On March 7, 2014, Vice Chancellor Travis Laster of the Delaware Court of Chancery found a financial advisor liable for aiding and abetting breaches of fiduciary duties by the board of Rural/Metro Corporation in connection with the company’s 2011 sale to an affiliate of Warburg Pincus LLC. In its 91-page, post-trial opinion, the Court concluded that the financial advisor allowed its interests in pursuing buy-side financing roles in both the sales of Rural/Metro and Emergency Medical Services to negatively affect the timing and structure of the company’s sales process, that the board was not aware of certain of these actual or potential conflicts of interest, and that the valuation analysis provided to the board was flawed in several respects. Both the Rural/Metro board of directors and a second financial advisor to Rural/Metro settled before trial for $6.6 million and $5.0 million, respectively.
This opinion is the latest example of the Court of Chancery’s focus on conflicts of interest involving sell-side financial advisors, as most recently demonstrated in the Del Monte and El Paso decisions. Rural Metro thus underscores the very real and potentially significant liabilities to financial advisors. It also serves as a salient reminder that the actions of advisors, including those carried out unbeknownst to the board, may be imputed to boards that fail to exercise reasonable oversight of their so-called informational “gatekeepers” in a sale process.
We recently distributed a client memorandum discussing the Court’s ruling in more detail. See our recent memo.
- While the Court did not find that sell-side advisors providing financing to a bidder is per se impermissible—and the Court will continue to review such engagements on a case-by-case basis—the Rural Metro opinion underscores the risks where sell-side financial advisors also provide or seek to provide buy-side financing. The opinion further confirms that simply engaging a conflict-free second financial advisor to issue a fairness opinion does not cure any actual or perceived material conflicts of interest involving another financial advisor, particularly when those conflicts are not disclosed to the board.
- Financial advisors must be diligent in disclosing actual or potential material conflicts of interests to their clients and in applicable SEC filings. Indeed, Rural Metro likely will only amplify the already significant spotlight on investment banking conflicts of interest in M&A litigation. A troubling implication of the opinion is that it may encourage shareholder-plaintiffs to add investment banks as aider and abettor defendants at the outset, with the hopes that document discovery will uncover a previously undisclosed material conflict of interest. Such a development would compound the already difficult and complex judgments that investment banks and their advisors—and the Court of Chancery—wrestle with in determining what is a material conflict of interest that needs to be disclosed.
- The Rural Metro opinion is another sobering reminder of the need by boards to be active and reasonably informed participants in the sales process, including with respect to the board’s obligation to identify, consider, and proactively respond to actual or potential material conflicts of interest involving financial advisors. These conflicts issues need to be addressed in the sales process and cannot be cured entirely through robust disclosure in the SEC filings relating to the transaction.
- Consistent with long-standing Delaware law, it is important for boards of directors to issue clear mandates of authorities to the special committees they create and to ensure that special committees do not overstep such mandates. Throughout the Rural Metro opinion, the Court relied on the lack of the special committee’s authority to pursue a sale to establish the board’s underlying fiduciary breach.
- The Court appeared skeptical of the ad hoc fairness committee employed by the financial advisor to deliver its fairness opinion. The fairness committee was permitted to consist of any two or more managing directors who were available to review and approve the proposed opinion, which in this case included a managing director who had never sat on a fairness committee. The Court contrasted this with the process employed by some other investment banks, which have standing fairness committees staffed by designated senior bankers who oversee the opinion process and review opinions to ensure quality and consistency. Advisors may consider reviewing their fairness committee and opinion processes in light of the Vice Chancellor’s analysis of this committee’s level of quality control.