The August 2008 decision of the United States Court of Appeals for the Seventh Circuit in Edward T. Joyce, et al. v. Morgan Stanley & Co. held that an investment banking firm engaged by a company in connection with a merger transaction to provide, among other things, a fairness opinion, does not by virtue of that engagement owe a fiduciary duty to the shareholders of the company.  

The court concluded that neither a contractual obligation nor an extra-contractual fiduciary duty to advise the shareholders of the company arose. The court’s opinion illustrates the importance of the language used in engagement letters, which are carefully drafted by counsel for investment bankers.  

In the transaction, Morgan Stanley was engaged by the target company, 21st Century Telecom Group, to act as its financial advisor in a proposed acquisition of the company by RCN Corporation in a stock-for-stock merger. The merger agreement was signed on December 12, 1999, and Morgan Stanley delivered its fairness opinion on that date. Following the announcement of the transaction in December 1999, the market value of the RCN stock received by the shareholders of 21st Century in the merger plummeted. The merger transaction closed in April 2000, on the eve of the bursting of the “dot-com” bubble. The RCN stock eventually became worthless. In an action commenced in August 2006, the shareholders alleged that Morgan Stanley was responsible for their losses on the basis that it had breached a fiduciary duty it owed to the shareholders to give them advice about hedging strategies to minimize their exposure to a potential loss in value of the RCN stock they would receive upon completion of the merger.  

The nexus between the shareholders and Morgan Stanley asserted in the district court was the fairness opinion given by Morgan Stanley and relied upon by the shareholders. On appeal, the shareholders argued that apart from the fairness opinion, Morgan Stanley owed them an extra-contractual fiduciary duty to advise them about hedging.  

The Court of Appeal reviewed the engagement letter between Morgan Stanley and 21st Century, which explicitly stated that Morgan Stanley would have duties only to the company. The court also reviewed Morgan Stanley’s fairness opinion, which explicitly disclaimed any duty to the shareholders. On that basis, the court concluded there was “no doubt that Morgan Stanley did not accept any such responsibility and never owed any contractual or extracontractual fiduciary duty to the shareholders.” The Court of Appeal cited a decision it had rendered earlier in 2008 in The HA 2003 Liquidating Trust v. Credit Suisse Securities (USA) LLC. Here, the Court of Appeal had again concluded that the investment banking firm, in providing its fairness opinion, had in fact performed the services for which it was engaged pursuant to its engagement letter. In that case, the court characterized the suit as “nothing but an attempt to find a deep pocket to reimburse investors for the costs of [the] blunders [of the company’s managers].”

McCarthy Tétrault Notes:

Based on these decisions, investment banking firms in the United States can take comfort that the courts will rely on the language of their engagement letters, including disclaimers of fiduciary duty, descriptions of the services to be provided, waivers of conflicts of interest and rights to rely on information provided by their client. A similar outcome can be expected to prevail in Canada.