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Statutory Fair Value in Dissenting Shareholder Cases: Part I

Authors:
  • Sutter Securities Financial Services, San Francisco

Abstract

The predominant standard of value employed by state courts to determine the value of minority shares in appraisal cases is fair value, which is determined by state law. In most states, fair value is the shareholder’s pro rata portion of the value of a company’s equity. This measure of value differs from fair market value, third-party sale value, and fair value for GAAP purposes. This article discusses the valuation approaches accepted by the courts, focusing on the Delaware courts’ views as to how fair value is assessed, and contrasts Delaware’s views with those of other jurisdictions that differ from Delaware in their approach to fair value.
STATUTORY FAIR VALUE IN DISSENTING SHAREHOLDER CASES:PART I
Gilbert E. Matthews, MBA, CFA
The predominant standard of value employed by state courts to determine the value
of minority shares in appraisal cases is fair value, which is determined by state law. In
most states, fair value is the shareholder’s pro rata portion of the value of a company’s
equity. This measure of value differs from fair market value, third-party sale value, and
fair value for GAAP purposes. This article discusses the valuation approaches
accepted by the courts, focusing on the Delaware courts’ views as to how fair value is
assessed, and contrasts Delaware’s views with those of other jurisdictions that differ
from Delaware in their approach to fair value.
I. Fair Value as the Standard of Value in
Dissenting Shareholder Cases
In this article I address the predominant standard of
value, fair value, employed by state courts to determine
the value of minority shares in appraisal (dissent)
cases.
1
Appraisal statutes in most states expressly or
effectively stipulate that the minority’s shares are to be
valued at ‘‘fair value.’’ To understand fair value as a
standard of measurement, it must be contrasted to the
standards of value called fair market value and third-
party sale value, as will be discussed in this article and
continued in the next issue (Part II).
2
Please refer to the
article outline on page 16.
Appraisal cases are governed by state law, that is,
relevant corporate law statutes, the judicial interpretations
of those statutes, and the courts’ holdings under their
general equitable authority, even when the state lacks
corresponding statutes.
3
Although fair value is now the
state-mandated or accepted standard for judicial valua-
tions for appraisal in almost all states, differing
interpretations of its meaning and measurement have
evolved through legislative changes and judicial inter-
pretation.
The model statutes proposed by the American Bar
Association (ABA) and the American Law Institute
(ALI), together with Delaware corporate laws on
appraisals, have greatly influenced a majority of state
statutes. The ABA and the ALI have developed
definitions of fair value that are set forth in the ABA’s
Model Business Corporation Act (MBCA)
4
and the ALI’s
Principles of Corporate Governance.
5
Although statutes
and legal organizations have both contributed to the
development of the fair value standard, the courts’
decisions in dissenting shareholder cases are central to
its definition.
Delaware’s appraisal statute explicitly mandates fair
value as the measure of value, and the Delaware Supreme
Court clarified its meaning in Tri-Continental
6
in 1950.
Fair value was defined as the value that had been taken
from the dissenting shareholder:
The basic concept of value under the appraisal statute is that
the stockholder is entitled to be paid for that which has been
taken from him, viz., his proportionate interest in a going
concern. By value of the stockholder’s proportionate interest
in the corporate enterprise is meant the true or intrinsic value
of his stock which has been taken by the merger. In
determining what figure represents this true or intrinsic
Gilbert E. Matthews, MBA, CFA, is Chairman of
Sutter Securities Incorporated in San Francisco,
California. He headed the fairness opinion practice
at Bear Stearns in New York for twenty-five years. He
is on the editorial review board of Business Valuation
Resources.
1
Since shareholders who dissent from a transaction are entitled to
appraisal of their shares, the terms dissenters’ rights and appraisal
rights are interchangeable.
2
Fair value for appraisal is distinct from fair value for US GAAP. As
defined in FAS 157, fair value for accounting purpose is a form of fair
market value.
3
Douglas K. Moll, ‘‘Shareholder Oppression and ‘Fair Value’: Of
Discounts, Dates, and Dastardly Deeds in the Close Corporation,’’ 54
Duke L.J. 293 (2004): 310.
4
The MBCA is a model code designed for use by state legislatures in
revising and updating their corporation statutes. It was initially published
by the ABA in 1950 and revised in 1971, 1984, and 1999. There were
amendments with respect to appraisals in 1969, 1978, and 2008.
5
The Principles of Corporate Governance were written to ‘‘clarify the
duties and obligations of corporate directors and officers and to provide
guidelines for discharging those responsibilities in an efficient manner,
with minimum risks of personal liability.’’ ALI, Principles of Corporate
Governance (Philadelphia: American Law Institute Publishers, 1992) at
President’s Foreword, xxi.
6
Tri-Continental v. Battye, 74 A.2d 71 (Del. 1950) (‘‘Tri-Continental’’).
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value, the appraiser and the courts must take into
consideration all factors and elements which reasonably
might enter into fixing the value.
7
This concept of value has since been cited in numerous
appraisal cases as the basic standard. In recent years, most
jurisdictions have accepted the position that appraisal
should measure what has been taken from the sharehold-
er and that this amount is a pro rata share of the value of
the company as a going concern.
The appraisal action is a ‘‘limited legislative remedy
which is intended to provide minority shareholders who
dissent from a merger asserting the inadequacy of the
[consideration], with an independent judicial determina-
tion of the fair value of their shares.’’
8
Dissenting
minority shareholders may petition for appraisal under a
state statute, commonly known as appraisal or dissenters’
rights. Shareholders customarily have appraisal rights
when they are involuntarily cashed out in a merger or
consolidation, but some states also permit dissenters to
seek appraisal in other circumstances, such as a sale of
assets, recapitalization, stock-for-stock merger, amend-
ments to articles of incorporation, or other major changes
7
Id. at 72.
8
Alabama By-Products Corp. v. Neal, 588 A.2d 255, 256 (Del. 1991).
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to the nature of their investment. In an appraisal action,
the exclusive remedy is cash.
Importantly, defining fair value as a proportionate
share of a company’s value, as Delaware did in Tri-
Continental, differentiates it from the other two relevant
standards of value: fair market value and third-party sale
value. Professors Hamermesh and Wachter write:
‘‘[T]he measure of ‘fair value’ in share valuation proceed-
ings is superior, in both fairness and efficiency, to its two
main competitors, [fair] market value and third-party sale
value.’’
9
Fair market value is ‘‘the price at which the property
would change hands between a willing buyer and a
willing seller when the former is not under any
compulsion to buy and the latter is not under any
compulsion to sell, both parties having reasonable
knowledge of relevant facts.’’
10
In contrast, fair value is
used in statutory appraisals where the seller is not a
willing seller, is compelled to sell, and has less
knowledge of the relevant facts than does the buyer.
When fair market value is used in (for example) tax
cases, substantial discounts for the minority’s lack of
control and lack of marketability are often applied to the
value of minority shares. Courts have noted that a fair
market value valuation based on such discounts would be
less than the value of the minority shareholders’
proportionate interest in the company. With a fair market
valuation, the controller (or majority) would reap a
windfall at the expense of the minority. Consequently,
statutes and judicial interpretations in most states now
reject minority or marketability discounts in the determi-
nation of fair value.
On the other hand, if the courts used the standard of
third-party sale value, those shares may be valued at a
level that would usually be higher than fair value. An
augmented value results when third-party sale price
includes additional elements of value resulting from the
transaction, such as synergies. Minority shareholders are
not entitled to those incremental values. Hamermesh and
Wachter explain:
Third-party sale value necessarily derives from transactions
in which corporate control is acquired. The Delaware cases
establish, however, that it is the nature of the enterprise itself
at the time of the merger that is the key parameter in the
valuation exercise [emphasis in original]. Because the prices
paid in such transactions reflect elements of value created by
the transaction—notably synergies—that would not other-
wise exist in the enterprise itself, the use of such prices in
determining fair value conflicts with the statutory mandate
that ‘‘any element of value arising from the accomplishment
or expectation of the merger or consolidation’’ must be
excluded.
11
These writers maintain that the fair value standard is
fairer to opposing parties in a dispute than either fair
market value or third-party sale value because fair value
attempts to balance the dangers that lie in either direction:
on one side, the danger of awarding a windfall to an
opportunistic controller who has forced out the minority
shareholders; on the other side, the danger of incentiv-
izing litigation by minority shareholders attempting to
capture value from controllers whose energies and
abilities have resulted in increased company value
through a synergistic transaction. They posit that fair
value strikes the best balance for valuing what was taken
from the minority by awarding them the pro rata share of
the existing company’s going-concern value, that is, the
present value of the cash flows to be generated from the
corporation’s existing assets plus its reinvestment oppor-
tunities.
12
To further understand the issues and complexity
surrounding fair value in appraisal and fiduciary duty
cases, this article examines what elements of value are
addressed by the courts in their determination of fair
value, and looks at how various courts address current
valuation concepts and techniques.
A. Appraisal rights today
Currently, the ABA and the ALI recognize various
events that can trigger dissenters’ rights. States have
adopted their own triggering events in their statutes, and
these may have developed differently from those of the
MBCA and the Principles of Corporate Governance
because of each state’s corporate law history. Some
common triggers contained in the MBCA and the state
statutes include:
Merger
Share exchange
Disposition of assets
Amendment to the articles of incorporation that
creates fractional shares
Any other amendment to the articles from which
shareholders may dissent
Change of state of incorporation
Conversion to a flow-through, unincorporated or
nonprofit entity
9
Lawrence A. Hamermesh and Michael L. Wachter, ‘‘Rationalizing
Appraisal Standards in Compulsory Buyouts,’’ 50 Boston College L. Rev.
1021 (2009): 1021 (‘‘Rationalizing Appraisal Standards’’). In this article,
we extensively cite these professors’ expert writings on appraisal and fair
value.
10
IRS Rev. Ruling 59-60, §2.02.
11
Hamermesh and Wachter, ‘‘Rationalizing Appraisal Standards’’ at
1028, quoting 8 DEL.CODE ANN. §262(h).
12
Id. at 1022.
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STATUTORY FAIR VALUE IN DISSENTING SHAREHOLDER CASES:PART I
In practice, a majority of appraisal cases today arise
when control shareholders squeeze out minority share-
holders for cash.
Professor Robert Thompson points out that the
appraisal remedy serves as a check against opportunism:
Now the remedy serves as a check against opportunism by a
majority shareholder in mergers and other transactions in
which the majority forces minority shareholders out of the
business and requires them to accept cash for their shares. In
earlier times, policing transactions in which those who
controlled the corporation had a conflict of interest was left
to the courts through the use of fiduciary duty or statues that
limited corporate powers. Today, that function is left for
appraisal in many cases.
13
Thompson makes the case that that several statutory
appraisal provisions work counter to providing fairness in
the opportunism context:
Excluding from the fair value calculation any appreciation
or depreciation attributable to the merger transaction;
Requiring minority shareholders seeking appraisal to take
four or more separate legal steps to perfect the remedy
(and withdrawing relief if the actions are not perfect);
Excluding appraisal when shares are traded on a public
market;
14
and
Making appraisal an exclusive remedy even when the
valuation remedy does not include loss from breaches of
fiduciary duty.
15
Dissenters are required to follow precisely the complex
timing and other requirements of state law in a process
referred to as perfecting dissenters’ rights. The process
and timetable of these events vary from state to state, but
in most cases are strictly enforced. A company’s board of
directors is required to give notice (commonly in a proxy
or information statement) of a contemplated corporate
action from which shareholders may dissent. Dissenters
must then decline the consideration and demand payment
of their shares in a notice to the board prior to the action.
This dissent triggers an appraisal. Upon notice of dissent,
dissenters relinquish all rights except the right to receive
payment of the fair value of their shares (plus interest
from the valuation date) and, in many states, will receive
no payment until the conclusion or settlement of
litigation. (In some states, however, the company must
[or may elect to] pay or put into escrow, the amount that it
contends to be fair value, as recommended by the
MBCA.) Furthermore, dissenters become unsecured
creditors of the company or its successor, which often
is a highly leveraged entity. In an unpublished 1999
Alabama appraisal, Delchamps,Inc. v. Kuykeldall,in
which the author was an expert witness, petitioners were
awarded an amount materially above the transaction
price, but the highly leveraged acquirer filed for
bankruptcy shortly after the verdict without paying
petitioners.
B. Fair Value as defined by various authorities
and statutes
‘‘Fair value’’ is the standard of value for statutory
appraisal in forty-eight states and the District of Colum-
bia.
16
State statutes vary, but most draw inspiration from
the MCBA (1969) and the later revised MBCAs (1984,
1999, and 2008). The definitions in the various iterations
illustrate the evolution of the fair value standard.
The 1969 MBCA set out that ‘‘fair value’’ was to be the
measure by which the minority shareholder was to be
paid for his or her shares, but it provided no details on fair
value’s definition. It stated that:
[S]uch corporation shall pay to such shareholder, upon
surrender of the certificate or certificates representing such
shares, the fair value thereof as of the day prior to the date on
which the vote was taken approving the proposed corporate
action, excluding any appreciation or depreciation in
anticipation of such corporate action.
17
In 1984, the ABA issued a revised MBCA, adding
important additional concepts to the definition of fair
value. It excluded from the value of minority shares
the synergy value of the objected-to transaction
‘‘unless exclusion would be inequitable.’’ It reads:
‘‘The value of the shares immediately before the
effectuation of the corporate action to which the
dissenter objects, excluding any appreciation or
depreciation in anticipation of the corporate action
unless exclusion would be inequitable [newly added
language in italics].’’
18
The 1984 definition provided a guideline, however
nonspecific, by which fair value should be determined.
The company should be valued without any of the effects
of the transaction unless that exclusion would be unfair.
The passage did not give instructions on what method or
13
Robert B. Thompson, ‘‘Exit, Liquidity, and Majority Rule: Appraisal’s
Role in Corporate Law,’’ 84 Georgetown L. Rev. 1 (Nov. 1995): 4.
14
Shareholders of publicly traded companies are denied appraisal rights
in all transactions in thirteen states, in transactions other than interested
party transactions in eleven states, and in stock-for-stock transactions in
Delaware and twelve other states. See Gilbert E. Matthews and Michelle
Patterson, ‘‘Public Shareholders, Fair Value, and the ‘Market-Out
Exception’ in Appraisal Statutes,’’ 21 Business Valuation Update 17,
Feb. 2015: 17–25.
15
Thompson at 5.
16
The exception are California, whose appraisal statute specifies fair
market value, and Ohio, whose statute uses the phrase fair cash value.
Wisconsin uses fair value for most transactions but uses market value for
certain related party transactions. See ‘‘States Using a Standard Other
than Fair Value’’ in Part II.
17
1969 MBCA §13.01.
18
1984 MBCA. This provision is currently in many state statutes. See,
e.g., COLO.REV.STAT. §7-113-101(4).
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valuation technique should be utilized to determine the
fair value, nor does it define inequitable. The intentional
ambiguity in this definition allowed for wide interpreta-
tion of the assumptions that underlie this standard of
value. Comments published by the ABA explained that
this definition left the matter to the courts to determine
‘‘the details by which fair value is to be determined within
the broad outlines of the definition.’’
19
Although most state statutes use a definition of fair
value from a version of the MBCA, some states have
utilized the definition provided by the ALI. In its
Principles of Corporate Governance, published in 1992,
the ALI defined fair value as
the value of the eligible holder’s proportionate interest in the
corporation, without any discount for minority status or,
absent extraordinary circumstances, lack of marketability. Fair
value should be determined using the customary valuation
concepts and techniques generally employed in the relevant
securities and financial markets for similar businesses in the
context of the transaction giving rise to appraisal.
20
Following the development of substantial case law on
valuation of dissenters’ shares, as well as the publication of
the ALI’s Principles of Corporate Governance, the MBCA
was revisedin 1999 so that the definition of fair value reads:
The value of the shares immediately before the effectuation
of the corporate action to which the shareholder objects
using customary and current valuation concepts and
techniques generally employed for similar businesses in
the context of the transaction requiring appraisal, and
without discounting for lack of marketability or minority
status except, if appropriate, for amendments to the
certificate of incorporation.
21
This definition (unchanged in 2008) affords a more
inclusive view of opportunities, which may affect the
determination of fair value. It mirrors the ALI’s
Principles of Corporate Governance in that it adds
important concepts to the framework: the use of
customary and current valuation techniques, and the
explicit rejection of the use of marketability and minority
discounts.
22
Other states, including Delaware, have developed their
own definitions of fair value
23
or have used different
standards of value in their statutes. It should be recognized
that ‘‘there has been a constructive symbiosis between the
MBCA and Delaware.’’
24
The amended MBCA’s language
calling for ‘‘using customary and current valuation
concepts and techniques generally employed’’ is substan-
tially the standard that Delaware had adopted in Wein-
berger
25
in 1983. A review of published appraisal
decisions indicates that, in practice, many state courts
had already been following the Weinberger standard.
The diversity among states in their definitions of fair
value combined with the complexity of each state’s
statutes compels the valuation expert to closely consult
counsel for guidance before undertaking either appraisal
testimony or a fairness assessment.
C. The importance of Delaware
More than half of all publicly traded US corporations
and about two-thirds of the Fortune 500 are incorporated
in Delaware,
26
and a major portion of corporate litigation
takes place in Delaware. Delaware has by far the most
extensive body of case law. The Delaware General
Corporation Law is comprehensive and widely under-
stood. Delaware has a trial court, the Court of Chancery,
which is dedicated to equity cases and is knowledgeable
and widely respected.
D. Appraisal arbitrage
Much of the rise in appraisal petitions is attributable to
‘‘appraisal arbitrage,’’ in which investors, primarily hedge
funds, purchase shares eligible for appraisal to obtain
returns through an appraisal proceeding rather than
through the merger itself.
27
This practice has been
particularly effective in related party transactions.
In 2007 the Court of Chancery held in Transkaryotic
28
that appraisal rights are available to investors who hold
shares in ‘‘street name’’ at the date of the stockholder
meeting, even if they had purchased shares after the
record date:
[S]tockholders . . . [learn] key information that will help
them evaluate the merger . . . only when they see the
company’s proxy statement, which also . . . is generally
19
ABA, A Report of the Committee of Corporate Laws,‘‘Changes in the
Revised Model Business Corporation Act: Amendments Pertaining to
Close Corporations,’’ 54 Bus. Lawyer 209 (Nov. 1998).
20
Principles of Corporate Governance at §7.22.
21
1999 MBCA §13.01.
22
The exception permitting discounts for certain amendments to the
certificate of incorporation has minimal impact.
23
Some states have explicitly accepted the Delaware definition in their
case law. See, e.g., Vortex Corp. v. Denkewicz, 334 P.3d 734 (Ariz. App.
2014).
24
Jeffrey M. Gorris, Lawrence A. Hamermesh, and Leo E. Strine, Jr.,
‘‘Delaware Corporate Law and the Model Business Corporation Act: A
Study in Symbiosis,’’ 74 Law & Contemp. Prob. 107 (2011): 107.
25
Weinberger v.UOP, Inc., 457 A.2d 701 (Del. 1983) (‘‘Weinberger’’ ).
26
John L. Reed and Ashley R. Altschuler, ‘‘Delaware Corporate Law and
Litigation: What Happened in 2014 and What It Means for You in
2015,’’ available at https://www.dlapiper.com/en/us/insights/
publications/2015/01/delaware-corporate-litigation-review-2014-2015/.
27
Charles R. Korsmo and Minor Myers, ‘‘Appraisal Arbitrage and the
Future of Public Company M&A,’’ 92 Wash.U.L.Rev. 1551 (2015).
28
In re Appraisal of Transkaryotic Therapies, Inc., 2007 Del. Ch. LEXIS
57 (May 2, 2007).
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STATUTORY FAIR VALUE IN DISSENTING SHAREHOLDER CASES:PART I
when they learn of the record date—and that record date is
almost always publicly disclosed after it has passed.
29
As a result of Transkaryotic, hedge funds and others
can evaluate potential appraisal claims and choose to
accumulate shares between the record date and the
closing date.
30
The decision widened the door for
appraisal arbitrage. Numerous hedge funds have actively
pursued this activity, and some hedge funds have been
created specifically for this purpose.
Another factor is the interest rate applicable to
Delaware appraisals. Shareholders are awarded interest
at a rate of 5% over the Federal Reserve discount rate,
compounded quarterly, on the fair value of their shares.
This generous interest rate has contributed to the rise of
appraisal arbitrage in the low-interest-rate environment
that has prevailed since 2008. As of August 1, 2016,
Delaware amended its appraisal statute to permit
companies to reduce interest accruals by prepaying to
petitioners an amount chosen by the company.
In the past decade, appraisal arbitrage has resulted not
only in an increase in the portion of eligible Delaware
transactions where appraisal is sought, but also in a
material increase in the aggregate number of shares
involved in appraisals of public companies. The increase
is attributable not only to hedge fund activity but also to
an increased proclivity of mutual funds to seek appraisal
in related party transactions.
II. Fair Value in Delaware
A. Delaware fair value standards
The concept of fair value under Delaware law is not
equivalent to the economic concept of fair market value.
Rather, the concept of fair value for purposes of
Delaware’s appraisal statute is a largely judge-made
creation, freighted with policy considerations.
31
The Delaware Supreme Court developed the standards
for valuations in appraisal cases in four seminal cases:
Tri-Continental (1950), Sterling v.Mayflower (1952),
32
Weinberger (1983), and Cavalier (1989):
33
Tri-Continental described fair value as that which
has been taken from the shareholder and stated that
fair value should be determined based on facts
known or knowable at the valuation date.
34
Sterling v.Mayflower stated that the proper test of
fairness was whether the ‘‘minority stockholder will
receive the substantial equivalent in value of the
shares he held [emphasis added].’’
35
Weinberger permitted the use of valuation tech-
niques customarily accepted in the financial com-
munity and endorsed forward-looking valuation
approaches.
36
Cavalier confirmed that discounts for lack of
marketability or minority interest should not be
applied in calculating fair value.
37
Subsequent case law is based on these principles.
Delaware’s appraisal statute
38
has been further clarified in
numerous decisions interpreting how fair value is to be
determined and explaining which factors should be
considered and excluded. We discuss these developments
in this section.
B. Fair value is proportionate share of equity
value
The Delaware appraisal statute states that ‘‘the Court
shall determine the fair value of the shares exclusive of
any element of value arising from the accomplishment or
expectation of the merger or consolidation. . . . In
determining such fair value, the Court shall take into
account all relevant factors.’’
39
Interpreting the statute, the
Delaware Court of Chancery ruled in 1988 that a
dissenting shareholder was entitled to a pro rata share
of the equity value of the company:
Under §262 [of the Delaware General Corporation Law], the
dissenting shareholder is entitled to his proportionate interest
in the overall fair value of the corporation, appraised as a
going concern. The amount of the holdings of a particular
dissenting stockholder is not relevant, except insofar as they
represent that shareholder’s proportionate interest in the
corporation’s overall ‘‘fair value.’’ That a particular dissent-
ing stockholder’s ownership represents only a minority stock
interest in a corporation is, therefore, legally immaterial in
determining the corporation’s ‘‘fair value.’’
40
The Delaware Supreme Court upheld the lower court
decision, explaining that if minority shareholders did not
29
Korsmo and Myers, ‘‘Reforming Modern Appraisal Litigation,’’ 41
Del. J. Corp. L. (2017) [forthcoming], available at http:ssrn.com/
abstract=2712088, p. 70.
30
Shareholders as of the record date are eligible for appraisal even if they
bought their shares after the announcement date.
31
Finkelstein v.Liberty Media, Inc., 2005 Del. Ch. LEXIS 53 (Apr. 25,
2005) at *39.
32
Sterling v.Mayflower Hotel Corp., 93 A.2d 107 (Del. 1952).
33
Cavalier Oil Corp. v. Harnett, 564 A.2d 1137 (Del. 1989)
(‘‘Cavalier’’). See discussion of Cavalier in ‘‘Fair value is proportionate
share of equity value’’ below.
34
Tri-Continental at 72.
35
Sterling v.Mayflower at 110.
36
Weinberger at 713.
37
Cavalier at 1145.
38
8DEL.CODE ANN. §262.
39
8DEL.CODE ANN. §262(h).
40
Cavalier Oil Corp. v. Harnett, 1988 Del. Ch. LEXIS 28 (Feb. 22,
1988) at *27; aff’d, 564 A.2d 1137 (Del. 1989).
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receive ‘‘the full proportionate value’’ of their shares, the
majority shareholders would ‘‘reap a windfall’’ :
[T]o fail to accord to a minority shareholder the full
proportionate value of his shares imposes a penalty for lack
of control, and unfairly enriches the majority shareholders
who may reap a windfall from the appraisal process by chasing
out a dissenting shareholder, a clearly undesirable result.
41
This decision clearly supports the pro rata share concept,
ruling that in an appraisal the minority shareholder should
not receive a lesser price for his shares because he or she
does not share in the exercise of control of the corporation.
Because minority shareholders are entitled to proportionate
value, the controller cannot benefit disproportionately from
forcing out the minority at a diminished price.
C. Fair value is going-concern value
The Delaware courts have consistently held that the best
measure of fair value is going-concern value.
42
In Delaware,
the concept of going-concern value is based on earnings
from existing assets plus the value of anticipated reinvest-
ment opportunities:‘‘ [G]oing concern value must include
not only the discounted free cash flow to be generated by the
corporation’s current assets, but also the discounted free cash
flow to be generated by the reinvestment opportunities
anticipated by the corporation.’’
43
A Delaware company is appraised as it exists at the
transaction date, inclusive of its anticipated reinvest-
ments. This concept of going-concern value is often
referred to as operative reality. In the 2012 Just Care
decision, the court cited precedent and wrote:
In an appraisal proceeding, ‘‘the corporation must be valued
as a going concern based upon the ‘operative reality’ of the
company as of the time of the merger.’’ The Court should
consider ‘‘all factors known or knowable as of the Merger
Date that relate to the future prospects of the Companies,’’
but should avoid including speculative costs or revenues.
44
D. Fair value may be greater or less than the
transaction price
1. Arm’s-length price may be fair value
When considering fair value, the court may elect to give
substantial weight to a price negotiated in an arm’s-length
transaction. The Delaware Supreme Court wrote in 1999
that ‘‘a merger price resulting from arm’s-length negotia-
tions where there are no claims of collusion is a very strong
indication of fair value.’’
45
The court wrote in 2004:
In view of the market’s opportunity to price UFG directly as
an entity, the use of alternative valuation techniques like a
DCF [discounted cash flow] analysis is necessarily a second-
best method to derive value. A DCF analysis depends
heavily on an assumption about the cost of capital that
rational investors would use in investing in UFG, and
assumptions about the accuracy of UFG’s cash-flow
projections. The benefit of the active market for UFG as
an entity that the sales process generated is that several
buyers with a profit motive, were able to assess these factors
for themselves and to use those assessments to make bids
with actual money behind them.
46
In 2010 it ruled that the Court of Chancery can decide
whether or not to give any weight to the transaction price:
Requiring the Court of Chancery to defer—conclusively or
presumptively—to the merger price, even in the face of a
pristine, unchallenged transactional process, would contravene
the unambiguous language of the statute and the reasoned
holdings of our precedent. . . . [I]nflexible rules governing
appraisal provide little additional benefit in determining ‘‘fair
value.’’ . . . Appraisal is, by design, a flexible process.
47
In a 2013 decision involving an acquisition by a
financial buyer, Vice Chancellor Sam Glasscock III
rejected the experts’ analyses and appraised the dissent-
ers’ shares at the transaction price less ‘‘the synergy value
of the transaction, if any.’’
48
Four 2015 Delaware decisions appraised companies at
or minimally below arm’s-length transaction prices. Vice
Chancellor Glasscock appraised a company at the
transaction price, writing:
I note that my DCF value . . . is still below that paid by the
actual acquiror without apparent synergies; it would be
hubristic indeed to advance my estimate of value over that of
an entity for which investment represents a real—not merely
an academic—risk.
49
Vice Chancellor John Noble stated that ‘‘the Merger
price appears to be the best estimate of value’’ and
41
Cavalier at 1145.
42
Hamermesh and Wachter, ‘‘Rationalizing Appraisal Standards’’ at
1022.
43
Id.
44
Gearreald v.Just Care, Inc., 2012 Del. Ch. LEXIS 91 (Apr. 30, 2012)
(‘‘Just Care’’ ) at *21, citing M.G. Bancorp., Inc. v. LeBeau, 737 A.2d
513, 525 (Del. 1999) and In re U. S. Cellular Operating Co., 2005 Del.
Ch. LEXIS 1 (Jan. 6, 2005) at *56.
45
M.P.M. Enterprises., Inc. v. Gilbert, 731 A.2d 790, 797 (Del. 1999). See also
Miller Bros. Industries, Inc. v. Lazy River Inv. Co., 272 A.D. 2d (N.Y. App.
2000); Dermody v.Sticco, 465 A.2d 948, 951 (N.J. Super. 1983).
46
Union Ill. v. Union Financial, 847 A.2d 340, 359, citing Barry M.
Wertheimer, ‘‘The Shareholders’ Appraisal Remedy and How Courts
Determine Fair Value,’’ 47 Duke Law Journal 613 (1998): 655 (‘‘The
best evidence of value, if available, is third-party sales value. If such
evidence is not available, there is no choice but to resort to less precise
valuation techniques.’’).
47
Golden Telecom, Inc. v. Global GT LP, 11 A.3d 214, 218 (Del. 2010).
48
Huff Investment Fund v. CKx, Inc., 2013 Del. Ch. LEXIS 262 (Nov. 1,
2013) at *48-*49; aff’d, 2015 Del. LEXIS 77 (Del., Feb. 12, 2015).
49
In Re Appraisal of Ancestry.com, Inc., 2015 Del. Ch. LEXIS 21 (Jan.
30, 2015) at *76.
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determined that the company’s appraised value was the
price negotiated in a transaction that was negotiated after
an extensive marketing process.
50
Vice Chancellor Donald Parsons, Jr. rejected DCF
because ‘‘the management projections that provide the
key inputs to the petitioner’s DCF analysis [were] not
reliable;’’ he valued the company at 99% of the price paid
in a hostile transaction
51
and commented that ‘‘hypothet-
ical statements about how much money someone
allegedly would have paid, if they actually had the
money to do so, . . . are significantly less probative’’ than
‘‘bids with actual money behind them.’’
52
Later in 2015, Vice Chancellor Glasscock valued a
company acquired in an arm’s-length transaction at the
acquisition price even though it was 4% lower than his
calculated DCF value:
I undertook my own DCF analysis that resulted in a
valuation of BMC at $48.00 per share. . . .
Taking these uncertainties in the DCF analysis—in light of
the wildly-divergent DCF valuation of the experts—together
with my review of the record as it pertains to the sales
process that generated the Merger, I find the Merger price of
$46.25 per share to be the best indicator of fair value of
BMC as of the Merger date.
53
In December 2016, Vice Chancellor Laster wrote:
If the merger giving rise to appraisal rights ‘‘resulted from an
arm’s-length process between two independent parties, and
if no structural impediments existed that might materially
distort the ‘crucible of objective market reality,’’’ then ‘‘a
reviewing court should give substantial evidentiary weight
to the merger price as an indicator of fair value.’’
54
He concluded:
Small changes in the assumptions that drive the DCF analysis,
however, generate a range of prices that starts below the
merger price and extends far above it. My best effort to
resolve the differences between the experts resulted in a DCF
valuation that is within 3% of the Final Merger Consideration.
As noted, a DCF analysis depends heavily on assumptions.
Under the circumstances, as in AutoInfo and BMC, I give
100% weight to the transaction price.
55
Laster did not adjust valuation for synergies because
the respondent’s expert ‘‘declined to offer any opinion on
the quantum of synergies or to propose an adjustment to
the merger price.’’
56
Vice Chancellor Joseph Slights rejected the projections
underlying the petitioners’ DCF analysis and appraised
the company at the deal price. He concluded:
In the wake of a robust pre-signing auction among informed,
motivated bidders, and in the absence of any evidence that
market conditions impeded the auction, I can find no basis to
accept the Petitioners’ flawed, post-hoc valuation and ignore
the deal price. Nor can I find a path in the evidence to reach
a fair value somewhere between the values proffered by the
parties. And so I ‘‘defer’’ to deal price, not to restore balance
after some perceived disruption in the doctrinal Force, but
because that is what the evidence presented in this case
requires.
57
A major law firm recently commented:
These cases suggest that the court is likely to apply a
‘‘merger price minus synergies’’ valuation if the sales
process is thorough, effective and free from conflicts of
interest. Additionally, the court has been more willing to
defer to the merger price if the other evidence, such as the
petitioners’ expert valuation evidence, is seen as problem-
atic. For example, the court has viewed discounted cash flow
analyses as less persuasive than the merger price when the
reliability of the projections, discount rates and other inputs
to the financial analysis are effectively called into question.
58
If the court determines that a purported third-party
transaction was not arm’s-length due to conflict of interest
and/or improper actions by the buyer, the merger price is
not credible evidence of fair value.
59
2. Arm’s-length price may be greater than fair value
Fair value is going-concern value, while third-party
sale value is the price that results from arm’s-length
negotiations. Because of synergies, as well as a buyer’s
ability to make changes to the operations and financial
structure of a company, fair value is often less than third-
party sale value:
Since the [appraisal] remedy provides going concern value
and the shareholders [in an arm’s-length transaction] are in
fact receiving the higher amount, third-party sale value, the
likely award in appraisal will be a lower amount than the
50
Merlin Partners LP v. AutoInfo, Inc., 2015 Del. Ch. LEXIS 128 (Apr.
30, 2015) at *48.
51
Longpath Capital, LLC v. Ramtron Intl. Corp., 2015 Del. Ch. LEXIS
177 (June 30, 2015) at *2.
52
Id. at *87.
53
Merion Capital LP v. BMC Software, Inc., 2015 Del. Ch. LEXIS 265
(Oct. 21, 2015) at *64–*65.
54
Merion Capital LP v. Lender Processing, 2016 Del. Ch. LEXIS 189 at
*40-*41, quoting Highfields Capital, Inc. v. AXA Financial, Inc., 939 A.
2d 34, 42 (Del. Ch. 2007).
55
Id. at *89.
56
Id. at *90.
57
In Re Appraisal of PetSmart, Inc., 2017 Del. Ch. LEXIS 89 (May 26,
2017) at *88.
58
Ronald N. Brown, III, and Keenan D. Lynch, ‘‘Recent Opinions
Highlight Different Appraisal Valuation Methods Employed in Merger
Transactions by Delaware Courts,’’ in Insights: The Delaware Edition,
Skadden, Arps, Slate, Meagher & Flom LLP, Nov. 17, 2016, p. 1.
59
See, e.g., Just Care at *15, n. 26; Laidler v. Hesco Bastion
Environmental, Inc., 2014 Del. Ch. LEXIS 75 (May 12, 2014) at *22.
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dissenting shareholder will receive by voting in favor of the
merger and taking the merger price.
60
Dissenting shareholders seek appraisal when they
believe that the fair value of their shares is greater than
the consideration that they were offered in the transaction.
Dissenters have sometimes been awarded far more than
the price they were originally offered, but this rarely
happens when the buyer was a third party. The Supreme
Court wrote in 1999:
A fair merger price in the context of a breach of fiduciary
duty claim will not always be a fair value in the context of
determining going concern value.
A merger price resulting from arms-length negotiations where
there are no claims of collusion is a very strong indication of
fair value. But in an appraisal action, that merger price must be
accompanied by evidence tending to show that it represents the
going concern value of the company rather than just the value
of the company to one specific buyer.
61
Importantly, dissenting shareholders have been awarded
amounts lower than an arm’s-length transaction price when
the court determined that the transaction price included
synergies and/or a control premium that should not have
been included in fair value under Delaware law. A 2005
case concluded that the fair value of a company was $2.74
per share, even though the minority shares had been
acquired for $3.31 in stock.
62
A 2003 decision awarded the
petitioner ‘‘the value of the Merger Price net of syner-
gies,’’
63
which gave the dissenters only 86% of the merger
price. In 2012 a company acquired by a competitor was also
appraised at 86% of the purchase price.
64
In 2017, a
company was appraised using DCF at 82% of the value of
the consideration at the time of the acquisition agreement
(92% of the value of the consideration at closing).
65
3. Arm’s-length price may be less than fair value
Although the Delaware courts have often equated fair
value in appraisal with fair value in ‘‘entire fairness’’
cases,
66
there are several decisions in which the Court of
Chancery stated appraisal valuations could be higher than
transaction prices that were deemed to meet the entire
fairness standard.
In the long-running Technicolor case, in which there
were more than twenty decisions over a twenty-one-year
period, the Court concluded that ‘‘the $23 per share
received constituted the highest value reasonably available
to the Technicolor shareholders’’
67
and that the ‘‘ transaction
was in all respects fair to the shareholders of Technicolor.
68
In the appraisal case, however, the Supreme Court
determined that the fair value of Technicolor was
$28.41.
69
This difference resulted in part because the
valuation date for the appraisal was several months after the
date that the transaction had been approved by Techni-
color’s board and because (as discussed in the next section)
new higher projections were deemed relevant.
The Court of Chancery explained in 2014:
The entire fairness test is a standard of review, and the fair
process aspect of the unitary entire fairness test is flexible
enough to accommodate the reality that ‘‘[t]he value of a
corporation is not a point on a line, but a range of reasonable
values.’’
70
A price may fall within the range of fairness for
purposes of the entire fairness test even though the point
calculation demanded by the appraisal statute yields an
award in excess of the merger price.
71
A clear-cut example of the value for entire fairness
being lower than appraised value is the 2016 Dell
decision.
72
In this prominent case, Dell, Inc. was taken
private in a leveraged buyout (LBO) led by the founder,
Michael Dell. The transaction price was $13.88 per share,
and Vice Chancellor J. Travis Laster awarded $17.62 to
the eligible dissenting shareholders based on his DCF
analysis.
73
He wrote:
In this case, the Company’s process easily would sail
through if reviewed under enhanced scrutiny. The Commit-
tee and its advisors did many praiseworthy things. . . . In a
60
Hamermesh and Wachter, ‘‘The Fair Value of Cornfields in Delaware
Appraisal Law,’’ 31 J. Corp. Law 119 (2005): 142 (‘‘Cornfields’’ ).
61
M.P.M. Enterprises, Inc. v. Gilbert, 731 A.2d 790, 797 (Del. 1999).
62
Finkelstein v.Liberty Media, 2005 Del. Ch. LEXIS 53 at *84.
63
Union Ill. 1995 Investment LP v. Union Financial Group, Ltd., 847
A.2d 340, 364 (Del. Ch. 2003).
64
Just Care at *1.
65
In Re Appraisal of SWS Group, Inc., 2017 Del. Ch. LEXIS 90 (May
30, 2017) at *3-*4, *23. The value of the consideration was lower at
closing because of a decline in the market price of the acquiror’s stock.
66
Hamermesh and Wachter, ‘‘Rationalizing Appraisal Standards’’ at
1030.
67
Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1142 (Del. Ch.
1994), aff’d in relevant part, Cede, Inc. v. Technicolor, Inc., 663 A.2d
1156 (Del. 1995).
68
Id. at 1154.
69
Cede, Inc. v. Technicolor, Inc., 884 A.2d 26, 30 (Del. 2005).
70
Quoting Cede & Co. v. Technicolor, 2003 Del. Ch. LEXIS 146 (Dec.
31, 2003) (‘‘Technicolor 2003’’) at *2; aff’d in part, rev’d in part on
other grounds, 884 A.2d 26.
71
In re Orchard Enterprises, Inc. Sh’holder Litig., 88 A.3d 1, 30 (Del.
Ch. 2014). See also Reis v.Hazelett Strip-Casting Corp., 28 A. 3d 442,
466 (Del. Ch. 2011) (‘‘Reis’’); In re Trados Inc. Sh’holder Litig., 73 A.3d
17, 78 (Del. Ch. 2013); Ancestry.com, 2015 Del. Ch. LEXIS 21 at *50
(‘‘[A] conclusion that a sale was conducted by directors who complied
with their duties of loyalty is not dispositive of the question of whether
that sale generated fair value.’’); Merion Capital v. Lender Processing ,
2016 Del. Ch. LEXIS 189 at *43 (‘‘Because the two inquiries are
different, a sale process might pass muster for purposes of a breach of
fiduciary claim and yet still constitute a sub-optimal process of an
appraisal.’’).
72
InreAppraisalofDellInc., 2016 Del. Ch. LEXIS 81 (May 31, 2016).
73
Id. at *167.
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liability proceeding, this court could not hold that the
directors breached their fiduciary duties or that there could
be any basis for liability. But that is not the same as proving
that the deal price provides the best evidence of the
Company’s fair value.
74
He observed the fairness opinions on which the
directors relied were based on the values determined by
the LBO models, and the valuations were constrained by
the 20% minimum target internal rate of return used by
LBO buyers.
75
E. Fair value is based on how the company is
being managed prior to transaction
An important part of operative reality is how the company
is being managed at the time of the transaction. A Delaware
company being appraised is valued ‘‘as is’’ under its current
management, not as it might be run by a different party:
The company, with all of its warts and diamonds, is valued in
terms of the discounted free cash flow generated by the
company’s assets and reinvestment opportunities. In measur-
ing the value of the warts and diamonds, the warts are valued
as warts and the diamonds as diamonds. . . . The minority’s
claim is equal to the value of the shares into the future, and
that value is a mix of the existing warts and diamonds.
76
It is important to note, however, that some ‘‘warts’’ can
be disregarded; see ‘‘Fair value includes changes
contemplated by management’’ below.
Management’s plans, not those of an independent
acquiror, are a company’s operative reality. When a third-
party buyer projected a higher growth rate for the target
than did the target’s management, the court determined that
the appropriate input for the court’s DCF calculation in an
appraisal was the growth rate expected by the target’s CEO,
not the buyer’s expectation.
77
Similarly, a company should
be valued on its existing capital structure rather than on an
optimal capital structure or the buyer’s plans.
78
Actions planned by existing management prior to a
squeeze-out merger are part of operative reality. Delaware
normally excludes actions planned by a third-party
acquiror before it acquires control. However, if control
actually changes hands before a second-stage merger (a
merger that squeezes out any minority shareholders
whose shares were not acquired in an initial tender or
exchange offer), the new control party’s plans may be
taken into account. The Delaware Supreme Court ruled in
its 1996 Technicolor decision that dissenting shareholders
were entitled to benefit from changes being made or
planned by a new management that had assumed control
prior to the valuation date.
79
In that case, nontendering
shareholders were squeezed out in the second-stage
merger at the same price that had been paid for the bulk
of the shares in November 1982 pursuant to a friendly
tender offer by MacAndrews & Forbes. By the time the
squeeze-out merger was consummated in January 1983,
MacAndrews & Forbes had taken operating control. The
Supreme Court ruled that MacAndrews & Forbes’ plan,
which involved disposing of certain unprofitable opera-
tions and increasing profit margins, was the operative
reality and that the projections based on the buyer’s plan
should be the basis for the valuation.
The Court of Chancery’s 2006 Delaware Open MRI
decision stated, ‘‘The expansion plans for [additional MRI
Centers] were clearly part of the operative reality of
Delaware Radiology as of the merger date and under
Technicolor and its progeny must be valued in the
appraisal.’’
80
It ruled:
The decision of [the control group] to cash out the
[dissenters] at a price that did not afford it any of the value
of the gains expected from [the additional MRI Centers]
clearly bears on the fairness of the merger. Not only that, if
the concept of opening [them] was part of the business plans
of Delaware Radiology as of the merger date, then the value
of those expansion plans must be taken into account in
valuing Delaware Radiology as a going concern.
81
The court added that ‘‘when a business has opened a
couple of facilities and has plans to replicate those
facilities as of the merger date, the value of its expansion
plans must be considered in . . . determining fair value.’’
82
The court may, however, reject the projected benefits
of a planned expansion if it deems the project to be too
speculative. In Just Care, a case appraising a company
that operated a prison health-care facility in South
Carolina, the financial projections included renovating a
Georgia prison as a medical detention facility, the Court
of Chancery distinguished this expansion from Delaware
Open MRI and rejected the portion of the projection that
related to a potential Georgia facility:
74
Id. at *88–*89.
75
Id. at *90–*91.
76
Hamermesh and Wachter, ‘‘Cornfields’’ at 143–144.
77
Crescent/Mach I Partnership, L.P. v. Dr Pepper Bottling Co. of
Texas, 2007 Del. Ch. LEXIS 63 (May 2, 2007) at *16–*17 and *38.
78
In re Radiology Associates, Inc. Litig., 611 A.2d 485, 493 (Del. Ch.
1991).
79
Cede & Co. v. Technicolor, 684 A.2d 289, 298-299 (Del. 1996)
(‘‘Technicolor 1996’’ ). The MBCA now concurs with Delaware that
changes prior to the squeeze-out merger in a two-step transaction should
be included in fair value: ‘‘[I]n a two-step transaction culminating in a
merger, the corporation is valued immediately before the second step
merger, taking into account any interim changes in value.’’ (Official
Comments to MBCA, §13.01 (2008), citing Technicolor 1996.).
80
Delaware Open MRI Radiology Associates v. Kessler, 898 A.2d 290,
316 (Del. Ch. 2006) (‘‘Delaware Open MRI’’).
81
Id. at 313.
82
Id. at 314–315.
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I find that the Georgia Case was too speculative to be
included in the valuation of the Company as of the merger
date. . . . [E]ven if the new facility was successful, there was
a risk that Georgia would move its prisoners currently
housed at the Columbia Center back to Georgia, thereby
reducing the value of the Columbia Center.
83
Just Care could not undertake the expansion unilater-
ally without a decision by Georgia to move forward. The
fact that the company was focused on expanding into
Georgia and had taken actions in furtherance of that goal
is insufficient to make the Georgia Case part of Just
Care’s operative reality.
84
The court did consider Just Care’s planned expansion
of its existing South Carolina facility but probability-
weighted the calculated DCF value because of the
uncertainty as to whether the state’s Department of
Correction would proceed with the project. To risk-adjust
the planned expansion, the court deducted 33.3% from
the calculated value.
85
F. Fair value excludes synergies resulting from
the transaction but includes enhancements
obtainable by current controller
In Delaware, the fair value standard does not permit the
benefits of synergies resulting from a transaction to be
included in a going-concern valuation:
[S]ynergies dependent on the consummation of an arm’s-
length acquisition or combination may not contribute to ‘‘ fair
value’’ in appraisal proceedings. Similarly, we conclude that
operating efficiencies that arise from the acquiror’s new
business plans are not properly included in determining ‘‘ fair
value,’’ as long as they are not operationally implemented
before the merger, even though they derive solely from the
enterprise’s own assets.
86
The Delaware Supreme Court has stressed that the
value of synergies imbedded in a third-party purchase
price should be excluded: ‘‘In performing its valuation,
the Court of Chancery is free to consider the price
actually derived from the sale of the company being
valued, but only after the synergistic elements of value
are excluded from that price’’ [emphasis added].
87
Under the going-concern ‘‘operative reality’’ concept,
the court did not include the benefits to a near-bankrupt
airline of the transaction’s cancellation of preferred stock,
a debt restructuring, and a planned capital infusion.
88
The
court declined to credit the existing shareholders for
benefits that could not have been achieved without the
transaction. The acquiror’s future plans and projections
assumed the completion of the merger, which was
conditioned on concessions from creditors and the
infusion of new capital. The court followed the practice
of excluding from fair value any gains that would not
have occurred but for the transaction. The court noted:
[T]he Concessions were not being implemented—and thus
were not an ‘‘operative reality’’ —as of the merger date. On
that date the only ‘‘operative reality’’ was that the parties had
entered into a contract which provided that the Concessions
would become operative if and when the merger closed.
89
Another example of a situation where the dissenter could
not benefit from the consequences of the transaction was
when a shareholder who refused toconsent to the conversion
of a C corporation into an S corporation was squeezed out.
90
The prospective tax benefits from the conversion were
excluded from fair value because they could not have been
achieved without the transaction: ‘‘Heng Sang’s conversion
to an S corporation cannot be considered for valuation
purposes, because without Ng’s consent it was not possible
for Heng Sang to convert to subchapter S status before the
merger, and Ng never granted his consent.’’
91
In contrast, if the controller can achieve the benefits
without the transaction, the court may include the present
value of those enhancements in fair value. In the 2004
Emerging Communications decision, the court concluded
that the substantial posttransaction benefits that defen-
dants attributed to the merger were in fact contemplated
and achievable before the transaction. It ruled that the
control shareholder could have achieved the benefits
without the merger by other means, such as entering into
a contract between his wholly owned private company
and the public company he controlled:
The cost savings attributed to the consolidation were
properly includable in the June projections, because they
were contemplated well before the going private merger and
could have been achieved without it. Prosser had identified
potential consolidation savings before the Privatization
occurred. Because Prosser controlled both ECM and ICC,
he had the power to accomplish those savings without a
business combination, such as by intercompany contractual
arrangements [emphasis added]. To put it differently, the
value achieved by Prosser’s existing pre-merger ability to
effect those cost savings was an asset of ECM at the time of
the Privatization merger.
92
83
Just Care at *21–*22.
814
Id. at *24.
85
Id. at *30.
86
Id. at 151.
87
Montgomery Cellular Holding Co. v. Dobler, 880 A.2d 206, 220 (Del.
2005).
88
Allenson v.Midway Airlines Corp., 789 A.2d 572, 585-6 (Del. Ch. 2001).
89
Id. at 583.
90
An election to become an S corporation requires the unanimous
approval of its shareholders (INT.REV.CODE §1362(a)(2)).
91
Ng v.Heng Sang Realty Corp., 2004 Del. Ch. LEXIS 69 (Apr. 22,
2004) at *18. The benefits of converting a C corporation to an S
corporationwerealsoexcludedinIn re Sunbelt Beverage Corp.
Sh’holder Litig., 2010 Del. Ch. LEXIS 1 (Jan. 5, 2010) at *53.
92
In re Emerging Communications, Inc. Sh’holders Litig., 2004 Del. Ch.
LEXIS 70 (Del. Ch. May 3, 2004) at *48–*49.
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The court decided that the fact that the controller’s ability
to accomplish the cost savings before the merger was an
asset of the public company at the merger date and that all
shareholders were entitled to share pro rata in that benefit.
G. Fair value includes changes contemplated by
management
If management is contemplating changes in the
company at the time the relevant transaction is completed,
or if new management has begun implementing its plans
prior to a squeeze-out merger, the Court of Chancery will
deem these changes to be operative reality. Professors
Hamermesh and Wachter explain certain adjustments that
Delaware will recognize in an appraisal:
[I]n appropriate circumstances in which a controlling
shareholder is acquiring the minority shares, the courts have
interpreted ‘‘fair value’’ to include elements of value that
arise from assets or plans that were not in place operationally
at the time of the merger. Those three areas . . . involve:
(1) pro forma inclusion of assets not formally owned by the
corporation at the time of the merger, but constructively
attributed to the corporation because they had represent-
ed a corporate opportunity wrongfully usurped prior to
the merger;
(2) projections of post-merger returns in which actual costs
are disregarded and excluded because they represent
improper benefits to the controlling shareholder; and
(3) operating improvements that the controlling shareholder
implements following the merger but that do not depend
causally upon the consummation of the merger.
93
The next three subsections discuss the three categories
listed by Hamermesh and Wachter. They include
examples of adjustments rejected by the court as
unacceptable under the fair value standard in Delaware
appraisals, even though they might be considered by a
financial buyer under the third-party sale value standard.
1. Usurped corporate opportunities
If a corporate opportunity is wrongfully usurped prior
to the transaction, the court will constructively attribute
the corporate opportunity to the corporation and adjust
fair value to reflect this misconduct. Misappropriation of
a corporate opportunity by a control shareholder has been
addressed in appraisal cases when the misconduct was not
known to the dissenters until after the transaction that
triggered the appraisal.
In its seminal 1989 Cavalier decision, the Supreme
Court discussed a diversion of assets to a related company
and stated:
The . . . corporate opportunity claim, if considered on its
derivative merits, would inure almost entirely to the benefit
of the alleged wrongdoers, an inequitable result at variance
with the fair value quest of the appraisal proceeding. . . .
[T]he Vice Chancellor found that [petitioner] did not have
knowledge of the basis for the corporate opportunity claim
prior to the institution of the appraisal proceeding and that,
as a matter of credibility, those claims were based on
misrepresentations by the principal shareholders. We
conclude that, under the unusual configuration of facts
present here, the corporate opportunity claim was assertable
in the [appraisal] proceeding.
94
ONTI v. Integra Bank also involved an abuse of corporate
opportunity. Within days of closing the squeeze-out cash
merger, the control shareholder merged his company with a
publicly traded company. Plaintiffs asked that the appraisal
valuation take into consideration their pro rata portion of the
market value of shares that the defendant received in the
later merger. The court ruled in favor of the plaintiffs,
stating, ‘‘I think it is clear that it is ‘not the product of
speculation’ that the [subsequent] Transaction was effec-
tively in place at the time of the Cash-Out Mergers.’’
95
2. Improper benefits to control shareholder
The court may make adjustments to eliminate the
agency costs of improper actions by a control party that
were not known to shareholders before the transaction
and that affect current and future cash flow. For example,
in ONTI, the court adjusted the projection underlying the
DCF calculation by doubling the fees receivable from an
affiliate of the controller, which had been paying less than
the contractual rate.
96
In another case, the court accepted adjustments to
eliminate the adverse consequences of the abusive actions
of the Controller. The court adjusted for ‘‘excessive
management fees, an unexplained inter-company loan, an
unexplained corporate allocation, and an overcharge by a
vendor’’
97
as well as ‘‘thesaleandleasebackof
Montgomery’s cell sites and towers,’’ which ‘‘was clearly
an inappropriate exaction by [the controller] due to its
corporate control.’’
98
The court may also make adjustments when it can be
shown that payments to inside shareholders were not for
services rendered. In 1991 the court accepted a DCF
93
Hamermesh and Wachter, ‘‘Cornfields’’ at 159.
94
Cavalier at 1143–1144.
95
ONTI,Inc.v.IntegraBank,751 A.2d 904,930 (Del. Ch. 1999).
96
Id. at 910.
97
Dobler v.Montgomery Cellular Holding Co., 2004 Del. Ch. LEXIS
139 (Oct. 4, 2004) at *69; aff’d in part, rev’d in part on other grounds,
Montgomery Cellular v. Dobler, 880 A.2d 206 (Del. 2005). The Court of
Chancery stated, ‘‘The management fee charged by [parent] can be
reasonably interpreted to be a corporate charade by which the parent
removed money from its subsidiary.’’
98
Id. at *71.
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analysis in which officers’ salaries were adjusted to
exclude a portion that, because compensation was
proportional to equity ownership, was deemed to be a
return on equity.
99
That decision was cited in a 2011
decision where the court pointed out that ‘‘Delaware law
on fair value . . . empower[s] a court to make normalizing
adjustments to account for expenses that reflect controller
self-dealing when the plaintiff/petitioner provides an
adequate evidentiary basis for the adjustment.’’
100
Claims relating to the control shareholder’s improper
conduct that were known (and thus could have been
challenged) prior to a squeeze-out have been excluded
from consideration in Delaware appraisals. For example,
in two cases where the petitioners claimed that improp-
erly issued shares had diluted their interests, the court
determined that it could not address these claims in an
appraisal context.
101
3. Improvements not dependent on merger
The court considers future events that were not
speculative as part of going-concern value under the fair
value standard. Hamermesh and Wachter summarize this
concept:
In fact, we believe that both finance theory and Delaware
case law are consistent with our view that minority
shareholders have a right to ‘‘fair value’’ that incorporates
not only current assets but also future reinvestment
opportunities, so long as those reinvestment opportunities
reflect pre-merger plans or policies of the corporation and
its controlling shareholder [emphasis added]. . . . These
reinvestment opportunities will not have been taken at the
time of the merger, because they are to be funded with future
free cash flow. Consequently, the assets purchased as part of
the reinvestment opportunities will not exist at the time of
the merger. However, these assets are as much a part of the
present value of the corporation as are the value of the
existing assets.
102
Consistent with this view and with customary valuation
practice, income should be normalized so that nonrecur-
ring items should be excluded from valuation calcula-
tions. The Court of Chancery has faulted an expert for not
normalizing earnings data, pointing out, ‘‘The earnings
figures used to derive the earnings base should be
adjusted to eliminate non-recurring gains and losses.’’
103
Normalizing adjustments include not only items
classed as ‘‘extraordinary’’ under GAAP, but also
nonrecurrent items in the income account such as gains
or losses from litigation and (if truly nonrecurrent)
restructuring costs. The normalizing adjustments accepted
in Delaware include the adjustments described in Chris
Mercer’s ‘‘Business Valuation: An Integrated Theory’’ as
‘‘Type 1 Normalizing Adjustments’’ :‘‘ These adjustments
eliminate one-time gains and losses, other unusual items,
discontinued business operations, expenses of non-
operating assets, and the like. . . . [T]here is virtually
universal acceptance that Type 1 Normalizing Adjust-
ments are appropriate.’’
104
The cost of reinvestment opportunities should be taken
into account. The court decided in a 2005 appraisal that it
was not speculative to consider the cost of a cellular
telephone company’s prospective conversion of its
network to higher future industry standards. It ruled that
the expert ‘‘should have incorporated the effects of this
expected capital improvement in his projections.’’
105
H. Fair value is not third-party sale value
Fair value in Delaware is not hypothetical third-party
sale value. The Delaware Supreme Court wrote in 2010:
‘‘Importantly, this Court has defined ‘fair value’ as the
value to a stockholder of the firm as a going concern, as
opposed to the firm’s value in the context of [a strategic]
acquisition or other transaction [emphasis added].
106
For this reason, some normalizing adjustments that an
analyst might normally consider in performing a
valuation are rejected in Delaware appraisals. These are
the adjustments that Mercer describes as ‘‘Type 2
Normalizing Adjustments’’:
These adjustments normalize officer/owner compensation
and other discretionary expense that would not exist in a
reasonably well-run, publicly traded company. Type 2
Normalizing Adjustments should not be confused with the
control adjustments or Type 1 Normalizing Adjustments.
107
The position of the Delaware courts is that a company
should be valued as it is being run and that such
adjustments as normalizing officer/owner compensation
would reflect third-party sale value. In addition, pro forma
adjustments that Mercer describes as ‘‘Financial Control
Adjustments’’ and ‘‘Strategic Control Adjustments’’
108
clearly reflect value to an acquiror and therefore are
rejected in Delaware appraisals.
In 1997 the Delaware Supreme Court rejected
petitioner’s claim that earnings and projections should
be adjusted because the control shareholder had been and
99
Radiology Associates, 611 A.2d 485, 491–492.
100
Reis at 472.
101
Cavalier at 1146; Gentile v.SinglePoint Financial, 2003 Del. Ch.
LEXIS 21 (Del. Ch. Mar. 5, 2003) at *17–*21.
102
Hamermesh and Wachter, ‘‘Cornfields’’ at 158.
103
Reis at 470.
104
Z. Christopher Mercer and Travis W. Harms, Business Valuation: An
Integrated Theory, 2d ed. (New York; John Wiley & Sons, 2007), p. 113.
105
U. S. Cellular, 2005 Del. Ch. LEXIS 1 at *56.
106
Golden Telecom, 11 A.3d 214 at 217.
107
Mercer & Harms at 113.
108
Id. at 117–120.
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STATUTORY FAIR VALUE IN DISSENTING SHAREHOLDER CASES:PART I
continued to be materially overpaid. It noted that there
was no plan prior to the merger to adjust that
compensation. The court ruled that ‘‘in the absence of a
derivative claim attacking excessive compensation, the
underlying issue of whether such costs may be adjusted
may not be considered in an appraisal proceeding.’’
109
It
concluded that ‘‘going business value of the corporation
at the moment before the merger . . . does not include the
capitalized value of possible changes which may be made
by new management [emphasis added].’’
110
A 2011 decision rejected an adjustment to earnings
premised on the assertion that that the company was
overspending on research. The Court of Chancery ruled,
‘‘Because a reduction in R&D expense only could be
made by a new controller of Hazelett Strip-Casting,
adjustments to reflect those changes would generate a
third-party sale value, not going concern value.’’
111
The
court stated that its conclusion was based on ‘‘the well-
established principle of Delaware law that minority
shareholders have no legal right to demand that the
controlling shareholder achieve—and that they be paid—
the value that might be obtained in a hypothetical third-
party sale.’’
112
Similarly, the Court of Chancery declined in ISN
Software (2016) to make adjustments for challenged
expenditures that it did not deem to be wasteful:
I do not make separate adjustments for executive compen-
sation, charitable contributions, or private jet usage. Those
expenditures were a part of the Company’s operative reality
on the date of the Merger, and there is no evidence
sufficient, in my opinion, to demonstrate that they represent
waste or actionable breaches of fiduciary duty; as such, they
would have likely continued in a going-concern ISN.
113
I. Taxes are considered only if they are
‘‘operative reality’’
The operative reality concept has also been used to
justify the exclusion of deferred taxes on investment
assets (built-in capital gains) that management does not
currently intend to sell. In Paskill, the Supreme Court
ruled:
The record reflects that a sale of its appreciated investment
assets was not part of Okeechobee’s operative reality on the
date of the merger. Therefore, the Court of Chancery should
have excluded any deduction for the speculative future tax
liabilities that were attributed by Alcoma to those uncon-
templated sales.
114
This differs from the Supreme Court’s ruling that
accepted deferred taxes in Technicolor because in that
case, Technicolor’s management had already decided to
sell the relevant assets. The built-in gain on that asset sale
was the operative reality on the date of the merger.
115
In a 2006 decision, the Court of Chancery used the
operative reality concept when it accepted taxes and other
expenses paid as a result of an asset sale directly related to
a merger. Carter-Wallace sold the assets of its consumer
products business simultaneously with the merger into
MedPointe Healthcare of its health-care business. Each
transaction was contingent on the other. The asset sale
resulted in substantial capital gains taxes and expenses.
The petitioner unsuccessfully argued that the taxes and
expenses should not be deducted in determining appraisal
value because the asset sale was not completed prior to
the date of the merger. The court said, ‘‘ There is no
principled distinction between an asset sale occurring a
few hours before the merger and a sale on the day before
the merger’’ and based its appraisal of Carter-Wallace on
the company’s value after the asset sale, giving effect to
all related expenses including taxes on the asset sales.
116
A 2011 decision rejected the deduction of potential
taxes and selling expenses and ‘‘add[ed] the full appraised
value of the non-operating real estate’’ that the company
had no current intent to sell.
117
Moreover, since the
company expected to utilize its net operating losses, the
Court of Chancery also added the potential tax benefit of
the carryforward:
Hazelett Strip-Casting has a history of generating taxable
earnings, and the capitalized earnings valuation anticipates
that it will continuing doing so in a manner that will enable
the Hazelett family to take advantage of the NOL. I therefore
add $258,000, representing the full value of the NOL.
118
J. Tax-affecting S corporations
Since a company is valued in a Delaware appraisal as it
is being run by its current management, not as it might be
run by the buyer, a C corporation is valued based on C
corporation taxes even if the buyer intends to convert it to
an S corporation, and an S corporation is valued inclusive
109
Gonsalves v.Straight Arrow Publishers, 701 A.2d 357, 363 (Del.
1997).
110
Id.
111
Reis at 471.
112
Id., quoting Hamermesh and Wachter, ‘‘Cornfields’’ at 154.
113
In re ISN Software Corp. Appraisal Litig., 2016 Del. Ch. LEXIS 125
(Aug, 11, 2016) at *17, fn. 46.
114
Paskill Corp. v. Alcoma Corp., 747 A.2d 549, 552 (Del. 2000).
115
Technicolor 1996 at 298.
116
Cede & Co., Inc. v. MedPointe Healthcare, 2004 Del. Ch. LEXIS 124
(Aug. 16, 2004) at *29 (‘‘The inquiry here is not one of hours, but of
whether one two-step transaction, with all components occurring in a
certain order and substantially simultaneously, may (or must) be divided
for valuation purposes.’’).
117
Reis at 476.
118
Id.
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of the tax benefits of being an S corporation. In Delaware
Open MRI (2006), then-Vice Chancellor Leo Strine, Jr.
(now Chief Justice of the Delaware Supreme Court)
explained that ‘‘an S corporation structure can produce a
material increase in economic value for a stockholder and
should be given weight in a proper valuation of the
stockholder’s interest.’’
119
He ruled:‘‘[W]hen minority
stockholders have been forcibly denied the future benefits
of S corporation status, they should receive compensation
for those expected benefits and not an artificially
discounted value that disregards the favorable tax
treatment available to them.’’
120
He determined the implied effective S corporation tax
rate in a 2006 appraisal case. Using a 40% corporate tax
rate, a 40% personal tax rate, and a 15% tax on S
corporation dividends, he calculated the implied pro
forma S corporation tax rate at the corporate level that
would give shareholders the same after-tax earnings that
C corporation shareholders would receive after both
corporate taxes and taxes on corporate dividends to be
29.4% (Table 1).
The 29.4% effective pro forma S corporation tax rate
was calculated by taking the amount available to S
corporation shareholders, grossing it pro forma for a 15%
dividend tax, and then determining the implied effective
tax rate.
Chancellor Andre Bouchard applied the same method
in a C corporation appraisal in 2015.
122
He used the
dissenter’s ‘‘actual tax rates as a Maine resident’’ and
calculated the taxes applicable to C corporation dividends
as 31.75%: ‘‘the sum of the 20% federal tax on dividends,
the 3.8% Net Income Investment Tax (NIIT) imposed by
the Affordable Care Act, and the 7.95% Maine state tax
on dividends.’’
123
The Strine formula can be expressed in a mathematical
formula that can be applied using different tax rates. If P
is the relevant marginal personal tax rate, Dis the tax rate
applicable to C corporation dividends, and Eis implied
effective tax rate on the S corporation, then
E¼1ð1PÞ=D:
When applying this formula, the valuator should consider
the impact of state personal income taxes. Interestingly, the
formula is independent of the C corporation tax rate.
III. Valuations in Other Jurisdictions May Differ
from Delaware
A. Appraisals under the MBCA could be higher
than in Delaware
The Delaware statute excludes appreciation ‘‘arising
from the accomplishment or expectation’’ of the transac-
tion without the ‘‘inequitable’’ qualification that had been
included in the pre-1999 MBCA. The Official Comments
to the 1999 MBCA point out: ‘‘[T]he exclusionary clause
in the prior Model Act definition, including the
qualification for cases where the exclusion would be
inequitable, has been deleted. Those provisions have not
been susceptible to meaningful judicial interpretation.’’
124
The Official Comments further state:
Customary valuation concepts and techniques will typically
take into account numerous relevant factors, including
assigning a higher valuation to corporate assets that would
be more productive if acquired in a comparable transaction
but excluding any element of value attributable to the unique
synergies of the actual purchaser [emphasis added].
For example, if the corporation’s assets include undeveloped
real estate . . . the court should consider the value that would
be attributed to the real estate . . . in a comparable
transaction. The court should not, however, assign any
additional value based upon the specific plans or special use
of the actual purchaser.
125
The revised MBCA is thus more expansive than
Delaware in that it includes in fair value any improvement
Table 1
Court’s Calculation from Delaware Open MRI
121
C Corporation S Corporation S Corporation Valuation
Income before Tax $100 $100 $100
Corporate Tax Rate 40% 29.4%
Available Earnings $60 $100 $70.60
Dividend or Personal Income Tax Rate 15% 40% 15%
Available after Dividends $51 $60 $60
119
Delaware Open MRI at 327.
120
Id. at 328
121
Id. at 328.
122
Owen v.Cannon, 2015 Del. Ch. LEXIS 165 (June 17, 2015) at *72.
123
Id. at *71.
124
Official Comments to MBCA, §13.01 (1999).
125
Id.
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STATUTORY FAIR VALUE IN DISSENTING SHAREHOLDER CASES:PART I
that could be made without unique input from a third-
party acquiror. While Delaware includes any improve-
ments that are planned or contemplated by existing
management, it excludes ‘‘the capitalized value of
possible changes which may be made by new manage-
ment.’’
126
In contrast to Delaware, the 1999 MBCA
would determine fair value adjusted for business
opportunities which management has not yet planned to
exploit or for excessive compensation paid to manage-
ment. Thus, states that adopt the language in the 1999
MBCA could accept Mercer’s ‘‘Type 2 Normalizing
Adjustments’’ that Delaware rejects.
127
B. Some states consider financial control value
Most states follow the Delaware interpretation of fair
value, valuing a company as it exists at the valuation date.
The case law of some states, however, defines going-
concern value more expansively. In 1986, the Supreme
Judicial Court of Massachusetts ruled:
As a going concern, the value of an enterprise such as the
Old Patriots is the price a knowledgeable buyer would pay
for the entire corporation, including the National Football
League (NFL) franchise, the stadium lease, various con-
tracts, goodwill, and other assets and liabilities [emphasis
added].
128
Three years later, in the widely cited McLoon case, the
Supreme Judicial Court of Maine concluded:
Especially in fixing the appraisal remedy in a closely held
corporation, the relevant inquiry is what is the highest price
a single buyer would reasonably pay for the whole
enterprise, not what a willing buyer and a willing seller
would bargain out as the sales price of a dissenting
shareholder’s share in a hypothetical market transaction
[emphasis added].
129
New York similarly defines ‘‘fair value’’ as the amount
that would be paid by an arm’s length non-synergistic
buyer, that is, financial control value:
[I]n fixing fair value, courts should determine the minority
shareholder’s proportionate interest in the going concern
value of the corporation as a whole, that is, ‘‘ what a willing
purchaser, in an arm’s length transaction, would offer for
corporation as an operating business’’ [emphasis in origi-
nal].
130
In the recent AriZona Beverages case, the New York
trial court stated:
[The Court] value[d] AriZona using the ‘‘financial control’’
measurement, that is, ‘‘the value of a company exposed to a
representative group of buyers who are not expecting
synergies, who are looking at the value of the business on
a standalone basis, who may not be able to run the company
a little differently . . . a little better but not differently like the
synergies.’’
131
Other states where decisions have cited the above
language from McLoon include Connecticut,
132
Florida,
133
Indiana,
134
Iowa,
135
Missouri,
136
Vermont,
137
and Virgin-
ia.
138
In these states that define fair value as financial
control value, nonsynergistic changes that a new manage-
ment might undertake would be relevant to an appraisal.
Thus, normalizing for these potential changes, described
by Mercer as Type 2 Normalizing Adjustments,
139
would
be generally be accepted in those states, as would the use
of a normalized capital structure rather than a company’s
actual capital structure. These adjustments would have a
positive impact on valuations in most situations.
However, a financial control standard could have a
negative effect on valuations of flow-through entities such
as S corporations. If the likely acquiror of a C corporation
is an S corporation, the appropriate pro forma tax rate for
valuation purposes would be a C corporation tax rate.
When the standard is going-concern value as the
company is being run, the valuation includes the tax
benefits of an S corporation, as was done in Delaware
Open MRI.
140
Similarly, a court using a financial control standard
could arrive at a lower value than a Delaware court when
a company has significant built-in capital gains on
marketable assets. Delaware does not accept deductions
for taxes on built-in gains unless there is an intent to sell
the assets,
141
but a financial control buyer would be
126
Gonsalves v.Straight Arrow, 701 A.2d 357, 363.
127
See ‘‘Fair value is not third-party sale value’’ above.
128
Sarrouf v. New England Patriots Football Club, Inc., 492 N.E.2d
1122, 1125 (Mass. 1986).
129
In re Val. of Common Stock of McLoon Oil Co., 565 A.2d 997, 1004
(Me. 1989) (‘‘McLoon’’).
130
Friedman v. Beway Realty Corp., 87 N.Y.2d 161, 168 (N.Y. 1995)
(‘‘Beway’’ ), quoting Matter of Blake v. Blake Agency, 107 A.D.2d
139,146 (N.Y. App. 1985) (‘‘Blake’’).
131
Ferolito v.AriZona Beverages USA LLC, 2014 N.Y. Misc. LEXIS
4709 (N.Y. Supr., Oct. 14, 2014) at *19–*20, quoting Chris Mercer’s
trial testimony.
132
Devivo v.Devivo, 2001 Conn. Super. LEXIS 1285 (May 8, 2001) at
*16.
133
G & G Fashion Design, Inc. v. Garcia, 870 So. 2d 870, 872 (Fla. App.
2004).
134
Lees Inns of America, Inc. v. Lee, 924 N.E.2d 143, 156 (Ind. App.
2010).
135
Northwest Investment Corp. v Wallace, 741 N.W.2d 782,791 (Iowa
2007).
136
Swope v.Siegel-Robert, Inc., 243 F.3d 486, 492 (8th Cir. 2001).
137
In re 75,629 Shares of Common Stock of Trapp Family Lodge, Inc.,
725 A.2d 927, 931 (Vt. 1999).
138
U.S. Inspect, Inc. v. McGreevy, 57 Va. Cir. 511, 526, 2000 Va. Cir.
LEXIS 524, at *33–*34 (Nov. 7, 2000).
139
Mercer & Harms at 113.
140
Delaware Open MRI at 330.
141
See ‘‘Taxes are considered only if they are ‘operative reality’’’ above.
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highly likely to bid a lower price for such a company than
for an otherwise identical company whose marketable
assets had a higher tax basis.
C. Appraisals by the Controller of the Currency
National banks are incorporated under federal law.
Shareholders dissenting from mergers of national banks
or conversion of national banks into state banks are not
entitled to a judicial appraisal, but instead are granted the
right to an appraisal by the majority of a three-person
panel.
142
The panel consists of one person chosen by
holders of a majority of the dissenting shares, one chosen
by the bank, and a third person chosen by the first two.
Either party may appeal and ask the Controller of the
Currency for a binding reappraisal.
143
However, in stock-
for-stock mergers, the shares that would have been
delivered to the dissenters must be sold in a public
auction. If the auction price is higher than the appraised
value, the dissenters are entitled to the higher price.
144
This article will be continued in the next issue of
Business Valuation Review.
This article is materially revised and updated from
Chapter 3 in Standards of Value: Theory and Application,
2nd ed. (New York: Wiley, 2013) and is published with
permission of John Wiley & Sons, Inc. Michelle
Patterson, JD, PhD, assisted with the conceptualization,
organization, and writing.
142
12 U.S.C. § 214a, § 215, § 215a.
143
Valuations by the OCC use the Delaware block method and do not use
DCF. (OCC, Business Combinations, Dec. 2006, pp. 39–40, available at
http://www.occ.gov/publications/publications-by-type/licensing-
manuals/bizcombo.pdf.).
144
12 U.S.C § 215(d), § 215a(d).
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STATUTORY FAIR VALUE IN DISSENTING SHAREHOLDER CASES:PART I
Thesis
The valuation of private companies is a matter of interest for many stakeholders, including valuation professionals, auditors, courts, and tax authorities. The matter is deceptively complex, notably because there is no consensus on the nature, size, and determinants of the so-called discount for lack of marketability (DLOM). The DLOM can be defined as an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability. Indeed, most valuation methods lead to value indications for a marketable interest, and it is generally accepted that investors attach a lower price to assets that are not readily marketable. The DLOM is oftentimes oversimplified as the difference in value between an illiquid (unlisted) stock and an all-else-equal liquid (listed) security. This value gap is important but ill understood. Leading scholars have noted time and time again that fair market value calculations often boil down to taking a marketable value estimate and reducing that amount by a contrived percentage. In practice, DLOMs of 20% to 40% are routinely used for valuing private businesses. The extant literature has proposed various DLOM estimation methods that fall into two broad categories: theoretical and empirical models. All of these models have been challenged, either because they require the input of information that cannot be objectively determined for private companies (theoretical models), or because estimates based on the comparisons between liquid and illiquid valuation subjects are by nature always imperfect and thus prone to discussion (empirical models). Nevertheless, and in the absence of better information, the empirical models, especially, have received lots of attention and the averages presented in these studies are often used in practice without much formal reasoning or economic justification. In order to shed more light on the determinants of the DLOM we have turned to an alternative source of information that can bring additional insights. Specifically, we have turned to court decisions that decide on private company valuations, including the DLOM to be applied. The court typically justifies its decision by referring to how the specific company is situated, and the rights and obligations attached to the valuation subject. This contextual information provides more background than the pure financial information that can be found in traditional data sources. This method which combines elements of qualitative and quantitative analysis has allowed us to demonstrate that the company’s ownership structure, its operations, the transfer restrictions on shares, the exit possibilities for shareholders, and the level of control attached to the valuation subject have a significant impact on the DLOM.
Article
This Article makes several contributions to the literature on Delaware appraisal law. We first argue that the "going concern value" standard adopted by the Delaware courts as the measure of "fair value" in share valuation proceedings is superior to its two main competitors, market value and third-party sale value, on grounds of both fairness and efficiency. Application of the going concern value standard has two important consequences. First, it is critical that going concern value be measured in a way that includes not only the present value of the existing assets of the corporation, but also the present value of the reinvestment opportunities available to and anticipated by the firm at the time of merger. Second, going concern value should not include the value of corporate control in a case where the merger creates control through the aggregation of previously dispersed shares. In that case, the benefits created by the aggregation of shares belong to the party that created the increased value.We address differently, however, the situation where a pre-existing controlling shareholder squeezes out the minority. Our concern here is the potential for a controlling shareholder to acquire the minority shares at a price that fails to reflect the firm's going concern value. Where a controller fails to present a valid discounted cash flow analysis and relies instead on a comparable company analysis that is based solely on historical data, the minority shareholders and the court are deprived of access to projections of future free cash flows of the firm. We therefore advocate that in this situation the courts adopt a penalty default in the form of a presumption that fair value includes the value of control as reflected in comparable company acquisitions. Such a presumption is consistent with common law doctrines of fiduciary duty and the entire fairness standard, as well as adverse evidentiary inferences drawn from failure to produce relevant evidence. The controller as faithful fiduciary can avoid the proposed presumption by preparing and submitting to judicial scrutiny a valid discounted cash flow analysis. The opportunistic controller, on the other hand, is subjected to a fair value determination that amounts to third-party sale value minus synergies.
Article
Despite criticism of Delaware’s corporate statutes by the drafters of the original Model Business Corporation Act (MBCA), there has been a constructive symbiosis between the MBCA and Delaware’s corporation law, including its statutory component: each set of statutes has been informed by drafting and case-law experience generated under the other; especially in recent years, Delaware’s legislature and judiciary have initiated important new elements of corporate law, subsequently adopted by the MBCA; and the MBCA’s more deeply deliberative style has led to useful refinements of Delaware law.
Article
The Delaware Supreme Court's opinions in Weinberger and Technicolor have left a troublesome uncertainty in defining the proper approach to the valuation of corporate shares. That uncertainty - increasingly important as going private mergers become more frequent - can be resolved by a blend of financial and doctrinal analysis. The primary problem--the potential opportunism by controlling shareholders in timing going private mergers--can be addressed by a more complete understanding of corporate finance. The definition of fair value must include not only the present value of the firm's existing assets, but also the future opportunities to reinvest free cash flow, including reinvestment opportunities identified, even if not yet developed, before the merger. This issue has been incompletely articulated by the courts. On the other hand, value created by the merger that can only be achieved by means of the merger itself - such as reduced costs of public company compliance - should not be included in determining fair value. We also show that except in the case of acquisitions by third parties (where actual sale value, minus synergies, is a useful measure of fair value), hypothetical third party sale value does not and should not ordinarily be taken as a measure of fair value.
Changes in the Revised Model Business Corporation Act: Amendments Pertaining to Close Corporations
  • A Aba
ABA, A Report of the Committee of Corporate Laws, ''Changes in the Revised Model Business Corporation Act: Amendments Pertaining to Close Corporations,'' 54 Bus. Lawyer 209 (Nov. 1998).
Delaware Corporate Law and Litigation: What Happened in 2014 and What It Means for You in 2015
  • John L Reed
  • Ashley R Altschuler
John L. Reed and Ashley R. Altschuler, ''Delaware Corporate Law and Litigation: What Happened in 2014 and What It Means for You in 2015,'' available at https://www.dlapiper.com/en/us/insights/ publications/2015/01/delaware-corporate-litigation-review-2014-2015/.
Appraisal Arbitrage and the Future of Public Company M&A
  • R Charles
  • Minor Korsmo
  • Myers
Charles R. Korsmo and Minor Myers, ''Appraisal Arbitrage and the Future of Public Company M&A,'' 92 Wash. U. L. Rev. 1551 (2015).
Reforming Modern Appraisal Litigation
  • Myers Korsmo
Korsmo and Myers, ''Reforming Modern Appraisal Litigation,'' 41
  • Finkelstein V. Liberty
  • Media
  • Inc
Finkelstein v. Liberty Media, Inc., 2005 Del. Ch. LEXIS 53 (Apr. 25, 2005) at *39.
  • Finkelstein V Liberty Media
Finkelstein v. Liberty Media, 2005 Del. Ch. LEXIS 53 at *84.
663 A.2d 1134, 1142 (Del. Ch. 1994), aff'd in relevant part
  • Inc V Cinerama
  • Technicolor
  • Inc
Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1134, 1142 (Del. Ch. 1994), aff'd in relevant part, Cede, Inc. v. Technicolor, Inc., 663 A.2d 1156 (Del. 1995).