Delaware Court Holds M&A Financial Advisor Liable For $76 Million

The following post comes to us from Jason M. Halper, partner in the Securities Litigation & Regulatory Enforcement Practice Group at Orrick, Herrington & Sutcliffe LLP, and is based on an Orrick publication authored by Mr. Halper, Peter J. Rooney, and Louisa S. Irving. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On October 10, 2014, the Delaware Court of Chancery issued a decision awarding nearly $76 million in damages against a seller’s financial advisor. In an earlier March 7, 2014 opinion in the case, In re Rural/Metro Corp. Stockholders Litigation, Vice Chancellor Laster found RBC Capital Markets, LLC liable for aiding and abetting the board’s breach of fiduciary duty in connection with Rural’s 2011 sale to private equity firm Warburg Pincus for $17.25 a share, a premium of 37% over the pre-announcement market price. The recent decision reinforces lessons from the March 7 decision and provides new guidance for directors and their advisors in M&A transactions and related litigation.

Background

Prior to trial, the other defendants—Rural’s board of directors and its “secondary” financial advisor, Moelis & Company LLC—agreed in principle with plaintiffs to settle the action. RBC then amended its answer to assert a cross-claim for contribution, but did not allege (and at trial did not argue) any wrongdoing by the other defendants. After trial, at a hearing at which RBC did not object, the Court approved the proposed settlements, which barred all claims for contribution against the settling defendants but provided that damages against RBC would be reduced to the extent of the pro rata shares of liability on the part of the settling defendants.

In the March 7 post-trial opinion, Vice Chancellor Laster found that RBC was monetarily liable even though a majority of the directors were shielded from liability under the company’s Section 102(b)(7) exculpatory provision. The Court cited evidence that RBC: (i) did not disclose its efforts to secure a buy-side financing role from Warburg; (ii) manipulated its financial analysis to justify the transaction and offered false reasons for certain changes in the analysis; and (iii) provided false information to the Board regarding its financial analysis that led to misleading disclosure in the proxy statement.

In the October 10 opinion, the Court determined that compensatory damages as measured by plaintiffs’ out-of-pocket loss represented the correct method for awarding a recovery. The Court found that out-of-pocket loss is the difference between what plaintiffs received as merger consideration and the stock’s “fair” or “intrinsic value” at that time determined using the same methodologies employed in an appraisal proceeding. After considering expert testimony, the Court found that the intrinsic value of Rural stock at the time of the merger was $21.42/share, or $4.17/share more than the merger consideration. Since there were 25,380,542 shares of Rural common stock outstanding, the class sustained damages of $91,323,554.61. In reaching this conclusion, the Court did not address the fact that Rural filed for bankruptcy approximately two years after the transaction closed, wiping out Warburg’s equity stake.

The Court then addressed RBC’s arguments for reduction of the damages award based on apportioning fault to the settling defendants, and in doing so made a number of significant findings that have implications for boards and their advisors in company sale transactions and related litigation.

Takeaways

  • Denying Contribution or a Settlement Credit Based on Equities: After lengthy analysis the Court found that a defendant that commits an intentional tort can, under the Delaware Uniform Contribution Among Tortfeasors Act (DUCATA), seek contribution from a joint tortfeasor, i.e., contribution is not available only to those defendants who acted with a less culpable state of mind. Even though permitted by statute, courts retain discretion to deny contribution “if warranted by the facts of the case,” including based on equitable considerations. In considering the equities the Court made clear that the relevant analysis was RBC’s conduct vis-a-vis other joint tortfeasors and not vis-a-vis the class. The Court found that RBC was barred from claiming a settlement credit to the extent it perpetrated a “fraud upon the board,” which it characterized as a “failure of insiders to come clean” about their own or others’ wrongdoing. The Court found that RBC’s conduct, as described above, precluded it from claiming a settlement credit, except for the aspect of the breach of fiduciary duty involving two of the directors initiating a sales process without authorization.The decision reinforces recent Delaware caselaw making clear that Delaware courts will closely scrutinize the conduct of financial advisors and not hesitate to hold the advisors accountable for self-interested conduct deemed detrimental to their clients. Rural, In re El Paso Corp. Shareholder Litigation, In re Del Monte Foods Co. Shareholder Litigation, and other decisions have criticized the conduct of financial advisors who appeared to act to further their self-interest rather than acting in the interests of the company they were advising.
  • The Court questioned but did not decide whether RBC would have waived its right to a settlement credit or contribution in a jury trial because RBC never sought a determination that the directors or Moelis were joint tortfeasors. The Court found that in a bench trial, it could make that determination based on the available record.This ruling highlights the difficult strategic questions for counsel in a jury trial involving whether to present alternative but inconsistent arguments to a jury that, on the one hand, there was no breach of fiduciary duty but, on the other, if there was, it was the responsibility of the other defendants. And, even in a bench trial, there is no guarantee that a different judge would rule as did Vice Chancellor Laster that it is permissible to apportion fault without the defendant found liable having presented such an argument at trial.
  • The Court rejected RBC’s argument that the settlement agreement among plaintiffs and the other defendants contained admissions of liability such that the Court could find the settling defendants joint tortfeasors on that basis. The settlement agreement provided that the “damages recoverable against non-settling defendant RBC … will be reduced to the extent of the pro rata shares, if any, of Moelis and the Rural/Metro Defendants.” To the Court, the “if any” language meant that the settling defendants contemplated they might not have any share of liability and thus might not be joint tortfeasors.Counsel for settling defendants need to exercise great care in drafting language surrounding contribution and settlement credits. Settling defendants want to preserve the possibility that they will not be found joint tortfeasors, while non-settling defendants need at the very least to hold open that possibility, including where appropriate raising objections to approval of a settlement that purports to preclude or limit the availability of contribution.
  • The Court rejected RBC’s argument that it should not have to establish that the other defendants were joint tortfeasors because their settlement deprived RBC of the chance to prove its claims for contribution at trial. The Court observed that “the situation that RBC faced is a function of being the last non-settling defendant” and was “endemic to the litigation process.” The Court further noted that the settling defendants remained parties in the action for purposes of trial after agreements-in-principle were reached and RBC had the opportunity to develop a record at trial to support its contribution claims, including based on three of the director defendants testifying at trial.Once again, non-settling defendants face important tactical considerations by proceeding alone to trial, including whether and to what extent to put on trial the conduct of the settling defendants. Non-settling defendants risk liability for the full amount of a damages award (less available settlement credits) notwithstanding that settling defendants breached fiduciary duties.
  • The Court determined that those directors protected from monetary liability by Rural’s Section 102(b)(7) exculpatory provision were not “joint tortfeasors” under DUCATA such that the settlement credit would not be available with respect to the conduct of these defendants. The Court then found that only two of the seven directors (both of whom were called to testify at trial) engaged in unprotected conduct based on breaches of the duty of loyalty and therefore qualified as joint tortfeasors.The Court’s ruling on this issue yields three significant lessons. First, the exculpatory provision resulted in RBC having to shoulder an increased portion of the damages award since it could not claim a settlement credit with respect to the conduct of the exculpated directors. Second, the ruling emphasizes again the Delaware Chancery Court’s intolerance of conduct suggesting disloyalty toward the company. The Court, for instance, rejected RBC’s argument that Moelis, as a financial advisor to Rural, was equally at fault for aiding and abetting the directors’ breaches of fiduciary duty. Even though both served as financial advisors, the Court concluded that RBC “pushed hard” for a near-term sale whereas Moelis did not. Further, Moelis did not provide false information regarding financial analyses to the Board and did not seek to provide buy-side transaction financing. Therefore, RBC was not afforded the benefit of a settlement credit based on any fault attributable to Moelis. Third, the decision underscores the importance of recognizing the tactical issues raised in deciding whether to call a defendant to testify at trial. The Court might have found that a third director breached a duty of loyalty and attributed a percentage of fault to him, thereby reducing RBC’s damages, if he had testified at trial. The Court refused to so hold, notwithstanding “evidence suggesting that selfish motives played a role in [his] actions” because “[c]ritically … no one called [him] at trial, and I did not have an opportunity to evaluate his credibility. In my view it would take a powerful and persuasive evidentiary showing to permit a court to find in absentia that a director acted disloyally or in bad faith.”
  • The Court assigned 87% of the fault to RBC and 13% to the two non-exculpated directors. The Court arrived at these percentages by concluding that: (i) the disclosure and sales process claims weighed equally in causing damages; (ii) RBC was solely responsible for the false disclosure, and therefore the full 50% of the damages attributable to that claim was assigned to RBC; (iii) RBC was not entitled to a settlement credit with respect to the breaches of duty that involved its “fraud upon the board,” to which the Court attributed another 25% of the damages to RBC; and (iv) based on the Court’s assessment of relative fault, RBC, Shackelton and Davis were allocated 8%, 10% and 7% fault, respectively, with respect to the directors’ initiating a sales process without authorization.This aspect of the decision calls into question whether non-settling defendants need to attempt to apportion responsibility for a damages award among different claims, in addition to different defendants, and how to do so. At the very least, consideration should be given to introducing expert and possibly fact testimony on this issue.

For a copy of the decision, click here.

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