Rural/Metro May Affect Delaware Breach of Fiduciary Duty Litigation
By Morris James LLP on November 10, 2014
Authored By Edward M. McNally
This article was originally published in the Delaware Business Court Insider |
November 5, 2014
A recent decision of the Court of Chancery may significantly affect how breach of fiduciary litigation is conducted in the Delaware courts. In re Rural/Metro Stockholders Litigation,
2014 Del. Ch. LEXIS 202, held that RBC Capital Markets as a financial adviser to Rural/Metro was liable for about $75.8 million as a result of the Rural/Metro directors improperly negotiating a merger at too low a price and sending stockholders misleading information. Even more startling, the directors had settled the claims against them for just $6.6 million and had no obligation to contribute to the $75 million that RBC had to pay. How could this happen?
To begin with, it is important to note that the liability decision issued earlier in the Rural/Metro
case had laid much of the blame for the board of directors' bad acts at the feet of RBC. The court concluded that RBC's advice to the Rural/Metro board was tainted by RBC's efforts to get a piece of the financing in another deal involving Rural/Metro's competitor. Hence, RBC was far from blameless for the liability incurred by the board of directors. Moreover, after the directors had settled before trial, RBC had elected to contest any liability, not just for itself, but even on behalf of the directors. RBC did not cross-claim to try to prove the directors were more culpable than RBC.
Faced with the odd situation of directors having settled and huge damages to pay, the court turned to how to allocate damages between RBC and the settling defendants. Under the provisions of the Delaware Uniform Contribution Among Tortfeasors Act, the defendants who settled could not be required to pay any part of the damages awarded after the trial. Instead, RBC, as the remaining defendant, was entitled to a credit against the judgment in proportion to the liability of the other defendants. That credit was what the Court of Chancery had to determine.
First, the court made several preliminary rulings. It held that RBC was entitled to claim a contribution credit from the other defendants even though RBC had not filed a cross-claim seeking that credit until after damages were determined. The court also determined that RBC could not seek a contribution credit for conduct that constituted a "fraud upon the board." These are important rulings insofar as they permit defendants to blame each other, after liability is established. Note, however, that the liability decision may foreclose that sort of claim later once the facts have been determined. For example, RBC was found guilty of a "fraud upon the board" in the liability decision. This means that even absent a cross-claim, defendants need to be mindful of the need to carefully differentiate their conduct from that of the other defendants during a liability trial.
This will not be easy to do in any case, but is particularly difficult because of a special aspect of Delaware corporate law. The right to contribution turns on joint liability. That is different from joint culpability. Most Delaware corporations have a charter provision that exculpates directors from liability for their negligence, commonly referred to as a "duty of care" liability. Hence, if directors are not liable for a breach of their fiduciary duty to use care in making decisions because of such an exculpation provision, then they are also not subject to contribution claims based on their negligence. They may be culpable, but they are not liable.
This point made a big difference in the outcome of the Rural/Metro
case. The court concluded that only two of the seven directors were liable for the breach of duty it found. The others were exculpated by Rural/Metro's charter. That dramatically reduced the contribution credit RBC received. That factor, plus the decision that RBC was precluded from seeking contribution credit for that part of the claim based on the "fraud upon the board," meant that RBC ended up with responsibility for 83 percent of the damages.
What, then, does all this mean in the real world? There are several practice points that Rural/Metro
suggests. First, as Rural/Metro
shows, the defendants in breach of fiduciary duty cases may have different interests, even if they are all on the same board of directors. That potential conflict of interests needs to be addressed, including possibly retaining separate counsel. You do not want to face questions from one client about why she cannot get contribution credit after trial from your other client.
Second, when representing non-settling defendants in such a case, you need to be mindful of the limits on your contribution rights. Do not expect to get a contribution credit from directors whose liability is exculpated under charter provisions dealing with breach of duty claims. Your client may be stuck with most of the damages. That will affect whether you should join the settlement.
Finally, the Rural/Metro
decision was fairly lenient in its ruling that permitted RBC to assert contribution claims post-trial on liability. While its ruling seems correct, there is not a controlling Delaware Supreme Court decision that would permit that post-trial procedure. This cautions that care is needed to preserve contribution rights that might otherwise be lost.
is a major decision from a well-respected court. It deserves full and careful reading that will disclose a lot more than this short article discusses.