Sometimes Silence is Golden: “Dell Compliance” Following Aruba III

Michael Kass is Portfolio Manager at BlueMountain Capital Management, LLC. This post is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Using the Deal Price for Determining “Fair Value” in Appraisal Proceedings (discussed on the Forum here) and Appraisal After Dell, both by Guhan Subramanian.

The frequently discussed but generally unwritten story underlying the three judicial opinions in Verition Partners v. Aruba Networks involves a dispute between two luminaries of the Delaware Corporate Law—Vice Chancellor Travis Laster and Chief Justice Leo Strine.

The story goes that Vice Chancellor Laster, fuming over his “rebuke” in Dell, a decision not written but generally attributed to the Chief Justice, sought to force acknowledgement of the faults in that decision by adopting an extreme view of its logic and interpreting it reductio ad absurdum for a “result that no litigant would even ask for”. He did so by (i) finding an odious transaction process involving rampant conflicts of interest, negotiating negligence and selective disclosure to be sufficiently reliable to evidence fair value (“FV”) because its record of defects was, in his view, no worse than the one in Dell, while, nevertheless, (ii) ruling that the cleanest measure of FV was the Company’s so-called unaffected stock price (“USP”), a metric that was neither argued by any party at trial nor particularly well suited to the FV measurement objective, given strong evidence of conflicts of interest and the exploitation of material non-public information found in the trial record. Similar to the first holding, on process sufficiency (or what was subsequently coined by Vice Chancellor Glasscock as “Dell Compliance” in AOL), the latter holding on “USP Relevance” was grounded in the Vice Chancellor’s comparison of the factual record of Aruba against those in Dell and DFC, and the Delaware Supreme Court’s heavy deference to observable market measures of value in those cases. Not to be outdone by this deft, “hoisted on your own petard” tactic by the Vice Chancellor, the Chief Justice returned the favor in a manner that only a superior tribunal can—by (a) reversing the Chancery Court on the USP Relevance holding via a scathing criticism of its reductionist argumentation, (b) affirming its Dell Compliance holding with virtually no discussion on the merits of the Chancery Court’s adjudication of that issue, and (c) directing a verdict in reliance on the Dell Compliance holding—notwithstanding obvious conflicts in the trial record on the quantification of deductible synergies that, absent judicial gloss, would have frustrated such implementation. While motives remain opaque, the twin effects of this directed verdict are to establish finality (i.e., ensure there will be no Aruba IV or, more importantly, Aruba V) and, by implication, to set in stone the Vice Chancellor’s findings of fact that implicitly sanction as “reliable” a very, very dirty deal.

While certainly titillating in the context of an otherwise reserved forum, the ascription of personal motives to the judges in the above story is not merely unknowable and irrelevant—it is also unfortunate. While it is generally difficult for third parties to distinguish judges’ personal motives from their argument styles, it is particularly difficult in situations such as Aruba, in which so much of the reasoning is reductionist. On what basis, for example, could a practitioner distinguish whether the Vice Chancellor’s “real” motivation in holding that DFC/Dell’s heavy emphasis on a particularly prescriptive view of the efficient capital market hypothesis (“ECMH”) required deference to Aruba’s USP was some form of animus or simply an effective means of cajoling further guidance from the high court on the ambiguities of how to implement their mandate to emphasize “market evidence” in appraisal cases. These potential motivations are neither objectively distinguishable nor mutually exclusive. If the non-gratuitous purpose in divining judges’ personal motives is to better understand their reasoning, such speculation serves no useful role here. Unfortunately, this speculation also has the perverse effect of discouraging forthright discussion of their reasoning styles when, as I contend, the interplay of those styles, itself, is key to understanding the functional meaning of these decisions.

This effect is particularly true with regard to the standard for Dell Compliance—the threshold for M&A process care and loyalty required for that process is to deserve evidentiary weight (whether simply probative or dispositive) in appraisal’s fair value determination. Following Aruba III, this standard remains both more relevant and more amorphous than ever. By relegating USP to an informative data point rather than a direct measure of FV in most appraisal cases, Aruba III returns the battle lines in appraisal litigation to the fork of Dell Compliance to establish whether the more observable, and judicially less burdensome, metric of (adjusted) deal price is sufficiently reliable for adoption. Absent the availability of this “presumption-except-in-name only,” the Chancery Court, by process of elimination, will still need to wrestle with fundamental economic analysis, in some form, to determine FV. At the same time, post-Dell Chancery Court decisions on this standard in AOL, Aruba, Solera, and Norcraft have reached wildly inconsistent—some would argue inverted—results, and the Delaware Supreme Court’s sparse treatment of this issue in Aruba III does nothing to clarify the standard.

On its face, the “black-letter law” Aruba III holding on Dell Compliance is rather anemic given the standard of review—the Chancery Court did not abuse its discretion by giving decisive evidentiary weight to deal price (adjusted for its estimate of allocated synergies) despite the litany of process defects and conflicts it identified. Contrary to the claims asserted in many a defense-firm client memo on the decision, the affirmance of lower court discretion does not equate to substantive agreement. However, while Aruba III consequently says little about how Chancery should administer the Dell Compliance standard, the Supreme Court’s deliberate choice to avoid any meaningful discussion of that holding implies some guidance on how Delaware courts should not administer Dell Compliance—namely, they should avoid the type of relative case assessment regarding process adequacy that the Vice Chancellor utilized in Aruba I (comparing the sales processes of Dell and DFC to that of Aruba) and analyze process adequacy on an endogenous basis. Under this approach, Dell and DFC establish that this endogenous analysis must account for and explain otherwise contrary market evidence (consisting of both relevant share prices and transaction prices) and, more importantly, must do so for case-specific reasons not widely applicable across broad categories of M&A transactions. By so doing, Aruba III re-vests the Chancery Court’s discretion in adjudicating Dell Compliance by confirming its breadth and clarifying the aberrance of Dell and DFC as outlier cases in which process failures and market failures in the record were simply too generic and typically present in “run-of-the-mill” M&A. Such a pro-discretion view of the Aruba III treatment of the Dell Compliance standard comports well with a continuing role for appraisal litigation—whether brought by historical or post-announcement shareholders—as a more surgical or lighter-touch private law mechanism to assist the Delaware courts in policing deviations from agency law less craven, than those addressable via fiduciary claims cognizable under current law. Conversely, an alternative view of Dell Compliance under Aruba III, which simply reads the decision as setting an unconscionably low bar for process adequacy, as other commentators have noted, would rob the availability of appraisal in the public company context of any cogent purpose, while also increasingly putting the Chancery Court in the unenviable position of blessing ambivalence to fiduciary principles.

The complete article, including all relevant disclaimers and footnotes, is available for download here.

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