Tuesday, December 1, 2015
No, no, no. The sky isn't falling. Yes, it's true that the $75 million damage award against RBC for aiding and abetting a duty of care violation by the board of Rural/Metro in connection with the company's sale was upheld, but the sky is not falling.
In the Rural/Metro Chancery Court opinion, Vice Chancellor raised the spectre of a falling banker sky when he emphasized the role of bankers as gatekeepers of the M&A process:
The threat of liability helps incentivize gatekeepers to provide sound advice, monitor clients, and deter client wrongs. Framed for present purposes, the prospect of aiding and abetting liability for investment banks who induce boards of directors to breach their duty of care creates a powerful financial reason for the banks to provide meaningful fairness opinions and to advise boards in a manner that helps ensure that the directors carry out their fiduciary duties when exploring strategic alternatives and conducting a sale process, rather than in a manner that falls short of established fiduciary norms. It is not irrational for the General Assembly to have excluded aiders and abettors from the ambit of those receiving exculpation under Section 102(b)(7). The statutory language therefore controls.
By holding bankers' feet against the fire and expanding liability for bankers, the fear of aiding and abetting liability might ensure financial advisors are more attentive to their obligations to clients. This prospect sent some shockwaves through the world of bankers. But that fear might have been a little over-wrought.
In yesterday's ruling, the Delaware Supreme Court made it clear that although the facts in this particular case supported an aiding and abetting claim, the ruling was not an expansion of banker liability along the lines suggested in the Chancery Court opinion: "[O]ur holding is a narrow one that should not be read expansively to suggest that any failure on the part of a financial advisor to prevent directors from breaching their duty of care gives rise to a claim for aiding and abetting a breach of the duty of care."
In narrowing its ruling, the court expanded on Vice Chancellor Laster's gatekeeper analysis and in the process narrowed its bite:
In affirming the principal legal holdings of the trial court, we do not adopt the Court of Chancery’s description of the role of a financial advisor in M & A transactions. In particular, the trial court observed that “[d]irectors are not expected to have the expertise to determine a corporation’s value for themselves, or to have the time or ability to design and carryout a sale process. Financial advisors provide these expert services. In doing so, they function as gatekeepers.” Rural I, 88 A.3d at 88 (citations omitted). Although this language was dictum, it merits mention here. The trial court’s description does not adequately take into account the fact that the role of a financial advisor is primarily contractual in nature, is typically negotiated between sophisticated parties, and can vary based upon a myriad of factors. Rational and sophisticated parties dealing at arm’s-length shape their own contractual arrangements and it is for the board, in managing the business and affairs of the corporation, to determine what services, and on what terms, it will hire a financial advisor to perform in assisting the board in carrying out its oversight function. The engagement letter typically defines the parameters of the financial advisor’s relationship and responsibilities with its client. Here, the Engagement Letter expressly permitted RBC to explore staple financing. But, this permissive language was general in nature and disclosed none of the conflicts that ultimately emerged. As became evident in the instant matter, the conflicted banker has an informational advantage when it comes to knowledge of its real or potential conflicts. See William W. Bratton & Michael L. Wachter, Bankers and Chancellors, 93 TEX. L. REV. 1, 36 (2014) (“The basic requirements of disclosure and consent make eminent sense in the banker-client context. The conflicted banker has an informational advantage. Contracting between the bank and the client respecting the bank’s conflict cannot be expected to succeed until the informational asymmetry has been ameliorated. Disclosure evens the field: the client board has choices in the matter . . . and needs to make a considered decision regarding the seriousness of the conflict.”). The banker is under an obligation not to act in a manner that is contrary to the interests of the board of directors, thereby undermining the very advice that it knows the directors will be relying upon in their decision making processes. Adhering to the trial court’s amorphous “gatekeeper” language would inappropriately expand our narrow holding here 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.
So, bankers are not insurers of bad director behavior. Bankers are insurers of their own behavior. If bankers want the benefit of conflict waivers, then specific disclosure is the answer. If you are going to act in a way that might raise a conflict, then disclose the facts and allow the client board to make an informed waiver of those specific acts. I suspect that for the vast majority of the investment banking community, this is not going to be an issue. Conclusion: sky intact.