SoftBank’s $9.5 billion takeover of WeWork last month capped off a remarkable downfall for the coworking startup. Once America’s highest-valued private unicorn, the company has become a cautionary, contemporary tale of corporate hubris. But amid the postmortems on co-founder and former CEO Adam Neumann’s excesses and the reckless patronage of his Japanese private equity backer, one group had remained conspicuously quiet and unaccounted for.
SoftBank’s buyout saw the Masayoshi Son-led firm double down on its big WeWork bet in an attempt to save face; Neumann, meanwhile, emerged from a wreckage handsomely compensated with a payout reportedly worth $1.7 billion. But what about WeWork’s minority stakeholders—the employees who have seen the value of their stock options decimated? Not to mention the venture capital investors who poured money into the company at sky-high valuations, only to lose millions in the subsequent writedown.
It appears some of those spurned parties are finally making themselves known. On November 4, former WeWork employee Natalie Sojka filed a lawsuit in San Francisco County Superior Court against Neumann, SoftBank, and members of WeWork’s board of directors, accusing them of “using their control of The We Company to benefit themselves to the detriment of the company’s minority shareholders.”
At the crux of the lawsuit, which is seeking class action status, is the allegation that Neumann and the WeWork board breached their fiduciary duty to the company’s minority shareholders by arranging and approving a “self-interested” transaction.
Neumann, according to the complaint, “abused his control of the company to usurp $1.7 billion in payments to himself,” while SoftBank is “increasing its stake by buying up shares at depressed values which were created by [the] defendents’ own wrongdoing.” Meanwhile, minority shareholders like Sojka, who received WeWork stock as an employee of the company, have seen the value of their stakes “eviscerated due to Neumann’s wrongdoing.”
A WeWork spokesperson tells Fortune that the company “believes this lawsuit is meritless.” Representatives for SoftBank declined to comment for this story, while representatives for Neumann did not return requests for comment.
In accepting SoftBank’s buyout offer last month—consisting of roughly $5 billion in debt, a $3 billion buyout of existing shareholders, and the acceleration of $1.5 billion in equity funding that was previously committed—WeWork’s board of directors turned down a competing $5 billion high-yield debt financing package arranged by JPMorgan Chase.
To ensure that WeWork’s deliberations of the competing offers were fair and not influenced by conflicting interests, the board established a special committee—reportedly consisting of two board members, Bruce Dunlevie of Benchmark Capital and former Coach CEO Lewis Frankfort—to consider the proposals. Neumann and SoftBank were supposedly excluded from the process. (Dunlevie and Frankfort did not return requests for comment. A spokesperson for Wilson Sonsini Goodrich & Rosati, the special committee’s legal counsel, declined to comment.)
Yet it appears that separating the former CEO and the company’s largest financial backer from the process was easier said than done. For one, Neumann allegedly maintained outsize control over the company with what Sojka’s lawsuit claims was 10-to-1 voting power (though some reports have suggested that figure dropped to a 3-to-1 ratio after Neumann stepped down as WeWork’s CEO in September). That influence would mean that Neumann remained a central figure in the board’s deliberations of the competing offers, a claim that the lawsuit says is backed by the handsome compensation package Neumann was able to negotiate with SoftBank.
In exchange for ceding his voting power and becoming a mere “observer” on the WeWork board, SoftBank provided Neumann with a $500 million loan—allowing him to pay off a separate line of credit from JPMorgan Chase and other lenders—and a $185 million “consulting fee,” according to reports cited by the lawsuit. As part of SoftBank’s $3 billion tender offer to WeWork shareholders, Neumann is also able to sell up to $970 million worth of equity in the company, provided he uses the proceeds to pay back the SoftBank loan.
Sojka’s attorney, Frank A. Bottini, tells Fortune that the WeWork board “absolutely needed” Neumann’s consent in order to ratify the SoftBank financing deal. “He absolutely controlled all aspects of the company; he could throw the entire board off, and his votes were crucial to getting approval for the financing,” Bottini says. “They had to go through him—they needed his approval.”
SoftBank, meanwhile, appears to have been exerting its own influence over the board’s process. As Reuters reported last month—and as confirmed to Fortune by a source with knowledge of the negotiations—SoftBank pressured WeWork’s board by claiming that it would not provide the company with its previously pledged, $1.5 billion funding commitment should the board opt for the JPMorgan debt deal instead. While JPMorgan bankers questioned the legality of such a maneuver given the terms of SoftBank’s commitment, the WeWork board’s fear of losing out on that sorely needed liquidity was perceived as tilting the balance further in SoftBank’s favor. (SoftBank declined to comment, and the firm’s legal counsel did not return a request for comment.)
In accepting SoftBank’s financing, which pushed the firm’s ownership stake in WeWork to roughly 80%, WeWork’s valuation fell precipitously, from that now-notorious $47 billion figure to less than $8 billion. So, too, did the value of the mid-to late-stage investments made in the company by various venture capital firms and institutional investors—as well as WeWork employees who were awarded stock options by the company.
‘The burden of proof is on the company’
Sojka’s lawsuit claims that SoftBank’s buyout is subject to the “entire fairness standard,” a legal provision designed to prevent controlling shareholders from engaging in “self-interested transactions” involving “substantial personal benefits that are not shared by the company’s minority shareholders,” per the complaint.
In defending themselves against entire fairness claims, companies and their controlling shareholders have to prove that neither the process behind the transaction, nor the price procured, were unfairly influenced by such personal considerations—standards known as “fair dealing” and “fair price.”
What’s more: in entire fairness cases, the onus falls on the defendants, rather than the plaintiffs, to justify the legitimacy of the transaction in question.
“The burden of proof is on the company to show that what they did was fair,” according to Shant Chalian, a partner at Hartford, Conn.-based law firm Robinson & Cole.
Chalian notes that one possible defense against the entire fairness standard could be that the company in question found itself in a “distressed situation”—such as an “impending bankruptcy”—that meant the deal it ended up taking was the best possible outcome.
That could be one potential avenue for WeWork to pursue. The company was reportedly on the verge of running out of money and found itself having to choose between the SoftBank deal, which significantly wrote down the company’s value, and the JPMorgan offer, which would have further levered it with billions in junk-grade debt.
But Sojka’s attorney, Frank Bottini, believes the lawsuit is “on very strong legal footing” as far as the entire fairness standard is concerned. “When you have a controlling shareholder—an insider who entirely controls and dominates the company, and who received improper personal benefits—the entire fairness standard applies to those types of transactions,” he says.
Bottini adds that his law firm has been “retained by other [WeWork] shareholders” to join the proposed class action, which he says would represent all of company’s minority shareholders. In his conversations with both former and current WeWork employees, they have described recent practices by the struggling company—which is reportedly set to lay off thousands of workers—that Bottini deemed “unfair” and legally questionable.
Those include departing employees allegedly having to exercise their existing stock options at prices “way above the tender price” of $19.19 per share that SoftBank is paying in its $3 billion offer to shareholders. Bottini says employees have found that they have to pay “$30 [per share] or more” per share in order to exercise those options—a price that would leave those shares effectively underwater immediately—or risk forfeiting them altogether.
“We think it’s unfair that because of Neumann’s wrongdoing, if you leave without exercising your options, you’re going to lose them,” he says. “[WeWork] should allow [employees] to keep the options without having to exercise them, given what’s gone on lately.”
He also claims that WeWork has moved to withhold severance pay from departing employees who refuse to sign agreements barring them from taking, or joining, legal actions against the company.
“[WeWork’s] wrongdoing has resulted in thousands of people getting laid off—and now they know that because of all that wrongdoing they’re going to get sued, and they’re trying to prevent people from being able to participate,” Bottini says. “We may file a motion to enjoin that; we think that’s highly illegal.”
A spokesperson for WeWork declined to comment on Bottini’s allegations.
‘This shows that governance matters’
Beyond the decision-making process behind WeWork’s acceptance of the SoftBank buyout, the Sojka lawsuit invokes larger questions about the circumstances that brought the company to this point.
Between the time that WeWork released its S-1 prospectus in mid-August and its decision to accept SoftBank’s buyout offer in late October, the fact is that very little changed about the nature and composition of the company’s business. What did change was what the public—and indeed, many of WeWork’s own investors—knew about the business, and the way Neumann was running it up to that point.
That included revelations of “self-dealing and breaches of fiduciary duty” by the co-founder, according to Sojka’s lawsuit—such as WeWork’s decision to lease office space at buildings that Neumann himself owned, and Neumann’s move to trademark the “We Company” name and license it back to his own firm. Coupled with the company’s other personal and financial entanglements with Neumann—as well as heightened concerns over the viability of its cash-intensive, growth-heavy business model—these revelations had the effect of diminishing the market’s confidence in WeWork, destroying billions of dollars of value in the process.
The Sojka lawsuit claims that WeWork’s minority investors were unaware of the extent of such activities within the company, having been granted neither financial materials nor disclosures prior to the release of its S-1. As such, Chalian says that investors could, in theory, invoke Rule 10b-5 of the Securities Exchange Act of 1934—which prohibits companies from misleading investors by either misrepresenting or omitting material facts about the security in question.
Like the 1934 Act at large, the rule is most often deployed in securities fraud cases involving publicly traded companies. But Chalian notes that, legally, it also applies to private securities, as well. “A pre-IPO investor could claim that they didn’t receive all the materials they could have received to make a good investment decision,” he says.
A spokesperson for the U.S. Securities and Exchange Commission declined to comment on WeWork and the agency’s stance on pursuing securities fraud cases against private companies. On Friday, Bloomberg reported that the SEC is indeed examining WeWork’s disclosures to investors, and whether the company violated financial regulations.
And on Monday, it emerged that the New York State Attorney General’s office has launched an investigation into WeWork that is reportedly examining whether Neumann engaged in self-dealing, according to Reuters. A WeWork spokesperson acknowledged the inquiry and told Reuters that the company is “cooperating in the matter.”
“What went wrong here was the market belatedly learning that [WeWork’s] governance was terrible,” according to Mark Lebovitch, a partner at law firm Bernstein Litowitz Berger & Grosssman. “People lost faith not because the business model was flawed, but because the people running the business were flawed.”
Lebovitch thinks that the WeWork debacle “shows that governance matters” in an era when myriad startups have parlayed a frothy market into runaway, multibillion-dollar private valuations.
That sentiment was echoed by one of the company’s own investors. Matt Novak, managing partner of London-based investment firm All Blue Capital, tells Fortune that the saga of WeWork “brings to light an enhanced series of governance that is required in the private sector.”
“The concept of information rights is something that is becoming more important in the private equity world,” Novak says. “There is a standard that institutional investors like our group comes to expect. These companies should be deploying best standards and practices from day one.”
While Novak declined to discuss financial details of All Blue’s investment in WeWork, PitchBook data indicates that the investment firm participated in its $1.7 billion Series G funding round, which WeWork closed in August 2017 at a $21.2 billion valuation.
Novak acknowledges that his firm experienced “a significant mark-to-market writedown of our holdings” in WeWork as a result of the SoftBank buyout. Yet despite such losses, he has a surprisingly bullish outlook for WeWork under SoftBank’s leadership from “a medium- to long-term perspective.”
“WeWork dispersed its focus by trying to do a lot of things and be a lot of things to a lot of people,” he says. “I still believe WeWork is a spectacular company with growth potential. I think it will bring value back to its minority shareholders in a rapid fashion.”
It could also bring value back to SoftBank, which has “done very well” in doubling down on its WeWork position at a significantly lower valuation, according to Novak. “Some would argue that they were in too deep; in reality, the turnaround story is quite compelling. From this [valuation] level, I think a lot of money can be made for SoftBank.”
And while he agrees that the JPMorgan financing deal “would have preserved the valuation better for [WeWork’s] investors,” Novak claims the short-term pain of the company’s crash could ultimately be in its best interest as far as developing a long-term, sustainable business model.
“If taking a writedown now means that they can steady the shop, rebuild the business, and exit at a healthier valuation, then that’s okay—I’d rather have a real valuation that reflects an accurate underlying value of the business,” he notes.
It’s unclear whether some of WeWork’s other minority investors share Novak’s optimism. The likes of Chinese private equity backer Hony Capital, as well as U.S.-based investment firms like Benchmark Capital, Catalyst Investors, and Glade Brook Capital Partners, all either declined to comment or did not return requests to speak for this story.
For his part, Novak says All Blue Capital will not be pursuing any legal action against WeWork.
“It’s America, and America is known to be litigious. Every investor makes their decisions on their own,” he says. “We will not be litigious, and will continue to support the company.”
This story has been updated to include the report of the New York State Attorney General’s investigation into WeWork.
More must-read stories from Fortune:
—The stock market has hit 19 new highs in 2019 alone. Why?
—The 2020 tax brackets are out. What is your rate?
—How “VSCO Girls” are killing makeup sales
—What is “quantitative easing”—and why is everyone so worked up about it?
—What powered such a great decade for stocks? This formula explains it all
Don’t miss the daily Term Sheet, Fortune’s newsletter on deals and dealmakers.
