appear to be a negotiable defect. Clause 7 of his employment contract governs non-competition and non-solicitation. Section 8 governs privacy, and section 9 usually covers intellectual property rights. However, there is no such section 9. Instead, that section is a standard publicity provision. Moreover, it did not appear so in the original draft of the contract. Section 5(e) of the Morris employment agreement states: “The rights to confidentiality and invention obligations set forth in Sections 8 and 9 of this Agreement shall survive termination of this Agreement pursuant to this Section.” Looks like someone neglected to remove the cross-reference in the document.
Ultimately, Morris acquired a valuable interest in founding Hive while serving as Freshpet’s president and chief operating officer and being paid by Freshpet to “participate 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 building Hive. If the rights to the inventions were retained in the clause, the company would have a very strong claim to its interest in Hive.
To make matters worse, Freshpet’s current vice chairman and former CFO, Richard Cassar, has simultaneously served as Freshpet’s vice chairman and Hive’s CFO until August 2022. In addition, according to Jan, directors J. David Basto and Olu Beck served as director and official advisor, respectively, on Hive. Basto resigned from Freshpet’s board effective May 31, according to a filing with the Securities and Exchange Commission.
This situation appears to be contrary to the company’s general ethical policy: “Team members shall not engage in outside work or conflicting outside activities that have or may have a significant impact on the team member’s duties to the Company; means sponsorship. or be sponsored by the Company; Having a negative impact on the reputation of the company; or otherwise compete with the Company.”
Jana tried to resolve this by talking to Freshpet about improving corporate governance and adding new directors identified by Jana to the board. The Company could decline Jana’s proposal to (i) replace two of Freshpet’s chosen directors with Jana directors, and (ii) resolve ongoing conflict and governance issues (including the overlap of certain officers and directors with competitor Hive) ; and (iii) allow Jan to provide information and feedback about any potential future board chairperson. Jana even agreed to defer (ii) above until the directors appointed by Jana joined the board.
The Freshpet board must have seen this as a godsend. Instead, the board went in the opposite direction and apparently attempted to create obstacles to a fair election, including moving the annual meeting from that fall to July. This could be interpreted as an attempt to partially disenfranchise Jana and accommodate incumbent directors. Jana was forced to spend time and money filing a lawsuit in Delaware Court of Chancery, which she did on June 1. In less than a week, Freshpet reverted management changes to what they were before Jana’s involvement, including. postponement of the annual meeting to October.
Such tactics by Freshpet do three things: (i) cause both Jana and the company to waste unnecessary time and money; (ii) it creates self-distractions for management—friendly companies typically complain whenever an activist starts a proxy fight—and (iii) it undermines 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 too difficult to control. By making ill-advised reinforcement management changes, Freshpet did just that, despite attempts to undo it. The damage has already been done.
If it wasn’t for a confused board, I think Jana would have a good chance of getting most of the board seats given the company’s behavior and performance. Only thanks to Freshpet’s reinforcement device, Jana is limited to four candidates. If the company can settle for less than that, it should count its lucky stars, take the best settlement it can get, and focus on running Freshpet and only Freshpet.
Ken Squire is the founder and president of 13D Monitor, an institutional shareholder activism research service, and he is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Freshpet is a holding company of the fund. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving the ESG practices of portfolio companies.