Delaware Supreme Court upheld US$76M award against RBC Capital for “tainted” merger advice
Whether or not Canadian courts would come to the same conclusion as the Delaware Supreme Court in upholding a US$76 million award against RBC Capital is unclear, but the late November decision has already had an impact on the way that Canadian boards and their financial advisors relate in change-of-control situations.
In re Rural/Metro Corp. Shareholders Litig.’s conclusion was that RBC had given Rural tainted merger advice by urging it to sell to private equity firm Warburg Pincus LLP without disclosing that the bank was seeking fees from both vendor and purchaser in the deal.
The upshot is that financial advisors have been increasingly careful to ensure they disclose any conflicts of interests and they often require further consents when they take on new assignments.
“The old wishy-washy approach of ‘we do all sorts of things for all sorts of people’ is disappearing when parties are explaining conflicting or potentially conflicting relationships,” says Benoît Dubord of Stikeman Elliott LLP in Montréal. “The discussions are now much more specific.”
Ultimately, the case has become a cautionary beacon.
“It’s a good reminder of the importance of independent advice for boards on the sell side,” says Matthew Cumming of McCarthy Tétrault LLP in Toronto. “The case has also been helpful in raising awareness of what might amount to tainted advice.”
In 2010, Rural/Metro was contemplating a bid for American Medical Response (AMR), its sole competitor in the ambulance business and a subsidiary of Emergency Medical Services Corporation (EMS).
At the time, the street had it that EMS was up for sale. RBC advised Rural that private equity firms might also be interested in AMR. But RBC also believed that a private equity firm that acquired EMS might decide to buy Rural rather than sell AMR. The advisor reasoned that if RBC led a sale process for Rural, it could use its position by become a buy-side advisor with the private equity firm bidding for EMS. As RBC saw it, the private equity firms bidding for EMS might believe they would be in a better position to buy Rural if RBC was part of the financing package for their EMS bid.
Rural formed a special committee to consider its M&A alternatives, but the committee’s mandate did not include pursuing a sale of Rural. The committee retained RBC as its financial advisor, who promptly put Rural in play without board authority. Although six private equity firms were contacted, only Warburg Pincus made a bid. Another private equity firm, which had just won the bidding for EMS, was refused an extension of time to make a formal offer.
In March 2011, the special committee instructed RBC to engage in final negotiations with Warburg. At the same time, and without Rural’s knowledge, RBC was pursuing a role in providing financing to Warburg. But after both RBC and another financial advisor provided favourable fairness opinions, the sale was approved with a 72 per cent majority of voting shares.
Subsequently, a group of shareholders sued Rural’s directors for breach of fiduciary duties and failure to meet disclosure obligations. As well, they sued RBC and the other financial advisors for aiding and abetting the breaches of fiduciary duty. The directors and the additional financial advisor settled for a total of $11.5 million, but RBC proceeded to trial.
At first instance, the Delaware Court of Chancery found both the directors and RBC liable, concluding that RBC had “knowingly participated in the Board’s breach of its duty of care by creating the informational vacuum that misled the Board.” Among its transgressions, RBC had failed to disclose its interest in the buy-side financing and failed to uphold its duty as a “gatekeeper” of the M&A process.
On appeal, the Delaware Supreme Court rejected the “gatekeeper” characterization: it was not the case, the higher court ruled, that any failure by a financial advisor to prevent directors from breaching their duties gave rise to an aiding and abetting claim against the advisor.
Still, because RBC, motivated by its conflicting interests, had knowingly created an informational gap that led to the directors’ breach of their duties, the finding of liability against RBC stood.
Dubord points out that the court’s reasoning “contains certain concepts that don’t exist” in Canadian law.
“So it’s difficult to say exactly how the decision would translate into Canadian jurisprudence,” he notes. “At the same time, that doesn’t detract from the fact that Rural/Metro’s teachings are highly relevant here. At the very least, the case is ensuring that the discussion about potential conflicts is happening at the outset of a relationship.”