Delaware Supreme Court endorses deal price as strong evidence of fair value in appraisal cases, but rejects judicial presumption.
This article was published in Transaction Advisors (October 2017), produced by Finance Information Group.
In DFC Global Corp. v. Muirfield Value Partners, L.P. (Aug. 1, 2017), the Delaware Supreme Court issued its highly anticipated ruling on the determination of fair value in statutory appraisal cases. The court held that the deal price represents strong evidence of fair value but rejected a judicial presumption that, even in an arm's-length merger, the deal price is the best indication of fair value.
DFC was a publicly traded company in the payday loan industry. The company had previously experienced rapid growth and was highly leveraged as a result of that expansion. In recent years, the company faced increased scrutiny from regulators in its key markets.
Concerned about an uncertain regulatory future, DFC's board engaged a financial advisor to explore a potential sale of the company. The advisor contacted several private equity sponsors, none of which elected to pursue an acquisition of DFC. Over the next year, the financial advisor reached out to 35 more private equity sponsors and three strategic buyers. A few expressed interest and commenced discussions about a possible acquisition. Over the course of the negotiations and subsequent sale process, the company adjusted its financial projections downward several times. DFC was ultimately acquired for $9.50 per share. Several dissident stockholders pursued appraisal rights.
In determining fair value, the Court of Chancery gave equal weight to three considerations: (1) the deal price; (2) a comparable companies analysis; and (3) a discounted cash flow analysis, which the court developed from competing analyses submitted by the parties' experts. The Chancellor did not provide a rationale for this weighting analysis and determined that fair value was $10.21 per share. Both sides appealed.
On appeal, DFC argued that Delaware's appraisal statute (8 Del. C. § 262) precludes the use of traditional valuation methodologies to determine fair value when a company is acquired through an arm's-length, conflict-free auction process. The plaintiffs cross-appealed, arguing that section 262 precludes application of bright-line rules, and that the Court of Chancery erred in placing any weight on deal price.
Supreme Court Rejects Chancellor's Analysis
In an opinion by Chief Justice Strine, the Supreme Court reversed the Court of Chancery. The Supreme Court held that (1) the Court of Chancery did not provide a sufficient basis for deciding to give only one-third weight to the deal price in the determination of fair value and (2) the Court of Chancery erred in adjusting some of the inputs in its cash flow calculation when it subsequently revised its fair-value calculations.
The Supreme Court declined to establish an express judicial presumption in favor of deal price as determinative of fair value in any particular class of mergers, noting that any such presumption would be inconsistent with section 262, which requires the Court of Chancery to determine fair value in its discretion by "taking into account all relevant factors." No presumption would be permissible unless the Delaware General Assembly amended section 262.
Although it did not adopt a formal presumption, the Supreme Court strongly endorsed deal price as often "the best evidence of fair value," particularly in cases involving an arm's-length merger resulting from a vigorous sale process. The Supreme Court explained:
[O]ur refusal to craft a statutory presumption in favor of the deal price when certain conditions pertain does not in any way signal our ignorance to the economic reality that the sale value resulting from a robust market check will often be the most reliable evidence of fair value, and that second-guessing the value arrived upon by the collective views of many sophisticated parties with a real stake in the matter is hazardous.
The Supreme Court emphasized that the Court of Chancery, in determining fair value, must consider the reliability of all appropriate factors (such as the merger price and a discounted cash-flow analysis) and justify, based on the "economic facts" before it and corporate finance principles, the weight it places on the results of those methodologies given their relative reliability as predictors of fair value. Importantly, the Supreme Court stated that the Court of Chancery's "decision to give one-third weight to each [of the three] metric[s] [it considered] was unexplained and in tension with the Court of Chancery's own findings about the robustness of the market check." The Court of Chancery should, in the future, evaluate factors such as deal price and discounted cash-flow analysis on a spectrum, based on the vigor of the sale process and the reliability of available projections for a discounted cash-flow analysis.
The Supreme Court remanded the case and instructed the Court of Chancery to reconsider the weighting of the various valuation methodologies, particularly in light of the strong reliability of deal price in this case in contrast to the unreliability of the available discounted cash-flow projections.
What does this mean for appraisal actions going forward? When a transaction has an adequate market check, and when the transaction is arm's-length and conflict-free, the Court of Chancery should consider the deal price as strong evidence - although not presumptive - that the deal price is the fair value.
The Supreme Court's DFC Global ruling offers some guidance for companies defending future appraisal cases. Despite the "visual appeal" of adding up all the valuations presented and dividing that sum by the number of valuations, it is not the appropriate method for calculating fair value. Rather, the application of various methods depends entirely on the facts present in a given case. And the Court of Chancery can now reasonably be expected to explain and justify its weighting analysis in each case.
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