A recent post-trial decision in In Re: Rural Metro Corporation held that a financial advisor was liable for aiding and abetting breaches of the duty of care by the board of directors in connection with the sale of the company, despite the fact that the company’s charter contained exculpatory provisions authorized by Section 102(b)(7) of the Delaware General Corporation Law. The decision is problematic for financial advisors as it potentially serves as an invitation to plaintiffs’ attorneys to try to avoid dismissal of duty-of-care claims through aiding-and-abetting claims against a company’s financial advisor. It also serves a reminder to Special Committees of the importance of process in change-of-control transactions.
In a post-trial decision in In Re: Rural Metro Corporation, C.A. No. 6350-VCL (Mar. 7, 2014) (Rural Metro), Vice Chancellor Travis Laster held that a financial advisor was liable for aiding and abetting breaches of the duty of care by the board of directors of Rural/Metro Corporation (the Company) in connection with the sale of the company, where the company’s charter contained exculpatory provisions authorized by Section 102(b)(7) of the Delaware General Corporation Law; the directors and another financial advisor settled the claims against them before trial. The decision reinforces the lessons from Vice Chancellor Laster’s Del Monte decision1 that boards and financial advisors need to pay close attention to investment bank conflicts in the sale process. It also puts a focus on the role of financial advisors as “gatekeepers” that have a role in preventing wrongdoing. The decision also serves more generally as a reminder of the importance of a good process in sale-of-control transactions.
1 In re Del Monte Foods Co. S’holders Litig., 24 A.3d (Del. Ch. 2011)
The facts proved at trial raised a number of concerns for the court. The company’s board consisted of seven members, six of whom were “facially independent, disinterested, outside directors.” A Special Committee, consisting of three directors took the lead in considering three M&A alternatives, including the sale process at issue, between August 2010 and March 2011. The court noted that two of the three Special Committee members had personal circumstances that inclined them towards a near-term sale. One member, Christopher Shackelton, was the managing director of a hedge fund that would benefit from a quick sale.2 A second member wanted a sale in order to reduce the number of boards he served on while also receiving over
$200,000 from accelerated vesting of his equity awards.
The Special Committee was originally formed in August 2010, when RBC Capital Markets LLC (RBC) pitched the board the idea of acquiring American Medical Response (AMR), which was a subsidiary of Emergency Medical Services Corporation (EMS).3 Neither that transaction, nor a subsequent potential sale of the company to two private equity funds, moved forward. The board reactivated the Special Committee in December 2010 when rumors started circulating that EMS was up for sale. RBC suggested to Shackelton (chair of the Special Committee) and Michael DiMino (CEO of the company) that some of the private equity funds looking at EMS believed AMR should be separated from EMS and saw the company as a potential partner in an acquisition. The board authorized the Special Committee to retain advisors to evaluate strategic alternatives and generate a recommendation to the board, but did not authorize it to pursue a sale.
The Special Committee interviewed three investment banks, including RBC, on December 23, 2010. Unlike the other firms, RBC’s presentation focused on a sale transaction. Although the board had not decided to pursue a sale of the company, the Special Committee retained RBC for a sell-side process and also hired Moelis & Company LLC (Moelis) to provide a second fairness opinion in light of RBC’s proposal to offer staple financing. RBC did not disclose to the Special Committee its intention to use its role as a sell-side advisor to the company to secure a financing role for a private equity buyer of EMS. On December 26, 2010, Shackelton advised the board that RBC and Moelis had been retained and were reaching out to private equity firms to gauge their interest in the company, either as an acquisition target or as a partner in the acquisition of AMR.
RBC designed a process for the company that favored private equity funds that were involved in the EMS process. The court noted that RBC hoped to generate up to $60.1 million in fees, including an M&A advisory fee of $5.1 million for the sale of the company, staple financing fees of $14–$20 million, and financing fees of $14–$35 million for the EMS deal.
A sale would reduce the fund’s excessive concentration in the company, and realize attractive returns that would assist in raising a new fund.
Kaye Scholer represented EMS in the sale process that forms much of the background for the Rural/Metro transaction. However, references to EMS in this memorandum are based solely on Vice-Chancellor Laster’s opinion.
Twenty-eight private equity funds were contacted during late December and January. Twenty- one signed confidentiality agreements, but 15 of these declined to move forward to the final round. Financial buyers engaged in the EMS process were reluctant to participate in the company’s process given constraints under EMS confidentiality agreements and concerns EMS would have about leakage of EMS confidential information to the company. The only final- round bidder that was also involved in the EMS process was Clayton, Dubilier & Rice (CD&R).
The Special Committee met on February 6, 2011 to review the bidders’ preliminary indications of interest, and again on February 22, 2011. At the latter meeting, the Special Committee was advised that CD&R had won the EMS bidding. The Special Committee started to express
concerns about keeping CD&R in the company’s process, given timing issues associated with the EMS acquisition and potential competitive concerns. The Special Committee set a bid deadline of March 21. As the date approached, CD&R requested an extension until April.
On March 15, 2011, the board met to receive its first update on the process at a meeting in more than three months. Resolutions adopted at the meeting granted the Special Committee, for the first time, authorization to pursue the sales process that it had been pursuing for more than two months. No valuation analysis was presented. The board also decided not to extend the bid deadline as requested by CD&R, and accepted RBC’s advice not to involve strategic buyers in the sale process.
Warburg Pincus LLC (Warburg) was the only bidder to submit a final bid, which was for $17.00 per share. The trial record showed that Warburg knew that it was management’s and RBC’s preferred bidder. CD&R also submitted an indication of interest at $17.00 per share, but stated that it could not fully commit to the deal until after closing of the EMS deal, which was expected in late April. CD&R noted its belief that synergies with EMS’ AMR division would permit it to make an offer resulting in the highest available price per share for the company.
The Special Committee met on March 23, with other directors also invited to attend. The meeting materials included a one-page transaction summary that compared metrics implied by a $17.00 per share offer to the company’s $12.38 closing price the previous day, but did not include a valuation analysis of the company. At the meeting, the Special Committee decided not to engage further with CD&R, given timing and deal certainty issues. The Special Committee directed RBC and Moelis to engage in final negotiations with Warburg over price. On March 25, Warburg submitted a best and final offer of $17.25 per share.
The Warburg bid did not include RBC in its financing package. RBC engaged in a major push during the last few days prior to signing to get a role as a financing source, without success. RBC also worked internally to lower its analyses in its draft fairness presentation to make the Warburg deal appear more attractive. Among the changes made, RBC changed the precedent transaction analysis by increasing the reliance on a 2004 precedent transaction involving AMR, and by not appropriately adjusting “consensus” adjusted EBITDA for 2010, which resulted in
the precedent transaction range changing from between $13.31 and $19.15, to a range of between $8.19 and $16.71. RBC’s board book falsely represented that Wall Street research analysts do not make such adjustments.
The board approved the deal at a meeting on March 27, 2011. The directors received RBC’s written valuation analyses for the deal for the first time approximately 80 minutes before the meeting started.
The Court’s Decision
The plaintiffs brought an action against the members of the board based on alleged breach of fiduciary duty during the sales process and material omissions and misstatements in the company’s proxy statement. The plaintiffs contended that Moelis and RBC aided and abetted in those claims. The directors and Moelis settled before trial. In the post-trial decision relating to the aiding and abetting claims against RBC, the court first set out the four elements of the claims as: (i) the existence of a fiduciary relationship, (ii) breach of the fiduciary’s duty, (iii) the defendant’s knowing participation in the breach, and (iv) damages proximately caused by the breach. The first element was easily satisfied, given that the individual defendants were directors of the company.
The court then analyzed the breach under Revlon’s4 enhanced-scrutiny standard of review. To satisfy the test, the reasonableness of the Board’s decisionmaking process must be established, including the information relied on, and the reasonableness of the directors’ action in light of the circumstances existing.5 According to the court, directors must maintain “an active and direct role” in the sale process. They must become “reasonably informed about the alternatives available to the company,” which includes ascertaining “how the merger consideration being offered . . . compares to the company’s value as a going concern.” Another part of active and direct oversight is “acting reasonably to learn about actual and potential conflicts faced by directors, management, and their advisors,” which includes acting “reasonably to identify and consider the implications of the investment banker’s compensation structure, relationships, and potential conflicts.”
The court rejected an argument by RBC that exculpatory provisions in the company’s charter limiting the liability of directors for a breach of their duty of care apply equally to a party charged with aiding and abetting such a breach of duty. The court held that exculpatory provisions authorized by Section 102(b)(7) of Delaware General Corporation Law provided an affirmative defense that protected directors from liability from a breach of the duty of care, but did not eliminate the underlying duty of care or the potential for breaches of that duty. Both the language of Section 102(b)(7),which only covers directors, and the policy behind it suggest that it does not protect aiders and abettors. According to the court, while Section 102(b)(7) ensures
4 Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173 (Del. 1994)
The court noted that in a typical breach of fiduciary duty claim, the directors have the burden of proof. However, in an aiding-and- abetting claim, the plaintiffs have the burden of proving conduct falling outside the range of reasonableness.
that directors do not become overly risk averse, it encourages financial advisors to function as gatekeepers, for whom the threat of liability “helps incentivize [them] to provide sound advice, monitor clients, and deter client wrongs.”
The court then considered whether the Board’s actions fell within a range of reasonableness. The court held that the decision to run a sale process in parallel with the EMS process fell outside the range of reasonableness for a few reasons. First, the decision was not made by an authorized decisionmaker. The decision was made by the Special Committee in December 2010, but the board did not authorize the sale process until March 2011. The decision also failed the
enhanced-scrutiny test because RBC did not disclose that running the sale in parallel with the EMS transaction served RBC’s interest in gaining a financing role for the EMS deal.
The court also held that the board’s decision to accept Warburg’s bid of $17.25 per share fell outside the range of reasonableness because the Board “failed to provide active and direct oversight of RBC.” As a result, the board was unaware of RBC’s efforts to solicit a financing role from Warburg, had not received valuation information until shortly before the meeting to approve the deal, and did not know about RBC’s manipulation of the valuation metrics. According to the court, “[r]ather than pushing for the best deal possible for [the Company], RBC did everything it could to get a deal, secure its advisor fee, and further its chances for additional compensation from Warburg.” According to the court, the valuation deck that RBC provided to the board was designed to convince the board to accept Warburg’s $17.25 per share bid. Given that the board had not received any valuation materials until a few minutes before the meeting at which it approved Warburg’s bid, the board did not have the opportunity to examine RBC’s valuation information critically and “did not have a reasonably adequate understanding of the alternatives available to [the Company], including the value of not engaging in a transaction at all.”
The court next considered the third prong of the aiding-and-abetting test. The court held that while the Delaware Supreme Court has not ruled on it, one Supreme Court decision and several Chancery Court decisions indicated that “knowing participation” can be based on a board breach of the duty of care and does not require an intentional breach by the board of its fiduciary duties. The court held that the claim against RBC could be based on a showing that the “third party [i.e., RBC], for improper motives of its own, misleads the directors into breaching their duty of care.” The court quickly found this test satisfied because RBC created the unreasonable process and information gaps that led to the board’s breach of duty through: (i) not disclosing its interest in obtaining a financing role on the EMS deal, (ii) knowing that the board and Special Committee were uninformed about valuation when making critical decisions, and (iii) never disclosing to the board its continuing interest in a buy-side financing role or plans to engage in last-minute lobbying of Warburg.
The court also found the fourth prong of the aiding and abetting test satisfied because the evidence at trial showed that the fair value of the Company’s stock exceeded the $17.25 per share deal price.
The court then considered plaintiffs’ claims based on disclosure violations. The court held that the Proxy Statement contained material misstatements and omissions regarding RBC’s financial presentation and RBC’s conflicts of interest, and that RBC knowingly participated in these disclosure violations.
The court did not specify a damages award, pending submission of further briefs by the parties.
Similar to Del Monte, the decision puts a spotlight on the role of the financial advisor in the deal process, and the board’s role in overseeing the financial advisor and monitoring its potential conflicts. It also emphasizes the need for active and informed direction of the sales process by the board or an authorized board committee. In particular:
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be able to evaluate the deal consideration and the company’s stand-alone valuation properly. The court was heavily critical of the failure of the board to receive any written valuation information until less than two hours before the board meeting to approve the deal. Moreover, the board should also ensure that it understands the methodology and assumptions used for the financial advisor’s analyses. The court was very critical that RBC was permitted to manipulate its analyses in order to make Warburg’s bid look more attractive.
The decision is problematic for financial advisors because it potentially makes them more of a target for future litigation. Duty-of-care claims against directors can be dismissed based on exculpatory language in the target company’s charter. Plaintiffs’ attorneys try to avoid dismissal by also alleging director breaches of the duty of loyalty. This case potentially serves as an
invitation to plaintiffs’ attorneys to also try to avoid dismissal through aiding-and-abetting claims against the company’s financial advisor.6
The decision also provides a reminder as to the importance of process in change-of-control transactions. The court was critical of the way the Special Committee simply engaged in an unauthorized process to sell the company. A Special Committee’s mandate should be carefully delineated in authorizing resolutions, and the Special Committee should not exceed its authority. The court’s view of the transaction may also have been colored by the arguably conflicting motives of two of the Special Committee’s members.