Shareholders challenged the merger of Zale Corporation with Signet Jewelers Ltd.
In a decision dated October 1, 2015, the Delaware Court of Chancery credited allegations that the board of directors of Zale breached its fiduciary duty in failing to uncover a potential conflict of interests by its financial advisor, an investment bank that advised Zale in its merger with Signet. In re Zale Corp. Stockholders Litigation, C.A. No. 9388-VSP. Although the court dismissed the claims against Zale’s board of directors (the “Board”) because of the exculpatory provisions in Zale’s charter, the court allowed claims against Zale’s financial advisor for aiding and abetting the alleged breach of duty to continue. In its decision, the court reminded boards and their advisors that financial advisor conflicts of interests are not to be taken lightly.
Background Zale was acquired by Signet in 2014. However, Zale’s financial advisor (the “Advisor”) on the deal had previously made a presentation to Signet regarding a possible acquisition of Zale, seeking to advise Signet on any such deal, and proposing a specific price range of between $17 and $21 per share for Zale’s stock. The same managing director at the Advisor participated in the presentation to Signet and was part of the team that eventually advised Zale.
Zale’s Board was unaware of this, and accepted the Advisor’s representations that it was unconflicted and that its prior dealings with Signet were “limited.”
The deal eventually closed at a buyout price of $21 per share. Plaintiff shareholders filed suit, alleging that Zale’s Board breached its fiduciary duties in a number of ways, aided and abetted by Signet and by the Advisor.
Analysis As a preliminary matter, Vice Chancellor Parsons rejected plaintiffs’ claims that Zale’s largest shareholder was interested as to the merger and that material information was omitted from the proxy, and accordingly held that a fully informed and disinterested majority of Zale’s shareholders had voted in favor of the merger. Defendants contended that these facts should shift the standard to the more defendant-friendly business judgment rule, but the court nevertheless applied the intermediate Revlon level of scrutiny.
The court also dismissed the claims against the Board members because they largely overlapped with the scope of the exculpatory provision in Zale’s charter, which had been adopted pursuant to 8 Del. C. section 102(b)(7). The court held that the Complaint did not assert a breach of the duty of loyalty, and that the directors could not be held liable for breaching their duty of care because such breaches were exculpated. Nevertheless, the court analyzed whether such a breach had occurred, because a breach of the duty of care could still serve as a predicate for claims of aiding and abetting against Signet or the Advisor.
In analyzing the alleged violations of the duty of care, the court dismissed allegations that the Board was conflicted or acted in bad faith with regard to the merger; that it undervalued Zale’s stock or agreed to unreasonable deal protections; and that it improperly favored Signet or inappropriately catered to Zale’s largest shareholder.
However, the court found that plaintiffs had sufficiently alleged that the Board’s reliance on the Advisor breached its duty of care. Although the Board did not learn about the conflict until after the merger agreement was signed, the court reasoned that the Board had a duty to “act reasonably to learn about actual and potential conflicts faced by . . . their advisors,” and to “act reasonably to identify and consider the implications of the investment banker’s compensation structure, relationships, and potential conflicts.” Opinion at 50, quoting In re Rural Metro Corp., 88 A.3d 54, 90 (Del. Ch. 2014).
The court suggested that the Board’s “oversight duty could include negotiating for representations and warranties in the engagement letter as well as asking probing questions to determine what sorts of past interactions the advisor has had with known potential buyers, such as Signet here.” Opinion at 50. Instead of applying that degree of rigor, Zale’s Board selected the Advisor without considering any other potential advisors, and “apparently relying without question on the Advisor’s representations” that its prior relationship with Signet was “limited.” Id. at 51.
In light of the important role that financial advisors typically play in merger transactions, including in the evaluation and negotiation of deal price and related terms, the court further found that the alleged breach of the duty of care here could possibly have caused the shareholders damage. In its presentation to Signet, the Advisor had recommended a purchase price in a range up to $21 per share. Ultimately, the deal price was exactly $21 per share. Accordingly, the court noted that this may have been no coincidence, and that it was at least “reasonably conceivable” that if the Advisor had attempted to negotiate a deal price higher than $21 per share, it could have “undermined both [its own] and Zale’s credibility” in the eyes of Signet, by pushing for a price that it had already told Signet was too high. Id. at 52.
On this basis, the court held that although the direct breach of fiduciary duty claims against the Board were exculpated and therefore dismissed, and although the aiding and abetting claims against Signet were also dismissed, the aiding and abetting claims against the Advisor survived.
Conclusion The Zale decision serves as a warning to financial advisors and to boards engaging financial advisors to carefully explore and seek to avoid conflicts that could impair the impartiality or judgment of the advisor, and that all such potential conflicts need to be disclosed in a timely fashion. Boards should ask probing questions, follow up on simple representations that prior interactions with potential counterparties were “limited,” and seek specific representations regarding possible conflicts on the part of their advisors.