Statutory appraisal remains an active area of litigation in Delaware, notwithstanding recent legislation1 designed to reduce appraisal arbitrage and judicial decisions that established a prominent role for market-based evidence.
This article distills important considerations for practitioners and their clients from the 2020 appraisal decisions of the Delaware Supreme Court and Delaware Court of Chancery.
Chief among these is anticipating the weight courts might assign to different valuation methodologies, including deal price, market price and discounted cash flow analyses.
Bearing these considerations in mind can aid practitioners and clients at every step — from structuring a merger to litigating appraisal proceedings — and enable them to assess prospects for success and potential benefits and costs of their decisions.
1. Deal Price as a Persuasive Indicator of Fair Value, Despite an Imperfect Process
Deal price can be a persuasive indicator of fair value in an appraisal proceeding.2 If a transaction bears indicia of reliability — including an efficient market, no significant conflicts, active market checks and opportunities for a topping bidder to emerge — then the Court of Chancery is likely to assign significant or dispositive weight to the deal price in its determination of fair value.
Structuring a transaction to justify dispositive weight for the deal price in subsequent appraisal litigation can be important for a party that prioritizes reduced litigation risk.
Decisions in 2020 confirmed the potential primacy of the deal price, even with imperfections in the deal process. In Brigade Leveraged Capital Structures Fund Ltd. v. Stillwater Mining Co.,3 the Delaware Supreme Court affirmed a Chancery Court determination that a deal price had sufficient indicia of reliability to merit dispositive weight in an appraisal valuation.
Importantly, the Supreme Court held that a perfect deal process was not essential for establishing the primacy of deal price. Even though there had been early "unsupervised activities" by the CEO in developing the transaction outside the board's oversight, the Supreme Court confirmed that a presigning canvass, repeated offer rejections by the board, and a post-signing market check established sufficient indicia of reliability in the deal price.
Likewise, in In re: Appraisal of Panera Bread Co.,4 the Court of Chancery gave full weight to the deal price. The court identified several indicators of reliability:
- The stock had traded in an efficient market;
- An independent, unconflicted board led the arms-length negotiations;
- The acquirer had access to extensive public and nonpublic information;
- Several rounds of negotiation resulted in multiple price increases; and
- No competing bidders emerged, even with a news leak, nonpreclusive deal protection devices, and the company having solicited all logical buyers.
These indicators of reliability overcame several imperfections in the process, including the board's early disclosure of a target price range, rapid due diligence, the CEO having made preliminary sale overtures without board approval, and modest conflicts of the financial adviser.
These cases demonstrate that a robust deal process, even if imperfect, can increase the likelihood that a court will give significant weight to the deal price when determining fair value.
2. Unaffected Market Price and Stock Buybacks: Market-Based Evidence Amid Flawed Deal Process
In the context of a flawed deal process for a public company, a court might assign weight to other market- based indicators, including unaffected market price and pricing from recent stock buybacks.
In Fir Tree Value Master Fund LP v. Jarden Corp.,5 the deal price was an unreliable indicator of fair value due to flaws in the deal process: A conflicted CEO had dominated the process, the board had little oversight, and there had been no presigning or post-signing market check.
In the absence of a reliable process, the Delaware Supreme Court affirmed the Court of Chancery's use of unaffected market price to determine fair value, based on an event study as persuasive evidence that the unaffected market price had reflected all material nonpublic information.
The Supreme Court found additional support in the company's recent stock buybacks at similar prices, rejecting the petitioner's argument that buybacks inherently mean the company believes its stock is undervalued. The Fir Tree reasoning provides reassurance to practitioners and litigants that a flawed deal process need not render irrelevant all market-based indicators.
3. Evidentiary Considerations for Discounted Cash Flow Analyses
Absent a reliable deal process or other market-based indicators, courts might turn to the widely accepted discounted cash flow analysis. Though the discounted cash flow model might be familiar, it can present evidentiary complexities that litigants should bear in mind, particularly regarding the record they need to develop prior to and at trial.
In Manichaean Capital LLC v. SourceHOV Holdings Inc.,6 the Court of Chancery based its fair-value determination solely on a discounted cash flow analysis; the privately held company lacked a reliable sales process.
Three issues dominated the court's analysis of the discounted cash flow model. First, harming its credibility, the respondent disagreed with its own expert over which financial projections to use; the respondent advocated for projections it had barely used before, whereas its expert advocated for projections that the respondent had used in the ordinary course of business. The court agreed with the expert.
Next, the court rejected the expert's novel method for calculating beta in determining the weighted average cost of capital. Finally, the court rejected the respondent's inclusion of restricted stock units in total shares outstanding, noting the speculative nature of whether the units would vest.
Seeking reargument, the respondent sought to distinguish unvested units from units that had vested but still remained unsettled. The court rejected the new argument at that stage7 and a motion for a new trial,8 explaining that the respondent could have presented the related evidence at trial and noting the speculation inherent in including units that had not yet been settled.
In Kruse v. Synapse Wireless Inc.,9 the court relied exclusively on a discounted cash flow analysis to determine fair value; there had been no contemporaneous market-based evidence, nor a market check or public sale process. The court expressed concern with several elements of the parties' discounted cash flow models.
The court doubted the reliability of management cash flows but ultimately accepted them because both parties had said there was no alternative. The court also had concern with the parties' calculations for the discount rate, and selected the more credible of the two. The court noted that in an appraisal proceeding it must calculate fair value even if concerned about the evidence presented.
Discounted cash flow analyses remain an important valuation methodology, particularly when market-based evidence is absent or flawed. Parties that anticipate a discounted cash flow analysis might merit weight should plan carefully, to ensure the discovery process identifies key information and the court hears the necessary arguments and evidence at trial.
Preparation can significantly affect a litigant's ability to establish credibility and meet its evidentiary burden.
4. Insufficiency of Comparability
Comparable company analyses and transactions analyses did not fare well in 2020 appraisal proceedings, for a common reason: insufficiency of comparability.
In Fir Tree Value Master Fund, the Delaware Supreme Court determined none of the proposed comparables were reliable enough to assign them any weight. In Panera, the court determined there were no suitable peer groups for a comparable companies analysis and no sufficiently comparable transactions for a comparable transactions analysis. In Kruse, the court deemed comparable company transactions as too unreliable.
A litigant hoping to convince a court to use a comparables analysis bears a burden to establish comparability, and the cases demonstrate that a court will assign no weight to this analysis if a party fails to meet that burden.
5. Court of Chancery's Independent Duty to Value a Company Does Not Relieve Parties of Evidentiary Burdens
Although the Court of Chancery has a statutory duty to determine fair value in an appraisal proceeding, a litigant must still mind its own credibility and evidentiary burden.
In Stillwater, parties disputed the impact of a post-signing change in metal values. The Supreme Court explained that the merger agreement was designed to provide stockholders with certainty, not to guarantee upside protection from a post-signing swing in metal prices.
Having affirmed the Court of Chancery's acceptance of deal price as a reliable indicator of fair value, the Delaware Supreme Court required no adjustment for post-signing changes in metal value, holding that the Court of Chancery had not abused its discretion in declining to make an adjustment because petitioners had failed to meet their burden of proof regarding what the adjustment should be.
6. Synergies and the Downside of Prepaying Consideration to Avoid Interest
Recent legislation permits respondents in appraisal proceedings to pre-pay consideration to a petitioner to avoid prejudgment interest during the appraisal proceeding.10
This interest-saving mechanism can benefit a respondent, particularly given the rate of prejudgment interest.11 But prepayment comes with a risk: The statute makes no provision for a refund if the Court of Chancery determines fair value is below the deal price that the respondent had prepaid, such as when deducting the value of synergies from the deal price.
This was the scenario in Panera. The court examined the acquirer's internal documents and models, noting that respondents bear the burden of proving synergies. The court determined that the evidence supported a finding of synergies from cost savings and tax benefits, and that expert testimony supported an estimate of synergies' inclusion in the deal price.
Yet because the respondent had prepaid the entire deal price, it was not able to realize any benefit when the court determined the deal price had included synergies.
Before prepaying, respondents should carefully consider whether savings on interest from prepayment are likely to exceed the court's calculation of anticipated synergies and their deduction from the deal price to determine fair value.
7. Directors and Officers Liability Insurance Might Not Apply to Appraisal Proceedings
The cost of appraisal litigation provides incentive for structuring a transaction to increase the reliability of deal price as an indicator of fair value and, thus, potentially discourage an appraisal petition. This incentive grows when cost recovery might be unavailable from directors and officers liability insurance.
In In re: Solera Insurance Coverage Appeals,12 the Delaware Supreme Court reversed a Superior Court decision that had held a directors and officers excess insurance policy covered prejudgment interest and defense expenses. The Supreme Court examined the language of the policy coverage and reasoned that it did not apply to an appraisal proceeding, which by its nature does not involve an allegation of wrongdoing and therefore did not meet the definition of "securities claim" under the policy.
A company should be mindful of the terms of its insurance policies and whether they might apply to an appraisal proceeding, in order to assess the potential total costs of litigation and the overall costs-benefits of various deal strategies and litigation strategies.
The last year's Delaware Supreme Court and the Court of Chancery opinions related to statutory appraisal continue prior years' trend toward assigning significant or entire weight to deal price when there are sufficient indicia of reliability. Key indicia include an actively involved, well-informed board and the opportunity for competing bidders to emerge.
A court might also weigh other market-based evidence. In the absence of a reliable deal price or other persuasive market-based evidence, the court favors discounted cash flow analyses, requiring litigants to be thorough and deliberate to establish credibility and meet their evidentiary burdens.
1 Del. H.B. 371, 148th Gen. Assem., 80 Del. Laws ch. 265 (2016).
2 Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., 210 A.3d 128 (Del. 2019); Dell Inc. v. Magnetar Global Event Driven Master Fund, 177 A.3d 1 (Del. 2017); DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017).
3 240 A.3d 3 (Del. 2020) ("Stillwater").
4 C.A. No. 2017-0593-MTZ (Del. Ch. Ct. Jan. 31, 2020).
5 236 A.3d 313 (Del. 2020).
6 C.A. No. 2017-0673-JRS (Del. Ch. Ct. Jan. 30, 2020), affirmed No. 215, 2020 (Del. Jan. 22, 2021).
7 C.A. No. 2017-0673-JRS (Del. Ch. Ct. Mar. 11, 2020).
8 C.A. No. 2017-0673-JRS (Del. Ch. Ct. June 11, 2020).
9 C.A. No. 12392-VCS (Del. Ch. Ct. July 14, 2020).
10 8 Del. C. § 262(h) (2021).
12 240 A.3d 1121 (Del. 2020).
Law360 | February 5, 2021