Delaware Court Of Chancery Confirms Market-Based Factors Constitute The Best Indicators Of Fair Value

Author:Mr Jason Halper, Nathan M. Bull, Monica Martin and Sara Bussiere
Profession:Cadwalader, Wickersham & Taft LLP

Three recent Delaware Court of Chancery appraisal decisions offer a wealth of guidance not only regarding the determination of a merger partner's fair value, but also regarding elements that potentially undermine a quality sale process and strategic considerations for litigating valuation and sale process issues.

Statutory appraisal litigation, initiated after virtually every sizeable merger, requires the Delaware Court of Chancery to determine the fair value of a target company's shares, exclusive of any merger-created value, as of the effective date of the merger. Though the appraisal statute broadly empowers the Court to consider "all relevant factors" in determining fair value,1 the Delaware Supreme Court has clarified the particular importance of certain market-based factors, namely, unaffected market price and merger consideration.2 Though the unaffected market price is an "important indicator" of fair value (so long as the stock is trading in an efficient market),3 deal price that is the product of "a robust market check will often be the most reliable evidence of fair value[.]"4

In a trio of recently issued appraisal decisions, the Delaware Court of Chancery reaffirmed the importance of market-based factors as indicators of fair value but came to divergent outcomes, including, in one case, (i) a fair value determination based on the unaffected market price, which was a substantial discount to the merger consideration, and, in the other two cases, (ii) a fair value determination based on the full deal price with no deduction for merger-related synergies. In In re Appraisal of Jarden Corporation,5 Vice Chancellor Joseph R. Slights determined that the unaffected market price was the best indicator of the fair value of Jarden's stock (representing a 18.4% discount to the merger consideration). The Vice Chancellor found that the deal price, though relevant, was less reliable than the unaffected market price due to the flawed sale process undertaken by the Jarden Board of Directors.6 In In re Appraisal of Columbia Pipeline Group, Inc.,7 Vice Chancellor J. Travis Laster endorsed the reliability of deal price as the best indicator of fair value in finding that the fair value of Columbia Pipeline's shares was $25.50 per share, the merger consideration. Less than two weeks later, Vice Chancellor Laster again found the deal price persuasive evidence of fair value in In re Appraisal of Stillwater Mining Company,8 in which he determined that the fair value of Stillwater Mining Company's stock on the date of the merger was $18.00 per share. In all three cases, the Court declined to rely upon more traditional valuation methodologies, such as comparable companies methodology or discounted cash flow ("DCF"), in favor of market-based evidence.

Although the Delaware Supreme Court has offered more guidance in recent years on the appropriate valuation methodology for appraisal actions, Jarden, Columbia and Stillwater serve as reminders that because the valuation process is a case-specific "fact-finding exercise," the valuation methodology used to determine fair value will largely depend on the facts of each case.9 However, these decisions ultimately underscore the preeminence of market-based factors over other valuation methodologies.

Jarden Background

On July 19, 2019, Vice Chancellor Slights issued a post-trial decision in an appraisal proceeding arising from the acquisition of Jarden Corporation ("Jarden") by Newell Rubbermaid, Inc. ("Newell") for cash and stock totaling $59.21 per share. The Court found that Jarden's unaffected market price was the most reliable indicator of fair value and determined a fair value of $48.31 per share.

The Court held that the deal price was unreliable due to a flawed sale process, "if one can call it that," which "may well have set an artificial ceiling on what Newell was willing to pay." Among other flaws in the sale process, the Court found that Jarden's CEO did not inform the Board of meetings with Newell's CEO, suggested a sales price without authorization from the Board, made unauthorized counteroffers, negotiated change-in-control compensation without authorization from the Board, and recommended a financial advisor without disclosing his prior "substantial relationship" with the bank.

Instead, the Court found the unaffected market price to be a "powerful indicator of Jarden's fair value" because Jarden's stock traded in a highly efficient market, never closed above the merger price, and was frequently analyzed by professional analysts. Jarden also did not have a controlling stockholder. The Court engaged in comparable companies and DCF analyses, but found the former unreliable and the latter consistent with the market evidence.

Columbia Background

On August 12, 2019, Vice Chancellor Laster issued a post-trial decision in a statutory appraisal proceeding arising out of the July 1, 2016 acquisition of Columbia Pipeline Group, Inc. ("Columbia") by TransCanada Corporation ("TransCanada") for $25.50 per share, holding that the deal price was the most reliable indicator of fair value. Despite management conflicts, the Court held that the deal price was reliable because the sale process "bore objective indicia of fairness."10 Among other things, the Court noted that the acquisition was an arm's-length transaction with a "pure outsider" third party, the Board was free of conflicts, and Columbia extracted several price increases over the course of negotiations. The Court also noted favorably that TransCanada conducted due diligence and obtained confidential information, and that other potential buyers failed to pursue a merger either pre- or post-signing (notwithstanding the absence of unusual deal protection provisions).

Though the Court seriously evaluated allegations that management was conflicted due to a desire for immediate retirement, the Court was unpersuaded that the conflict undermined the reliability of the deal consideration as evidence of fair value, stating that "management's divergent interests fell short of the conflicts that failed to undermine the sale process in Dell."

The Court also considered, and rejected, an argument that the sale process was undermined by Columbia's willingness to engage with TransCanada notwithstanding a standstill that precluded TransCanada (and three other suitors) from engaging without the Board's prior written invitation. Despite finding that TransCanada breached its standstill "several times" before Columbia waived the standstills binding the other potential bidders, the Court held that the standstills did not undermine the fairness of the deal price because none of the standstill parties bid even after the standstills were waived.

However, the Court was persuaded that the failure to disclose the standstills, and the fact that TransCanada was allowed to breach its standstill, rendered the proxy materially defective. The Court also found that Columbia should have disclosed management's desire to retire, and its failure to do so constituted a material omission. In light of the flawed proxy, the Court declined to give any weight to the overwhelmingly favorable stockholder vote in its evaluation of the deal price as evidence of fair value.

As in Jarden and Stillwater, the Court declined to deduct synergies from the deal price because the company failed to offer adequate proof quantifying the appropriate downward adjustment, and thus failed to meet its burden. According to the Court, it declined to make any downward deduction because "TransCanada likely could have justified a smaller synergy deduction, but it claimed a larger and unpersuasive one." The Court also rejected reliance on unaffected market price, noting that, in light of its determination that the deal price is the most reliable indicator of fair value, "[r]elying on the trading price would only inject error into the fair value determination." The Court also rejected reliance on a DCF analysis, noting the difficulty in assessing drastically different inputs offered by competing experts. The Court explained, "If this were a case where a reliable market-based metric was not available, then the court might have to call the balls and strikes of the valuation inputs. In this case, the DCF technique 'is necessarily a second-best method to derive value.'"11 Because the sale process—though not perfect—resulted in a fair price for the Columbia stockholders, the deal price was the most reliable indicator of fair value.

Stillwater Background

On August 21, 2019, Vice Chancellor Laster...

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