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July 06, 2021 Articles

Advisors, Beware: Delaware Court Eases the Pleading Standard for Alleging a Claim of Aiding and Abetting Breach of Fiduciary Duty

The shifting of this standard has potentially significant consequences for financial advisors and other entities that are repeat players in the world of mergers and acquisitions.

By Jeremy K. Beecher

It is bedrock law that when a corporation is on the auction block, its directors and officers owe stockholders a fiduciary duty to obtain “the highest price reasonably available for the company, provided it was offered by a reputable and responsible bidder.” Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1282 (Del. 1989). What is less well known, however, is that third-party advisors involved in the sale who themselves owe no fiduciary duty to the corporation or its shareholders whatsoever may nevertheless be held jointly and severally liable for the fiduciaries’ breach under an aiding and abetting theory. Laventhol, Krekstein, Horwath and Horwath v. Tuckman, 372 A.2d 168, 170–71 (Del. 1976).

Delaware courts have traditionally viewed claims for aiding and abetting breach of fiduciary duty with a “skeptical eye,” given the nearly unlimited liability that could otherwise attach to third parties’ interactions with corporate fiduciaries. Ronald A. Brown, Jr., “Claims of Aiding and Abetting a Director’s Breach of Fiduciary Duty—Does Everybody Who Deals with a Delaware Director Owe Fiduciary Duties to That Director’s Shareholders?,” 15 Del. J. Corp. L. 943, 944–45 (1990). Accordingly, Delaware courts generally have permitted a third party to be found liable for aiding and abetting a corporate fiduciary’s breach only where the third party “knowingly participates” in it. Malpiede v. Townson, 780 A.2d 1075, 1096 (Del. 2001).

“Knowing participation,” in turn, generally requires a showing that a third party acted with an “illicit state of mind”—either because it had “improper motives of its own” or there was “an understanding between the parties regarding their complicity in any scheme to defraud or in any breach of fiduciary duties.” In re Rural Metro Corp. S’holders Litig., 88 A.3d 54, 99 (Del. Ch. 2014); In re Comverge, Inc. S’holders Litig., 2014 WL 6686570, at *18 (Del. Ch. Nov. 25, 2014) (internal quotation marks and citation omitted). The Delaware Supreme Court has observed that this legal standard provides third parties “with a high degree of insulation from liability” and “effective immunity from due-care liability” by requiring a plaintiff to “prove scienter.” Singh v. Attenborough, 137 A.3d 151, 152 (Del. 2016). Given this requirement, claims against third parties for aiding and abetting corporate fiduciaries’ breaches routinely have been dismissed on the pleadings absent specific, concrete allegations of wrongdoing beyond the mere fact that the third party assisted the fiduciaries with a transaction that breached their own fiduciary duties to a corporation.

A recent decision by the Delaware Court of Chancery, however, arguably relaxes the showing a plaintiff must make to establish “knowing participation” at the pleading stage under certain circumstances. See Firefighters’ Pension Sys. v. Presidio, Inc., No. CV 2019-0839-JTL, 2021 WL 298141, at *37 (Del. Ch. Jan. 29, 2021). The shifting of this standard has potentially significant consequences for financial advisors and other entities that are repeat players in the world of mergers and acquisitions.

Firefighters’ Pension System v. Presidio, Inc.

In Firefighters’ Pension System v. Presidio, Inc., the plaintiff stockholder sued a slew of parties in the wake of a corporate sale. The plaintiff alleged that various direct fiduciaries improperly sought to steer the transaction to a lesser purchaser for self-interested reasons. In the case of the chief executive officer (CEO), for instance, the plaintiff alleged he favored the lesser purchaser because it would be more likely to continue to employ him after the sale. The plaintiff further alleged that the company’s financial advisor had aided and abetted the corporate fiduciaries’ breach of their own duties in various ways, including by tipping off the lesser purchaser as to the amount of the competing bid, which it ultimately exceeded by a few cents.

The financial advisor moved to dismiss the claim against it on the grounds that, inter alia, there was no plausible allegation in the complaint that it had “knowingly participated” in any breach of fiduciary duty because it had no “improper motive,” such as a profit interest, in seeing the lesser purchaser prevail in the auction. (Although its advisory fee increased minimally due to the higher bid, it argued with some justification that it was not “reasonably conceivable that [it] put its reputation and professional responsibilities in jeopardy for a less than 1/10th percent increase in its advisory fee.”)

The court denied the financial advisor’s motion, finding the plaintiff adequately alleged the advisor’s “knowing participation” in the fiduciaries’ breaches. While some of the court’s alternative rationales for that finding were case-specific and idiosyncratic, one of them is ominous for any third party (whether a financial advisor or otherwise) that has cultivated relationships in its field:

Investment banking is also a business that is grounded in relationships. . . . The complaint alleges that [the financial advisor] had established relationships with both [the controlling shareholder] and [the lesser purchaser]. [The financial advisor] also had an established relationship with [the CEO] and the Company, and as the CEO of the post-transaction entity, [he] would be in a position to send future business to [the financial advisor]. . . . . The allegations of the complaint support an inference that [the financial advisor] sought to achieve an outcome that would please [the CEO] and [the lesser purchaser] while providing [the controlling shareholder] with a satisfactory price.

Id. at *42.

To be sure, the court’s holding on this point appears to have been motivated by an understandable concern: that “parties who engage[] in duplicitous activity do not generally advertise their actions or motives, which may not be readily apparent from the surface facts.” Id. at *41. Nevertheless, the court’s finding that the mere existence of established relationships between the third party and others involved in the transaction, coupled with the plaintiff’s allegation that the third party would seek to do business with them in the future, were sufficient to allege that the third party “knowingly participated” in a breach of fiduciary duty seems at odds with Delaware’s policy of providing third parties with a “high degree of insulation from liability” and requiring plaintiffs to truly “prove scienter.” Singh, 137 A.3d at 152. If followed widely, the Presidio ruling could lead to a deluge of claims of aiding and abetting breach of fiduciary duty against entities such as financial advisors that routinely advise clients regarding mergers and acquisitions, given the difficulty those entities might face in obtaining dismissal on the pleadings.

It remains to be seen whether other Delaware courts will follow Presidio’s holding on this point or if they will instead seek to limit the holding to its convoluted facts. In the meantime, practitioners should consider advising clients operating in this space to exercise heightened awareness about the evidentiary record they create during a transaction involving parties with whom they have existing relationships, given the potentially increased likelihood that any claim of aiding and abetting a fiduciary breach brought against them would proceed to discovery.

Jeremy K. Beecher is a litigator in the Los Angeles, California, office of Munger, Tolles & Olson.

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