Delaware ‘abetting’ ruling v. RBC should scare M&A advisors

March 10, 2014

If there were any remaining shreds of doubt that Delaware Chancery Court has come to regard financial advisors in M&A deals with considerable mistrust, they ought to be erased by Vice-Chancellor Travis Laster‘s 92-page decision Friday in a shareholder class action stemming from Warburg Pincus’s $17.25-per-share acquisition of the ambulance company Rural/Metro.

Rural/Metro’s directors settled the case last year for $6.5 million, which meant that when shareholder lawyers from Robbins Geller Rudman & Dowd and Bouchard, Margules & Friedlander went to trial against Royal Bank of Canada for aiding and abetting the board’s breach of duty, they had to show that RBC induced directors to make unreasonable decisions about selling the company. That made the case tougher for shareholders, but they nevertheless convinced Laster that RBC was conflicted by its hope of earning big financing fees from Warburg in this deal and from other banks in a related transaction. The judge concluded that RBC is indeed liable for aiding and abetting the board’s breach – a precedent-setting opinion that means the litigation risk to financial advisors in M&A deals just got very real.

Laster’s RBC decision is the logical extension of a couple of recent Chancery Court rulings involving conflicted financial advisors. In 2011, Laster enjoined the acquisition of Del Monte by a private equity consortium, finding that Del Monte’s advisor, Barclays, was secretly receiving financing fees from the consortium. Barclays later settled with Del Monte shareholders for $90 million. A year after the Del Monte ruling, Chancellor Leo Strine (now Delaware’s chief justice) issued a scathing opinion describing Goldman Sachs’s “furtive” and “troubling” decision to advise El Paso Corporation in its sale to Kinder Morgan, even though Goldman held a big equity stake in Kinder. Goldman eventually agreed to waive more than $20 million in fees and legal costs as part of Kinder Morgan’s $110 million settlement.

But Laster appears to be the first Delaware Chancery judge to conclude, after a full-blown trial, that an M&A financial advisor is liable to shareholders for abetting a board’s breach of its duty of care. We don’t know yet how big the hit will be for RBC; the plaintiffs originally claimed they were shortchanged in the Warburg deal by more than $151 million, but Laster has ordered rebriefing on damages. He has also ordered briefing on how to apportion responsibility between RBC and other defendants, which could greatly reduce the bank’s outlay.

Nevertheless, this case isn’t significant for its mere dollars. Laster’s opinion represents a new risk for financial advisors. Going forward, investment banks will have to weigh their potential exposure to shareholders when they decide what sort of business to pursue. Given that banks typically earn much more from financing fees than advisory fees – and that Delaware courts look askance at deals in which bankers are involved on both the buy and sell sides – we may see big banks begin to avoid the deal advice business, opting instead to focus on buy-side financing.

What’s especially troubling for banks about Laster’s opinion is that RBC and Rural/Metro apparently thought they had insulated the sale process from the kind of conflict accusations that emerged in the Del Monte case. In Laster’s telling, RBC was originally eager to be named Rural/Metro’s advisor because it hoped to secure financing fees in a private-equity buyout of Rural/Metro’s chief rival, Emergency Medical Services Corporation. (The idea was that the same private equity funds considering the acquisition of EMS would be interested in making Rural/Metro part of the strategic plan, and if RBC were advising Rural, the funds would give it a financing role in the EMS deal in exchange for a channel to Rural.)

As it turned out, RBC’s strategizing didn’t pay off with a lucrative role in EMS financing. But the bank did succeed in pushing Rural/Metro into play, which opened up the possibility of participating in Warburg’s financing of Rural’s buyout. According to Laster’s opinion, Rural and RBC were quite aware of the potential for conflict when the entire board met in March 2011 to discuss a sale process that had never actually been authorized by all of the directors. The judge noted that his Del Monte decision seemed to have spooked the Rural board, whose minutes presented a “rose-colored description of the sale process.” Laster’s skepticism aside, Rural did employ a second financial advisor, Moelis, with the intention of avoiding Del Monte-style conflict problems. RBC’s lawyers at Milbank, Tweed, Hadley & McCloy argued that RBC did not initially prepare a fairness opinion on Rural’s per-share value precisely to avoid a conflict as it pitched Warburg for a share of the financing fees.

Laster, however, concluded that RBC and a couple of eager Rural directors had manipulated the entire Rural sale process. And when circumstances forced the bank to come up with a valuation opinion, according to Laster, RBC tinkered with certain parameters to make Warburg’s offer seem better than it was. RBC’s final presentation on Warburg’s bid “conflicted with RBC’s earlier advice, contravened the premises underlying the board’s business plan for Rural, and contained outright falsehoods,” Laster said. “Rather than pushing for the best deal possible for Rural, RBC did everything it could to get a deal, secure its advisory fee, and further its chances for additional compensation from Warburg.”

So clearly, Laster considered RBC’s supposed conflict to have tainted Rural’s sale process. But for that alleged misconduct to translate into a legal finding of liability to shareholders, he had to determine that the Rural board had made unreasonable decisions – and that a clause in Rural’s certificate of incorporation called the exculpatory provision did not bar aiding and abetting claims against the bank. Exculpatory provisions, which are authorized by the Delaware legislature, protect directors from money damages for breaching their duty of care. (That’s as opposed to their duty of loyalty, which was not at issue in shareholder’s allegations against RBC.) The Delaware Supreme Court has never said whether the provisions extend to advisors accused of aiding and abetting breaches. RBC argued that it should: If directors don’t have to pay for their breaches, according to the bank, it doesn’t make sense to hold their advisors responsible. Laster rejected that reasoning. “The threat of liability helps incentivize gatekeepers to provide sound advice, monitor clients, and deter client wrongs,” he said.

To evaluate the board’s decisions, Laster used the intermediate standard of review, enhanced scrutiny, that the Delaware Supreme Court established in 1985 in Unocal v. Mesa and extended in 1986 in Revlon v. MacAndrews & Forbes. In most enhanced scrutiny cases, the burden is on directors to show that their conduct was reasonable. Because the Rural directors had settled, however, Laster found that the burden of proof shifted back to shareholders, who had to show the board’s decisions were unreasonable. That burden-shifting turned out to be more more than a speed bump for the plaintiffs. Laster concluded that the board acted outside of the bounds of reason when Rural first went into play, since the timing of the sale, which overlapped with bidding for Rural’s main rival, restricted the universe of potential buyers. That might have been a reasonable strategic decision, Laster said, except that the entire board never authorized the sale process. The failure was especially damning in the context of RBC’s push for Rural bidding to overlap with the EMS sale because it wanted a piece of the EMS financing.

The judge also said that the board’s decision to accept Warburg’s $17.25-per-share bid was not reasonable because the board was unaware of RBC’s conflicting motives. “The combination of RBC’s behind the scenes maneuvering, the absence of any disclosure to the board regarding RBC’s activities, and the belated and skewed valuation deck caused the board decision to approve Warburg’s offer to fall short under the enhanced scrutiny test,” he said.

I’m sure RBC will appeal – its counsel Alan Stone of Milbank declined to comment – but Laster based his holding that RBC can be liable, as a third party, for aiding the board’s breach of the duty of care in part on a 1999 decision by newly elevated Chief Justice Strine, from when Strine was a vice-chancellor. In that opinion, Strine said aiding and abetting liability may apply when a third party, for its own motives, “intentionally duped the  directors into breaching their duty of care.” That’s exactly what Laster found RBC did.

Shareholder lawyer Randall Baron of Robbins Geller declined to comment. Baron, who was co-counsel with Grant & Eisenhofer in the Del Monte case, could still add to RBC’s pain: Laster ordered briefing on whether the bank should be compelled to pay plaintiffs’ firms because “it seems possible that the facts could support a bad-faith fee award.” Aiding and abetting liability and paying the other side’s legal fees to boot? For financial advisors, that’s a discouraging development.

(Reporting by Alison Frankel)

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