After the merger, the plaintiffs amended their complaint, adding a claim against Zale’s financial advisor, Merrill Lynch, Pierce, Fenner & Smith Inc., for aiding and abetting the board’s breach of its fiduciary duties. Merrill Lynch had, about five weeks earlier, met with Signet to propose that Signet should purchase Zale but not pay more than $21 per share (the eventual transaction price). Zale Corp. later engaged Merrill Lynch to run its sale process. Merrill Lynch did not tell Zale Corp. about its prior pitch to Signet—at least, not until after the Zale board had already agreed to the $21-per-share transaction with Signet. This prior pitch to Signet was disclosed, however, to Zale’s stockholders in the proxy seeking approval of the merger. Thus, when a majority of Zale’s stockholders approved the merger, they knew about Merrill Lynch’s prior pitch to Signet.
The Court of Chancery Refuses to Dismiss the Aiding and Abetting Claim
On October 1, 2015, the chancery court denied a motion to dismiss the aiding and abetting claim against Merrill Lynch. In re Zale Corp. S’holders Litig. (Zale I), 2015 WL 5853693 (Del. Ch. Oct. 1, 2015). Merrill Lynch’s late disclosure troubled the court because the board’s ignorance about Merrill Lynch’s conflict appeared to taint the negotiating process—Signet’s initial offer was at $20.50, and Zale’s board, while ignorant of Merrill Lynch’s pitch to Signet, countered at $21 (the same price Merrill Lynch had previously pitched to Signet). The court held:
I can only speculate as to why the topic of Merrill Lynch and Rose’s prior presentation to Signet apparently did not come up in connection with the decision of the Board to make a counter offer of $21 per share as opposed to something higher, in response to Signet’s all cash offer of $20.50 per share.
Id. at *22.
The court applied the stricter standard of scrutiny mandated by Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), because the merger was a sale of control, and held that the board breached its duty of care by making an uninformed negotiating decision and that Merrill Lynch knowingly participated in, and therefore aided and abetted, that breach.
A Delaware Supreme Court Opinion Leads to Reargument and Dismissal of the Aiding and Abetting Claim
The next day, the Delaware Supreme Court issued its opinion in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015). Corwin held that in a post-closing damages action, the business judgment rule is the appropriate standard of review “when a merger that is not subject to the entire fairness standard of review has been approved by a fully informed, uncoerced majority of the disinterested stockholders.” Id. at 305–6. Corwin resolved a dispute about the type of stockholder vote that could have this effect, holding that even a stockholder vote required by statute (like the Zale stockholders’ vote in favor of the merger) changes the standard from the stricter scrutiny of Revlon to the far more lenient standard of business judgment review.
Corwin shifted the legal landscape underlying the Delaware Court of Chancery’s initial decision in Zale I, which had expressly based its decision on the idea that only non-statutorily mandated stockholder votes could change the standard of review. The Zale I court’s determination to apply Revlon rather than business judgment review determined the outcome. When applying Revlon scrutiny, the court considers whether the board made reasonable decisions for the situationally appropriate purpose of obtaining the best price reasonably available. Crucially, and as the chancery court’s Zale I opinion illustrated, a board’s conduct can fail to withstand Revlon scrutiny if the board makes a decision premised on inadequate knowledge.
After the Corwin issuance, Merrill Lynch moved for reargument in Zale. The court then dismissed the claim for aiding and abetting, holding that as a matter of law no predicate breach of fiduciary duty occurred. See In re Zale Corp. S’holders Litig. (Zale II), 2015 WL 6551418 (Del. Ch. Oct. 29, 2015). Based on Corwin, the stockholders’ fully informed and uncoerced vote meant the business judgment rule applied to the transaction. The court applied the gross negligence standard to determine whether the board breached its duty of care but held that the directors’ ignorance about Merrill Lynch’s conflict did not meet the higher standard for gross negligence. Thus, any issues arising from Merrill Lynch’s belated disclosure of its discussions with Signet were cured because the stockholders voted in favor of the transaction after being fully informed about the conflict.
The Delaware Supreme Court Affirms and Clarifies Aiding and Abetting Law
The Delaware Supreme Court affirmed dismissal of the claim against Merrill Lynch but distanced itself from some portions of the Delaware Court of Chancery’s analysis.
First, the supreme court held that the chancery court should not have applied the gross negligence standard with regard to the board’s conduct after deciding that business judgment review applied.
Absent a stockholder vote and absent an exculpatory charter provision, the damages liability standard for an independent director or other disinterested fiduciary for breach of the duty of care is gross negligence, even if the transaction was a change-of-control transaction. Therefore, employing this same standard after an informed, uncoerced vote of the disinterested stockholders would give no standard-of-review shifting effect to the vote.
Singh, 2016 WL 2765312, at *1.
After a favorable stockholder vote, the claim should be dismissed unless the transaction meets the test for waste.
The Delaware Supreme Court reiterated the basic framework for post-closing litigation involving claims for both breaches of fiduciary duty and aiding and abetting those breaches. The standard for determining whether a director breached his or her fiduciary duties varies based on the remedy sought. When suing a director for damages after a transaction occurs, the director obtains the dual protections of (1) the gross negligence standard to determine whether the director breached his or her duty of care and (2) the protection of a charter provision enacted under Title 8, section 102(b)(7) of the Delaware Code, which relieves liability for a breach of the duty of care.
But when determining aiding and abetting liability—potentially regarding the very same transaction—the alleged aider and abettor receives neither of these protections. A director who breaches his or her situational duties commits a breach of fiduciary duty sufficient to be the basis for damages liability imposed on an aider and abettor. And, “to the extent the Court of Chancery purported to hold that an advisor can only be held liable if it aids and abets a non-exculpated breach of fiduciary duty, that was erroneous.” Singh, 2016 WL 2765312, at *2.
Alleged aiders and abettors enjoy only one protection, but it is a critical one: “Delaware has provided advisors with a high degree of insulation from liability by employing a defendant-friendly standard that requires plaintiffs to prove scienter and awards advisors an effective immunity from due-care liability.” Id. That is, advisors who perform their own work negligently, or even with gross negligence, breach only their duty of care and do not knowingly participate in a fiduciary breach.
The supreme court appears to have made an effort to calm fears about the potential extent of financial advisor liability by going out of its way to state, in dicta, that the chancery court’s Zale I opinion erred by holding that Merrill Lynch’s conduct showed knowing participation in a fiduciary breach. Rather, the supreme court was “skeptical that the supposed instance of knowing wrongdoing—the late disclosure of a business pitch that was then considered by the board, determined to be immaterial, and fully disclosed in the proxy—produced a rational basis to infer scienter.” Id.
The supreme court contrasted Merrill Lynch’s conduct with the conduct at issue in RBC Capital Markets, LLC v. Jervis, 129 A.3d 816, 862 (Del. 2015). RBC affirmed a large damages award against a financial advisor based on the chancery court’s factual findings that the financial advisor engaged in “illicit manipulation of the Board’s deliberative processes for [the] self-interested purposes” of providing the winning bidder in the transaction process with buy-side financing and using the sale as a means to obtain a financing role in an entirely different transaction. Id. The Delaware Court of Chancery found that the advisor’s behavior resulted in “a poorly-timed sale at a price that was not the product of appropriate efforts to obtain the best value reasonably available. . . .” Id. at 863. The Delaware Supreme Court thus held that the financial advisor committed a “fraud on the board,” “intentionally duped” the board, and “purposely misled the Board. . . .” Id. at 865. By contrast, the Delaware Supreme Court in Singh held that “[n]othing in this record comes close to approaching [that] sort of behavior [found in RBC]. . . .” Singh, 2016 WL 2765312, at *2.
The court appears to be isolating the advisor’s conduct in RBC as a factually exceptional outlier and may be suggesting that Merrill Lynch’s failure to disclose its earlier pitch to Signet may be considered to be more of a garden-variety shortcoming, which will not suffice to state a claim, particularly where any malfeasance was disclosed to stockholders and cleansed by a fully informed vote.
Practical Lessons from Singh
Although the Delaware Supreme Court did not delineate exactly what conduct on the part of a financial advisor will lead to aiding and abetting liability, two practical points emerge from Singh.
First, financial advisors have a second opportunity to disclose all potential problems in a transaction—namely, before the corporation prepares the proxy. Disclosures of all potential conflicts of interest should, of course, be made before securing an engagement. But as Singh illustrates, financial advisors do not always meet the ideal of completely fulsome and up-front disclosure of all relevant information. Financial advisors should thus take advantage of this second opportunity to disclose any potentially concerning issues after the board approves the transaction but before the proxy is written so that the stockholders can be fully informed of any issues.
Second, what constitutes knowing participation is a matter of great interest to financial advisors. Singh signals that to find knowing participation in a fiduciary breach, the Delaware courts are likely to require atypical factual findings. A financial advisor’s failed sales pitch is unlikely to justify aiding and abetting liability, particularly if it is disclosed to the board and the board determines it is immaterial. In contrast, a financial advisor can face liability if the Delaware Court of Chancery, after examining all the facts, determines that the advisor manipulated a sales process for his or her own private motives. Singh thus signals that only factual findings of extreme conduct will lead to financial advisor aiding and abetting liability.
Keywords: litigation, commercial and business, aiding and abetting, board of directors, corporations, Delaware Supreme Court, fiduciary duty, financial advisor, knowing participation, merger