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:
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 …"
John Healy, Partner, email@example.com
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.
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