The Examiners: Paul Leake 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 Delaware Chancery Court’s ruling in Rural/Metro—and similar decisions handed down by the Chancery Court in the aftermath of the financial crisis (e.g., Del Monte Foods and El Paso Corp.)—indicate that, at least in Delaware, courts continue to engage in a greater degree of scrutiny of potential conflicts of interest that investment banks and other financial advisers may have in connection with M&A transactions.

In Rural/Metro (which involved “staple financing”), the court was focused in particular on the investment bank’s undisclosed dual roles as sell-side adviser and buy-side arranger of financing. The court sounded a warning shot to investment banks in similar M&A deals, stating that “the threat of liability helps incentivize gatekeepers [like investment banks] to provide sound advice, monitor clients, and deter client wrongs.” The court also ruled that an exculpatory provision in Rural/Metro’s certificate of incorporation that protected directors from liability did not apply equally to the investment banker.

As a consequence of this line of cases, advisers in M&A transactions should undoubtedly be careful in dealing with and disclosing conflicts, even if the scrutiny of this behavior is in some situations misguided. That said, we do not anticipate that Rural/Metro will have a significant impact on advisers to distressed companies in bankruptcy. A strict set of conflict rules has long applied to financial advisers and other professionals in bankruptcy cases, where compliance with mandatory “disinterestedness” requirements and disclosure of conflicts (and even potential conflicts) is both mandatory and routine practice before a bankruptcy engagement is commenced and subject to scrutiny at the outset of the case by the U.S. trustee, other parties in interest and the bankruptcy judge. That contrasts with out-of-court M&A transactions, where scrutiny is typically after the fact when shareholder litigation arises. In light of outcomes like the liability imposed in Rural/Metro, perhaps the strict rules regarding conflicts in bankruptcy are to the professionals’ benefit.

Paul Leake is a partner in Jones Day’s New York office and the global practice leader of the firm’s business restructuring and reorganization practice.

Bankruptcy Beat readers, does the threat of liability provide enough incentive “to provide sound advice, monitor clients, and deter client wrongs,” as the court says?