In February 2009, the Ontario Superior Court stopped a hostile bid by Rusoro Mining Ltd. for the shares of Gold Reserve Inc. because Rusoro's financial advisor, Endeavour Financial International Corporation, had a conflict of interest.
Background
Endeavour had acted as Gold Reserve's financial advisor since 2004, advising on potential business transactions and project financing for Gold Reserve's main asset, the Brisas gold and copper project in Venezuela, and making presentations to potential lenders and investors. Gold Reserve paid Endeavour fees of $1.2 million for its services over the four-year period preceding the bid.
In providing these services, Endeavour accessed Gold Reserve's confidential financial, technical and operational information, established a data room for Gold Reserve, and was involved in preparing confidential cash flow models for the Brisas project. Under its financial advisory agreement with Gold Reserve, Endeavour agreed not to disclose Gold Reserve's confidential information and not to use it for Endeavour's own purposes or to Gold Reserve's detriment.
The agreement contained an acknowledgement by Gold Reserve that Endeavour also acted as financial advisor to other mining companies whose interests might conflict with those of Gold Reserve. However, Endeavour agreed that it would not "knowingly act against the interests of Gold Reserve in a material way" and would inform Gold Reserve of any conflict and then would either act solely for Gold Reserve, agree on another solution, or terminate the agreement.
In April 2007, Rusoro engaged Endeavour as its financial advisor. Key Endeavour employees who worked on Gold Reserve matters, and thus had access to Gold Reserve's confidential information, also worked on the Rusoro retainer. As part of their mandate, these employees provided Rusoro with a valuation opinion on Gold Reserve and advised Rusoro on the proposed bid. After its overtures for a friendly merger transaction were rebuffed by Gold Reserve, Rusoro launched an unsolicited bid on December 15, 2008. By e-mail to Gold Reserve minutes after Rusoro announced the bid, Endeavour purported to terminate its advisory agreement with Gold Reserve.
The Decision
The Ontario Superior Court held that in advising Rusoro in connection with the bid, Endeavour had breached its obligations under its advisory agreement with Gold Reserve not to disclose confidential information or use it to the detriment of Gold Reserve. Even absent the specific prohibitions in the advisory agreement, the court considered that professional advisory relationships give rise to fiduciary duties of loyalty and confidentiality. In the court's view:
The court indirectly sanctioned the use of ethical walls where a conflict exists, stating that "in the absence of special measures such as institutionalized ethical walls," there is a presumption that confidential information will be used to the disadvantage of the provider of the information. Accordingly, in the court's view an advisor in possession of relevant confidential information from a client or former client cannot, in the absence of informed consent and appropriate ethical walls, act against that client in a hostile bid (and a requirement for informed consent from the target would, practically speaking, make it unlikely that an advisor could so act in the context of a hostile bid). As a result, the court granted Gold Reserve's motion for an injunction to stop Rusoro's bid.
Importance of the Decision
Because this was only a decision on a motion for an interim injunction (and therefore was based solely on affidavit evidence), the court did not need to finally decide whether Endeavour in fact had a conflict. This will be the issue in the subsequent trial, in which Gold Reserve will be seeking damages from both Rusoro and Endeavour. In order to grant the injunction, the court only had to be satisfied that there was a serious issue for trial. Nevertheless, the decision represents an important statement of the law on conflicts, as confirmed by a review panel of the court which, in subsequently denying Rusoro's request to appeal the granting of the injunction, stated:
While both the rules of professional conduct governing lawyers, and various judicial decisions, have sensitized the legal profession to conflicts, this appears to be the first case to consider the existence and impact of potential conflicts of other advisors in M&A transactions. Accordingly, the case should serve as a warning to other professional advisors in M&A transactions (including financial, accounting and technical advisors) to be alert for, and to ensure they have internal systems to identify, potential conflicts.
If a conflict is identified, the advisor should proceed only after obtaining the informed consent of the parties and implementing appropriate ethical walls. Failure to do so could expose a conflicted advisor to damages. Depending on the circumstances, potential damages could include the expenses incurred by the acquiror in pursuing the failed transaction, the expenses incurred by the target in defending against it, compensating the acquiror for the lost opportunity to complete a transaction, and compensating the target for losses suffered as a result of improper disclosure of its confidential information.
A company retaining professional advisors should ensure that the retainer agreement, in addition to dealing with confidential information, contains the advisor's confirmation that a) it does not have a conflict, and b) if one does arise during the course of the retainer, it will not act contrary to the interests of the company.
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