Financial Adviser Update Regarding Disclosure of Fees

March 27, 2017

A recent Delaware Court of Chancery case, Vento v. Curry, highlights Delaware courts’ treatment of financial adviser relationships, how these relationships intersect with directors’ fiduciary duties, and the importance of financial advisers and clients disclosing detailed fee information. 

This decision concerns a proposed stock-for-stock transaction whereby Consolidated Communications Holdings, Inc., agreed to purchase FairPoint Communications, Inc. A leading global financial services firm was Consolidated’s lead financial adviser and provided a fairness opinion in the transaction, while an affiliate of the adviser agreed to provide part of $935 million in debt refinancing for FairPoint. 

In early March 2017, a Consolidated stockholder filed a complaint alleging that the Consolidated board of directors breached its fiduciary duties by not disclosing the precise dollar amount associated with the refinancing. Specifically, the plaintiff’s allegation was that while Consolidated disclosed several fees incurred prior to and as a result of the transaction — such as a contingent transaction fee of $13 million payable to the adviser upon the consummation of the transaction; aggregate fees, paid to the adviser by Consolidated, of between $3 million and $4 million in connection with previous financial advisory and financing services; and aggregate fees of less than $1 million paid to the adviser from FairPoint in connection with previous financing services — a registration statement produced by Consolidated did not adequately disclose the amount the adviser expects to earn from the debt refinancing. 

The court identified the relevant legal standard, highlighting that whether information is required by law to be disclosed “[depends] on whether the financial adviser’s interest in the transaction [is] material and, if so, whether that interest [is] quantifiable.” Applying this standard, the court held that “the financing fees [the adviser] stands to receive in connection with the transaction create a potential conflict of interest for [the adviser]” and that such fees are material and quantifiable. 

The court held that the amount of the refinancing fee to the affiliate must be provided before allowing the required vote to take place at Consolidated’s special stockholder meeting. The stockholder meeting at issue was scheduled for March 28, 2017. The court ordered a preliminary injunction enjoining holding of the meeting under five days after disclosure of the amount of the fee associated with the refinancing. The precise amount of such fees (approximately $7 million) was disclosed later that same day (on March 22, 2017), and thus the stockholder meeting may go forward as planned on March 28, 2017. 

In analyzing the legal standard required to issue a preliminary injunction, the court held that the potential of an uninformed stockholder vote constituted irreparable harm. Applying a balancing test, the court also held that “the potential burden caused by a limited delay is outweighed by the benefit of the added disclosure …” and thus that “the balance of equities favors the issuance of a preliminary injunction ….” The court did not elaborate on its claim that a “limited delay” outweighed “added disclosure.” Regarding the court’s analysis that the amount at issue was material and quantifiable, the court recited the defendant’s estimates that such an amount could be approximately $5.6 million. 

Even though a contingent $13 million transaction fee, fees between $3 million and $4 million in connection with previous financial advisory and financing services, and fees from FairPoint of less than $1 million in connection with previous financing services were disclosed to stockholders, the court found that the fees to be paid to the adviser as a result of the debt refinancing were “material and quantifiable,” and thus should have been disclosed. As a result of the disclosures made by Consolidated, Consolidated stockholders could likely already have known that the fees to be paid to the adviser totaled approximately $18 million to $20 million. It was unlikely that the additional disclosure of the exact amount to be paid to the adviser as a result of the debt refinancing, approximately $7 million, would have caused a stockholder to change his or her vote, calling into question whether such additional disclosure was indeed “material.”  

The facts in the transaction underlying this decision were altogether different from those of prior decisions involving financing, the key difference being that this decision involved refinancing the target’s debt (similar to acquisition financing in that the financial adviser was engaged only by the buyer), while in stapled financing the financial adviser advises the seller from an M&A perspective, but provides financing to the buyer. For instance, the court in Globis Partners v. Plumtree in 2007 dismissed inter alia plaintiffs’ claims that the defendants breached their disclosure obligations pursuant to a merger between two software companies by failing to provide details about their financial adviser’s compensation in the proxy statement to stockholders, specifically, that such compensation was partially based on the successful completion of the merger. The proxy statement said the financial adviser’s fees were “customary” and partially contingent, and offered no further details. That court found that, without an “allegation of exorbitant or otherwise improper fees, there is no basis to conclude the additional datum of the [adviser’s] actual compensation, per se, would significantly alter the total mix of information available to stockholders.” 

In contrast, in March 2011, the court in In re Atheros Communications, Inc. Shareholder Litigation enjoined the target, Atheros Communications, Inc., from holding a stockholders meeting to approve a merger with Qualcomm, Inc., pending curative proxy disclosure of the amount of contingent fees to be paid to the financial adviser, among other issues. Like Globis, the original proxy statement did not disclose the exact amount of the financial adviser’s fee nor the exact percentage of the fee that was contingent upon closing of the merger. The proxy statement did state that the financial adviser would “be paid a customary fee, a portion of which is payable in connection with the rendering of its opinion and a substantial portion of which will be paid upon completion of the [m]erger.” The financial adviser was to be paid a flat fee, of which approximately 98 percent was contingent upon the closing of the transaction. Though declining to announce a bright-line rule, that court reasoned “it is clear that an approximately 50:1 contingency ratio requires disclosure to generate an informed judgment by the shareholders as they determine whether to rely upon the fairness opinion in making their decision to vote for or against the [t]ransaction.” The amount of fees paid to the financial adviser was also required to be disclosed.

A February 2011 case also highlighted the treatment of a company’s board of directors with respect to a claim of breach of fiduciary duty in a stapled financing context. The In re Del Monte Foods Company Shareholders Litigation case halted a stockholder vote on the proposed buyout of Del Monte Foods Company, finding that the merger agreement among Del Monte and a group of private equity firms resulted from collusion among Del Monte’s financial adviser and those private equity firms. In this decision, Vice Chancellor Laster criticized the financial adviser for its conflicting roles in bringing together competing bidders, thus limiting the competition, and seeking to provide buy-side financing while simultaneously acting as the financial adviser assisting the board of Del Monte in its potential sale. The financial adviser stood to earn $21 million to $24 million from the financing and approximately $23 million for its advisory role, and Del Monte paid an additional $3 million by engaging another financial adviser to provide a second opinion. The court ultimately enjoined the stockholder vote for 20 days and found that Del Monte’s board of directors breached its fiduciary duty of care to stockholders. 

Del Monte followed a 2005 decision by then-Vice Chancellor Strine, who criticized the board of Toys “R” Us for creating “an appearance of impropriety” by allowing its financial adviser to finance the winning bidder of the company. In that opinion, however, Strine also said in a footnote that he was not making a bright-line statement and could “imagine a process when a board decides to sell an entire division or the whole company, and … obtains a commitment from its financial adviser to provide a certain amount of financing to any bidder, in order to induce more bidders to take the risk of an acquisition,” that would be wholly consistent with the best interests of the company. 

What financial advisers and their clients should gain from this decision is that all fees should be disclosed with specificity.