(a) What were the reasons for the Delaware Supreme Court’s decision?
The Delaware Supreme Court (“Del Court”) rejected the Court of Chancery method for valuation of fair value of shares based on 30-day average unaffected market price. The Del Court ruled that, in a statutory appraisal case, fair value of what has been taken from shareholders of a merging company is “the value of the company to the stockholders as a going concern, rather than its value to a third party as an acquisition”. The right valuation is the deal price minus synergies. The Del Court provided the following reasons for its ruling.
The use of 30-day market price is incorrect
The Del Court criticized the Court of Chancery that it abused its discretion in arriving at the corporation's 30-day average unaffected market price as the fair value of appellants' shares. The decision to use the corporation's stock price instead of the deal price minus synergies was rooted in a flawed factual finding that lacked evidence. Therefore, this conclusion was based on inapt theory that it needed to deduct additional costs for unspecified agency expenses from the deal price.
The right approach to appraisal cases
In appraisal cases, the right approach is what has been taken from the shareholders - the proportionate interest is a “going-concern”, rather than its value to a third party in acquisition transaction. The Court must value the company as an operating entity without accounting for post-merger events or other possible business combinations that may alter the share price. In this case, the during the months leading to the valuation, it was possible for material information related to the company’s future earning to emerge. This is consistent with the “efficient market hypothesis”, which the Court of Chancery ignored. The hypothesis states that market price reflects fair value based on information available to the public. In essence, the stock price represents the very essence of the value that investors give the share based on the information available to them. Therefore, in theory, the market price should accurately reflect stock price. However, in this case there were a few adjustments that needed to be made. Furthermore, not only the buyer had a chance to study the target more closely than usual, but also had access to confidential information that was not readily available to the general public, and therefore, could not have been reflected in the public trading price.
Therefore, according Delaware law, the appraisal should exclude “any award the amount of any value that the selling company's shareholders would receive because a buyer intends to operate the subject company, not as a stand-alone going concern, but as a part of a larger enterprise, from which synergistic gains can be extracted."
Here, not only there was no efficient market, but also the agency costs had already been priced in the synergies because there was no change of ownership. The shares were simply transferred from one group of dispersed public stockholders to another. There was no change in ownership such that the management’s goals conflict with the owner’s goals of maximizing profits, such as in the case of private owners (for example, hedge funds). The Court of Chancery's approach that it had to deduct for agency costs ignored the reality that the buyer’s synergies likely already been included any agency cost reductions it may have expected.
(b) Do you agree or disagree with the Delaware Supreme Court, and why?
I agree with the Del Court’s decision for several reasons. First, as the “efficient market hypothesis” states, market prices only reflect information that is publicly available at the time. It is the public that assigns value to the share based on the information available. However, in
Merger and acquisition deals, it is commonplace for target firms to share nonpublic information with the bidder
under confidentiality agreements. In this case, for example, the bidder knew that the target
was about to report stronger than expected quarterly results. The parties negotiated and priced the deal while such information remained non-public. The existence of a potential merger was strategically leaked to the public prior to the disclosure of Aruba’s quarterly results, making it difficult to infer fair value from the pre-announcement share price.
Second, the pre-announcement trading price does not account for information that is revealed or events that take place between the announcement date and the closing date. Events that occur in the weeks or months between announcement and closing, whatever they may be, will necessarily not be reflected in the pre-announcement trading price because at the time they were not disclosed to the public.
Third, market prices reflect the value that investors assign to the cash-flow rights associated with a single share of stock. By contrast, the Del Court requires courts to value the target firm as a “going-concern”, and then assign each dissenter its pro-rata interest. Because the market price is discounted to reflect a lack of control, the calculation of multiplying the number of outstanding shares by the market price will typically produce a low valuation for the target firm. Furthermore, in this case, the transaction did not add value due to reduction of agency cost. In fact, agency costs never changed because the previous owners – Aruba’s public shareholders – were simply replaced by a new group of public shareholders. Therefore, there was no transfer of ownership between dispersed group of owners to a concentrated group of owners whose interest does not align with maximizing profits. Additionally, ever if there was a change in ownership, such as in private equity transaction, the cost would already be priced into synergies. Therefore, agency costs would be priced into synergies in either situations.
I believe that the Del Court, apart from deciding the fair value of Aruba, used this case as a platform to set a policy that could potentially reduce the appraisal arbitrage in Delaware, which I support.
Appraisal arbitrage refers to when stockholders – such as private equity - purchase shares of a target company after a transaction is publicly announced and invoke their appraisal rights, hoping that the court will find fair value to be in excess of the transaction consideration. This relies on the influence of public access to information that may vary share price. However, the Del Court’s decision may provide deterrence to commencing appraisal litigation without compelling reasons to believe that the transaction consideration does not accurately reflect fair value - such as in cases where conflict of interests exist. However, absent of any evidence, fair value determination is likely to be capped at the merger price and possibly less some synergies, which provide very little incentive to engage in appraisal arbitrage.
(c) Would the assessment of “fair value” change if Verition Partners were to be decided in the context of an amalgamation or plan of arrangement under current Canadian law?
As discuses above, the Del Supreme Court decided that the fair value of the stocks would be valuated based on deal price minus synergies. Canadian courts have applied various valuation methods and it appears as if there is no emerging preferred approach. Each decision was highly fact specific. I think that, in light of all circumstances, the fair value in Verition would still remain deal price minus synergies if it was to be decided in the context of amalgamation or plan of arrangement under current Canadian law.
In Carlock v. ExxonMobil Canada Holdings ULC, the dissenting shareholders used their rights in the context of a plan of arrangement. The Court rejected the transaction price as the right valuation method due to various corporate governance issues (conflict of interest, no independent legal advice, conflict of the CEO, and insiders with specific knowledge in the industry). Instead, the Court applied the discounted cash flow ("DCF”) model, which determined fair market value based on the projected future cash flows (income) of the company subject to valuation, based on the idea that a company’s value is based on its ability to generate future cash flow (income). The DCF was chosen, which reflected the price increase in oil. Apart from corporate governance issues, the nature of the commodity and the asset, which was projected to produce income in the future, all played a significant role in choosing the DCF valuation over others. However, this case is to be distinguished from Verition, where no evidence of corporate governance issues was found. On the contrary, the Verition transaction was negotiated in arm’s length; the price proposed was the higher bid among all bidders who, all, had access to the same confidential information; there was no other potential purchaser that was willing to pay the value reached by the dissenter’s DCF expert; and the transaction price was approved by the vast majority of >90% of shareholder and approved by all institutional shareholders.
However, the recent decision in Deer Creek Energy Ltd. v. Paulson & Co. Inc. may suggest an approach that is not favorable to shareholders when exercising their appraisal rights.
The dissent shareholder claimed that the bidder vastly undervalued the shares of the target. The court eventually found that the best measure of the value of the target’s shares was the market price, leaving the dissenter with no improvement to the deal price following years of litigation. The Court did not let dissenters capitalize on a spike in market price of shares in the interim period between two-step transactions. This is consistent with the current reasoning of the Del Court, which stated that any increase in share price post-merger announcement is not to be factored into the fair value. In Deer, the market price was equal to the deal price. This approach is also consistent with the decision in Bamrah v. Waterton Precious Metals Bid Corp. The Court considered the following similar factors: there was no coercion or compulsion, there was an independent investment banking firm valuation, shareholder approval (which suggests that the price was fair and reasonable), and the transaction was negotiated in arm’s length. In this case, the market price reflected the fair value of the deal price and a truly open market was found.
In Verition, there was no evidence to suggest lack of disclosure of the financial analysis underlying the fair report, nor is there evidence to show that the shareholders were not fully informed when voting to approve the transaction. The transaction is thought to have occurred in good faith and in arm’s length. However, the “efficient market hypothesis” could not be applied in this case because during the months leading to the valuation date, it was possible for new and material information pertaining to a company's future earnings to arise. Moreover, the purchasing company had an incentive to study the target very closely while having a substantial, nonpublic information that could not have been factored into the public trading price. Such information, for example, could have included the target’s quarterly earning prior to its release to the public. These special circumstances has led to the conclusion that the market value did not accurately reflect the deal price. Also, the double-count of synergies had to be accounted for – the shares were simply displaced from one group of owners, namely public shareholders, to another. Therefore, the consolidation of the company aligned with the managerial goals and therefore the agency costs were factored into the synergies.
 Verition Partners Master Fund Ltd. v Aruba Networks, Inc., 210 A 3d 128 (Del 2019) at page 1 [Verition]
 Ibid at page 6
 Ibid at page 3
 Ibid at page 6
 Ibid at page 2
 Ibid at page 7
 Ibid at page 6
 Ibid at page 4
 2019 YKSC 10 (2019) [Carlock]
 Ibid at para 62
 Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., 2018 WL 922139 at page 12
 2009 ABCA 280 [Deer]
 Supra note 1 at page 4
 2019 BCSC 258 [Bamrah]
 Ibid at paras 126, 129, 162-165
 Supra note 1 at page 6
 Ibid at page 4
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