Liability for fairness opinions under Delaware Law.

• Author: Cushman, Cameron

1. Introduction II. Background A. Negligent Misrepresentation 1. Strict-Privity Approach 2. Actually Foreseen Approach 3. Reasonably Foreseeable Approach B. Agency III. Analysis A. Delaware Authority 1. Weinberger v. UOP, Inc 2. In re Shoe-Town, Inc. Stockholders Litig 3. Stuchen v. Duty Free International, Inc 4. Negligent Misrepresentation Under Delaware Law B. Application of Delaware Authority in Different Factual Circumstances 1. Scenario One: Management Hired Investment Bank, Shareholders Did Not Act in Reliance on Fairness Opinion 2. Scenario Two: Management Hired Investment Bank, Shareholders Did Act in Reliance on Fairness Opinion 3. Scenario Three: Special Committee Hired Investment Bank 4. The Schneider Situation IV. Recommendation V. Conclusion I. INTRODUCTION

   Fairness opinions are statements or reports issued by investment banks stating at what price a specific corporate transaction is fair, from a financial perspective, to a particular party. (1) These transactions are typically transactions that involve control of the corporation. (2) In Smith v. Van Gorkom, (3) the Delaware Supreme Court found a board of directors personally liable for an unfavorable merger--approved without an outside valuation--because they failed to fulfill their duty of care to make an informed business decision. (4) Since then, fairness opinions have become commonplace in corporate control transactions. (5)

   As fairness opinions have become more common, the liability that an investment bank may incur as a result of issuing an opinion has become an issue of great importance. (6) Courts differ on the extent to which an investment bank may face liability to shareholders of a company when that bank issues a fairness opinion to that company's board of directors, (7) and scholars disagree on the most appropriate solution. (8) Delaware--the state where more than half of the country's major corporations are incorporated (9) and whose state corporate law has been described as "a de facto national corporate law" (10)--has little authority on the subject. (11)

   This Note attempts to predict whether and to what extent Delaware courts will find investment banks liable to third-parties for negligently issued fairness opinions, and it argues which approach would be most beneficial. Part II examines the extent to which courts outside Delaware have found investment banks liable to third-party shareholders for issuing fairness opinions. Part III examines Delaware authority, analyzes what that authority could mean, and provides the likely outcomes to some common fact patterns under Delaware law. Part IV recommends that Delaware allow shareholders to bring negligent misrepresentation claims against investment banks for negligently issued fairness opinions, that Delaware should use the "reasonably foreseeable" approach to negligent misrepresentation for these claims, and that Delaware should follow New York courts by adopting the Schneider v. Lazard Freres & Co. holding.

2. BACKGROUND

   There are multiple theories under which an investment bank may be held liable to third-party shareholders for a fairness opinion issued to a board of directors. The most common is the tort of negligent misrepresentation. (12) One court has also imposed liability under the law of agency. (13) Shareholders sometimes bring claims against investment banks on the theory that the banks breached a fiduciary duty owed to the shareholders. (14) However, these claims have not been successful, (15) so this Note does not address them.

   1. Negligent Misrepresentation

      Negligent misrepresentation is "[a] careless or inadvertent false statement in circumstances where care should have been taken." (16) To succeed in a negligent misrepresentation claim, plaintiffs must show that the defendant owed them a duty. When applying negligent misrepresentation to professionals whose business involved issuing statements for the guidance of others (such as investment bankers or accountants), courts traditionally only found a duty to claimants with whom the professional was in privity. (17) Recently, however, courts have liberalized this privity requirement. (18) A line of cases decided by the New York Court of Appeals illustrates the development of this liberalization: Ultramares Corp. v. Touche, (19) Credit Alliance Corp. v. Arthur Andersen & Co., (20) and Wells v. Shearson Lehman/American Exp., Inc. (21)

      In Ultramares Corp. v. Touche, (22) the New York Court of Appeals dismissed a negligence claim against a firm of public accountants because the plaintiffs were not in contractual privity with the accounting firm. (23) In January 1924, Fred Stern & Co. hired Touche, Niven & Co., an accounting firm, to prepare a balance sheet showing the state of Fred Stern's business. (24) The accounting firm knew that Fred Stern would present this balance sheet to lenders in order to procure loans. (25) While conducting the audit, the accounting firm failed to verify accounts and investigate suspicious information that a "careful and skilled auditor would have desired to investigate." (26) In March 1924, relying on the certified balance sheet, ultramares Corporation--the plaintiff--agreed to loan Fred Stern a substantial amount of money. (27) In January 1925, Fred Stern declared bankruptcy. (28)

      Ultramares brought a claim against Touche, Niven & Co. for negligently conducting its audit of Fred Sterns. (29) The court stated that Touche did perform the audit negligently. (30) However, the court went on to hold that ultramares could not maintain a tort action against Touche because Touche did not owe ultramares any duty to conduct the audit with care. (31) The court reasoned that, because the duty of an accountant to use "care and caution proper to their calling" (32) arose from contract, ultramares was not in privity of contract with Touche. (33)

      Later, in Credit Alliance Corp. v. Arthur Andersen & Co., (34) the New York Court of Appeals reaffirmed Ultramares, but elaborated on its proper application. (35) Instead of requiring that parties be in strict contractual privity, the Credit Alliance court set forth a three-part test to determine whether the relationship between a professional and a third-party constituted "near privity," in which case the third-party could bring a negligent misrepresentation suit against the professional even though there was not actual privity. (36) The court held that in order for there to be near privity: (1) the professional must have known that its representation would be used for a particular purpose; (2) a known party or parties intended to rely on that representation; and (3) there was some conduct by the professional "linking them to that party or parties, which evidences the [professional's] understanding of that party or parties' reliance." (37)

      Although Credit Alliance concerned a claim against accountants, in Wells v. Shearson Lehman/American Exp., Inc., the New York Court of Appeals extended the application of its "near privity" test to investment bankers. (38) In Wells, the board of directors of Metromedia created a committee, comprised of four of its members, to evaluate the fairness of a proposed buyout to the corporation's shareholders. (39) That committee hired two investment banks-Shearson Lehman and Bear Stearns-to issue fairness opinions on the buyout. (40) Both banks issued opinions that were included in proxy materials sent to shareholders. (41) Based on these proxy materials, the shareholders voted to approve the buyout. (42) After the fact, it turned out that both opinions significantly undervalued the company. (43)

      A shareholder of the corporation brought a claim against the banks, asserting that they failed to use due care in issuing the fairness opinions. (44) The New York Supreme Court, Appellate Division, held that the plaintiff could maintain a claim against the investment banks. (45) The court explained that because the committee, and not the board itself, hired the investment banks and the committee's purpose was to determine the fairness of the buyout to the stockholders, the banks were actually retained to advise the shareholders. (46) Citing Credit Alliance, the Wells court found this bond sufficient to create liability to the shareholders. (47)

      With this line of cases, New York pioneered the application of negligent misrepresentation to investment bankers without contractual privity. (48) However, the requirements to bring a claim of negligent misrepresentation still vary from jurisdiction to jurisdiction. (49) There are currently three approaches to professional negligent misrepresentation: the strict-privity approach, the actually foreseen approach, and the reasonably foreseeable approach. (50)

      1. Strict-Privity Approach

         The "strict privity" approach limits liability for professional negligent misrepresentation to those in privity with the professional. (51) It does so based on the premise that any duty of care owed by professionals arises out of contract. (52) The approach was originally derived from Ultramares, discussed above. (53) Ultramares attempted to limit the liability of professionals, noting that otherwise professionals could be subject to near unlimited liability. (54) The Credit Alliance method of allowing claims by third parties in cases where the relationship between the professional and the third-party approaches "near privity" is a variation of this approach. (55)

      2. Actually Foreseen Approach

         The Second Restatement of Torts adopts the "actually foreseen" approach to professional liability to third-parties for negligence. (56) This is also the view adopted by a majority of jurisdictions. (57) This approach allows claims only when the professional actually knew that the third-party claimant was going to rely on their misrepresentation, so it avoids the unlimited liability feared in Ultramares without overly restricting third-party claims. (58) In the context of fairness opinions, this standard would often be met...