United States: Illinois Circuit Court Reinforces Seventh Circuit´s Limitation On Financial Advisors´ Liability Under Fairness Opinions

Three recent decisions, taken together, offer valuable guidance to financial advisors for avoiding liability when issuing financial opinions.

In a recent notable case, an Illinois circuit court enforced language in the engagement letter limiting the financial advisor's relationship, and thus liability, to its corporate client only. This decision follows two decisions by the U.S. Court of Appeals for the Seventh Circuit, affirming the principle that a financial advisor owes no duty to the stockholders of its corporate clients when issuing a fairness opinion, so long as such limitation on liability is explicitly stated in the contractual relationship.

Ron Young v. Goldman Sachs & Co.

In connection with the announcement in April 2008 of a merger agreement between Wm. Wrigley Jr. Company and Mars, Incorporated, Goldman Sachs issued a fairness opinion to the board of directors of Wrigley, stating that the consideration to be received by the stockholders of Wrigley in the proposed transaction was fair, from a financial point of view, to the stockholders of Wrigley. Goldman Sachs's compensation for its services to Wrigley was approximately $46 million, the bulk of which was contingent upon the consummation of the merger.

In a putative class action filed against Goldman Sachs, purportedly on behalf of all Wrigley stockholders, the plaintiff alleged that Goldman Sachs had a conflict of interest, preventing it from issuing an unbiased fairness opinion. The complaint alleged causes of action for breach of contract, breach of fiduciary duty, and aiding and abetting breaches of fiduciary duty by Wrigley's directors.

Goldman Sachs argued that the plaintiff stockholder lacked standing to assert his claims against Goldman Sachs, and filed a motion to dismiss. In granting the motion to dismiss on the grounds of standing, the court considered the language of the engagement letter between Goldman Sachs and Wrigley, the fairness opinion and the proxy materials submitted to the stockholders.

The court highlighted language from the engagement letter that stated Goldman Sachs's intent that its advice was exclusively for the board of directors of Wrigley and not for any other third party. The court also drew attention to language in the engagement letter stating that Goldman Sachs was an independent contractor and owed duties solely to Wrigley, and specifically disclaiming any fiduciary duties owed to Wrigley's stockholders.

Although the fairness opinion was submitted to the stockholders with the proxy materials, the introduction to the opinion and the opinion itself clearly stated that the opinion was for the "information and assistance of Wrigley's board of directors" and that it was "not a recommendation as to how any [stockholder] should vote with respect to the adoption of the merger agreement."

Based on the language in the engagement letter specifically limiting Goldman Sachs's relationship to be between it and the Wrigley board of directors, and the notice to the stockholders in both the proxy and the fairness opinion that Goldman Sachs's advice was not provided as a recommendation to the stockholders, the court held that the stockholders had no privity to or relationship with Goldman Sachs and dismissed the complaint for lack of standing.

This decision, citing to the recent decision of Edward T. Joyce, et al. v. Morgan Stanley & Co., Inc.538 F.3d 797 (7th Cir. 2008), is the latest decision supporting the principle that financial advisors may rely on the language contained in their engagement letter or fairness opinion to shield them from liability to the stockholders of their corporate clients. In The HA2003 Liquidating Trust v. Credit Suisse Securities (USA) LLC, 517 F.3d 454 (7th Cir. 2008), and Joyce, the Seventh Circuit considered the limitations on liability contained in engagement letters and fairness opinions, denying liability outside the scope defined by the parties.

Edward T. Joyce, et al. v. Morgan Stanley

In August 2008, the Seventh Circuit decided a case similar to Young, and similarly held that the financial advisor owed no fiduciary duties to the stockholders in relation to the issuance of a fairness opinion to the board of directors. In this case, Morgan Stanley issued a fairness opinion to the board of directors of 21st Century Telecom Group, Inc., in relation to its merger with RCN Corporation. When the stock of RCN sharply declined following the merger, the stockholders of 21st Century, who now held the devalued stock, sued Morgan Stanley, alleging that it owed a duty to advise the stockholders of 21st Century about hedging strategies.

In finding that Morgan Stanley owed no duty to the stockholders, the court examined the engagement letter between Morgan Stanley and 21st Century, and the fairness opinion. The court highlighted language in the engagement letter similar to the language the court later highlighted from the engagement letter in Young, specifically limiting Morgan Stanley's relationship to 21st Century as an independent contractor, owing duties solely to 21st Century. Also similar to Young was the fairness opinion disclaiming any duty to the stockholders and explicitly stating that the fairness opinion did not represent an opinion or recommendation as to how the stockholders should vote at the stockholders' meeting held in connection with the merger. Finally, the court drew attention to the conflict waiver clauses in the engagement letter and the fairness opinion, noting that the absence of any mention of the stockholders reinforced the conclusion that Morgan Stanley did not accept a duty toward the stockholders.

The HA2003 Liquidating Trust v. Credit Suisse

In February 2008, the Seventh Circuit, in contemplating financial advisors' liability in connection to the issuance of fairness opinions, held in Credit Suisse that financial advisors' responsibilities are set by contract.

In this case, HA-LO Industries hired Credit Suisse to issue a fairness opinion in connection with its proposed purchase of Starbelly.com, Inc. HA-LO also retained an accounting firm as a business consultant to review HA-LO's projected revenues from its acquisition of Starbelly.com. The accounting firm advised HA-LO that Starbelly.com was "unlikely to generate anywhere near the projected revenue stream."

HA-LO's CEO rejected the accounting firm's conclusions, presenting HA-LO's board of directors with only its own financial projections and not the evaluations of the accounting firm. Nor were the accounting firm's evaluations furnished to Credit Suisse, and the engagement letter specified that Credit Suisse would rely solely on HA-LO's financial projections. Pursuant to the terms of the engagement letter, Credit Suisse issued a fairness opinion stating that the consideration to be paid by HA-LO in the acquisition of Starbelly.com was fair, from a financial point of view, to HA-LO. In the fairness opinion, as indicated in the engagement letter, Credit Suisse specifically stated that it relied solely on HA-LO's financial projections, which Credit Suisse had not independently verified.

After HA-LO filed for bankruptcy, the HA2003 Liquidating Trust (the Trust) formed in connection with the bankruptcy, brought an action against Credit Suisse under the terms of the engagement letter for gross negligence in issuing the fairness opinion. The Trust argued that Credit Suisse was grossly negligent by failing to review the accounting firm's financial projections and instead relying solely on HA-LO's financial projections, and failing to withdraw the fairness opinion or issue a second opinion upon the change in market conditions indicating a decline in the dot-com boom.

In finding that Credit Suisse had not been grossly negligent, the court held that Credit Suisse could not be held liable for following the exact terms of its contract with HA-LO. Under the terms of the engagement letter, Credit Suisse would use only HA-LO's financial projections, and this reliance on HA-LO's financial projections was reiterated by Credit Suisse in its fairness opinion. Furthermore, Credit Suisse was under no obligation to either retract or amend its fairness opinion upon acquiring new knowledge relevant to the opinion.

Conclusion

These three decisions, taken together, offer valuable guidance to financial advisors for avoiding liability when issuing financial opinions. First, Credit Suisse offers financial advisors some assurance that they may rely on the terms of their engagement letters and fairness opinions. Second, Joyce expands on Credit Suisse, shielding financial advisors from liability to the stockholders of their corporate clients, at least in the Seventh Circuit, where such limitation on liability is explicitly stated in the engagement letters and related fairness opinions. Finally, in Young, the Illinois circuit court, citing to the Seventh Circuit decision in Joyce, demonstrated its willingness to enforce the contractual limitations on liability, highlighting the importance of careful drafting in explicitly limiting liability in engagement letters and fairness opinions.

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