RBC Capital Markets, LLC v. Jervis: Delaware Supreme Court Affirms Financial Advisor Liability for Aiding and Abetting Unreasonable Sale ProcessSullivan & Cromwell LLP - December 7, 2015
In a highly anticipated opinion, the Delaware Supreme Court last week affirmed the Delaware Court of Chancery’s decisions holding a financial advisor liable for approximately $75.8 million (plus interest) in damages for aiding and abetting breaches of fiduciary duty by directors of Rural/Metro Corporation in the course of a “flawed and conflict-ridden” sale process. In doing so, the Court concluded that a board’s financial advisor can be held liable for damages for aiding and abetting a breach of a director’s duty of care if the advisor, with knowledge that the directors are acting without adequate information, misleads the directors or otherwise creates an “informational vacuum” that induces the breach, irrespective of whether the breach rises to the level of gross negligence, the standard for director liability for damages for a breach of the duty of care. Further, under the Court’s interpretation of Delaware’s contribution statute, a financial advisor who is found to have aided and abetted a breach of fiduciary duty is not entitled to contribution from directors who are exculpated by operation of their charter provisions from monetary liability on the theory that such directors, absent an admission, are not joint tortfeasors.
In both the trial and appellate decisions issued in the case, the Delaware courts were critical of the Rural board’s lack of active oversight of its financial advisor’s conflicts of interest, the financial advisor’s failure to disclose its material conflicts to the Rural board, and the resulting unreasonable sale process. The courts found that the Rural sale process had been structured to facilitate the financial advisor’s undisclosed desire to be on the financing trees of the bidders for a parallel sale of a Rural competitor, which had the effect of reducing the universe of realistic bidders for Rural. Likewise, the courts were not persuaded that the presence of a second financial advisor had any cleansing effect on the flawed sale process, ostensibly because the main financial advisor failed to disclose its idiosyncratic conflicts that tainted the process beyond repair and because the second advisor’s compensation was contingent on completion of the transaction. Importantly, the Supreme Court expressly declined to adopt the trial court’s potentially far-reaching “gatekeeper” theory of financial advisors, observing that because the relationship between boards and their financial advisors primarily involves detailed contractual provisions negotiated between sophisticated parties, it would be inappropriate to conclude that any failure by an advisor to prevent a fiduciary breach gives rise to aiding and abetting liability. Nevertheless, the Court stated that financial advisors still are under an obligation not to act in a manner contrary to the interests of the boards they serve.
With this opinion, the Supreme Court confirmed that financial advisors that fail to disclose material information to a board regarding their actual or potential conflicts can be held liable for damages that flow from their knowing participation in unreasonable sale processes. Moreover, because of the interplay between Delaware’s joint tortfeasor contribution statute and charter provisions that exculpate directors who breach their duty of care from monetary liability, financial advisors that cause an unreasonable sale process or that withhold material information from a proxy statement could be liable for the vast majority, if not all, of the damages to stockholders caused by their tortious conduct. Repeatedly referring to its opinion as “narrow,” the Court seemed to suggest that it would be the rare case where a financial advisor would be found to have acted with scienter and induced a fiduciary breach; however, the Court’s continued emphasis on ensuring that the financial advisor has disclosed sufficient information (about conflicts as well as process) to a board gives reason for financial advisors to continue to be cautious.
While the opinion makes clear that directors are free to employ conflicted financial advisors so long as they exercise appropriate oversight over their advisors’ conflicts and the sale process and employ sufficient safeguards to maintain a reasonable process, it is also clear that not every contractual relationship will suffice to protect financial advisors or the boards they advise. At the end of the day, financial advisors are not free to act in a manner that is contrary to the interests of the board, and boards cannot relinquish their obligation to provide meaningful oversight of a sale process.