Delaware’s Supreme Court Upholds Smack-down of RBC

Delaware’s Supreme Court Upholds Smack-down of RBC

In a decision that fund managers invested in the equities of Delaware chartered corporations, especially those inclined to trade on the possibility of mergers, will want to study, the Supreme Court of Delaware has upheld a decision adverse to RBC Capital Markets LLC, in litigation that arose out of RBC’s conflicted involvement in a bidding war in the world of privately owned ambulances.

In March 2014, Vice Chancellor Laster, on behalf of the Chancery Court, found that RBC was liable for aiding and abetting breaches of fiduciary duty by Rural Metro’s board of directors. In October of that year Chancery fixed the amount of damages at close to $76 million. Thirteen months later, the state’s Supreme Court has now upheld the chief factual and legal findings of the court below.

The key factual points are as follows:

  • During the liability phase, Chancery found that three of the directors of ambulance firm Rural Metro had (in the words of the appellate decision), “personal circumstances that inclined them toward a near-term sale” even at the expense of optimal return for their shareholders.
  • RBC served both Rural Metro and its primary competitor, EMS, in an advisory capacity. Responsible RBC officials came to understand that a private equity firm that acquired EMS might then decide to buy RBC.
  • Accordingly, these officials decided that “if Rural engaged in a sales process led by RBC, then RBC could use its position as sell-side advisor to secure buy-side roles with the private equity firms bidding for EMS.”
  • The board of Rural “failed to become informed about strategic alternatives and about potential conflicts of interest faced by the advisors, and approved the merger [with an affiliate of Warburg Pincus] without adequate information, including the value of not engaging in any transaction.”
  • In May 2011 Rural filed a proxy statement with material misstatements of fact involving EBITDA as well as misleading omissions about the auction process.

Neither Perfect nor Reasonable

As to the standard for its own scrutiny of this matter on appeal, the Supreme Court quoted its decision last year in C&J Energy Services, “There is no single blueprint that a board must follow to fulfill its duties, and a court applying Revlon’s enhanced scrutiny must decide whether the directors made a reasonable decision, not a perfect decision.” Italics in original.

In this instance, the Supreme Court found, the board’s “passivity and lack of effective oversight of the sales process was unreasonable,” not merely somewhere in the zone of tolerable imperfection.

The board members are not parties to this action. The significance of the above findings is that their passivity in the face of RBC’s shenanigans is sufficiently unreasonable, in fact, to serve as a predicate for a finding of aiding and abetting liability against RBC. That sounds a bit circular to a layperson. RBC aided and abetted the board of Rural in … its passivity in allowing RBC to control the sale. Still, the point seems to be that the shareholders were cheated, that Rural was sold at a price well below its fair market value, and that RBC has both the liability and the deep pockets necessary to make that right.

The opinion as a whole confirms the general trend that the Delaware courts are becoming more intrusive in their inquiries into mergers and acquisitions. This may mean, in months and years to come, that some mergers won’t happen that otherwise would have, because individuals and institutions concerned will back away from deals that could come under this sort of after-the-act judicial scrutiny.

A Long Footnote

But … the Supreme Court didn’t authorize quite as aggressive a level of after-the-fact scrutiny as some of the language of the Chancery opinion had suggested. Rolling back some of the judicial rhetoric seems to be the point of a long footnote to be found deep into this decision, on pages 82-83 in fact.

The Chancery had observed that “financial advisors … function as gatekeepers” in the sales process, providing services, including valuation, that the board does not have the expertise to do for itself.

The Supreme Court disapproves of this language, which would it says inappropriately expand the narrow basis of a liability finding “by suggesting that any failure by a financial advisor to prevent directors from breaching their duty of care gives rise to an aiding and abetting claim against the advisor.”

The test for an aiding and abetting claim against a third party advisor must remain a “stringent” one, the high court says.

That footnote is destined to find itself quoted in law review articles, trial memorandum, and appellate briefs, often and for a long time to come.

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