October featured significant M&A opinions from Delaware that are already having an impact on board processes and relationships between corporations and their financial advisors. While the most recent opinion dismisses claims against the financial advisor for aiding and abetting breaches of duties by the target board, a careful reading of the case reveals that the decision is unlikely to change the practical impact of the holdings from earlier in the month.
Vice Chancellor Donald Parsons issued the most recent of these opinions on October 29 in In re Zale Corp (Zale II) where he concluded that an October 2, 2015 Delaware Supreme Court decision, Corwin v. KKR Fin. Holdings, required him to reverse the outcome of his October 1 ruling (Zale I) that had denied the motion to dismiss claims against the board’s financial advisor for aiding and abetting breaches of the board’s duty of care in connection with the all-cash sale of Zale to a competitor.
When the board of Zale had initially engaged the financial advisor, the directors allegedly relied, without further inquiry, on the financial advisor’s generic statements that it had “limited prior relationships” with the eventual acquirer and “no conflicts”. Eventually, following the receipt of a fairness opinion and execution of the merger agreement, the board of Zale learned that four months earlier its financial advisor had made an unsolicited “pitch presentation” to the acquirer, based on publicly available information, in which the advisor proposed that the acquirer seek to buy Zale and included a suggested price range, the upper end of which turned out to be the merger price accepted by the Zale board. Zale amended its proxy statement to provide lengthy disclosure about this “pitch presentation” and thereafter Zale’s stockholders approved the merger. In Zale I, V.C. Parsons observed that the board cannot satisfy its duty of care by accepting generic statements about “no conflicts” on their face and that the board should make further inquiry of the financial advisor at the outset of the engagement, including by asking “whether the potential financial advisor had made any presentations regarding Zale to prospective buyers within, e.g., the last six months or since [the advisor] had undertaken to represent Zale.” Although Zale I dismissed the liability claims against the board based on the exculpatory provision in the Zale charter, the court found that the financial advisor, which failed to disclose the information about the pitch presentation until after the merger was announced, could nonetheless be liable for aiding and abetting the underlying breach of duty by the board.
Over the last month, following Zale I, the process to engage a financial advisor by a board considering a possible sale transaction has been characterized by a marked increase in attention to presentations the financial advisor has made to (as well as other relationships with) the likely bidders. This can be a challenging task when there are lots of teams of enterprising investment bankers regularly roaming the world to make pitches about all sorts of ideas for combinations in this active era of vertical and horizontal consolidation transactions.
On October 2, the day after Zale I, the Delaware Supreme Court handed down the welcome Corwin decision that removed ambiguity from the proposition that post-closing claims for breaches of duties of care by directors should be subject to the deferential business judgment rule standard when there has been an uncoerced, informed approval of the merger by disinterested stockholders. On October 29, 2015, Zale II concluded, in view of the informed approval of the merger by the Zale stockholders per Corwin, Zale I had applied the wrong standard when determining whether the complaint had adequately alleged a predicate breach of duty by the board that the financial advisor had aided and abetted. Although Zale II characterizes the board’s inadequate inquiry into the financial advisor’s potential conflicts at the outset of the engagement as “troubling”, the opinion concludes that the board’s failure did not descend to the depths of “gross negligence” by the directors – i.e., a “wide disparity” between the process used and the process that “would have been rational” – and therefore there could not have been a breach of duty by the directors that the financial advisor aided and abetted.
Where does this leave us?
- We do not expect boards or managements to ease up in their inquiries into and consideration of material relationships and interests on the part of the target’s financial advisor – including those implied by recent meetings between the target’s financial advisor and potential bidders or merger partners. The reasons are twofold:
- First, at the foundation of the dismissals of the claims in both Zale and Corwin were the fully informed stockholder approvals. If the Zale proxy statement had not gone into detail about the meetings that the Zale board’s financial advisor had with the acquirer about a takeover of Zale, then the court would likely have found that a fully informed stockholder approval had not occurred and therefore refrained from applying the deferential standard of review that led to dismissal of the claims against the financial advisor. Thus, although Zale II does stand for the proposition of a standard of review favorable to boards and financial advisors, the availability of this standard of review is contingent on taking the necessary steps to obtain all material details about recent relationships and interests of the financial advisor and disclosing them in the proxy statement.
- Indeed, Zale II reiterates the statement from Zale I that “it is reasonable to expect directors to take additional steps to obtain information material to the evaluation of their financial advisors’ independence, such as by ‘negotiating for representations and warranties in the engagement letter as well as asking probing questions to determine what sorts of past interactions the advisor has had with known potential buyers.’” Receipt of this information in a confidential memorandum from the financial advisor should be equally effective as the receipt of formal representations in an engagement letter, especially if there is an opportunity to ask follow-up questions.
- Second, both the Zale and Corwin suits were seeking damages post-closing of the merger. If a plaintiff is able to uncover undisclosed material relationships and interests on the part of the target’s financial advisor before the stockholder vote on the merger, then there will continue to be a risk of injunction if those relationships and interests are not adequately uncovered and disclosed in advance.
- Keeping the scorecard straight on what liability standards apply to whom:
- For post-closing duty of care claims, directors continue to benefit from director-friendly interpretations of the exculpatory provisions in the charters of Delaware corporations per the recent Corwin and Cornerstone decisions. The standard for exculpation is the good faith/bad faith distinction, which is very favorable to directors.
- The financial advisors are not entitled to exculpation, but there does have to be a predicate breach of duty by the directors for the financial advisors to be liable for aiding and abetting.
- Even a breach for which the directors themselves are personally entitled to exculpation is sufficient to support an aiding and abetting claim against the financial advisors.
- If there has been an informed stockholder approval as will be the case for many post-closing claims, then the standard for determining whether such a predicate breach occurred is the “gross negligence” (or “wide disparity” with what “would have been rational”) standard.
- Is it possible for the board to have acted in good faith, but still acted with “gross negligence”? In fact, another Chancery Court opinion from October 2015 in a case involving claims against the financial advisor for aiding and abetting, In re Tibco, makes clear that, just because a board’s process was not so bad as to fail to entitle the board to exculpation (i.e., the directors met the “good faith” test), the board may still have failed to meet the “gross negligence” standard and therefore the aiding and abetting claims against the advisor for its role in that good faith, but grossly negligent, process will survive a motion to dismiss.