Here’s an interview that I recently conducted with Kevin Miller, a Partner with Alston & Bird LLP in New York, looking back at RBC v. Jervis (aka Rural/Metro) on its first anniversary. The Delaware Supreme Court’s Rural/Metro decision affirmed the Chancery Court’s decision holding RBC Capital Markets liable for aiding & abetting breaches of the fiduciary duty of care by Rural/Metro’s directors – and was one of the most significant decisions of 2015.
John: Kevin, the Delaware Supreme Court’s opinion in Rural/Metro was issued on November 30, 2015, a little over a year ago. Looking back, what do you think were the key takeaways from the Supreme Court & Chancery Court’s decisions?
Kevin: It should come as no surprise that the Delaware Courts want to hold “bad actors” liable for their bad behavior, particularly where the Courts have determined that the defendant acted with scienter, i.e., knowing that its behavior was legally improper. Having said that, certain aspects of the legal architecture relied upon in Rural/Metro to find RBC liable for aiding and abetting breaches of fiduciary duty, particularly aspects of the predicate finding that Rural/Metro’s directors breached their fiduciary duty of care, continue to raise a number of doctrinal issues and concerns.
John: What do you mean by “legal architecture”?
Kevin: In most tort cases, the plaintiff only has to prove that the defendant breached a duty that caused demonstrable harm to the plaintiff. But a claim for aiding and abetting a breach of fiduciary duty additionally requires proof of a predicate breach of fiduciary duty in which the defendant knowingly participated. The need to find a predicate breach of fiduciary duty creates significant tension in the legal architecture for aiding and abetting claims and can actually prevent a finding of liability against a culpable bad actor.
To put those issues and concerns in context and frame a potential solution to the doctrinal issues raised by the legal architecture relied upon in Rural/Metro, I think it is important to understand why Rural/Metro was not brought as a contract claim or a claim for a breach of the common law duties a financial advisor owes its client, despite those arguably being the simpler and more obvious claims.
John: Why do you say a contract claim or a claim for a breach of the common law duties a financial advisor owes its client would have been simpler?
Kevin: As a matter of contract and common law, RBC owed duties to Rural/Metro as its financial advisor and the Delaware Courts in Rural/Metro identified conduct by RBC that likely constituted a breach of those duties. Although financial advisor engagement letters typically exculpate financial advisors from most claims arising out of the performance of their engagement, there is always a carve-out from the exculpation provision for damages resulting from the financial advisor’s gross negligence and bad faith or willful misconduct. And the requisite finding by the Delaware Courts in Rural/Metro that RBC acted with scienter (knowing that its behavior was legally improper) appears to be the functional equivalent of a finding that RBC acted in bad faith or with willful misconduct.
As a consequence, it would have been simpler to bring a claim against RBC for breach of contract or breach of the common law duties owed by a financial advisor to its client relying on the evidence used in Rural/Metro to prove scienter to prove RBC’s unexculpated bad faith or willful misconduct. That approach would have obviated the need for the Delaware Courts in Rural/Metro to find a predicate breach of fiduciary duty by Rural/Metro’s directors in order to hold RBC liable for its misconduct.
John: So, if those claims were arguably simpler to bring, why weren’t they brought against RBC?
Kevin: It’s a function of the difference between direct and derivative claims under Delaware law. Technically, those claims belonged to Rural/Metro as RBC’s client and not to Rural/Metro’s stockholders. If brought by a Rural/Metro stockholder, the claims would have had to have been brought as derivative claims on behalf of Rural/Metro. And Rural/Metro’s stockholders would have lost their standing to pursue those claims upon the closing of Rural/Metro’s acquisition by Warburg Pincus for failure to satisfy the continuous share ownership requirement necessary to maintain a derivative action. To avoid that result, the plaintiff in Rural/Metro brought a direct claim against RBC for aiding and abetting breaches of fiduciary duty by Rural/Metro’s directors that would survive the closing of the merger.
John: OK, so what are your concerns about the predicate finding of a breach of the fiduciary duty of care by Rural/Metro’s directors?
Kevin: As the Delaware Supreme Court acknowledged in Rural/Metro, Revlon is a standard of review. Revlon does not impose new fiduciary duties or alter the nature of the fiduciary duties that generally apply. So in determining whether Rural/Metro’s directors breached their fiduciary duty of care, the dispositive question, regardless of the standard of review, should have been: Did the Rural/Metro directors fail to act with the ordinary care expected of a reasonably prudent fiduciary?
But, in Rural/Metro, the Delaware Courts acknowledged that the aiding and abetting claim against RBC was premised on RBC’s fraud on the Rural/Metro board where, for its own motives, RBC intentionally duped Rural/Metro’s directors by, among other things, creating an informational vacuum that effectively prevented Rural/Metro’s directors from detecting the fraud. Requiring a director acting with the ordinary care expected of a reasonably prudent fiduciary to detect such fraudulent behavior seems tantamount to blaming the victim for being knowingly and intentionally duped by a third party’s fraudulent acts.
John: Do you have other concerns?
Kevin: A potentially more serious concern is that the standard of review relied upon by the Delaware Courts in Rural/Metro to find a predicate breach of fiduciary duty by Rural/Metro’s directors implies that the form of consideration in the underlying transaction will likely determine whether a third party can be held liable for aiding and abetting a breach of the fiduciary duty of care.
John: Can you explain?
Kevin: Rural/Metro involved a cash merger but if the consideration in the underlying merger had been stock rather than cash (i.e., so that the merger did not result in a change of control), the plaintiff would have had to prove that the Rural/Metro directors acted with gross negligence (requiring proof of reckless indifference or gross abuse of discretion), not merely that the directors breached their fiduciary duty of care under the more exacting Revlon standard of review applicable in a change of control transaction (focusing on whether the directors behaved reasonably).
A third party’s liability for committing fraud on or intentionally duping a board should not depend on the form of consideration in an underlying transaction. As the Delaware Supreme Court noted in an opinion rendered shortly before the Delaware Supreme Court’s decision in Rural/Metro, “Unocal and Revlon are primarily designed to give stockholders and the Court of Chancery the tool of injunctive relief to address important M & A decisions in real time, before closing. They were not tools designed with post-closing money damages claims in mind, the standards they articulate do not match the gross negligence standard for director due care liability under Van Gorkom….” As far as I’m aware, Rural/Metro is the first and only case in which a defendant’s monetary liability was predicated on a breach of the so-called Revlon rule.
John: You also mentioned that the necessity of finding a predicate breach of fiduciary duty could actually prevent a finding of liability against a culpable bad actor. Can you give an example?
Kevin: Suppose a company’s directors had on several occasions personally questioned representatives of their financial advisor to ascertain whether the financial advisor had any disabling conflicts or ulterior motives but, despite intensive questioning, the financial advisor had knowingly and intentionally hidden and otherwise denied the existence of any such conflicts or ulterior motives even though they materially prejudiced the advice it provided to the board. Where’s the breach? Did the directors fail to act with the ordinary care expected of a reasonably prudent fiduciary? But without a predicate breach of fiduciary duty by the company’s directors, there can be no judgment for aiding and abetting a breach of fiduciary duty and, despite having the requisite scienter, the financial advisor would escape liability.
John: Do you think there is a better approach?
Kevin: One alternative approach that would eliminate the need for plaintiffs to prove, and a court to find, a predicate breach of fiduciary duty in order to hold a bad actor accountable would be to allow stockholders to continue to pursue certain derivative actions post-closing by providing an exception to the continuous share ownership requirement where the claims relate to conduct inextricably linked to the transaction whose closing would otherwise extinguish stockholder standing to pursue those derivative claims.
That approach would permit stockholders to pursue derivative contract claims against a financial advisor and claims for a breach of the common law duties a financial advisor owes to its client post-closing without having to prove a predicate breach of fiduciary duty whose existence is not essential to proving the harm caused by the financial advisor’s bad faith or willful misconduct. While the devil is always in the details, there already exists an exception to the extinguishment of standing to pursue a derivative claim when the purpose of the underlying transaction was a fraudulent attempt to deprive stockholders of their derivative standing or a mere reorganization that otherwise does not affect the stockholders’ relative ownership in the resulting corporation. Recognizing another limited exception would not necessarily stray too far from existing doctrine regarding derivative claims.
John: Why are these issues and concerns important?
Kevin: Various rulings by the Delaware Courts over the past few years have made it more difficult for plaintiffs to successfully challenge mergers, causing plaintiffs’ counsel to focus on alternative causes of action. Post Rural/Metro, we have seen a significant increase in the number of aiding and abetting breach of fiduciary duty claims brought against financial advisors and, more recently, law firms, so it’s important that we get the legal architecture right, not only for the parties involved, but to ensure the efficient use of judicial resources. It’s not surprising that the Delaware Courts think there should be consequences if an advisor, acting with scienter, breaches its duties to its client but the availability of a remedy should not depend on a predicate finding that defrauded or duped directors breached their fiduciary duties.
– John Jenkins