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E-MailGuhan Subramanian is Joseph H. Flom Professor of Law and Business at Harvard Law School and H. Douglas Weaver Professor of Business Law at Harvard Business School. This post is based on a recent article by Professor Subramanian, forthcoming in The Corporate Contract in Changing Times: Is the Law Keeping Up? This post is part of the Delaware law series; links to other posts in the series are available here.
In a recent article I present new data on appraisal litigation and appraisal outs. I find that appraisal claims have not meaningfully declined in 2016, and that perceived appraisal risk, as measured by the incidence of appraisal outs, has increased since the Dell appraisal in May 2016.
After reviewing current Delaware appraisal doctrine, I propose a synthesizing principle: if the deal process involves an adequate market canvass, meaningful price discovery, and an arms-length negotiation, then there should be a strong presumption that the deal price represents fair value in an appraisal proceeding; but if the deal process does not have these features, deal price should receive no weight. The test is a stringent one: it requires not just a “good enough for fiduciary duty” deal process, but rather a deal process that ensures that exiting shareholders receive “fair value” for their shares.
This approach would represent a middle-ground between the competing approaches advanced by twenty-nine law, economics, and finance professors in the DFC Global appraisal, currently on appeal to the Delaware Supreme Court. In that case, Chancellor Bouchard awarded one-third weight to the deal price even though he concluded that the company was sold in an “arm’s-length sale,” in a “robust” process that “did not involve … conflicts of interest.”
On one end of the spectrum, nine law and corporate finance professors have submitted an amicus brief urging reversal. These scholars propose that appraised value should depart from the deal price only “where the transaction price bears indications of misinformation or bias.” For reasons described in the Essay, this approach would represent an overly broad reliance on the deal price. The approach would break from well-established Delaware doctrine by requiring a fiduciary duty breach in order to depart from the deal price in appraisal. Delaware courts have repeatedly acknowledged that the inquiry in a fiduciary duty proceeding is not the same as the inquiry in an appraisal proceeding, yet the proposed approach tethers these two things together. Similarly, requiring “misinformation” in order to depart from the deal price sets an unduly high bar. Take Dell: no one would claim that there was “misinformation” in that deal, but just because the Dell shareholders were not deceived does not mean that they received fair value.
At the other end of the spectrum, twenty professors of law, economics, and finance have submitted an amicus brief urging affirmance of DFC Global. These scholars argue that Chancellor Bouchard’s conclusion that the deal price should be afforded one-third weight should be treated as any other finding of fact. Under their proposed approach, the weight afforded to the deal price by the Chancery Court should be disturbed only for abuse of discretion. However, this approach does not adequately acknowledge the fact that valuation is notoriously imprecise. In my recent Mergers & Acquisitions executive education course at Harvard Business School, for example, experienced valuation practitioners deviated from each other by as much as 30-40% in valuing the same M&A target. In an appraisal proceeding, Delaware Chancery Court judges are asked to engage in the artificially precise task of providing a point estimate of value. Even investment bankers, who are finance professionals, only provide a valuation range in their fairness opinions. Awarding anything less than 100% weight to the deal price when the deal process is good would create unnecessary appraisal risk and would unnecessarily chill value-creating deals.
To summarize, the approach proposed by the nine scholars would require reversal of both DFC Global and Dell, because there was no “misinformation or bias” in either deal process. As such, the deal price would govern in both deals. The approach proposed by the twenty scholars would require affirmance of both cases (unless there was abuse of discretion), through deference to the finder of fact on the appropriate weight for the deal price. In contrast, my proposed approach would suggest reversal of DFC Global and affirmance of Dell. This middle-ground approach would defer entirely to the deal price when the deal process is good (thus reversing DFC Global) but cast a “hard look” as to whether the deal process included an adequate market canvass, meaningful price discovery, and an arms-length negotiation (as in Dell).
The complete article was prepared for the forthcoming volume, The Corporate Contract in Changing Times: Is the Law Keeping Up? (U. Chicago Press) and is available here.
