On August 1, 2017, the Delaware Supreme Court issued its opinion in DFC Global Corporation v. Muirfield Value Partners, L.P., et al, relating to how the Court of Chancery should determine the fair value of a company for purposes of Section 262 of the Delaware General Corporation Law (the Delaware appraisal statute). To the disappointment of many, it refused to find that in a transaction between unrelated parties, there is a presumption that the agreed upon price constitutes fair value. But the Delaware Supreme Court did reverse the finding of the Court of Chancery under the specific circumstances of the DFC case, finding among other things that, given the robust sale process that had taken place, the deal price should have been accorded more weight.
Under Section 262, a stockholder of a company that is a party to a merger or consolidation in which the merger consideration includes anything other than stock of the resulting corporation or listed stock of another corporation can seek the fair value of the holder’s shares, as determined by the Court of Chancery in an appraisal proceeding, instead of the agreed upon merger consideration.
The right to appraisal has been around for a long time. However, until relatively recently, demands for appraisal were uncommon, due to the expense inherent in appraisal proceedings and the risk that the Court of Chancery will determine that the fair value of the shares was less, not more, than the agreed upon merger consideration. Recently, however, funds have begun acquiring shares of companies after they announced mergers in order to bring appraisal proceedings. As a result, the number of Delaware appraisal proceedings brought in 2016 was more than double the number brought in 2012 and 45% more than the number brought in 2015.
Appraisal proceedings pose a particular problem to acquirers because there is no limit on the amount by which the Court of Chancery may determine the fair value exceeded the agreed upon price. The merger is completed before fair value is determined in the appraisal proceeding, and therefore the acquirer cannot walk away from the transaction if the appraisal award raises the total price above what the acquirer would have been willing to pay.
Chancery appraisal decisions over the past two years fell into two strains. In one group, the Court decided that where merger terms were the result of arm’s length bargaining between unrelated persons, the agreed upon price was, virtually by definition, the fair value of the acquired company stock. The second group rejected the idea that the Court of Chancery could simply look to the agreed upon price as determining fair value, and instead applied discounted cash flow analyses or other financial analyses it deemed relevant in determining the fair value of the holders’ stock.
The Court of Chancery decision in the DFC case fit primarily in the second group. The transaction was the result of a robust market check that had resulted in only one fully interested buyer, and there was no relationship between DFC and the buyer that would taint the arm’s length nature of the merger negotiations. Nonetheless, the Court of Chancery held that regulatory uncertainties might have kept what potential buyers were willing to pay from reflecting the true value of DFC. Instead it valued DFC by giving equal weight to (a) the agreed upon merger price, (b) an analysis of comparable transactions, and (c) a discounted cash flow analysis. Both DFC and the petitioning shareholders appealed.
In the Delaware Supreme Court, DFC argued that in cases involving arm’s length mergers, there should be a presumption that the price of the transaction giving rise to appraisal rights is the best estimate of fair value. The Supreme Court rejected this argument, pointing out that the statute requires the Court of Chancery to determine the fair value of shares by taking into account “all relevant factors.”
However, the Delaware Supreme Court ruled that the Court of Chancery was not justified in giving each of three factors equal weight without explaining its weighting in a manner that was grounded in the record before it.
The Delaware Supreme Court indicated that in appropriate situations, the Court of Chancery might base its determination of fair value entirely on the agreed upon transaction price, saying “In some cases, it may be that a single valuation metric is the most reliable evidence of fair value and that giving weight to another factor will do nothing but distort that best estimate.” The Delaware Supreme Court acknowledged that the collective view of market participants is often more reliable than the views of experts given in the context of litigation.
Accordingly, the DFC decision did not create the bright line for determining fair value in appraisal cases that many had been seeking. A number of years earlier, the Delaware Supreme Court had insisted on compliance with the statutory requirement that in an appraisal proceeding, the Court of Chancery must take into account all relevant factors. In its DFC decision, the Delaware Supreme Court made it clear that this requirement had not changed. Each determination of fair value will be based on a tailored analysis by the Court of Chancery.