A 2017 Delaware Supreme Court Decision provides helpful clarity on the circumstances in which market data about a target’s trading price and deal price will present strong evidence of a target’s fair value in U.S. appraisal litigation—a move that notably aligns closer with Canadian courts’ approach to assessing a target’s fair value in dissent cases.
In the appeal of the appraisal litigation concerning the take-private transaction of Dell Inc., the Delaware Supreme Court found that the Delaware Court of Chancery erred in not giving weight to the deal price in determining Dell's fair value, reversing the lower court's decision that dissenting Dell shareholders should be awarded a significant premium over the price paid for their shares. This decision represents a favourable outcome for private equity sponsors for whom the Court of Chancery's opinion had created a cause for concern about heightened appraisal risk on transactions involving financial buyers.
Last year, the Delaware Court of Chancery awarded dissenting Dell Inc. shareholders a premium of 28% over the price paid in a management buyout led by Michael Dell and his private equity sponsor, Silver Lake Partners. In reaching his decision, Vice-Chancellor Laster rejected the deal price as reflecting Dell's fair value, even though the sales process ran by Dell's board would have "sailed through" a challenge based on a fiduciary duty claim.
In 2012, Michael Dell proposed a take-private transaction. A special committee was formed and it reached out to several financial sponsors, including Silver Lake. Following the announcement of a deal with Silver Lake, Carl Icahn and others opposed the transaction. During the go-shop period, other sponsors showed interest but ultimately withdrew from the process. The court analyzed the sale process and found there was insufficient competition pre-signing among a small number of financial buyers, with no strategic buyers.
The market undervalued Dell due to the short-term focus of analysts and a massive investment by Dell in transforming its business.
Significantly, the court concluded that financial buyers were constrained in their ability to pay fair value because of the requirement on their part to achieve an acceptable return for their own investors. Finally, Dell's share price also affected the success of the pre-signing process; the market undervalued Dell due to the short-term focus of analysts and a massive investment by Dell in transforming its business. Having rejected the deal price as fair value, the court then used a discounted cash flow (DCF) approach to value Dell's shares. The conclusion was a price that vastly exceeded what a financial buyer would have paid for Dell in its sale process.
The Decision Reversal
Under Delaware law, as under Ontario law, the court in an appraisal proceeding is entitled to consider a range of approaches for determining the fair value of the corporation's shares. The Delaware Supreme Court found that the lower court erred in giving no weight to market data involving Dell—notably, Dell's stock price and the deal price—and for relying exclusively on its own DCF analysis to assess Dell's fair value.
Importantly, the court found that the evidence suggested the market for Dell's shares was efficient and therefore a likely indication of fair value. Dell had a deep public float, was actively traded with no controlling shareholder and was widely covered by analysts who scrutinized Dell's long-range outlook. Dell's sales process was also robust, and the lack of strategic bidders was not a credible reason for disregarding the deal price. In fact, the court found that there was no "rational connection" between a buyer's status as financial sponsor and whether a deal price was fair; both strategic and financial buyers have internal rates of return that they expect to achieve in exchange for taking on the risk of an M&A transaction.
The court concluded that the market-based indicators of fair value “deserved heavy, if not dispositive, weight."
And finally, the court concluded that there were no information asymmetries that might otherwise have existed in a management buyout given the extensive due diligence afforded to the bidders and Dell's cooperation in the process. The court concluded that the market-based indicators of fair value, such as deal price, "deserved heavy, if not dispositive, weight."
The ruling will be welcomed by financial buyers as it reverses the Delaware Court of Chancery's finding that the pricing (LBO) model used by sponsors may create a divergence between the price they are willing to pay and the target's "fair value." This view would have exposed financial sponsors to increased appraisal risk on their M&A transactions.
Canadian Approach to Appraisal Actions
Appraisal rights have become an attractive tool for dissenting shareholders in M&A transactions in the U.S., which has witnessed a rise in appraisal litigation in recent years. Although Canada has not experienced a similar trend, the approach taken by the Delaware Supreme Court in the Dell litigation aligns with the Canadian court's approach to assessing fair value in dissent cases.
For example, in the Deer Creek litigation in Alberta, investment manager Paulson & Co claimed that the bidder, Total, vastly undervalued the shares of the target Deer Creek, by a factor of at least 300%. After trial, though, Alberta's Court of Queen Bench found that the best measure of the value of Deer Creek shares was the market price, leaving the dissenter with no improvement to the deal price following years of litigation. While a Canadian court, like a U.S. court, can employ a range of valuation methodologies in fixing the fair value of shares, the decision in Deer Creek suggests that where the shares of a target are actively traded, the deal price likely represents fair value. A Canadian court could also take into account factors that might diminish the reliability of the deal price as an indicator of fair value, including the target's sales process, the impact of a controlling shareholder and information asymmetries.
Appraisal litigation is not the only area of alignment between Delaware and Canadian courts, whose approaches to reviewing M&A transactions in post-closing damages disputes also share similarities (for details, see "Informed Shareholders Take the Steam Out of Deal Litigation").