University of Pennsylvania Carey Law School Penn Law: Legal Scholarship Repository Faculty Scholarship at Penn Law 2014 Bankers and Chancellors William W. Bratton University of Pennsylvania Carey Law School Michael L. Wachter University of Pennsylvania Carey Law School Follow this and additional works at: https://scholarship.law.upenn.edu/faculty_scholarship Part of the Banking and Finance Law Commons, Business Law, Public Responsibility, and Ethics Commons, Business Organizations Law Commons, Contracts Commons, Corporate Finance Commons, Courts Commons, and the Law and Economics Commons Repository Citation Bratton, William W. and Wachter, Michael L., "Bankers and Chancellors" (2014). Faculty Scholarship at Penn Law. 1306. https://scholarship.law.upenn.edu/faculty_scholarship/1306 This Article is brought to you for free and open access by Penn Law: Legal Scholarship Repository. It has been accepted for inclusion in Faculty Scholarship at Penn Law by an authorized administrator of Penn Law: Legal Scholarship Repository. For more information, please contact [email protected]. BRATTON (WACHTER).FINAL.RESUBMIT (DO NOT DELETE) 11/21/2014 12:26 PM Articles Bankers and Chancellors William W. Bratton* & Michael L. Wachter** The Delaware Chancery Court recently squared off against the investment banking world with two rulings that tie Revlon violations to banker conflicts of interest. Critics charge the court with slamming down fiduciary principles of self-abnegation in a business context where they have no place or, contrariwise, letting culpable banks off the hook with ineffectual slaps on the wrist. This Article addresses this controversy, offering a sustained look at the banker–client advisory relationship. We pose a clear answer to the questions raised: although this is nominally fiduciary territory, both banker–client relationships and the Chancery Court’s recent interventions are contractually driven. At the same time, conflicts of interest are wrought into banker–client relationships: the structure of the advisory sector makes them hard to avoid and clients, expecting them, make allowances. Advisor banks emerge in practice as arm’s-length counterparties constrained less by rules of law than by a market for reputation. Meanwhile, the boards of directors that engage bankers clearly are fiduciaries in law and fact and company sales processes implicate enhanced scrutiny of their performance under Revlon. Revlon scrutiny, however, is less about traditional fiduciary self-abnegation than about diligence in getting the best deal for the shareholders. The Chancery Court’s banker cases treat conflicts in a contractual rather than fiduciary frame, standing for the proposition that a client with a Revlon duty has no business consenting to a conflict and then passively trusting that the conflicted fiduciary will deal in the best of faith. The client should instead treat the banker like an arm’s-length counterparty, assuming self-interested motivation on the banker’s part and using contract to protect itself and its shareholders. As a doctrinal and economic matter, the banker cases are about taking contract seriously and getting performance incentives properly aligned and not about traditional fiduciary ethics. They deliver considerably more than a slap on the wrist, having already ushered in a demonstrably stricter regime of conflict management in sell-side boardrooms. They also usher in the Delaware Chancery Court itself as a focal-point player in the market for banker * Deputy Dean and Nicholas F. Gallicchio Professor of Law; Co-Director, Institute for Law & Economics, University of Pennsylvania Law School. Our thanks to Deborah DeMott, Richard Hynes, Eric Klinger-Wilensky, Casey Kobi, Travis Laster, Tom Lin, Steven Rosenblum, Rob Spatt, Andrew Tuch, participants at the fall 2013 Penn Law ILE Roundtable for their comments on earlier versions, and to our research assistants John Cooper, Nicholas Griffin, and Marisa Kirio. ** William B. Johnson Professor of Law & Economics; Co-Director, Institute for Law & Economics, University of Pennsylvania Law School. B RATTON(WACHTER).FINAL.RESUBMIT (DO NOT DELETE) 11/21/2014 12:26 PM 2 Texas Law Review [Vol. 93:1 reputation. The constraints of the reputational market emerge as more robust in consequence. I. INTRODUCTION ....................................................................................... 3 II. THE BUSINESS SIDE .............................................................................. 11 A. Services Rendered ..................................................................... 11 1. Advising on Partner, Price, and Process ............................ 11 2. Opining on Price ................................................................. 14 3. Providing Financing ........................................................... 17 B. Banker Conflicts ....................................................................... 20 1. Relational Conflicts ............................................................. 20 2. Contractually Created Conflicts ......................................... 21 3. Conflicts Arising from Multiple Functions .......................... 23 C. Summary ................................................................................... 25 III. BANKER–CLIENT RELATIONSHIPS: ECONOMICS AND LAW ................. 26 A. The Economics of Banker Conflicts ......................................... 27 B. Legal Treatment: Agency and Contract .................................... 31 1. Fiduciary Characterization: Agency and Advisory Functions ............................................................................. 31 2. Scope: The Status of Shareholders ...................................... 33 3. Contracting Out .................................................................. 36 a. Disclosure ....................................................................... 36 b. Liability and Scope Limitations ...................................... 39 c. Lawyers Compared ......................................................... 43 C. Commentary .............................................................................. 45 IV. HARD LOOKS IN CHANCERY ................................................................. 46 A. Change of Context: Bankers under Revlon ............................... 46 B. An Early Warning ..................................................................... 48 C. Del Monte ................................................................................. 50 1. The Case .............................................................................. 50 2. Taking Contract Seriously ................................................... 53 a. Relational Characterization ............................................ 53 b. Dealing with Deception Under Revlon ........................... 54 c. Staples ............................................................................. 55 D. El Paso ...................................................................................... 56 1. The Case .............................................................................. 56 2. Taints and Consequences .................................................... 59 3. Still Taking Contract Seriously ........................................... 61 E. Aiding and Abetting .................................................................. 62 F. Law, Economics, and Consequences ........................................ 65 V. REGULATORY ALTERNATIVES: PER SE PROHIBITION AND SAFE HARBORS .............................................................................................. 69 A. Per Se Prohibition ..................................................................... 70 1. Auditor Duties and Prohibition ........................................... 70 2. Per Se Possibilities .............................................................. 72 a. Broad-Brush Prohibition ................................................ 72 i. Structural ..................................................................... 72 BRATTON(WACHTER).FINAL.RESUBMIT (DO NOT DELETE) 11/21/2014 12:26 PM 2014] Bankers and Chancellors 3 ii. Shareholder Benefits .................................................. 74 iii. Institutional ................................................................ 74 iv. Policy .......................................................................... 75 b. Narrow and Tailored Prohibition ................................... 77 3. Summary .............................................................................. 78 B. Safe Harbor ............................................................................... 78 1. The Case in Favor ............................................................... 79 2. Contrary Concerns .............................................................. 80 3. Conclusion .......................................................................... 82 C. Commentary .............................................................................. 82 VI. CONCLUSION ........................................................................................ 82 I. Introduction On Valentine’s Day 2011, Delaware’s Vice-Chancellor Travis Laster enjoined the shareholder vote on a private equity buyout of Del Monte Foods Company. The ground: the company’s board of directors was disabled from acting fairly in approving the merger due to the conflicted position of its investment banker–advisor, Barclays.1 The injunction lasted only twenty days, and the deal eventually