RBC Capital Markets, LLC v. Jervis

Transcription

1 Delaware Supreme Court Affirms Financial Advisor Liability for Aiding and Abetting Unreasonable Sale Process SUMMARY In a highly anticipated opinion, 1 the Delaware Supreme Court last week affirmed the Delaware Court of Chancery s decisions 2 holding a financial advisor liable for approximately $75.8 million (plus interest) in damages for aiding and abetting breaches of fiduciary duty by directors of Rural/Metro Corporation in the course of a flawed and conflict-ridden sale process. 3 In doing so, the Court concluded that a board s financial advisor can be held liable for damages for aiding and abetting a breach of a director s duty of care if the advisor, with knowledge that the directors are acting without adequate information, misleads the directors or otherwise creates an informational vacuum that induces the breach, irrespective of whether the breach rises to the level of gross negligence, the standard for director liability for damages for a breach of the duty of care. 4 Further, under the Court s interpretation of Delaware s contribution statute, a financial advisor who is found to have aided and abetted a breach of fiduciary duty is not entitled to contribution from directors who are exculpated by operation of their charter provisions from monetary liability on the theory that such directors, absent an admission, are not joint tortfeasors. In both the trial and appellate decisions issued in the case, the Delaware courts were critical of the Rural board s lack of active oversight of its financial advisor s conflicts of interest, the financial advisor s failure to disclose its material conflicts to the Rural board, and the resulting unreasonable sale process. The courts found that the Rural sale process had been structured to facilitate the financial advisor s undisclosed desire to be on the financing trees of the bidders for a parallel sale of a Rural competitor, which had the effect of reducing the universe of realistic bidders for Rural. Likewise, the courts were not persuaded that the presence of a second financial advisor had any cleansing effect on the flawed sale process, ostensibly because the main financial advisor failed to disclose its idiosyncratic conflicts that New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 tainted the process beyond repair and because the second advisor s compensation was contingent on completion of the transaction. Importantly, the Supreme Court expressly declined to adopt the trial court s potentially far-reaching gatekeeper theory of financial advisors, observing that because the relationship between boards and their financial advisors primarily involves detailed contractual provisions negotiated between sophisticated parties, it would be inappropriate to conclude that any failure by an advisor to prevent a fiduciary breach gives rise to aiding and abetting liability. Nevertheless, the Court stated that financial advisors still are under an obligation not to act in a manner contrary to the interests of the boards they serve. With this opinion, the Supreme Court confirmed that financial advisors that fail to disclose material information to a board regarding their actual or potential conflicts can be held liable for damages that flow from their knowing participation in unreasonable sale processes. Moreover, because of the interplay between Delaware s joint tortfeasor contribution statute and charter provisions that exculpate directors who breach their duty of care from monetary liability, financial advisors that cause an unreasonable sale process or that withhold material information from a proxy statement could be liable for the vast majority, if not all, of the damages to stockholders caused by their tortious conduct. Repeatedly referring to its opinion as narrow, the Court seemed to suggest that it would be the rare case where a financial advisor would be found to have acted with scienter and induced a fiduciary breach; however, the Court s continued emphasis on ensuring that the financial advisor has disclosed sufficient information (about conflicts as well as process) to a board gives reason for financial advisors to continue to be cautious. While the opinion makes clear that directors are free to employ conflicted financial advisors so long as they exercise appropriate oversight over their advisors conflicts and the sale process and employ sufficient safeguards to maintain a reasonable process, it is also clear that not every contractual relationship will suffice to protect financial advisors or the boards they advise. At the end of the day, financial advisors are not free to act in a manner that is contrary to the interests of the board, and boards cannot relinquish their obligation to provide meaningful oversight of a sale process. BACKGROUND Although the Delaware Court of Chancery s factual findings were not specifically challenged on appeal, the Supreme Court independently identified support for those findings in the record. In December 2010, the Rural board (comprised of six facially independent directors and the company s newly appointed CEO, Michael DiMino) re-activated a previously formed special committee, authorizing it to analyze the company s strategic alternatives, including pursuing the company s existing standalone business plan, and to retain a financial advisor to assist in that analysis, and charging it with making a recommendation to the board. -2-

3 The special committee, chaired by Christopher Shackelton, a managing partner at an investment firm that owned approximately 12% of Rural s common stock (representing more than 20% of the firm s portfolio), engaged RBC, which had previously performed debt financing and other advisory work for Rural. As described in the court s opinion, RBC s pitch presentation to the special committee focused on the benefits of an immediate sale of Rural in light of the strong M&A healthcare environment, particularly to financial sponsors, and sought authorization to provide stapled financing to any potential acquirer. The special committee retained RBC and agreed to the staple financing provision; as a result, the special committee also engaged Moelis & Company LLC as its secondary advisor. RBC did not disclose to the special committee that it sought to use its role as Rural s sell-side advisor to secure a buy-side financing role with potential private equity bidders for Emergency Medical Services Corporation, a Rural competitor, which had just announced that it was exploring strategic alternatives. RBC s calculation of the potential $55 million in total financing fees that it could earn in the Rural and EMS sale processes was more than ten times the $5.1 million advisory fee it eventually received as Rural s sell-side advisor. During December and January, RBC contacted twenty-eight private equity firms about the sale of Rural on the special committee s authority, even though the special committee s mandate did not expressly include initiating a sale process. Twenty-one firms executed confidentiality agreements that included a no-conflict provision that prohibited bidders from sharing Rural s information with individuals involved in the EMS process. No strategic acquirers were contacted. In February 2011, six firms, including Warburg Pincus LLC, submitted indications of interest to acquire Rural. The Rural board met in March for the first time since authorizing the special committee to assess Rural s strategic alternatives. At the meeting, the board decided, among other things, not to delay the final bid deadline which had been specifically requested by the acquirer of EMS to permit it to conduct additional due diligence on Rural even though RBC previously had recommended parallel sale processes because the acquirer of EMS might also be interested in acquiring Rural due to potential synergies. The Rural board also adopted a resolution that ratified and expanded its grant of authority to the special committee to solicit indications of interest and negotiate terms of a potential transaction, which was authority that the trial court found Shackelton and RBC had already assumed for themselves. As the sale process drew to a close, RBC repeatedly sought, unsuccessfully, to participate in Warburg s financing consortium for the acquisition of Rural while negotiating with Warburg with respect to its bid for Rural. RBC did not disclose its attempts to provide financing to Warburg to the Rural special committee or full board. Warburg subsequently submitted the highest bid: $17.25 in cash per share. The trial court found that RBC encouraged DiMino to get the Warburg bid approved and presented a board book designed to convince the board to accept Warburg s offer RBC and Moelis each opined that the $17.25 per share offer was fair, but the trial court found that RBC, the day before the board meeting, had made a series of undisclosed changes to its fairness analysis to make the Warburg bid more attractive. The Rural board approved the merger with Warburg, having received valuation materials from its financial

4 advisors for the first time at the meeting. In June 2011, the merger closed after receiving the approval of 72% of the shares outstanding. The plaintiff, a former Rural stockholder, filed a class action suit against the Rural directors for breach of fiduciary duty and against RBC and Moelis for aiding and abetting the fiduciary breaches. Before trial, the plaintiff settled with Moelis for $5 million and with the Rural directors for $6.6 million. Although it contractually barred RBC from seeking contribution from Moelis and the Rural directors, the settlement included joint tortfeasor releases, pursuant to which the damages recoverable against RBC would be reduced to the extent of the settling defendants pro rata shares as joint tortfeasors, as permitted by the Delaware Uniform Contribution Among Tortfeasors Act ( DUCATA ). As a result of the settlement, the case went to trial solely against RBC. The trial court found that the Rural board acted unreasonably and breached their duty of care by running a flawed sale process and by failing to disclose certain material information, including RBC s conflicts of interest, in the proxy statement in respect of the merger. Further, the trial court found that RBC had aided and abetted the Rural board s fiduciary misconduct by knowingly participating in the unreasonable sale process and in the disclosure violations. The trial court determined that the class was harmed by an amount equal to the difference between the merger price of $17.25 per share and Rural s going concern value on the date of the merger, which the court found to be $21.42 per share. The trial court calculated damages to the class as approximately $91.3 million and held RBC responsible under DUCATA for 83% of those damages, or approximately $75.8 million. RBC appealed the judgment. THE COURT S DECISION A. RURAL S DIRECTORS ACTED UNREASONABLY BECAUSE THEY DID NOT ACTIVELY OVERSEE THE SALE PROCESS OR RBC AND DID NOT ADEQUATELY UNDERSTAND THE COMPANY S VALUE Affirming the trial court s use of Revlon s 6 enhanced scrutiny review, the Supreme Court agreed with the trial court that the Rural board s overall course of conduct was unreasonable. In particular, the Court concluded that the directors breached their fiduciary duties by (1) allowing the special committee to run the sale process without board approval and in parallel with a sale process for EMS without understanding the negative implications to the potential sale of conducting a sale at the same time that a principal competitor was engaged in a similar process or RBC s motivation to be on the financing trees of the EMS bidders; (2) failing to effectively oversee the sale process, including by failing to address RBC s conflicts; and (3) failing to be adequately informed about Rural s value, including because of RBC s lastminute adjustments to its analysis. Additionally, the Court rejected RBC s argument that Moelis cleansed any defects in the sale process, concluding that the Rural board treated Moelis s advice as -4-

5 secondary to that of RBC s and, as was the case with RBC, Moelis s compensation was contingent upon consummation of a transaction. In so finding, the Supreme Court agreed with the trial court s conclusion that, absent RBC s conflicts of interest, the structure and timing of the sale process may have been viewed by the courts as one of those debatable choices that nonetheless fell within the range of reasonableness, but where undisclosed conflicts of interest exist, such decisions must be viewed more skeptically. 7 Acknowledging that a board is protected by Section 141(e) of the Delaware General Corporation Law ( DGCL ) in relying in good faith on expert advisors, the Supreme Court noted that a board s reasonable reliance on an advisor presupposes that it has remained reasonably informed while overseeing a sale process, including by identifying and responding to the advisor s potential conflicts. Moreover, because a conflicted advisor alone may possess the information about a conflict, the Supreme Court stated that a board should require disclosure from its financial advisor on an ongoing basis of material information that may affect the board s process. The Court proposed, as an example, that a board could insist as a contractual matter that a conflicted advisor disclose its conflicts both at the outset and throughout the sale process. The Supreme Court further noted that a board may be free to consent to certain disclosed conflicts, suggesting without further elaboration that some conflicts may not be waivable. The Supreme Court rejected RBC s argument that Revlon enhanced scrutiny review could not have applied to the decisions that Shackelton and the special committee made in December 2010 because the Rural board had only authorized an exploration of alternatives and not the type of active bidding process that triggers Revlon review. The Court held that Shackelton and RBC had expanded that mandate to include an active sale process managed by the special committee, and that because the Rural board had later ratified the special committee s unilateral expansion of its mandate at a March 2011 board meeting, Revlon review attached as of the committee s actions in December Moreover, it rejected RBC s contention that Revlon review only applies at the endpoint of a sale process, noting that such a view would potentially incentivize a board to defer active engagement during periods when it should be overseeing the process. 8 The Court took pains to point out that, in its view, its narrow ruling effects no shifts in the Revlon landscape. 9 The Supreme Court also rejected RBC s argument that, under the Court s recent C & J Energy 10 decision, the post-closing market check, in which no topping bidder emerged, cured any flaws in the sale process. Noting that a fundamental component of the C & J Energy decision was that the stockholders would have a fair chance to approve the transaction, the Supreme Court pointed out that neither the Rural board nor its stockholders were fully informed when they voted in favor of the merger since they were operating on the basis of an informational vacuum created by RBC. Finally, the Supreme Court rejected RBC s contention that the trial court erred by finding that directors violated their duty of care without finding that they were grossly negligent. The Court noted that a finding -5-

6 of gross negligence would be required to sustain a monetary judgment for a duty of care violation against disinterested directors who themselves face liability. However, agreeing with the trial court, the Court affirmed that a finding of breach of fiduciary duty could be made on the basis of unreasonable board conduct that fails Revlon review in the context of a claim for aiding and abetting liability against RBC without a specific finding that the Rural directors were grossly negligent. By so finding, the Court held that an aider and abettor of a director s breach of the duty of care can be financially liable even though the director would not have been. B. RURAL S DIRECTORS FAILED TO DISCLOSE MATERIAL INFORMATION WITHHELD BY RBC Separately, the Court affirmed that the board violated its fiduciary duty of disclosure (a derivative application of the directors duties of care and loyalty) as a result of material misstatements and omissions in the proxy statement regarding RBC s financial analysis and its conflicts of interest. The Court found that the proxy statement incorporated a false valuation analysis because it misstated the equity analysts consensus EBITDA range and because the precedent transaction analysis that RBC supplied for inclusion was materially false. Moreover, the Court rejected RBC s contention that, because the proxy statement disclosed RBC s right to provide staple financing, stockholders knew of RBC s potential conflicts. The Court stated that such information was only a partial disclosure, concluding that the proxy statement inappropriately failed to disclose RBC s use of the sale process to seek a financing role in the EMS transaction. The Court did not find that the Rural board had intentionally made these misstatements in fact, most were found to be the result of concealments by RBC and did not directly address the board s degree of culpability for these disclosure violations. C. RBC AIDED AND ABETTED THE RURAL BOARD S BREACHES OF FIDUCIARY DUTY The Supreme Court affirmed the narrow holding that RBC had knowingly participated in the Rural directors breaches of their duty of care by exploiting its own interests to the detriment of Rural and by creating an informational vacuum. The evidence cited in support of this legal conclusion included: (1) RBC s failure to disclose to the Rural board its interest in obtaining a financing role in the EMS transaction and how it planned to leverage its Rural engagement to capture that work; (2) RBC s knowledge that the Rural board was uninformed about Rural s value; (3) RBC s attempts to provide financing to Warburg while it was leading Rural s price negotiations with Warburg; and (4) RBC s last-minute modifications to its valuation analysis. The Court noted that RBC made no attempt to inform the Rural directors about these contextually shaping points. 11 The manifest intentionality of RBC s conduct was, according to the Court, demonstrative of RBC s knowledge that the Rural board was proceeding on the basis of incomplete and misleading information. 12 The Court rejected RBC s argument that any harm to Rural stockholders was not proximately caused by its actions because of Moelis s presence as a second financial advisor. The Court also rejected an argument of the Securities Industry and Financial Markets Association, an amicus curiae, that recognizing -6-

7 a claim for aiding and abetting a breach of the duty of care would create an anomalous imbalance of responsibilities because a non-fiduciary could be held liable for unintentional conduct by a fiduciary. 13 Noting that these concerns were overstated, the Court made clear that its finding was premised on RBC s fraud on the [b]oard, with ample evidence that RBC, for improper motives, intentionally duped the Rural directors into breaching their duty of care. 14 The Court underlined the fact that its holding was narrow and should not be read expansively to suggest that any failure on the part of a financial advisor to prevent directors from breaching their duty of care gives rise to a claim for aiding and abetting a breach of the duty of care. 15 As the Court observed, a claim for aiding and abetting against a financial advisor remains among the most difficult to prove under Delaware law because it requires proof that the advisor acted with scienter. In a noteworthy footnote, the Court emphasized that it was not adopting the trial court s dictum regarding the gatekeeper theory of financial advisors in M&A transactions. According to the Court, the trial court s gatekeeper approach does not adequately account for the fact that the role of a financial advisor is primarily contractual in nature, can vary based upon myriad factors and that it is for the board to determine what services and on what terms it hires its financial advisors in assisting it in carrying out its oversight function. Instead, in the Court s words, a financial advisor is under an obligation not to act in a manner that is contrary to the interests of the board of directors, thereby undermining the very advice that it knows the directors will be relying upon in their decision making processes. 16 D. THE TRIAL COURT DID NOT ERR IN CALCULATING DAMAGES OR RBC S ENTITLEMENT TO CONTRIBUTION The Court affirmed the trial court s use of the so-called quasi-appraisal remedy, in which the damages to Rural stockholders were calculated as the difference between the company s going concern value and the $17.25 per share merger consideration. Using a discounted cash flow methodology, the trial court calculated damages as $4.17 per share, or an aggregate amount of $91.3 million in damages to the class (plus interest). The Court rejected RBC s argument that the trial court abused its discretion by ignoring the results of the bidding process, including the absence of a topping bid during the passive, post-signing market check, as a potential indicator of Rural s fair value. In contrast to several recent appraisal proceedings, in which Delaware courts have found the merger price to be the most reliable indicator of fair value, 17 the $17.25 per share merger consideration for Rural was found to be tainted by RBC s conflicts and the resulting defective sale process as well as the failure of the market to understand adequately Rural s growth prospects. With respect to RBC s right to contribution from joint tortfeasors, the Court affirmed the trial court s conclusions that RBC was barred by the terms of the settlement agreement the directors and Moelis entered into and to which RBC did not object from seeking contribution from any of those defendants. Moreover, the Supreme Court agreed with the trial court that while RBC retained the right under the settlement to seek a judgment reduction under DUCATA for the pro rata share of liability of the settling -7-

8 defendants, the trial court correctly assigned RBC 83% of the responsibility for damages by (1) attributing sole responsibility to RBC for the disclosure claims, which accounted for 50% of the damages; (2) barring RBC under the doctrine of unclean hands from claiming a settlement credit for the Rural board s final approval of Warburg s offer, which accounted for 25% of the damages; and (3) apportioning 10% liability to Shackelton, 8% to RBC, and 7% to DiMino for the special committee s initiation of the sale process without board approval and in parallel with the EMS process, which accounted for the final 25% of the damages. In so holding, the Court dismissed RBC s contention that DUCATA does not permit disproportionate fault assignations among tortfeasors for judgment reduction (as opposed to contribution), stating that RBC s contention rested on the faulty presumption that DUCATA s use of the term pro rata means equal as opposed to proportionate. 18 It also rejected RBC s arguments that the trial court erred by requiring it to try to prove that the director defendants and Moelis were joint tortfeasors upon the record created at trial, particularly where the defendants had asserted a common interest privilege during the litigation. The Court found that RBC had ample opportunity to develop a record in support of its contribution claims at trial and through post-trial briefs and that RBC did not object to the settlement or partial final judgment entered by the Chancery Court. The Court also rejected RBC s contention that the trial court erred in not finding the settling Rural directors and Moelis as joint tortfeasors, noting that the settlement agreement did not contain an admission that they were joint tortfeasors, they had not been adjudicated joint tortfeasors and the settling directors (other than Shackelton and DiMino) would have been exculpated under Rural s charter from monetary liability and, thus, those individuals did not qualify as joint tortfeasors under DUCATA. Furthermore, the Court rejected RBC s contention that it would be inequitable for Rural s directors to be shielded from a claim for contribution because of Rural s exculpatory DGCL Section 102(b)(7) charter provision. The Supreme Court stated that the Delaware legislature did not intend for DGCL Section 102(b)(7) to protect third parties and thereby create a perverse incentive system wherein trusted advisors to directors could, for their own selfish motives, intentionally mislead a board only to hide behind their victim s liability shield when stockholders or the corporation seeks retribution for the wrongdoing. 19 Moreover, the Court rejected RBC s contention that the interplay of exculpatory charter provisions and DUCATA causes a financial advisor to bear a disproportionate and inequitable share of the liability of grossly negligent directors, noting that a financial advisor is potentially liable for aiding and abetting only if it acted with scienter. IMPLICATIONS The Court s opinion reinforces the need for boards to be actively engaged in establishing reasonable procedures to identify and monitor their advisors conflicts of interest to ensure that any sale process is not tainted by those conflicts. But it also makes clear that even if the board has instituted such safeguards, financial advisors need to be proactive in disclosing and documenting the disclosure of their -8-

9 conflicts as they may arise throughout a sale process or risk liability from any resultant unreasonable sale process. * * * ENDNOTES , No. 140, 2015 (Del. Nov. 30, 2015) [hereinafter Slip Op.]. See In re Rural Metro Corp. S holders Litig., 102 A.3d 205 (Del. Ch. 2014); In re Rural Metro Corp. S holders Litig., 88 A.3d 54 (Del. Ch. 2014). For a full discussion of the Court of Chancery s Rural Metro opinions, see our publication, dated October 17, 2014, entitled In re Rural/Metro Corp. Stockholders Litigation. Slip Op. at 59. Id. at 74. Id. at 34. Revlon, Inc. v. MacAndrews & Forbes Hldgs., Inc., 506 A.2d 173 (Del. 1986). Slip Op. at 60, 61. Id. at 59, n.121. Id. at 55, n.110. See C & J Energy Servs., Inc. v. City of Miami Gen. Emps. & Sanitation Emps. Ret. Trust, 107 A.3d 1049 (Del. 2014). Slip Op. at 76. Id. at 76. Id. at 79. Id. at Id. at 80. Id. at 80, n.191. See, e.g., Huff Fund Inv. P ship v. CKx, Inc., 2013 WL (Del. Ch. Nov. 1, 2013), aff d, 2015 WL (Del. Feb. 12, 2015). For a full discussion of the Huff Fund case, see our publication, dated February 18, 2015, entitled Huff Fund Investment Partnership v. CKx, Inc. Slip Op. at 92. Id. at Copyright Sullivan & Cromwell LLP

10 ABOUT SULLIVAN & CROMWELL LLP Sullivan & Cromwell LLP is a global law firm that advises on major domestic and cross-border M&A, finance, corporate and real estate transactions, significant litigation and corporate investigations, and complex restructuring, regulatory, tax and estate planning matters. Founded in 1879, Sullivan & Cromwell LLP has more than 800 lawyers on four continents, with four offices in the United States, including its headquarters in New York, three offices in Europe, two in Australia and three in Asia. CONTACTING SULLIVAN & CROMWELL LLP This publication is provided by Sullivan & Cromwell LLP as a service to clients and colleagues. The information contained in this publication should not be construed as legal advice. Questions regarding the matters discussed in this publication may be directed to any of our lawyers listed below, or to any other Sullivan & Cromwell LLP lawyer with whom you have consulted in the past on similar matters. If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Stefanie S. Trilling ( ; trillings@sullcrom.com) in our New York office. CONTACTS New York Francis J. Aquila aquilaf@sullcrom.com Audra D. Cohen cohena@sullcrom.com H. Rodgin Cohen cohenhr@sullcrom.com Mitchell S. Eitel eitelm@sullcrom.com Brian T. Frawley frawleyb@sullcrom.com Joseph B. Frumkin frumkinj@sullcrom.com C. Andrew Gerlach gerlacha@sullcrom.com Brian E. Hamilton hamiltonb@sullcrom.com John L. Hardiman hardimanj@sullcrom.com Matthew G. Hurd hurdm@sullcrom.com Alexandra D. Korry korrya@sullcrom.com Stephen M. Kotran kotrans@sullcrom.com Mark J. Menting mentingm@sullcrom.com Scott D. Miller millersc@sullcrom.com James C. Morphy morphyj@sullcrom.com Keith A. Pagnani pagnanik@sullcrom.com George J. Sampas sampasg@sullcrom.com Melissa Sawyer sawyerm@sullcrom.com Alan J. Sinsheimer sinsheimera@sullcrom.com -10-

11 Krishna Veeraraghavan Washington, D.C. Janet T. Geldzahler Los Angeles Eric M. Krautheimer Alison S. Ressler Robert A. Sacks Palo Alto Brendan P. Cullen Sarah P. Payne London Richard C. Morrissey David Rockwell Paris William D. Torchiana Frankfurt Krystian Czerniecki David Rockwell Melbourne Robert Chu Tokyo Izumi Akai Keiji Hatano Hong Kong William Y. Chua Michael G. DeSombre Chun Wei Beijing Garth W. Bray SC1: A -11-