The Examiners: J. Scott Victor on the Rural/Metro Ruling

What does the Delaware Chancery Court’s Rural/Metro ruling mean for advisers to distressed companies? Did the court reach the right conclusion?

The Chancery Court’s decision references bad actors, breaches of fiduciary duty, paradoxical valuation and gratuitous staple financing, so it’s easy to dismiss the Rural/Metro case as another Machiavellian tale of banker greed. However, the moral of the story is a serious issue for professionals, especially those who advise public or distressed companies: full disclosure.

In the Rural/Metro case, the sell-side adviser failed to disclose that its lending group was seeking to provide acquisition financing for the buyer. This lack of complete disclosure was the key culpable act in a case full of bad facts. A flawed sale process pursued by special committee members with pecuniary interests, a string of discomfiting emails and inadequate disclosure by the sell-side adviser resulted in the Chancery Court’s admonishment that general acknowledgements in engagement letters aren’t the same as full disclosure. The exculpatory provisions authorized by Delaware General Corporation Law do not extend to parties accused of aiding and abetting breaches of fiduciary duties, so the Court’s literal interpretation of the statute covered only the directors and left the advisers exposed.

While there is no per se rule that a sell-side adviser’s firm cannot finance the acquisition of the adviser’s client, the need for full and complete disclosure is clear and unambiguous. Undisclosed conflicts can negate the business judgment rule and pose major transaction risk in all deals, but advisers to distressed companies need to be even more vigilant considering the sensitive circumstances of their engagements.

Advisers to distressed companies must be completely disinterested—a requirement under the Bankruptcy Code—in all matters whether in an insolvency proceeding or not. The scrutiny of advisers in both healthy and distressed transactions will increase as the courts continue to take a dim view of conflicts of interest, whether those conflicts are potential or intentionally undisclosed.

J. Scott Victor is a founding partner and managing director of investment banking firm SSG Capital Advisors LLC and a member of the Turnaround Management Association’s global board of trustees.

Bankruptcy Beat readers, should there be more stringent rules regarding the roles advisers can play on a deal, or is the requirement to disclose multiple roles sufficient?