Friday, February 18, 2011

Delaware Chancery Rules that Target Company Directors Breached Fiduciary Duties in Failing to Properly Oversee Investment Bank

The board of directors of a target company facing a leveraged buyout by private equity firms breached its fiduciary duties by failing to provide the serious oversight that would have checked the misconduct of an investment bank involved in the deal, ruled the Delaware Chancery Court. In addition, the lead private equity firm aided and abetted the breach of fiduciary duties. In light of these actions, Vice Chancellor Laster enjoined the merger vote for 20 days in order to provide time for a serious bidder to emerge. (In re Del Monte Foods Company Shareholders Litigation, Consol CA No. 6027-VCL, Del. Chan. Ct., Feb 14, 2011).

Investment banks generate large fees from doing deals. To facilitate transactional activity, investment bankers routinely pitch deals to parties they hope might be interested. With regard to this LBO, the instant investment bank structured a small, private process that maximized the likelihood that it could provide acquisition financing. But the investment bank never disclosed to the board its interactions with the private equity shops or its desire to provide acquisition financing. Three private equity firms ultimately participated in the deal.

But for the manipulations of the investment bank, said the Chancellor, the LBO would have played out differently. If the directors had known at the outset of the investment bank’s intentions and activities, noted the court, the board likely would have hired a different banker.

Although the investment bank’s activities and non-disclosures in early 2010 were troubling, observed the Chancellor, what indisputably crossed the line was the surreptitious and unauthorized pairing of two of the private equity firms in violation of a no teaming provision, which materially reduced the prospect of price competition for the target company. Most egregiously, the investment bank actively concealed the pairing from the board.

Although the board was deceived and the blame for what took place lies with the investment bank, noted the court, the buck stops with the board. Delaware law requires that a board take an active and direct role in the sale process.