The recent stock market downturn could cause severe indigestion for several highly acquisitive companies. If the chief executive is looking to make the FD the scapegoat for a deal that went sour, the FD may not be able to lay the blame on the financial advice obtained at the time of the transaction. Before he settles down to re-read the financial advisers' engagement letter with the benefit of hindsight, the FD should perhaps reflect on the lessons of Ginora Investments Ltd v James Capel & Co. Ltd.
Some six years on, the case provides useful reminders for those reviewing engagement letters for corporate finance advice. In the case, the judge noted that the board of the public company retaining the adviser was not "an elderly widow with failing eyesight and no business experience".
In 1989, James Capel were retained at three days' notice to act as financial advisers to the property company Priest Marians Holdings plc in connection with a £115 million hostile acquisition of Local London Group plc.
Witnesses for Priest Marians alleged that Local London's indebtedness had been far greater than anticipated at the time of the bid. Priest Marians subsequently went into voluntary liquidation. James Capel was sued for alleged negligent misrepresentation and breach of the duties of care that Priest Marians claimed that Capel had assumed when they agreed to act as the bidder's advisers, albeit at such short notice. The amount claimed was £34 million. The cause of the action was assigned to Ginora Investments.
Capel's letter of engagement expressly assumed a duty to advise on "tactics and strategy". In these proceedings, it was alleged that Capel also assumed an implied duty of care to advise Priest Marians:
- On the financial implications of the proposed acquisition of Local London Group;
- On the suitability of the proposed acquisition, including the level of risk inherent in it and whether the possible benefits to Priest Marians justified the level of risk;
- On the timing, price and terms of the bid; and
- On the tactics to be employed and, in particular, whether the bid should have been a recommended or hostile one and whether or not it should have been declared unconditional in all respects.
Capel alleged that its duty of care was more limited. In this regard, it relied upon the report of the DTI Inspectors into Atlantic Computers Plc published in April 1994. That report described the role of a merchant bank in the takeover of a quoted company as:
"... essentially a co-ordinating and facilitating role, advising on regulatory and tactical matters and on the financing of the bid and its presentation to the market, with responsibility for ensuring that all documentation was properly prepared and that all regulatory requirements were satisfied".
The DTI Inspectors also indicated that, in the absence of any express agreement to the contrary, a merchant bank acting as a financial adviser on a takeover did not impliedly assume a responsibility for giving advice on the question of whether an acquisition was in the best interests of the offer or company's shareholders. The merchant bank's duty was no higher than "... to satisfy itself that the company has taken all reasonable steps to enable it to evaluate the target and judge whether the acquisition is in the best interests of shareholders". The judge, however, did not adopt this definition.
Why Capel Won
Ruling in Capel's favour, the judge thought two things were particularly important. First, the question of possible negligence had to be considered in the light of the circumstances obtaining at the time, rather than with the benefit of hindsight. Second, whatever Capel's duties were, they were owed to the board of the listed public company. The judge assumed that the directors of that company had the knowledge, wherewithal and the business acumen to run a company of that nature.
The advice given by the financial advisers may, of course, turn out to be wrong. But the judge made it clear that, provided the advice was given reasonably and in the light of what was known at the time, the directors could not assume that the company could recover its losses from its financial adviser.
Lessons to be learnt from the case
(i) For corporate finance advisers the decision emphasises:
- The importance of setting out in a letter of engagement the precise duties and obligations, which a merchant bank, acting as financial advisers in a takeover, is assuming to its client. That is particularly so in view of the judge's refusal to adopt the definition of the scope of a merchant bank's duty as outlined in the report of the DTI Inspectors on Atlantic Computers Plc.
- The information for which the adviser takes responsibility, and that for which it is relying on others.
- The need to apportion responsibility for the making of commercial decisions; in the case, the company directors were experienced property developers, yet they attempted to blame their financial advisers for a subsequent decline in property values.
- The need to maintain, as far as possible, an accurate note of telephone calls and meetings throughout the transaction.
For the board:
- The decision in Capel makes it very clear that a board must consider carefully whether its proposed strategy is correct. It is also vital that the board can subsequently demonstrate at any trial that it was justified in relying on its advisers.
- Perhaps most significantly, the board must recognise that the courts are likely to attribute to it a sufficient degree of knowledge of its own business sector to make informed strategic decisions, with or without financial advisers.
For the finance director, the case underlines the need to pay particular attention to the description of services in the letter of engagement with the financial advisers - not merely to the fees clause.
- Is the description of the role so narrow that the adviser appears to be taking no responsibility? So, for example, who will ensure that the different advisers or the deal team are co-ordinated, and that whatever is required to conclude the deal is delivered when anticipated by the timetable.
- Will the financial adviser be responsible for "plugging the gaps"? So, if the adviser considers that there are gaps in the investigation of the target - or in the other advisers' reports is it expected to "stick its hand up" and identify them?
- What sort of recommendation is the board going to receive from the adviser? Are the directors happy to rely on their own commercial assessments of the deal? If not, do they want the advisers to advise the board on whether they actually believe that the terms of the deal are reasonable in case the institutional shareholders and the press start sniping. One other point to watch is to whom the directors can disclose the financial advice they have received.
- In what form, if any, will the advice be presented to the board? Will there simply be an oral presentation or a written summary, which can be circulated to all directors, particularly those who cannot attend the sign-off meeting?
- Fees: check the fees clause carefully, particularly if there have been any late changes. For example: - Is there a monthly advisory fee? If so, is there an offset against a success fee? What is payable if the engagement is terminated by the Company? - What is payable at what stage of the engagement (for example, initially, on announcement and on the conclusion (or aborting) of the deal)? And - If there is a percentage success fee, what is it to be worked out on?
(iv) For the in-house lawyer or company secretary, it is important that decisions at board or committee meetings dealing with major acquisitions (and the financial advice given at the meetings) are carefully minuted. Check whether correspondence from the financial advisers sent to a specific individual within the Company at an earlier stage of the deal needs to be drawn to the attention of the board before rather than after the deal is announced. The letter may, for example, highlight a crucial aspect of the transaction, which is outside the financial adviser's expertise.
For further information, please contact:
Andrew Crawford, Mitre House, 160 Aldersgate Street, London EC1N 4DD
Phone: 020 7367 2867, e-mail: [email protected]
Simon Howley, Mitre House, 160 Aldersgate Street, London EC1N 4DD
Phone: 020 7367 3566, e-mail: [email protected]