Delaware Update: Chancery Court Continues Its Scrutiny Of Investment Banks' Behavior

On March 7, in a decision following a trial on the merits, the Delaware Court of Chancery held an investment bank liable to a selling company's shareholders for the bank's conduct during the sale process. In re Rural Metro Corp. Stockholders Litig., C.A. No. 6350-VCL (Del. Ch. Mar. 7, 2014). This decision is the latest in a string of post-Financial Crisis cases in which the Chancery Court has closely scrutinized the actions of investment banks in M&A transactions, and there is no reason to think the trend will end any time soon.

Summary

Vice Chancellor Laster held the investment bank liable for aiding and abetting fiduciary duty breaches by the Rural/Metro Corp. board of directors in connection with the sale of the company to a financial sponsor. The court found, among other things, that the investment bank took actions that were not authorized by the board (its formal authorization extended only to analyzing the range of available strategic alternatives) and that the sale process was tainted by the investment bank's desire to get the inside track on financing another deal in the same industry. The investment bank also sought to provide buy-side financing to the ultimately successful bidder for Rural/Metro, and the court found that those efforts were not adequately disclosed to the board. The court concluded that the bank's actions created an unreasonable process, caused the target board to act without sufficient information, and ultimately resulted in a lower sale price.

Key Takeaways

Rural Metro is the most recent in a growing line of post-Financial Crisis cases, including Del Monte and El Paso, in which investment banks have been criticized for alleged conflicts. In re Del Monte Foods Co. S'holders Litig., 25 A.3d 813 (Del. Ch. 2011); In re El Paso Corp. S'holder Litig., 41 A.3d 432 (Del. Ch. 2012). The underlying theory of these cases is that a bank that advises a selling company can have interests that diverge from those of its client, and that a deal process can be tainted when a selling board does not take steps to police those potential conflicts, or when a bank pursues its diverging interests without making appropriate disclosures to the board. In the eyes of the Chancery Court, banker conflicts can arise in multiple ways. The court has perceived conflicts when a sell-side bank also seeks to provide buy-side financing (as in Del Monte and Rural Metro), or when the bank is simultaneously pursuing other deals in the same industry...