On November 30, 2015, in RBC Capital Markets, LLC v. Jervis (C.A. No. 6350-VCL) the Delaware Supreme Court upheld the principal rulings finding financial advisor RBC Capital Markets, LLC liable for approximately $76 million in damages for aiding and abetting breaches of fiduciary duties by former directors of Rural/Metro Corporation in connection with the company’s 2011 sale to private equity fund Warburg Pincus LLC. The Court affirmed the trial court’s ruling that the board breached its duty of care under Revlon even though the board’s failures were primarily attributable to RBC’s undisclosed conflicts of interest. The Court then held that RBC was liable for aiding and abetting the board’s breach because it mislead the board and created the informational vacuum that led to the faulty sale process, which proximately caused the company to be sold at a price below fair value.
In late 2010, Rural/Metro’s board began considering strategic alternatives and assembled a special committee of independent directors. The board hired RBC as its primary financial advisor and Moelis as its secondary financial advisor. At around the same time, Emergency Medical Services (“EMS”), the parent company of a Rural/Metro competitor, had also announced its intention to sell itself. RBC wished to obtain a role providing buy-side financing to any bidder for EMS and believed it could use its position as sell-side advisor to Rural/Metro’s board to get on EMS bidders’ “financing trees.” RBC believed that a buyer of EMS might want to later combine EMS with Rural/Metro and that the buyer would give RBC a role in financing the EMS acquisition in order to gain access to Rural/Metro. With this in mind, RBC structured the Rural/Metro sale to occur on a parallel track with the EMS sale. Meanwhile, RBC also wished to provide acquisition financing to any bidder for Rural/Metro.
Approximately 28 financial bidders were contacted to participate in the Rural/Metro auction. Warburg Pincus submitted the only bid, although another private equity fund (the ultimate buyer of EMS) requested a bid extension but was denied.
On March 28, 2011, after RBC and Moelis delivered their fairness opinions, the board accepted Warburg Pincus’ bid for $17.25 per share in cash and the transaction closed in June 2011.
On April 8, 2013, former stockholders of Rural/Metro sued the former board members in the Delaware Court of Chancery on claims for breaches of fiduciary duty, and RBC and Moelis for aiding and abetting those breaches. Within a month, the directors and Moelis settled the litigation in exchange for broad releases of claims for $6.6 million and $5 million, respectively. The case proceeded to trial solely against RBC and on March 7, 2014, Vice Chancellor Laster of the Delaware Court of Chancery issued a post-trial decision holding RBC liable for aiding and abetting the board’s breach of its fiduciary duty of care. On October 10, 2014, the Court of Chancery set the amount of RBC’s liability at approximately $76 million, constituting 83% of the approximately $91 million in total damages that the stockholder class suffered based on the company’s value as a going concern. RBC appealed the decision.
Board’s Duty of Care Breach. As a threshold matter, the Delaware Supreme Court found that the enhanced scrutiny standard under Revlon applied when the special committee commenced the Rural/Metro sale in December 2010 because the evidence demonstrated that the committee had decided to sell the company and had already abandoned other strategic alternatives, even though the full board only technically authorized the sale on March 2011. The Court then held that the board failed to fulfill its Revlon duties to attain the best value for the stockholders because it failed to conduct an auction within the bounds of reasonableness. The Court held that, while a board is generally free to rely upon the advice of its financial advisor and to consent to conflicts, the Rural/Metro board failed to implement adequate procedures to actively oversee and manage the sale process, including the need to identify, respond and actively manage RBC’s conflicts of interest. The Court concluded that this failure led to a faulty sale process that rendered the pre- and post-signing market checks ineffective and left the board ill-informed of the company’s true value.
RBC’s Aiding and Abetting Liability. RBC had argued that it could not be found liable for “knowingly participating” in a breach of a fiduciary duty if the underlying breach by the directors is exculpated or not intentional. RBC further argued that it could not “knowingly participate” in the breach if its conduct was simply to mislead the board. The Court disagreed, holding that it is the aider and abettor, not the board, that must act with scienter for purposes of aiding and abetting liability. It then affirmed the trial court’s ruling that “[i]f the third party knows that the board is breaching its duty of care and participates in the breach by misleading the board or creating the informational vacuum, then the third party can be liable for aiding and abetting.”
Importantly, the Court noted that its ruling was narrow and should be cabined by the “unique facts” at hand. In response to an amicus brief that argued for a reversal due to the “anomalous imbalance of responsibilities” that would occur if a banker is held liable for aiding and abetting a duty of care breach for which the board, itself, is exculpated — the Court urged parties not to read the decision expansively. The Court noted that the decision was tightly premised on the financial advisor’s intentional “fraud on the board” and explained that the decision should not be read to subject a financial advisor or non-fiduciary to aiding and abetting liability for its failure to prevent a duty of care breach. It then dispelled the notion of “gatekeeper liability” for advisors and said that the decision should not be read to support the Court of Chancery’s dictum characterizing financial advisors as “gatekeepers” for boards generally in an M&A transaction.
Corwin v. KKK Financial Holdings. The Court also addressed what standard of review should apply to the underlying duty of care breach for purposes of a third-party’s aiding and abetting liability. In Corwin v. KKR Financial Holdings LLC (Del. October 2, 2015), the Court held that the business judgment rule (not Revlon) applied in post-closing claims against directors for monetary damages where the transaction was negotiated at arms-length and the stockholders had approved the transaction in an informed vote. RBC argued that under KKR Financial, the trial court had erred by finding a duty of care violation without finding that the board acted with gross negligence. The Court disagreed, finding that its application of Revlon was a sufficient predicate for its finding of aiding and abetting liability against RBC. The Court acknowledged KKR Financial but noted that the plaintiffs here were not seeking to impose liability on the director defendants and that for purposes of aiding and abetting liability, a duty of care breach had occurred. (While not discussed, the posture here was also different in that the stockholders’ vote was not informed.)
Takeaways. The RBC decision concludes the latest chapter in Delaware’s long-standing focus on banker conflicts that were initially highlighted in Del Monte and El Paso but also recently discussed in In re PLX and In re Zale Corporation. The ruling serves as another reminder that while boards are free to accept and waive financial advisor conflicts, it is ultimately the board’s responsibility to be active and diligent throughout the sale process, which includes the need to identify, manage, oversee and disclose those conflicts. While none of this is new, the more recent decisions strongly suggest the need for boards to thoroughly diligence (through contracts or otherwise) any actual or potential conflicts of interest and to disclose material conflicts to stockholders in as specific detail as possible. While many parties have already adopted these deal practices, for boards, RBC and the more-recent decisions should help combat bankers’ reticence to disclose and vet potential conflicts at the outset of (or even better, before) an engagement and to address such conflicts specifically in representations and covenants in the banker engagement letter and throughout the sale process. It is worth emphasizing, however, that a board decision to proceed with an engagement that is the product of best practices in spite of any real or perceived conflict should not impact the legitimacy of the engagement.
See RBC Capital Markets, LLC v. Jervis (Del. Nov. 30, 2015)