On March 7, the Delaware Court of Chancery published a post-trial opinion in In Re Rural Metro Corporation Stockholders Litigation (Rural Metro) finding Rural/Metro's financial advisor RBC liable for aiding and abetting the Rural/Metro's board of directors' breach of its fiduciary duties in connection with the acquisition of Rural/Metro by Warburg Pincus. The decision is the latest in a series of Delaware opinions concerning conflicts of interest of banks and investment firms in advising companies in buy-out transactions.
BACKGROUND
In March 2011, Rural/Metro Corporation was acquired by Warburg Pincus for $17.25 per share in cash, a total deal value of approximately $440 million. The sale process was led by a special committee of Rural/Metro's board of directors. The special committee was initially instructed to evaluate strategic alternatives available to the company and report back to the full board on those alternatives, but the special committee exceeded that mandate and hired RBC Capital Markets as its financial advisor to conduct a sale process. RBC recommended running a sale process in parallel with the ongoing sale of competitor Emergency Medical Services Corporation (EMS), suggesting that it would set up potential bidders to acquire both EMS and Rural/Metro and allow the target companies to share the synergies of putting these two companies together. However, RBC never disclosed to Rural/Metro that one of its primary goals in representing Rural/Metro was to obtain a role in financing bids for EMS in order to generate fees far in excess of its expected advisory fee from Rural/Metro.
The sale process did not unfold as RBC had hoped. Bidders for EMS, including many large private equity funds that would have been potential bidders for Rural/Metro, were generally reluctant to participate in the Rural/Metro sale process out of concern about violating use restrictions in EMS's confidentiality agreement and because participating in the Rural/Metro process would require diverting resources away from the EMS process (which was much further along). Additionally, the special committee, acting on advice from RBC, refused to extend the Rural/Metro sales process to allow Clayton, Dubilier & Rice, which had acquired EMS, to prepare a bid even though the sales process had ostensibly been designed to allow the acquirer of EMS to bid. Eventually, Warburg Pincus (who did not seriously participate in the EMS process) emerged as a potential acquirer of Rural/Metro, in part because Warburg Pincus perceived there to be a lack of competition for Rural/Metro.
During the process, RBC failed to provide the Rural/Metro board of directors with any formal valuation analysis of the company until one hour and 18 minutes before the board meeting approving the Warburg Pincus deal in connection with the delivery of its fairness opinion. In terms of the fairness opinion itself, the Court found that RBC engineered the fairness opinion to make the $17.25 per share offer appear reasonable by misrepresenting how market analysts treated certain one-time expenses and manipulating other aspects of their financial analysis. During these crucial moments leading up to signing — and without the knowledge of the Rural/Metro board — RBC met with and continued its push to convince Warburg Pincus to use RBC for its buy-side financing needs in connection with the acquisition of Rural/Metro, including sharing details regarding the internal dynamics of the Rural/Metro board. Despite those efforts, RBC ultimately failed to obtain any role in financing the transaction.
Shortly after the announcement of the Rural/Metro acquisition, various shareholders filed lawsuits objecting to the transaction. The plaintiffs ultimately settled with Rural/Metro directors and the company's secondary financial advisors, but the claims against RBC for aiding and abetting proceeded to trial.
At trial, the Court found that the Rural/Metro directors breached their fiduciary duties by failing to conduct a reasonable sale process and that RBC failed to serve its proper role as an advisor to the board. As a result, the Court found that RBC was liable for aiding and abetting breaches of the Rural/Metro directors' fiduciary duties.
KEY TAKEAWAYS
Aider and Abettor Liability. Aider and abettor
liability can attach to an agent who knowingly causes a breach of a
fiduciary duty by a director, regardless of whether the director
herself knows of the breach. In this case, the Court concluded that
RBC aided and abetted the Rural/Metro directors' breach of
their fiduciary duty of care and disclosure obligations to
Rural/Metro stockholders by creating an unreasonable sale process
and informational gaps between the Rural/Metro board and its
financial advisor (e.g., omitting disclosure on the extent of its
conflicts resulting from attempts to gain a place in the buy-side
financing for EMS and Rural/Metro). The Court found that RBC
perpetuated this informational gap by failing to provide any formal
valuation metrics on Rural/Metro until a little more than an hour
before the board meeting at which the deal was approved, which
metrics Vice Chancellor Laster found to be intentionally engineered
to mislead the Rural/Metro directors to conclude the acquisition
price was fair.
Statutory Limitations on Liability Do Not Extend to Aiders and
Abettors. Section 102(b)(7) of the Delaware General
Corporation Law, which allows corporations to absolve directors
from personal liability to stockholders for monetary damages for
breaches of duty of care, does not apply to non-directors who aid
and abet a breach of fiduciary duty, even when the directors
themselves are otherwise exculpated by a Section 102(b)(7)
provision.
The Delaware Courts Remain Highly Skeptical of Staple
Financing. Vice Chancellor Laster was critical of both the
vigor of RBC's desire to participate in buy-side financing (and
the conflict of interests it created) and the Rural/Metro
board's failure to monitor RBC in the process (such as failing
to inquire about the financing and its associated process, provide
guidance on when staple financing discussions should begin or end,
and impose practical checks on RBC's interest to maximize its
fees). This skepticism of staple financing echoes Vice Chancellor
Laster's critique of financial advisors in the February 2011
ruling in In re Del Monte Foods Company Shareholders
Litigation, where financial advisors similarly made efforts to
steer the sale process towards buyers that might have provided a
financing role for the investment bankers (and therefore, a slice
of financing fees). Given the skepticism of the Delaware Courts,
boards of Delaware corporations should exercise diligent oversight
to ensure that appropriate checks are in place on the inherent
conflicts that such staple financing creates.
The Process is Paramount. As should be well-understood by
now, the process by which boards of directors evaluate major
transactions is vitally important to good outcomes. Even actions
that one might expect to be routinely defensible become highly
problematic when the integrity of the process is effectively called
into question. In this case, the Court found that the threshold
decision to initiate the sale process itself did not satisfy the
standard of care as a fiduciary duty matter. This extraordinary
result flowed from the Court's finding that the decision to
initiate the process was undertaken unilaterally by a special
committee chairman who lacked the authority to put the company in
play and who, in doing so, acted on the advice of a financial
advisor that was motivated by self interest. As the Court
acknowledged, a well-informed board might have considered a variety
of pros and cons to the timing of the sale process, but the fact
that this basic step in the process was omitted helped render even
the decision to start the process unreasonable.
Engagement Letter Did Not Suffice to Waive RBC Conflicts.
Vice Chancellor Laster rejected RBC's arguments that a generic
conflicts acknowledgement in its engagement letter precluded aiding
and abetting claims. The Court found that RBC failed to disclose
the degree of its conflict to the Rural/Metro board, and Delaware
law requires that any conflict waiver be knowing and unambiguous,
including with respect to the degree of the conflict. Generic
boilerplate signed at the outset of a deal (and before the actual
conflict exists) will not suffice.
Buyers Should Diligence the Sale Process. Rural/Metro
provides another illustration of the importance for buyers to
diligence sale processes in M&A transactions in order to
understand what (if any) sale-related liabilities they may inherit
or become subject to in connection with the target company's
actions relating to the sale transaction and to incorporate those
potential costs into valuation models.
Not All Shareholder Litigation Settlements Will Be Approved by
the Court. The case was on the brink of a supplemental
disclosure-only settlement in January 2012. However,
following an objection to the settlement by a Rural/Metro
stockholder who had filed a parallel lawsuit in Arizona, Vice
Chancellor Laster rejected the disclosure-only settlement as
inadequate, serving as a reminder that proposed settlements need to
pass a hearing on fairness before the matter can be resolved. In
Delaware, the depth of the fairness inquiry has tended to vary,
slightly complicating the predictability of the sufficiency of a
disclosure-only settlement in any particular litigation before the
Delaware Courts.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.