Court of Chancery Addresses Monetary Liability of Directors in Follow-On Rural/Metro Opinion
In an opinion issued earlier this year, the Court of Chancery held RBC Capital Markets, LLC liable to stockholders of Rural/Metro Corporation for aiding and abetting the Rural directors’ breaches of fiduciary duties in connection with the sale of Rural to Warburg Pincus LLC. Last week, the Court issued a subsequent opinion determining the amount of damages suffered by the stockholder class and addressing RBC’s claims for contribution against its former co-defendants, who had previously settled with plaintiffs. Although the majority of the Court’s analysis is focused on the law of contribution, part of the Court’s analysis turns on whether the directors would have been monetarily liable despite the exculpation provision in Rural’s charter.
The litigation initially involved claims against the Rural directors and their two financial advisors. During the litigation, the Rural directors and one of their financial advisors settled with plaintiffs for $11.6 million ($6.6 million of which was paid by or on behalf of the directors and $5 million of which was paid by or on behalf of the financial advisor). RBC proceeded to trial. In its post-trial opinion, the Court found that the Rural directors breached their fiduciary duties in approving the sale of the company and that RBC aided and abetted those breaches. Because the directors had settled, the opinion did not have to address whether the directors breached their duty of care (so that the directors were exculpated from monetary liability under Rural’s charter and Section 102(b)(7) of the Delaware General Corporation Law) or their duty of loyalty (and thus were not exculpated).
After further submissions by the parties relating to damages and contribution, the Court issued an opinion dated October 10, 2014 determining that the class suffered damages of $93 million—a figure that represented more than $4 per share above the $17.25 per share consideration paid in the merger. RBC argued that it was entitled to a “settlement credit” under the Delaware Uniform Contribution Among Tortfeasors Act. Because the Court found that the availability of that credit was dependent upon whether RBC could meet its burden to show that the directors (i.e., the settling parties) otherwise would have been liable for monetary damages, the Court had to decide, on a director-by-director basis, whether the trial record supported a finding against each director of breach of the duty of care or the duty of loyalty. The Court’s focus in this regard was on three directors, and its analysis instructive.
The Court first determined that the Chairman of Rural’s board, who was also a managing director of an “activist hedge fund,” would have been monetarily liable for a breach of the duty of loyalty because he had “unique reasons to favor a near-term transaction”—including that the fund generally sought exits within three-to-five years, the fund’s position in Rural had become 22% of the fund’s portfolio, and the fund was seeking to raise new capital and a sale of Rural could be used in marketing the fund to new investors. Although the Court stated that “[a] party cannot simply argue in the abstract that a particular director has a conflict of interest because she is affiliated with a particular type of institution, like an activist fund,” the Court found that, in this case, “the trial record provided the necessary evidence.” The Court next determined that, although a “close case,” an outside director who, among other things, was seeking to leave the Rural board (because he was “over-boarded” as a matter of an ISS voting policy) and would obtain over $200,000 if he left the board in connection with a change-of-control, and who “had a potential interest in a sale because he often has joined boards as a hedge fund nominee or as an outside director acceptable to stockholder activists,” acted “consistent with his personal interests.” The Court stopped short of concluding that the director had breached his duty of loyalty, however, because the director did not appear at trial and thus the Court did not have a sufficient record to make a determination. Finally, the Court found that the then-CEO would have faced monetary liability because his support for the transaction stemmed from his desire to appease the directors who wanted a near-term sale (with the hope of securing his future employment under a new board) and because of his receipt of financial benefits in the cash-out. Having determined that RBC was entitled to a settlement credit as against two of the three directors who had been found to have breached nonexculpated fiduciary duties, the Court determined that RBC was responsible for 83% of the damages award, or approximately $75 million, and awarded pre- and post-judgment interest.
This opinion serves as a reminder of the nature of conflicts that directors and their advisors should remain vigilant to identify and address.
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