A trend in Delaware’s corporate law subjects investment banks to increasing levels of civil liability for the advice they give on M&A deals. This might constitute a significant new source of friction and risk for mergers between Delaware incorporated corporations. On the other hand, it might be a symptom that in the current zero-interest-rate environment investment banks have gotten overly enthusiastic about pushing deals through and are making bad decisions in the process.
In March 2014, Vice Chancellor Laster issued a decision in the Rural Metro case that some observers found surprising. This litigation arose out of RBC Capital Markets’ role in facilitating the merger of Rural with an affiliate of Warburg Pincus. Before going further, let’s review its facts.
The Rural Metro Case
Stockholders of Rural, an ambulance company, held that the directors of that company had breached their fiduciary responsibility by approving the sale, and that the bankers had facilitated this bad deal by keeping the directors uninformed.
In particular, Laster’s opinion highlighted the role of one director of Rural, Christopher Shackleton, to whom it said the other directors of the relevant committee of the board “generally deferred.” Shackleton was a managing director of a hedge fund, Coliseum Capital Partners, and Coliseum made its alpha by taking concentrated positions in small cap companies and then “facilitating an exit within approximately three to five years” as the post-trial opinion puts it. Shackleton had become a director of Rural by virtue of Coliseum’s position therein. The plaintiffs believed, (Laster seems to have accepted this view), that Shackleton’s take on the terms of the deal with Warburg was colored by his own desire for securing Coliseum a quick and profitable exit from its position, arguably to the detriment of other shareholders.
The directors themselves settled with the plaintiffs before trial, so the trial of this matter before the Court of Chancery involved the plaintiffs on the one hand and RBC on the other. As a consequence, the trial turned not on the issue of Coliseum/Rural conflict but on RBC’s alleged conflict. RBC was also involved with another potential merger involving an ambulance company at this same time: that other company was EMS, the nearest competitor of Rural.
It should have been obvious to RBC, Laster wrote, that “financial sponsors who participated in the EMS [auction] process would be limited in their ability to consider Rural simultaneously,” yet RBC’s advice was driven by their desire to remain involved in both deals.
In this context, Laster found that “certain decisions fell outside the range of reasonableness.” The bankers were liable.
Just an Anomaly?
It seemed possible at the time that investment bankers could have shrugged off the decision as an anomaly; that is, as an example of how bad cases make bad law. The court might have gone along with business as usual, keeping this particular holding limited to its narrow facts. But the bad news for IBs, and indeed it may be bad news from more systemic points of view as well, is that Rural Metro was not a one-trip-only ticket. It has proved to be the start of a trend.
For example, on October 1, 2015 the same court allowed a case to proceed to trial that pit stockholders in Zale against the Bank of America Merrill Lynch, which had played the advisory role in the sale of Zale to Signet. The court dismissed the claim in the Zale/Signet matter against other defendants, but it did allow the case against Merrill to proceed, on the theory that Merrill had failed to disclose potential conflicts. [That case has since been dismissed after all, but for reasons not pertinent to the basic question of a Rural Metro empowered supervisory role for the courts over IB advice.]
The prominent law firm Wachtell Lipton, a frequent defender of the view that directorial discretion should be in effect unlimited, suggested in a recent memo to its clients that such a “use of tort principles to directly challenge the work of bankers” impairs not only the discretion of those bankers, but that of the boards that hired them, and may have a range of unfortunate unintended consequences.
Questions about such consequences remain in abeyance for the moment, and the Supreme Court of Delaware will likely soon be heard on point. It heard oral arguments on an appeal from the Rural Metro decision on September 30.