Monday, March 10, 2014
Vice Chancellor Laster handed down a decision in Rural Metro Corporation Stockholders Litigation (opinion here) on Friday evening. It's Del Monte-like, in that it's the kind of opinion that's going to generate a lot of ink and opinions.
If it wasn't already clear to investment banks, it should be now. The Delaware courts are going to look very closely at transactions where there may be banker conflicts brought about by the prospect of staple financing. In this particular case, RBC was brought in to advise the Special Committee of Rural Metro on strategic alternatives. While advising on the potential sale, RBC pursued opportunities to assist the ultimate purchaser in providing financing for the transaction. Though RBC wasn't ultimately successful in securing that business from Warburg (the buyer), it did provide a $65 million revolver for Warburg. Warburg purchased Rural Metro for $17.25/share.
Stockholders subsquently sued the directors and brought an aiding and abetting claim against RBC. The directors sued and RBC went to trial on the aiding and abetting claim. The gist of the shareholders' argument was that RBC manipulated the sales process in order to benefit Warburg and thereby put itself in a good position to secure the financing business from the buyer. By failing to disclose or deal fairly with the board, RBC caused the board to violate its duty of care in approving the transaction.
By fooling with the DCF analysis, RBC was able to take a transaction that look just ok and make it look super:
The combined effect of lowering ―consensus adjusted EBITDA by $6.7 million and lowering the low-end multiple from 7.5x to 6.3x was dramatic. On Saturday morning, the consensus precedent transaction range was $13.31 to $19.15. On Saturday afternoon, it was $8.19 to $16.71, entirely below the deal price.
RBC‘s DCF analysis showed a range of $16.28 to $21.07, with a base case price of $18.73. RBC used an exit multiple range of 7.0x to 8.0x, which did not match up with the range used for RBC‘s precedent transaction analysis. On February 8, 2011, RBC had provided to DiMino an LBO analysis with an exit multiple range of 7.8x to 8.3x. If the bottom of the exit multiple range was 7.5x (the original bottom of the precedent transaction ranges), then the bottom of the DCF range would be $18.00, above the deal price. When Munoz saw the DCF range, he commented, ―"I thought we were going to try to reduce dcf?" JX 529.
During the afternoon of March 26, Munoz let Fleming know that Warburg was still refusing to include RBC on the financing side. Fleming responded, "I‘m gonna call [W]arburg myself. We just committed 65 to their effing revolver." JX 525. When he asked Munoz for a further update, Munoz wrote,"Not on email." Id.
Yes. Not on email. This is precisely the kind of thing that gives investment bankers a bad name... not to mention the process by which RBC generated a 'fairness opinion'. Oh, and those are 'air quotes' for a reason.
It's worth remembering, that when RBC was manipulating the models to make Warburg's deal look great, RBC and the Rural Metro board were also processing the Del Monte opinion. Funny that it appears not to really have sunk in. Maybe it will now.
In Rural Metro, the facts suggest just how a conflicted banker can work against its client in hopes of furthering its financing business. It's clear that the Chancery Court finds this kind of conflict pernicious. Staple financing and the kind of monkeying around done by RBC in this deal present real conflicts for bankers. These conflicts and the incentives that come along with bankers trying to generate additional business by using a position with another client may present an insurmountable hurdle.
These conflicts and the incentives are so real that the court makes it clear that generic conflict language of the type included in RBC's engagement letter is not going to be enough to generate a waiver of the bank's conflict:
This generalized acknowledgment that RBC and Moelis might extend acquisition financing to other firms did not amount to a non-reliance disclaimer that would waive or preclude a claim against RBC for failing to inform the Board about specific conflicts of interest. See RAA Mgmt., LLC v. Savage Sports Hldgs., Inc., 45 A.3d 107, 116-19 (Del. 2012) (explaining why clear and unambiguous non-reliance disclaimer clauses and waiver provisions are enforceable to bar certain fraud claims under New York and Delaware law). Rural did not waive any claim that RBC‘s sell-side advice was tainted by an undisclosed material self-interest. If RBC thought it was obtaining a waiver in the engagement letter without first disclosing the conflict and its import, then it was committing ―what, in the old days, might have been called "constructive fraud." Hollinger Int’l, Inc. v. Black, 844 A.2d 1022, 1068 (Del. Ch. 2004), aff’d, 872 A.2d 559 (Del. 2005).
Although the court's conclusion may be at odds with the way business is currently practiced and the standard language of investment banker engagement letters, the court is setting down a marker. Generalized acknowledgements of potential conflicts are not going to absolve banks from conflicts. If a bank is going to pursue financing opportunities along with its sell-side advice, it's going to be a lot more explicit about that going-forward. I wonder, if the Special Committee had full knowledge of the extent to which RBC was pursuing the Warburg business - and that it had provided a $65 million revolver whether that information might have changed the questions the committee asked of its bankers or perhaps up the information it would have wanted to see before making the decision to accept the offer.
No doubt, this opinion is going to draw a lot of attention and perhaps criticism. But, I suspect that the court's instinct here -- the get conflicts out in the open and explicitly acknowledged so that board can make fully informed decisions -- is going to win the day eventually.