On October 10, 2014, Vice Chancellor Laster of the Delaware Court of Chancery (Court) issued an opinion assessing damages in In re: Rural/Metro Corporation Shareholders Litigation. Having previously found the primary financial advisor liable for aiding and abetting the board of directors (Board) of Rural/Metro Corporation in breaching its fiduciary duty of care (see the McGuireWoods LLP Legal Update from March 21, 2014), the Court has now determined that the primary financial advisor is responsible for approximately $75.8 million in damages — 83 percent of the total amount the Court determined that the class of Rural/Metro stockholders suffered.
Relevant Findings by the Court
The Court held that the directors breached their fiduciary duties both when they initiated the sale process and when they approved the merger. The Court found that the Board’s actions fell outside the range of reasonableness during the sale process because the Court found that the Board had:
- permitted a special committee of the Board to retain a financial advisor and initiate a potential sale process despite the Board’s having granted the committee only the authority to “analyze strategic alternatives” and report those alternatives to the Board;
- neglected to have the primary financial advisor inform it of Rural/Metro’s valuation at various points during the sale process (the Court noted that the Board approved the merger with Warburg Pincus LLC despite receiving valuation materials only three hours prior to the Board meeting); and
- failed to provide proper oversight of the primary financial advisor (the Court found that the Board did not know about the primary financial advisor’s (1) desire to provide financing for the potential purchase of EMS, the lone national competitor of Rural/Metro, (2) last-minute manipulation of its valuation metrics, or (3) attempts to provide stapled financing to Warburg in the purchase of Rural/Metro).
The Court further found that the Board had committed a disclosure violation by including materially misleading information in its proxy statement by stating that the primary financial advisor:
- used “Wall Street research analyst consensus projections” in its precedent transaction analysis (which would have included adjustments for one-time expenses), when in fact the primary financial advisor used Rural/Metro’s reported results and did not adjust for one-time expenses; and
- was given the right to offer stapled financing because it could offer it on terms that “might not otherwise be available” (emphasis added), when in fact the Board did not make such a conclusion, andthat in any event such statement was false because the financing markets were open at the time of the sale.
The Court determined that fault for these breaches and violations did not lie solely with the Board, however, because the Court found that the primary financial advisor had “unclean hands,” in part because it had pushed for the sale of Rural/Metro without disclosing its self-interested attempts to get on the buy-side financing trees of the potential acquirer of EMS and it had undervalued the offer of Warburg Pincus to make it look more attractive to the Board.
Damages: Valuation, Contribution and Exculpation
The Court used a “quasi-appraisal” remedy to determine that the fair value of Rural/Metro was $4.17 per share greater than the sale price at the time of the merger, resulting in approximately $91.3 million in damages to the class of stockholders. A troubling aspect of the Court’s valuation of Rural/Metro is that Rural/Metro was fully shopped, received six offers and the winning bidder upping its offer by $0.25 to $17.25 per share (a 37 percent premium). In addition, the Court did not find the deal protections were preclusive, no topping bid was made and Rural/Metro filed for bankruptcy protection within two years of the transaction.
With respect to apportioning damages, the Court contended with the issues of contribution, settlement credit and exculpation. The Court determined that although contribution was available to the primary financial advisor despite the Court’s finding that the primary financial advisor committed an intentional tort, the doctrine of “unclean hands” prohibited the primary financial advisor from seeking settlement credit for the moneys previously given to the plaintiffs by the secondary financial advisor and the named director defendants (who had settled with the plaintiffs for $5 million and $6.6 million, respectively).
The primary financial advisor did not allege that the Board breached its fiduciary duties or that the secondary financial advisor aided and abetted any such breach of fiduciary duties by the Board; however, the Court found that two directors were joint tortfeasors and thus that they were not entitled to exculpation under Section 102(b)(7) of the Delaware General Corporation Law. The Court found that the other named director defendant and the other Board members were not joint tortfeasors and thus were entitled to exculpation. The result of this finding is that rather than merely shield directors who breached their fiduciary duty of care from liability, Section 102(b)(7) also shifts liability to those who either breached their fiduciary duties or are found to have aided and abetted such breaches, and in either case are not entitled to exculpation.
The Court apportioned liability of damages as follows: 50 percent of the damages were based on disclosure violations (and the primary financial advisor was solely at fault for such violations based upon its “unclean hands”); 25 percent of the damages were based on Board approval of the merger without its full knowledge of the facts (and the primary financial advisor was solely at fault for this breach again, based upon its “unclean hands”); and 25 percent of the damages were based upon the improper initiation of the sale process (and the Court found that the primary financial advisor was 8 percent at fault, one director was 10 percent at fault and another director was 7 percent at fault). Therefore, the Court held the primary financial advisor liable for 83 percent of the total damages.
In dollar terms, the Court found the primary financial advisor liable for approximately $45 million in damages because it provided “false” information to the Board in its precedent transaction analysis and related disclosure, and by positing that a potential buyer might not be able to get financing on similar terms. A more charitable interpretation would be that the primary financial advisor made an honest mistake in its precedent transaction analysis and related disclosure, and that the primary financial advisor was correct in asserting that the terms it was offering in its stapled financing package might not be available in the market at a later date. The Court found the primary financial advisor liable for approximately $23 million in damages because it failed to disclose to the Board its ongoing attempts to provide stapled financing to Warburg Pincus (note that the Court made this finding despite the fact that the primary financial advisor’s engagement letter with Rural/Metro clearly disclosed that the primary financial advisor had the right to seek to provide stapled financing, because the Court found that that was an ineffective waiver), it failed to provide valuation materials to the Board at various points of the process (note that the record is devoid of any indication that the Board ever requested such materials from the primary financial advisor), and it failed to disclose its last-minute manipulation of its valuation metrics that made the sale price fall within the upper end of the range, rather than the lower end (note that, in any event, under both valuation scenarios the sale price fell within the range of fairness determined by the primary financial advisor). And the Court found the primary financial advisor liable for approximately $8 million in damages because it improperly initiated the sale process (note that the Committee engaged the primary financial advisor to initiate a sale process, and the record is devoid of any indication that the primary financial advisor was aware that the Committee did not have the authority to initiate such a sale).
Our earlier article on the Court’s March liability opinion included 11 important takeaways, and it’s worth reiterating five of those takeaways here: (1) take extra care before agreeing to become a joint advisor; (2) if your client is a special committee, request confirmation that the committee has the proper authority and broad mandate; (3) offer to make valuation materials available upon request at various points in the process; (4) ensure complete and careful labeling in any and all presentations; and (5) thoroughly vet and disclose all conflicts. After this more recent decision, a few additional takeaways are in order:
- Preserve your ability to seek contribution in the event other parties settle and create a sufficient record to support such a claim;
- Consider New York law and/or jurisdiction instead of Delaware in your engagement letters (we don’t offer this lightly — we have the utmost respect for Delaware law and its judiciary, and one of the authors is a native Delawarean);
- Be less willing in engagement letters to give clients the right to assume your defense in any subsequent litigation and be more willing to at least the preserve the argument that your clients may not be entitled to exculpation in the event they are found liable; and
- Continue hoping that the primary financial advisor in this case will appeal this decision, as well as the liability decision, and that the Supreme Court of Delaware will rule that Vice Chancellor Laster’s gatekeeper discussion is not Delaware law, thereby returning the power to oversee a sale process to the Board (where such power and responsibility have traditionally rested), and that his analysis of exculpation and contribution is flawed.