Stout Managing Director Christina Carroll caught up with Myron Steele. In his career, he served as a Judge of the Superior Court and a Vice Chancellor of the Delaware Court of Chancery and former Chief Justice of the Supreme Court of Delaware (the “Court”) after 18 years in private litigation practice. During his time as Vice Chancellor, he presided over major corporate litigation and LLC and limited partner governance disputes and wrote over 400 opinions resolving disputes.
Stout: What advice would you give to directors of public companies as they enter into significant transactions?
Myron Steele: My advice to directors of public companies is, as Rural/Metro so clearly teaches, do not overlook your oversight responsibilities. Once you hire a banker and lawyer and the sale process begins, your job is not over. You are in it to the very end, and need to be focused on getting the process right and assuring that material information is given to your stockholders before they vote.
Stout: When we read the Delaware opinions, we're always surprised how well the justices grasp the technical valuation and corporate finance issues. We know that some justices will even dive into cash flow models in arriving at their opinions. How are they able to manage such complex valuation and corporate finance technical issues?
Steele: The justices do take corporate finance courses in law school, so they get some exposure initially. Their real training comes when they are preparing cases and cross-examining the experts as litigators. This issue really pertains most to vice chancellors, who have to delve deeper into valuation issues in a case, the experts’ assumptions and analysis used in developing an opinion. Chancellor Bouchard and Vice Chancellor Laster are excellent examples, because of the practices from which they came, where they prepared and cross-examined experts. You can’t cross-examine an expert unless you understand deeply the discipline the expert is testifying about. It is part of your job as a litigator, no matter what side you are on and even more important to a judge.
If you are adjudicating an appraisal case, you’d better understand about DCF (discounted cash flow analysis), how it applies and why, if it is, a better methodology than other methodologies available. Appraisal cases have their own difficulties, and most of the judges would tell you that they would rather have a colonoscopy than preside over an appraisal case!
I’ll give you an example of an appraisal case that illustrates this point, involving a construction firm in Missouri. I had no personal experience with or knowledge about infrastructure construction in Missouri, and the experts were 25% to 30% apart. The lazy way to decide a case is to split the difference down the middle, but the judges in Delaware really try to get the right answer. What you have to do is understand each expert’s underlying assumptions and see to what extent the record supports those assumptions. Very rarely will you want to tangle with the experts on why they chose DCF as opposed to something else or how they calculated the DCF, because they know more about it than you do. In the end, you end up focusing on the different assumptions each expert has made. In this case, the difference in value came down to an assumption about whether the company would get a permit to develop a gravel pit. Three days of testimony about valuation — a battle of the experts — and at the end of the day, the case came down to whether or not the company would get the permit. Most of us realize that whether an agency grants a permit in a regulatory context is difficult to predict. I had to rule and I had no experience or way of knowing with certainty that I would get it right. It came down to which expert’s assumption was correct.
Our judges read quite a bit of academic literature. Our new Chief Justice Strine, who as far as I am concerned is a whiz kid, is just so smart. He has written more than 30 law journal articles himself. I remember when Strine had the infamous Lord Conrad Black case, involving a fight over the Jerusalem Post and whether Lord Black had breached his fiduciary duties. Strine decided the case one afternoon, and in London, the deal was going to be consummated or not based on his ruling. The five of us in the Supreme Court were huddled around the fax machine waiting for his opinion because we had to rule before 10 a.m., to affirm or reverse, to confirm or reject Strine’s opinion. We were sitting there and then page after page after page came across on the fax machine, just a few hours after he had heard the last of the testimony in the case. In the end, he produced a 90-page opinion. He laid it out beautifully. It was really well-written; I was just amazed by it. Strine has an extraordinary facility for not only cranking the work out quickly and with a really firm understanding of the facts of the case, but also embellishing it with good humor. I continue to be amazed by his work ethic.
Stout: Four of five of the justices of the Supreme Court have joined the Court in the last two years. How is the Court changing since you left?
Steele: Well, you said it all when you pointed out that four of the five justices are new … so these folks are just getting ready to work together and it is too early to see if there is a change. Chief Justice Strine just said on Monday that there was continuity between my departure and his arrival. We will see about that. It is a younger court, made up of very experienced attorneys, but it is too early to tell if there are going to be any major changes. We have seen Chancery make a significant cutback on disclosure-only, or therapeutic, shareholder actions and take more aggressive stances on nuanced issues in several key areas of the law.
Stout: Does the Court or did you have any “pet peeves” related to valuation issues in particular?
Steele: I think there is frustration with appraisal cases, not “regular” valuation if you can call it that, such as in Rural/Metro — not so much valuation for purposes of a derivative suit or a class action suit or valuation in post-closing money damages. I think the Delaware judges love the latter cases.
The frustration with appraisal cases is that experts come in with such wide differences in expert opinions about valuation. Now there is also the frustration that hedge funds, for example, can buy into an appraisal case according to statute. The Court finds that very annoying. The inexactitude and lack of definitiveness in what the number should be or lack of confidence in the number is frustrating. It begins with two experts, and they know more than the judge, or they would not be allowed to testify. Just like in the Missouri case, it is difficult to know what to do with such widely disparate numbers from the experts.
Another frustration with appraisal cases is that they make it look like it takes a long time for cases to be heard in Delaware. In reality, Delaware has a disciplinary rule that says the justices have only 90 days to decide a case in Delaware or they may be subject to disciplinary action. The reason appraisal cases take so long has to do with the coordination of lawyers’ schedules before a case gets calendared.
For 19 years, I’ve been marketing Delaware as the place to be for corporate and commercial cases because it was part of my job as a chief justice and vice chancellor to promote Delaware as a jurisdiction that provides timely rulings. Of course, predictability, consistency and clarity are always important, but never overlook from the businessperson’s perspective how important it is to get a result out as quickly and efficiently as possible.
Stout: Rural/Metro involved a Delaware case against investment bank RBC and the Board of Directors of Rural/Metro, accusing the Board of breaching its fiduciary duties in approving the sale and also accusing RBC of “aiding and abetting” the directors in their breach of fiduciary duties. We know that you represented some of the parties in the appeal after Laster ruled. Some of the issues that arose in the appeal were:
What are the takeaways and lessons learned from Rural/Metro?
Steele: Revlon applies when it is an all-cash deal and a decision to sell initiates the process. It is not Revlon while you are exploring alternatives. It is only when there is a final decision to sell. There is significant leeway given to the Special Committee of the Board to explore alternatives that produce the highest possible price, but Revlon applies only after there is a clear, unequivocal decision to sell.
In Rural/Metro, in one proceeding RBC was put in the very difficult position of really not being able to argue simultaneously that the directors both had not breached their fiduciary duty and if they did how to apportion damages among all tort feasors in one proceeding. If RBC was found to have aided and abetted a breach, then they were all joint tort feasors and damages would be apportioned among the Board and RBC. You can’t make that argument when the premise is that they didn’t breach their fiduciary duty at all, because if they didn’t breach, then there is nothing to aid and abet.
You could read the record and conclude that the Rural/Metro Special Committee was authorized to sell the company, but Vice Chancellor Laster found that they were not so authorized. The Vice Chancellor saw that fact to be the first flaw in the process — that the Special Committee jumped the gun without authorization. You can read the engagement letter of RBC as allowing them to cut any side deal they wanted on the theory that as long as they are running a process that is likely to develop the highest possible price, who cares if the investment banker gets a side deal that is beneficial to them, as long as it doesn’t skew the process? RBC never cut any side deals in Rural/Metro, but Vice Chancellor Laster believed the process was unreasonable, and therefore failed the Revlon test. Was the process structured to get the highest possible price or not? It wasn’t any more complicated than that. He thought not.
Another interesting point about Rural/Metro is that for the first time in my experience, a failure to meet the Revlon test constituted gross negligence. Vice Chancellor Laster found liability based on gross negligence without articulating in the opinion following the case in chief how someone was grossly negligent, and based liability stemming on strictly on unreasonable process without any specific finding of gross negligence on the part of the fiduciaries.
Vice Chancellor Laster found the directors breached their duty of care by not exploring carefully enough whether RBC’s potential side deal (stapled financing) constituted a conflict such that it might prevent the process from achieving the highest possible price. The Board’s failure to explore the conflict adequately and their failure to adequately monitor the sole process resulted in a material disclosure violation that he found could have influenced the stockholders’ vote on the merger. In the end, the stockholders did get a sizable premium, and for months no topping bid came in before the transaction closed. Several months is a long time for the market to assess whether the price on the table is right, and then 18 months later Rural/Metro filed for bankruptcy. The shareholders that cashed out at the premium price were looking pretty good at that point.
It was RBC’s looking after themselves that created the issue in the case, according to Vice Chancellor Laster, and prevented a higher price. Laster is very concerned about fairness, equity and people, including investment bankers, allowing fiduciaries to discharge their duties meticulously.
The standard of care articulated in Rural/Metro may have been conflated with the standard of review. Reasonableness under Revlon is the standard for testing the process, but gross negligence must still be the basis for determining director liability.
The lessons from the Rural/Metro case are that the Court of Chancery is focused on the retention and engagement of investment bankers to ensure the sales process isn’t tainted. Not only do conflicts need to be disclosed, but it also must be documented that conflicts have been identified and that there is robust discussion and a reasonable basis, despite conflicts, for retaining a particular investment banker. If the investment bank wants to do stapled financing, the board should document why that is OK with the board. Boards cannot leave it to the engagement letter to take care of the conflict issue. Boards also must continue to monitor the process as it goes along. It is all about process in Delaware: structure, the price produced and disclosure of material information about that process to stockholders.
Stout: In your review of board and officer conduct in an M&A transaction, how often do you feel that with advice of counsel, the process is “done right”?
Steele: Overwhelmingly, I think the process is “done right” far more often than not. And while a lot of suits have been filed, numbers show that something like 80% to 95% of deals result in some sort of litigation, look at how many actually result in a successful trial and opinion with money damages awarded? Not many.
Stout: What was the biggest surprise to you after you left private litigation practice after 18 years and joined the Court?
Steele: After 18 years in private law practice, I thought there were changes to the Delaware Court system that needed to be made, and I didn’t think I could make those changes from the outside. The opportunity to join the Delaware Court comes around infrequently because of the 12-year term, so at the propitious age of 43, I had the opportunity for the “brass ring.” Delaware has a unique constitutional provision dating back to 1897 requiring a balanced court politically for each of its three major courts. With five members on a court, there must be three members of one party and the remaining two must be from the other party. All three major courts can have no more than a majority of one in toto.
The biggest surprise for me when I joined the Court was that I discovered that one person cannot enact unilateral change in the court system. I thought that I could make sweeping changes, but that just didn’t happen. You begin to realize that you have limited control as a judge, justice and even Chief Justice. I read in an ABA Journal many years ago that lawyers are 100% in favor of progress and 1,000% against change! There has been a lot of change in Delaware since I’ve been around the Court, going back to 1988, but it has been gradual change, based on broad consensus.
Stout: During your time on the Court, what was the most interesting case that you adjudicated?
Steele: The most interesting case for me was a case involving Cantor Fitzgerald. Cantor Fitzgerald’s founder, Bernie Cantor, had passed away, and according to their succession plan, Howard Lutnick was to become the managing partner of Cantor Fitzgerald. Bernie Cantor’s widow, Iris Cantor, disagreed with the succession plan so she teamed up with her nephew to try to compete with Cantor Fitzgerald. Cantor Fitzgerald sued Iris Cantor and the nephew for breaching the LP agreement.
The case was interesting because I learned so much about the US bond market and because of the issues pertaining to alternative entities and fiduciary duties. All the Cantor Fitzgerald partners had pledged in the limited partnership document not to compete and that they owed the entity a fiduciary duty of loyalty. The position has always been that limited partners in limited partnerships typically don’t owe a fiduciary duty and typically have limited exposure to liability. Fiduciary duties in English trust law informs our Common Law. LPs and LLCs did not exist at Common Law. The LP agreement unusually included a duty of loyalty provision. No existing cases discussed whether limited partners could be bound to a fiduciary duty of loyalty. After all, they were not fiduciaries in the Common Law sense. We could not find any previous cases where this issue had been ruled on. There you have the magic for me: it was in an area of the law that I love and spent a lot of time on, and it was also a high-profile case because Cantor Fitzgerald had such a dominant position in the US bond market. The Cantor Fitzgerald case was my own personal reality show: a unique legal issue with “Family Feud” mixed in.
In Chancery we also had a case involving the partnership fight between Viacom and Universal Studios pertaining to the USA Network. Edgar Bronfman Jr. and Sumner Redstone testified. We had a clash of experts. The surprise in that case was that one of the experts allegedly falsified his credentials — he did not have the degree from the Kennedy School at Harvard that he represented on his CV. I remember this because I had never seen anything like this and I had to rule whether the expert could testify in the matter. My position was that the crux of the issue for an expert is whether they are credible. I could sit there for a day listening to his testimony, but I wasn’t going to waste everyone’s time because in the end I couldn’t be sure I would believe any of his testimony. You don’t forget cases where events occur that are of first impression.
Stout: What do you do when you aren’t practicing law, teaching, speaking or writing on corporate governance and other pertinent issues?
Steele: My wife and I live on a small horse farm just outside of Dover. In hay season, I bring in the hay on the farm. In addition to farming, I like hunting and I love college sports. All college sports, men’s and women’s teams. I check my alma mater sports websites, the University of Virginia, every day to see how they are doing. It is an obsession. My wife says, “In some respects, you will never be older than 19.” I guess the only way I get to stay 19 is to follow college sports.
You unleashed a monster… now you have me talking about all the things I really care about!