On March 7, 2014, the Delaware Chancery Court in In Re Rural Metro Corporation Stockholders Litigation found a financial advisor to a target company liable for aiding and abetting a breach of fiduciary duties by the directors of the company. The Court reached this decision even though the directors themselves had settled before the trial. In a lengthy post-trial opinion, the Court determined that the financial advisor, motivated by a desire to earn large fees by providing “stapled financing” to a particular bidder, manipulated the sale process to favor that bidder and prepared misleading valuation materials for the board designed to make that bidder’s proposal seem more attractive. These misleading materials were then included in the target company’s proxy materials used in connection with the stockholder meeting held to approve the transaction. The full opinion can be read here.
Vice Chancellor Laster’s opinion contains numerous lessons for the key participants in a public M&A transaction. It echoes many of the teachings from the Delaware Chancery Court in the Del Monte and El Paso cases. We highlight in this Update some of the most important takeaways to consider from the most recent opinion.
Lessons for the Lead Director
- Don’t fail to involve the whole board in the M&A process.
- If the lead director has interests and incentives different from those of the target’s stockholders (in this case by running a hedge fund in fund-raising mode that was a large stockholder in the target and so might be motivated to achieve a quick sale), his or her motives could be questioned by a court.
Lessons for the Corporate Secretary
- A delay in preparing draft board minutes (and writing them with “the feel of a document drafted in anticipation of litigation”) will not escape a court’s attention.
Lessons for the Board as a Whole
- “Directors must maintain ‘an active and direct role in the context of a sale of a company from beginning to end.’”
- “[S]cope of required information [to enable a board to determine whether to approve a sale] includes a reasonably adequate understanding of the value of not engaging in a transaction at all.”
- “[A]nother part of providing active and direct oversight is acting reasonably to learn about actual and potential conflicts faced by directors, management and their advisors.”
- “[I]f directors ‘bias the process’ [in favor of bidders or fees for their bankers]… they commit a breach of fiduciary duty.”
Lessons for the Investment Banker to the Target
- The banker (and the bidder) can be subject to a claim of aiding and abetting a breach of fiduciary duty by directors even when the directors themselves are exculpated.
- The Delaware Chancery Court will scrutinize closely the banker’s role as “gatekeeper,” and emphasize the threat of liability as an incentive to “provide sound advice, monitor clients, and deter wrongs.”
- Participation (or even just attempted participation) in any stapled financing should require, among other things, clear disclosure to, and agreement with, the company’s board regarding the timing and scope of the banker’s interactions with any bidder.
- Changes to the valuation methodology during the course of a transaction may be viewed skeptically by a court and should be done only after careful consideration and appropriate documentation and disclosure to the board of the rationale.
- If the banker’s intention is to provide acquisition financing to a bidder (either for the transaction in question or another deal), make this clear in the engagement letter.
- A formal fairness committee process will be viewed more positively than an ad hoc one.