ATTORNEY: Ofer Ganot
POMERANTZ MONITOR, NOVEMBER/DECEMBER 2014
The Delaware Chancery Court is extremely unhappy, to say the least, with financial advisors, hired to advise a company on a potential going-private transaction, who have hidden conflicts of interest that taint their advice to the detriment of the company’s public stockholders. We saw this in the In Re Del Monte Foods Company Shareholder Litig. decided by the Delaware Supreme Court in 2011. Now we see it again, in spades, in the In Re Rural Metro Corporation Stockholders Litig.
There, Vice Chancellor Laster has come down hard on RBC Capital Markets (“RBC”), which advised Rural Metro that its acquisition by Warburg was fair to its stockholders when, in fact, the offering price undervalued the company by over $91 million.
Warburg’s acquisition of Rural Metro was announced in March 2011. The total value of the acquisition was approximately $438 million. Two stockholders filed lawsuits challenging the merger, contending that the members of the Rural Metro board breached their fiduciary duties in connection with the merger, and that the company’s financial advisors, RBC (which acted as Rural Metro’s lead financial advisor) and Moelis & Company (which acted as Rural Metro’s secondary financial advisor) aided and abetted the directors in breaching their fiduciary duties.
The court held two trials – one on the question of liability, decided last March, and the other, decided in October, on apportioning responsibility among the various defendants, including the directors of Rural Metro. At the end of the day, the court held that RBC was almost completely to blame, and accordingly ordered it to pay Rural Metro stock-holders 83% of their total damages, about $76 million.
What did RBC do wrong? In the court’s view, RBC created a conflict for itself by trying to earn multiple fees, from multiple parties, in the same deal. It offered to provide financing to Warburg to help finance its acquisition of Rural Metro, while at the same time advising the company that the acquisition was fair and should be approved.
Making matters worse, it also offered to finance an acquisition of Rural Metro’s lone national competitor -- AMR (and its parent company EMS) -- and scheduled the two bidding processes to occur simultaneously. While this was designed to maximize the fees RBC could potentially earn, this was a disastrous strategy for Rural Metro, because bidders could not make offers or even get involved in merger talks and discovery for both companies at the same time, and as a result fewer potential buyers for Rural Metro came forward to bid. The last straw was RBC providing a fundamentally misleading analysis of the fairness of Warburg’s offer, which Rural Metro’s directors then included in the proxy statement seeking stockholder approval.
The court decided that RBC was 100% responsible for the disclosure violations, which concerned its own financial analyses of Rural Metro’s acquisition. The court also decided that with respect to some of the other breaches of fiduciary duties, RBC had “unclean hands” because it committed “fraud on the board” of Rural Metro, misleading it about its financial analyses, talking it into a disastrous sale strategy, and concealing its conflicts of interest. In such cases, the court held, the advisers may not be entitled to contribution from the other de-fendants. This holding may have the most far-reaching consequences for financial advisors, because it ratchets up their exposure in cases where they mislead the directors.
The court’s analysis resolved several legal issues of first impression under Delaware law, resulting in a 95- page opinion dealing with questions of relative fault, and relative liability, of multiple defendants in a breach of fiduciary duty case. Complicating matters was that other defendants, including the Rural Metro directors, had settled the claims against them prior to trial, triggering complex issues relating to settlements involving some, but not all, “joint tortfeasors.” When such partial settlements happen, the non-settling defendants have the difficult job of proving that it was really the other guys -- those who settled -- who were primarily to blame for what happened and paid less than their fair share in their settlement. In this case, RBC failed at that job and will suffer the consequences.