Among the interesting data points highlighted in a new report on M&A appraisal litigation in Delaware is the steep decline in both appraisal petitions and cases since 2016.[1] That year, the Delaware Court of Chancery saw its highest-ever number of petitions (76) and cases (47), but over the past two years, those numbers have declined significantly. There were only 26 petitions in 2018, the lowest number since 2012; likewise, cases decreased to their 2012 levels as well. What explains this multiyear decline?
The Delaware Supreme Court’s reversal in DFC Global Corporation v. Muirfield Value Partners L.P.,[2] an appraisal decision on the 2014 acquisition of DFC Global Corporation, occurred in August 2017, and it is likely no mere coincidence that the trend line for appraisal petitions entered its swoon shortly thereafter. In DFC, the Chancery Court gave less weight to the deal price in favor of a “blend of three imperfect techniques”—including deal price, company valuation, and discounted cash flow (DCF) valuation, each equally weighted—and then proceeded to reach a deal price of $10.30 per share, an 8.4 percent premium over the deal price of $9.50 per share.
On appeal, the Delaware Supreme Court reversed and remanded. Chief Judge Leo Strine stopped short of embracing a full-scale presumption in the accuracy and reliability of deal price, but did make clear that under the prevailing circumstances, deal price should receive greater weight. He reasoned that “[m]arket prices are typically viewed superior to other valuation techniques because, unlike [for example], a single person’s discounted cash flow model, the market price should distill the collective judgment of the many based on all the publicly available information about a given company and the value of its shares.”
Furthermore, because the “Court of Chancery found that the sales process was robust and conflict-free,” the Supreme Court found no reason to justify giving the deal price merely one-third weight. The Supreme Court concluded its decision by rejecting the Chancery Court’s argument that the nature of the buyer—in this case, a private equity firm—reduced the fairness of the deal price because a private equity firm’s willingness to pay a certain price does not necessarily equate with an unfair value.
The Delaware Supreme Court’s stance on the primacy of deal price in DFC was further clarified shortly thereafter when the court weighed-in once more in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd.,[3] again reversing the Chancery Court’s decision and reaffirming its view of deal price as a useful metric, yet again stopping short of endorsing it as the sole and decisive metric. Ignoring both the company’s pre-deal announcement stock price and the deal price in reaching its fair value determination of $17.62—a 28.1-percent premium over the deal price of $13.75—the Chancery Court relied instead on its own DCF analysis. The Supreme Court reversed, holding that the record “suggested that the deal price deserved heavy, if not dispositive, weight.” As in DFC, however, the Supreme Court in Dell refrained from giving full weight to the deal price, stating that creating a presumption in favor of deal price runs afoul of the Delaware appraisal statute’s guidance to “consider all relevant factors.” Nevertheless, the Supreme Court cautioned that in particular cases, one factor—such as the deal price—may rise above others in terms of importance, depending on the evidence supported by the record. The Supreme Court also criticized the Chancery Court’s decision to award a fair value that is higher than what the market was willing to pay for Dell’s stock, taking a position that both courts would later endorse.
These two reversals form the backdrop against which we have seen the rapid decrease in appraisal litigation in Delaware. For those who might have hoped for a signal from the Delaware Supreme Court that it is backtracking on its embrace of deal price, the court’s April 2019 en banc opinion in Verition Partners Master Fund Ltd. v. Aruba Networks, Inc.[4] provides very little reason to believe the court is growing more skeptical of the primacy of deal price. Although the Aruba decision sheds light on the Supreme Court’s existing precedent, it leaves some related questions unanswered, particularly regarding target valuation in the take-private context.
Like DFC and Dell, which were decided while the Aruba appeal was still pending, Aruba involved a Delaware statutory appraisal claim by the shareholders of Aruba Networks, Inc. following its acquisition by Hewlett-Packard. Notwithstanding the precedent established in DFC and Dell, the Chancery Court ultimately relied solely on the unaffected trading price of the seller leading up to the transaction—that is, the average trading price of Aruba Networks’ shares during the 30 days prior to when the news of the merger with HP emerged. The Chancery Court considered two other valuation methods, including the parties’ competing DCF analyses and the merger price less synergies, but dismissed both as unreliable measures of fair value.
The Supreme Court once again reversed in an unusually combative opinion. Rejecting the Chancery Court’s reliance on Aruba Networks’ market price, the court reiterated the position it expressed in Dell that market prices “can be a proxy for fair value” and that “the price a stock trades in an efficient market is an important indicator of its economic value that should be given weight.” The Delaware Supreme Court concluded that Vice Chancellor Laster erred in finding “that an informationally efficient market price invariably reflects the company’s fair value in an appraisal.” Conversely, the Supreme Court reiterated that an efficient market price “further informed by the efforts of arm’s-length buyers” to find a fair deal price based on a diligence-driven analysis “is even more likely to be indicative of so-called fundamental value.” In other words, “after a process in which interested buyers all had a fair and viable opportunity to bid, the deal price is a strong indicator of fair value, as a matter of economic reality and theory.” The court made clear that its decisions in DFC and Dell did not compel “rote reliance” on market price when calculating fair value, but clearly held the conclusion that deal price less synergies is the best method to assess Aruba’s going concern value, where “synergies” is defined as “other value the Buyer expects from changes it plans to make to a company’s ‘going-concern’ business plan.” The valuation of such synergies is a matter of fact to be assessed based on the record.
Among its many noteworthy takeaways, Aruba strengthens the focus on deal price in an arm’s-length transaction and goes a step further than DFC and Dell by deducting the synergies from the deal price in order to get to the fair value price. Though critical of the Chancery Court’s opinion, the Delaware Supreme Court sides with the Chancery Court’s position—and reinforces recent Delaware jurisprudence—by holding that the deal price should act as a ceiling for a valuation, a result that will likely reinforce the trend in place since 2016 toward decreasing numbers of appraisal petitions. For example, the Supreme Court’s fair value appraisal in Aruba resulted in a 22.6-percent reduction from the deal price, an outcome that would remind petitioners not to overly rely on the statutory appraisal right, especially if there is no clear and convincing basis for such an appraisal claim.
However, Aruba did backtrack in one notable instance. In a clear change of positions, the Supreme Court in Aruba agreed with past Chancery Court arguments, noting that the type of buyer—such as a private equity firm versus public company—might impact the fair value determination because the synergies to be deducted from the deal price could be different based on the new owner. Unlike the case of a public company buyer with characteristically broad stock ownership, ownership of companies in the private equity setting tends to be far more concentrated, which can create efficiency and reduce agency costs. This circumstance can lead to a potentially different calculation for the cost of synergies to be deducted from the deal price. How this precedent will be applied to the valuation of targets in take-private transactions is not entirely clear from the recent jurisprudence, but we see no reason to believe that a return to 2016 levels of appraisal litigation is in the offing.
Chauncey M. Lane is a partner in the Dallas office of Reed Smith LLP. He regularly advises domestic and international clients on buy- and sell-side mergers, divestitures, asset acquisitions, going-private transactions, debt and equity offerings, and corporate governance. He also counsels fund sponsors on all aspects of fund formation, capital raises, and investment adviser compliance, often serving as outside general counsel.
George Khoukaz is an associate in the Kansas City office of Husch Blackwell LLP and a member of the firm’s Corporate and Securities practice group. He regularly advises domestic and international clients on complex commercial and capital market transactions.
This article has been published in PLI Current: The Journal of PLI Press, Vol. 4, No. 1 (2020).
[1] Cornerstone Research, Appraisal Litigation in Delaware: Trends in Petitions and Opinions 2006-2018 (2019).
[2] DFC Glob. Corp. v. Muirfield Value Partners L.P., 172 A.3d 346 (Del. 2017).
[3] Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017).
[4] Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., No. 368, 2018 (Apr. 16, 2019) (per curiam).
