September 29, 2015 / 7:50 PM / 4 years ago

Delaware court considers 'sea change' on banker liability in M&A

WILMINGTON, Del, Sept 29 (Reuters) - The Delaware Supreme Court will hear arguments on Wednesday in an appeal that if upheld could make it easier for shareholders to sue investment bankers when a board mishandles the sale of a company.

If shareholders prevail in the appeal, which stems from the sale of the Rural/Metro ambulance company, a financial trade group warned it would create “unprecedented” uncertainty in the merger market by changing the rules for investment banks.

At issue is a 2014 ruling that found RBC Capital Markets liable for its role in advising the Rural/Metro board, which accepted a buyout in 2011 that was found to be underpriced. RBC, an affiliate of the Royal Bank of Canada, was ordered to pay $76 million to Rural/Metro shareholders in one of the biggest judgments ever from the Court of Chancery, a key venue for shareholder lawsuits.

“If upheld, there is significantly greater risk for investment banks to be held liable in M&A deals,” said Andrew Tuch, a professor at the Washington University Law School.

In an amicus brief arguing for a reversal, the Securities Industry and Financial Markets Association called the case a “sea change.”

SIFMA said the ruling expanded liability for a company’s sale from directors to include the company’s financial advisor, something investment bankers never bargained for. As a result, the ruling “injects an unprecedented level of uncertainty into the M&A marketplace,” the SIFMA brief said.

The case stems from the all-cash acquisition of Scottsdale, Arizona-based Rural/Metro Corp by an affiliate of private equity firm Warburg Pincus for $17.25 a share, for a total of $438 million. A shareholder class action was filed in 2011 in the Court of Chancery and was pursued by the Robbins Geller Rudman & Dowd and Friedlander & Gorris law firms.

The Court of Chancery judge, Travis Laster, found last year after a four-day trial that RBC manipulated its valuation of Rural/Metro downward to convince the board to accept the Warburg offer. The board never knew that RBC was simultaneously trying to convince Warburg to use the bank to finance the bid, according to Laster.

Laster faulted the Rural/Metro board for not properly overseeing RBC, but he also went a step further and found RBC partly to blame for the board’s shortcomings. Laster labeled RBC a “gatekeeper,” which the judge said could be prodded to do its best work if it is exposed to potential lawsuits.


However RBC argued in its appellate briefs that there is no basis in Delaware law for transforming an advisor into a gatekeeper. The bank warned that if the Rural/Metro ruling was upheld, it would discourage investment banks from acting as advisors because they would not want to risk getting sued.

Legal experts said the case has heightened expectations that directors will focus on potential conflicts of the bankers that are advising them.

“What Delaware courts are doing is reshaping the deal process,” said Tuch, the professor at the Washington University Law School. “There is strong incentive now for boards to push back on investment banks.”

Jay Brown, a professor at the University of Denver’s Sturm College of Law, said financial advisors do not have to worry if the board they are advising runs a proper sale.

And even if there is a problem with the sale, Brown noted that Laster set a high bar requiring shareholders to prove an advisor had an “improper motive.”

“Shareholders are not likely to be able to meet this standard very often,” Brown said. (Reporting by Tom Hals in Wilmington, Delaware; Editing by Noeleen Walder and Frances Kerry)

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