In In re Rural Metro Corporation, C.A. No. 6350-VCL (Del. Ch. Mar. 7, 2014), Vice Chancellor Laster found a third-party financial advisor, RBC Capital Markets, LLC (“RBC”), liable for aiding and abetting breaches of fiduciary duties of the Board of Directors (“Board”) of Rural/Metro Corporation (“Rural” or the “Company”) during the Company’s merger with Warburg Pincus LLC (“Warburg”). Rural is a Delaware corporation that provides ambulance and fire protection services.
At the Board’s regular meeting in December 2010, the Board authorized a special committee (the “Special Committee”) to retain advisors and present a recommendation to the Board about whether the Company should pursue its own growth plan, a sale of the Company, or a transaction involving American Medical Response (“AMR”), Rural’s only competitor. The Board did not authorize the Special Committee to pursue a sale of the Company. Around the same time, private equity firms were looking to acquire Emergency Medical Services (“EMS”), AMR’s parent company, and some of those firms believed AMR should be separated from EMS.
RBC recognized that a sell-side position with Rural would help them secure a buy-side position with the firms seeking to acquire EMS. As a result, RBC actively pursued a role in the sale of Rural. In addition to RBC’s own economic interests in facilitating a sale of Rural, the Court found that Rural’s Special Committee was tainted with self-interest. Eventually, RBC and the Special Committee actively pursued a sale of the Company, despite not having Board approval to do so.
During this process, RBC and the Special Committee ignored several red flags. First, the firms that were pursuing EMS would be limited by confidentiality agreements as part of the EMS process and therefore, could not simultaneously engage in acquisition negotiations with Rural. This conflict dramatically reduced the pool of potential bidders. Second, JP Morgan advised against such a “near-term sale” and recommended postponing a sale until Rural’s growth plan played out. Third, of the twenty-one firms that received bid instructions from RBC, fifteen declined to participate and only one showed an interest in the acquisition. No one shared these red flags with the Board. At the end of the sale process, Warburg was the only firm that made a final bid. Meanwhile, the Court found that RBC continued to pursue its own economic interests in the deal by secretly lobbing Warburg for a buy-side financing role. Warburg declined RBC’s offers.
The Board convened on March 27, 2011 to review Warburg’s proposal and approve the sale. RBC did not distribute valuation materials – based in large part on its continued efforts to obtain a financing role with Warburg – until less than twelve hours before the deadline to approve Warburg’s offer. In addition, the materials contained inaccurate and misleading information.
The Board approved the merger. Shortly thereafter, Plaintiffs filed an action alleging the Board “breached their fiduciary duties by approving the merger and by failing to disclose material information in the Company’s definitive proxy statement.” In re Rural Metro Corp., C.A. No. 6350-VCL, slip op. at 1 (Del. Ch. Mar. 7, 2014). The individual directors settled with Plaintiffs before trial. Plaintiffs also brought claims against RBC for aiding and abetting the Board’s breaches of fiduciary duties. The parties tried those claims, at the conclusion of which the Court held RBC liable for aiding and abetting. The Court found that Plaintiffs proved the four elements of an aiding and abetting claim – (1) existence of a fiduciary duty; (2) breach of that fiduciary duty; (3) knowing participation in the breach by the non-fiduciary defendants; and (4) damages proximately caused – for breaches of fiduciary duties in connection with both the approval of the sale and failure to disclose material information.
The Court first addressed the Board’s approval of the sale of the Company. Because the Plaintiffs settled with the individual directors before trial, Plaintiffs “took up the burden of proof on each of the elements of aiding and abetting, including the existence of a fiduciary breach.” Id. at 42. It decided that the first element of the claim was “readily satisfied” as the individual defendants were directors of a Delaware corporation and therefore, owed a duty of loyalty and care to the Company. Id. at 34. Based on the totality of the evidence and applying the enhanced scrutiny standard, the Court also found that the Plaintiffs had also satisfied the second element of the claim. It determined that the Board’s conduct was unreasonable and breached its fiduciary duty of care when it failed to provide active and direct oversight over RBC during the sale process. Id. at 56. The Court concluded that the Board was not well-informed throughout the sale process and that RBC was biased by its own financial interests. Id. In addition, the Board breached its fiduciary duty of care when it failed to provide active and direct oversight in negotiations with Warburg and ultimate approval of its bid. As a result, the Court found the Board lacked a reasonably adequate understanding of Rural’s alternatives to the Warburg bid, including the possibility that the best option for the shareholders was not to pursue a transaction at all. Id. at 63-64. The Board’s lack of oversight, RBC’s concealed efforts to obtain a financing role with Warburg and the late delivery of its faulty valuation analysis also fell outside the range of reasonableness. The Court noted that the existence of an exculpatory clause in the Company’s Certificate of Incorporation did not apply to aiders and abettors and therefore, RBC could not rely on that defense. Id. at 45.
The Court found the third element was satisfied because RBC knowingly participated in the directors’ fiduciary breach by creating an unreasonable process and failing to provide all of the information necessary for the Board to make an informed decision. Id. at 69-70. RBC pushed a sale of Rural when the Special Committee lacked authority from the Board to sell, failed to provide a valuation analysis throughout the process, and never disclosed to the Board RBC’s interest in a financing role with Warburg. As a result, the Court concluded that RBC knowingly participated in the Board’s breaches of their fiduciary duty. In its analysis, the Court explained that although the Delaware Supreme Court has not directly ruled on the issue of whether a third party may “knowingly participate” in a breach of fiduciary duty, see Malpiede v. Townson, 780 A.2d 1075 (Del. 2001), the Arnold line of cases implied as much. Id. at 69 (citing Arnold v. Soc’y for Sav. Bancorp, Inc. (Arnold I), 1993 WL 526781 (Del. Ch. Dec. 17, 1993), rev’d, 650 A.2d 1270 (Del. 1994) (Arnold II); Arnold v. Soc’y for Sav. Bancorp, Inc. (Arnold III), 1995 WL 376919 (Del. Ch. June 15, 1995), aff’d, 678 A.2d 533 (Del. 1996) (Arnold IV)).
Finally, the Court found Plaintiffs successfully proved the fourth element of aiding and abetting – that the breach caused damages to Plaintiffs. Id. at 72. RBC proximately caused the Board’s breaches of fiduciary duty and damaged stockholders because a fully informed Board would have achieved a better result and the merger did not generate the best and most reasonably attainable value for the stockholders. Id. at 74. Further, the Court found the value of Rural as a going concern was greater than what the stockholders received in the merger. Id. The Court emphasized that RBC should have provided valuation materials “periodically throughout the process.” Id. Instead, the Board did not receive any information other than the Warburg bid. But for RBC’s withholding of material information regarding the transaction, a well-informed board likely would have proceeded differently.
The Court next addressed Plaintiffs’ claim that RBC’s aided and abetted a breach of the duty to disclose. Directors of a Delaware corporation owe a duty to disclose all material information when seeking shareholder action. The Court found that the Plaintiffs successfully proved the individual directors breached their duty of disclosure. The Court concluded that RBC provided materially misleading information when it provided a false valuation analysis. Id. at 79. In addition, RBC never disclosed its economic motivations in pursuing a sale of the Company, nor did it disclose its efforts to secure a financing role with Warburg. The Court decided that RBC knowingly participated in the breach of the duty of disclosure by purposefully withholding information, including false information in its valuation materials, and concealing the full extent of any conflicts. Id. at 83-84. As a result, its actions supported a finding of knowing participation. Finally, the Board relied on the materially false and omitted facts when voting on the merger, which it ultimately approved. As a result, the Court found RBC liable for aiding and abetting the Board’s breach of the duty of disclosure. Id. at 84.
Three points are worth highlighting from the Court’s opinion: First, the Court of Chancery has now explicitly held that a third party may be liable for aiding and abetting a breach of fiduciary duty. Second, Section 102(b)(7) of the Delaware General Corporation Law (“DGCL”) does not exculpate aiders and abettors. Finally, a financial advisory firm’s valuation analysis provides critical information to the Board during the M&A process and should be provided early-on and throughout the M&A process.
A copy of the opinion may be found here.