Putting RBC Capital In Context

The following blogpost is from one of the authors of the HLS teaching case study, Barclays Capital and the Sale of Del Monte Foods, on a recent court ruling related to the case.

Putting RBC Capital In Context

By John C. Coates, John F. Cogan, Jr., Professor of Law and Economics at Harvard Law School and Karina Shaw, Research Associate, Case Development Initiative at Harvard Law School

In a recent decision, the Delaware Supreme Court upheld Chancery Court decisions requiring RBC Capital – a unit of the Royal Bank of Canada – to pay $76 million to Rural/Metro shareholders based on RBC Capital’s advisory work for Rural/Metro in its 2011 sale to Warburg Pincus. RBC Capital sought a buy-side financing role for Warburg Pincus, a private equity firm, while giving Rural/Metro sell-side advice, and sought to leverage its role in the Rural/Metro deal for work in an unrelated deal without disclosing that fact to Rural/Metro’s board. As a result, under the Revlon standard the Court applied to the case, RBC Capital “aided and abetted breaches of fiduciary duty by former directors of Rural/Metro Corporation,” said the Court, even as it sought to limit the holding by stating that “a board is not required to perform searching and ongoing due diligence on its retained advisors … to ensure that the advisors are not acting in contravention of the company’s interests….”

The claims in Rural/Metro follow the line of cases initiated in litigation over the 2011 Del Monte buyout, as detailed in the HLS teaching case study, Barclays Capital and the Sale of Del Monte Foods, as well as in a case study of the roles played by Goldman Sachs in El Paso’s Sale to Kinder Morgan. Unlike in Rural/Metro, where RBC Capital sought but did not obtain a buy-side role, Barclays Capital and Goldman Sachs actually worked both the buy-side and sell-side of those transactions, and shareholders accused the boards of the target companies of failing their duty of care by inadequately learning about and policing the resulting conflicts. The case studies, which are taught at both Harvard Law School and Harvard Business School, explore issues of ethical leadership and deal process management. They also provide a basis for exploring the effects of the financial crisis of 2007-08 on the complex interaction – and arguably, competition for primacy – in regulating investment banks in the M&A context by the Delaware courts, Congress, the U.S. Securities and Exchange Commission, and the other financial regulatory agencies.

In its deal, Del Monte sold itself to a “club” of three private equity firms, Kohlberg, Kravis, Roberts, & Co. (KKR), Vestar Capital Partners (Vestar), and Centerview Capital LP (Centerview). In the standard shareholder lawsuit that followed, evidence was discovered suggesting a failure on the part of the Del Monte board to oversee the deal process, particularly the roles played by Barclays. In February 2011, Delaware Chancery Court Vice Chancellor Travis Laster provisionally enjoined the deal, criticizing both Del Monte’s board and Barclays Capital. The judge delayed the shareholder vote on the buyout by 20 days and essentially extended the “go-shop” period under the agreement to give other buyers a further opportunity to top KKR’s price. When no buyers emerged, the deal closed unchanged a few weeks later.  

In October 2011, Del Monte announced a settlement of its shareholder litigation with a payment of $90 million, funded by the private equity buyers ($65.7 million) and Barclays ($23.7 million, roughly the amount of its buy-side fees), generating $22.3 million in fees for plaintiffs’ lawyers.  In the El Paso dispute, the settlement amount was even larger ($110 million), as were the plaintiffs’ legal fees ($26 million). Now together with Rural/Metro, these settlements are among the largest recorded payouts in M&A-related litigation.

These cases demonstrate to Wall Street that banks’ conflicts of interests can have serious repercussions for both the banks and their corporate clients. In each case, the courts are confronted with behavior that has not been the conventional focus of fiduciary duty disputes – whether the target board failed to get basic information about the deal (as in the famous Van Gorkom case) or were themselves conflicted or beholden to conflicted participants (as in freezeouts or management buyouts).  Rather, the behavior in question relates to advisors on whom the board depends. The cases are difficult, as it is the directors themselves who have the duties giving rise to the litigation, and yet without allegations of bad faith or disloyalty on their part, they are typically exculpated from any liability for failing their duty of care. The results can be anomalous, with directors ultimately let off the hook, while their advisors’ conduct is scrutinized closely for any gap between their apparent conduct and either the directors’ documented understanding or judicially articulated and at-times nuanced standards, often on an incomplete record (as in the Del Monte buyout).

The impact of the court decisions has been significant. Stapled finance, for example, was common in both public and private target buyouts in the 2000s, but since Del Monte has largely disappeared in public target deals, even as its continued role in private deals suggests that it can have benefits that outweigh its risks. “Boutique” investment banks, too, have enjoyed a steep rise in fee income since Del Monte, as their focused practices generate fewer conflict risks, even as they offer fewer services. The disputes illustrate how Delaware courts can chasten and control a high profile and lucrative part of the business of multi-service Wall Street banks, even as Congress and the federal regulatory agencies wrestle with the broader need for regulation of the financial system. Our case studies are framed without prejudging the outcomes, allowing for rich student-led discussions of the issues embedded in the facts of the deals. They also provide a better means than dry lecture to convey vividly important trends in the institutional context of M&A, such as the rise of the private equity industry, the ever-elaborating process through which buyouts of public companies must pass, and the essentially “regulatory” role played by shareholder plaintiff lawyers. At the intersection of corporate law and finance, the cases link theory and practice in both law and business school classrooms.

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