Investment bankers seeking to profit as both adviser to the seller and financier to the buyer in corporate sales processes have faced increased scrutiny by Delaware courts over the last few years. In a highly-publicized 2011 decision, Vice Chancellor Laster criticized investment banker Barclays PLC for acting both as adviser to the seller and financier to the buyer in the Del Monte Foods Co. sale process. The following year, now Chief Justice, then Chancellor Strine, criticized Goldman Sachs’ role in the El Paso Corp. sales process for allegedly steering the sale to its favored buyer Kinder Morgan Inc.
In the latest Delaware decision criticizing bankers guiding corporate sales processes who seek to profit on both sides of a sale, In re Rural Metro Corp. Stockholders Litigation, the Supreme Court affirmed the Court of Chancery’s holding that investment banker RBC Capital Markets LLC (“RBC”) was liable for aiding and abetting the breach of fiduciary duties by the Board of Rural/Metro Corporation’s (“Rural” or the “Company”) in connection with its sale to private equity firm Warburg Pincus LLC (“Warburg”). (No. 140, 2015, 2015 WL 7721882 (Del. Nov. 30, 2015)).
Around the same time that a competitor of Rural, Emergency Medical Services Corporation (“EMS”), was being shopped for a sale, Rural’s Board directed a Special Committee to explore strategic alternatives and interview financial advisors. The Special Committee engaged RBC to act as its primary financial advisor and initiated a sale process. Several months later, Warburg acquired Rural for $438 million.
But, unbeknownst to Rural’s Board, RBC’s priority was to rush a sale and use its engagement with Rural to gain more lucrative buy-side financing work from bidders in the EMS sale while at the same time offering staple financing to the buyer in the Rural sale. These undisclosed conflicts of interests propelled RBC to mislead the Rural Board and undermine the sale process. First, RBC designed a sale process to proceed in parallel with EMS’s sale, which gave RBC an advantage to gain buy-side financing work from EMS bidders, but disadvantaged Rural by limiting the potential field of bidders unable to participate in the EMS and Rural sales simultaneously because of confidentiality restrictions and limited resources. Second, attempting to secure buy-side fees by providing staple financing to Warburg, RBC secretly gave Warburg insight on Rural’s deliberations in the sale process. Finally, RBC corrupted the valuation process by failing to provide any valuation analysis for most of the process and then manipulating its fairness opinion to make Warburg’s offer look more attractive.
A Rural stockholder challenged the transaction in the Delaware Court of Chancery. All defendants except RBC settled before trial. In highly-publicized post-trial decisions, Vice Chancellor Laster held that the transaction significantly undervalued Rural, the Board breached its fiduciary duties in approving the sale and through the proxy disclosures, RBC aided and abetted those breaches, and RBC was liable for almost $76 million. RBC appealed.
RBC is liable for Aiding and Abetting the Rural Board’s Breaches of Fiduciary Duty
The Court first affirmed the trial court’s holding that Rural’s Board breached its fiduciary duties by failing to take reasonable steps to attain the best value reasonably available to Rural stockholders under Revlon. RBC’s self-dealing conduct in the sale process misled Rural’s Board and induced the directors to breach their fiduciary duties by unknowingly approving a sale that significantly undervalued the Company. RBC structured and timed the sales process with the sale of EMS, which “impeded interested bidders from presenting potentially higher value alternatives.” The Court faulted the Board for being unaware of the negative implications of the dual-track structure of the EMS and Rural sales, and for making no effort to identify, address, or mitigate RBC’s conflicts. The Court explained that while directors may rely on experts and consent to conflicts, they “need to be active and reasonably informed when overseeing the sale process, including in identifying and responding to actual or potential conflicts of interest.” The Court emphasized that while directors do not have to perform searching and ongoing due diligence on retained advisors, they “should require [the advisor’s] disclosure of, on an ongoing basis, material information that might impact the board’s process.”
The Court also found that Rural’s Board was not adequately informed as to whether the stand alone value of the Company exceeded the sale price. RBC had failed to conduct or present a meaningful valuation analysis and strategic alternatives to the Board. Further, Rural’s directors were unaware of RBC’s conflicts and their impact, and failed to appropriately satisfy themselves that the sale was the best strategic course of action. In turn, Rural’s stockholders were operating under the same “informational vacuum” created by RBC as the Board. In sum, RBC’s faulty design “prevented the emergence of the type of competitive dynamic among multiple bidders that is necessary for reliable price discovery” and “did not generate for stockholders the best valuable reasonably attainable.”
The Court also affirmed the trial court’s holding that RBC aided and abetted the Board’s breaches of fiduciary duties. The Court found that the Board’s breach of its Revlon duties was a sufficient predicate to impose liability on RBC for aiding and abetting. In doing so, the Court rejected RBC’s argument that Revlon scrutiny exists only to determine whether stockholders should receive pre-closing injunctive relief and cannot be used to establish a breach of fiduciary duty warranting post-closing damages. In addition, the Court was careful to only affirm the “narrow” holding that “[i]f a third party knows that the board is breaching its duty of care and participates in the breach by misleading the board or creating the information vacuum, then the third party can be liable for aiding and abetting.” After finding that RBC “knowingly induced a breach by exploiting its own conflicted interests to Rural’s detriment and by creating an informational vacuum” that, in turn, impaired the Board’s ability to make an informed decision on the value of Rural, the Court had an ample record to conclude that RBC had aided and abetted the Board’s breach of its fiduciary duty of care.
Importantly, RBC’s aiding and abetting liability was not premised on its failure to prevent the Board’s breach of fiduciary duties, but on its own “fraud on the Board.” The Court explained that its holding was a “narrow one that should not be read expansively to suggest that any failure on the part of a financial advisor to prevent directors from breaching their duty of care gives rise to a claim for aiding and abetting a breach of the duty of care.” The Court added that the scienter requirement “makes an aiding and abetting claim among the most difficult to prove.” Notably, the Court expressly declined to adopt the trial court’s description of a financial advisor’s role in M & A transactions as a “gatekeeper.” The Court explained that this “amorphous ‘gatekeeper’ language would inappropriately expand [its] narrow holding here by suggesting that any failure by a financial advisor to prevent directors from breaching their duty of care gives rise to an aiding and abetting claim.”
Through Rural/Metro the Delaware Supreme Court sends a strong message to bankers standing on both sides of the deal process who do not disclose their actual or potential conflicts of interest. At the same time, the Court made clear that bankers are not required to serve as gatekeepers for boards and do not have an obligation to seek out and prevent breaches of directors’ fiduciary duties. Counsel to boards, special committees and investment bankers guiding corporate sales processes must emphasize the requirement for complete and ongoing banker disclosures of conflicts of interest to the seller’s board. Counsel is best advised to recommend memorializing this obligation in the banker’s engagement letter.