Rural Metro – More Lessons on Practices to Avoid When Selling a Publicly Traded Delaware Corporation

John Healy, Partner - Clifford Chance LLP

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At first glance, the all-cash third-party buyout addressed in a recent Chancery Court decision, In re Rural Metro Corp. Stockholder Litig., C.A. No. 6350-UCL (Del. Ch. March 7, 2014), seemed an unlikely candidate for criticism, judicial or otherwise.

The buyout of Rural Metro was at a respectable premium to the unaffected share price and was approved by 72% of its stockholders pursuant to the recommendation of a seven-member board of which six members were "facially independent, disinterested outside directors." The terms of the transaction were negotiated by a special committee comprised of three of those independent directors. The chair of the special committee was a co-founder of a hedge fund that held over 12% of the target's stock, which appeared to align his interests strongly with those of other stockholders. The lead financial advisor chosen by the special committee was authorized to offer stapled financing to prospective bidders, but only after the special committee discussed the possible pros and cons of such an arrangement and decided to manage the cons by appointing a reputable co-advisor that would not participate in acquisition financing. The lead financial advisor did not in fact provide acquisition financing to the successful private equity bidder. That advisor did provide acquisition financing for a sale of Rural Metro's principal competitor that was negotiated around the same time, but that private equity buyer was a competitor of the buyer of Rural Metro.

Notwithstanding these facts, the stockholder challenge addressed in the Rural Metro decision resulted in liability for the financial advisor, findings of fiduciary breaches by Rural Metro's directors and scathing judicial commentary regarding the conduct of bankers and directors alike. Why?

Well, the Court's findings included the following:

  • Two of the three members of the special committee had powerful and undisclosed personal incentives to favor a quick sale (the 12% stockholder hedge fund needed a near term liquidity event, changing the motivation of the special committee chair, and another special committee member had agreed to solve an ISS problem by resigning from the Rural Metro board and needed a change of control event before his promised resignation to avoid forfeiting unvested Rural Metro equity).

  • Those two directors effectively bullied Rural Metro's CEO into supporting the idea of a quick sale.

  • The special committee's mandate from the board was to review and report on all strategic alternatives but instead the special committee from the outset pursued a sale in a single-minded fashion.

  • Pursuing a sale process at that particular time was potentially a bad idea because Rural Metro had attractive growth prospects and because its principal competitor had just announced a sale process which likely would prevent various otherwise-likely bidders from participating in Rural Metro's process. The special committee and the full board never discussed whether different timing or different tactics might have delivered greater stockholder value.

  • Rural Metro's principal financial advisor appeared (from its conduct and internal emails) to be focused principally on maximizing its opportunity to provide financing fees on this and the competitor's sale process, and not on maximizing value for Rural Metro's stockholders. This led among other things to a recommendation to not grant an extension of time for submission of a competing bid by a credible bidder.

  • After its initial pitch to the special committee, the financial advisor did not present valuation materials to the special committee or the board until the day of the meetings held to approve the buyout transaction. Those valuation analyses contained obvious flaws.

  • The proxy materials provided to Rural Metro's stockholders failed to disclose the flaws in the process, the financial advisor's conflicts of interest, the special committee members' conflicts of interest or the flaws in the financial analysis provided to Rural Metro's board.

On this record, the court unsurprisingly found the directors (who had settled before trial) had breached their fiduciary duties of care and candor and that the financial advisor had aided and abetted those violations and therefore was liable in damages. The Court rejected the financial advisor's assertions that it was protected from liability here by the exculpatory provisions in its engagement letter and, indirectly, by the DGCL Section 102(b)(7) provision contained in Rural Metro's certificate of incorporation that the Court had found fully exculpated Rural Metro's directors. The Court found the exculpatory provisions in the engagement letter did not cover the type of egregious misconduct found here and that nothing in the company's certificate of incorporation or the DGCL required a finding that a party found to have aided and abetted a director's fiduciary breach could not be held liable if the directors in question were themselves exculpated.

In explaining its conclusion on this last point, the Court adopted reasoning that some banks may find rather chilling. The Court found that financial advisors "function as gatekeepers" and that public policy supports the imposition of liability on investment banks who fail to ensure their director clients behave properly. The Court explained that "the prospect of aiding and abetting liability for investment banks who induce boards of directors to breach their duty of care creates a powerful financial reason for the banks to provide meaningful fairness opinions and to advise boards in a manner that helps ensure that the directors carry out their fiduciary duties when exploring alternatives and conducting a sale process …"


  • First and foremost, process matters. Particularly on a topic as important as the sale of a company, directors have to show they are exercising rigorous oversight and are fully informing themselves as to all matters that reasonably appear relevant. Here, the board had failed to properly examine the motivations and potential conflicts of the special committee members and the financial advisor, had allowed the special committee and financial advisor to exceed their mandate and get too far out in front in running a sales process, had failed to ask a key question that should be asked any time a board considers a sale of the company ("why now?"), had failed to properly inform itself on the critical issue of value, and at the end had appeared to rubber-stamp a transaction after only cursory review of a flawed valuation analysis. The importance of a deliberate, orderly, fully-informed process is a topic on which Delaware courts have placed great emphasis for more than 30 years, but apparently it is a lesson that bears repeating.

  • Bankers appear ever more subject to scrutiny by a Delaware Chancery Court that has significant familiarity with how financial analyses are prepared and how investment banks' internal fairness opinion approval processes operate, and should assume that any lack of rigor in substance or process may be invoked as a basis for imposing liability.

  • Stapled financing is not per se impermissible but it remains perilous for banks that offer it and directors that approve its use. Appointing a second banker is not automatically an effective inoculation against potential liability. We continue to believe there are times when stapled financing can be appropriate and indeed helpful, but its use requires care.
  • Bankers should not assume that exculpatory provisions in their engagement letters or in their clients' charter documents will protect them from liability.

  • And finally, acquirers should be sensitive to these issues as well. The acquirer of Rural Metro may have managed to pay less for the company than the Chancery Court thought the company was worth, but since through the merger the acquirer inherited the indemnification obligation owed by Rural Metro to its banker, the acquirer may wind up footing some or all of the damages bill found to be due to the former stockholders.

John Healy, Partner,

John Healy advises acquiring, selling and target companies and their financial advisors on both negotiated and unsolicited acquisitions for privately and publicly held corporations.

Mr. Healy is admitted to practice in New York and California. He received a BA in law, with first-class honors, from the University of Cambridge in 1978 and an LLM in 1980 from the University of Pennsylvania Law School, where he was a Thouron Scholar. He has been a partner with the firm since 1987 and is based in the firm's New York office.

Clifford Chance LLP

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This article is for general information purposes and should not be taken as legal advice. The opinions expressed are those of the author and do not necessarily reflect the views of the firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Clifford Chance LLP. This work reflects the law at the time of writing in 2014.