On The Case

In landmark appraisal ruling, Delaware justices emphasize market’s wisdom

(Reuters) - If you read only the first page of Delaware Chief Justice Leo Strine’s 87-page treatise of an opinion in DFC Global v. Muirfield Value Partners, you might think Strine and his fellow justices believe the judges of Delaware’s Chancery Court have unfettered discretion to determine the fair value of the shares of a company whose sale price has been challenged in an appraisal action. Strine declined, in that opening page, to overturn 2010 precedent that says Chancery judges in appraisal cases can look beyond the sale price even if they decide the sale was well-run. If the Delaware legislature wants to require Chancery Court to defer to sale prices when they’re assessing fair value, the state Supreme Court said, then lawmakers should rewrite the appraisal statute. Until then, the opinion said, Chancery judges have discretion to consider “all relevant factors.”

So: a loss for DFC Global, the payday lender that brought the case to the Delaware Supreme Court, and for other appraisal defendants?

Not hardly.

In the pages that follow Chief Justice Strine’s opening refusal to overturn his court’s precedent, he and his fellow justices proceed to explain – repeatedly! – that the collective wisdom of the market is the best indicator of a company’s fair value. Chancery judges are not bound by law to defer to the market’s assessment, but this opinion suggests they’d better have a helluva good reason to believe they’re smarter than the market in a robust, unconflicted deal.

The court’s voluminous opinion provides dozens of quotations for future appraisal defense arguments that once Chancery judges determine the sale process was sound, they should give a lot of weight to the wisdom of the market.

“Our refusal to craft a statutory presumption in favor of the deal price when certain conditions pertain does not in any way signal our ignorance to the economic reality that the sale value resulting from a robust market check will often be the most reliable evidence of fair value, and that second-guessing the value arrived upon by the collective views of many sophisticated parties with a real stake in the matter is hazardous,” the chief justice wrote.

A single Chancery Court judge, evaluating hypothetical expert analyses in an adversary proceeding, probably isn’t going to reach a more reliable determination of fair value than “the collective judgment of value embodied in a market price,” the Supreme Court said. “This, of course, is not to say that the market price is always right, but that one should have little confidence she can be the special one able to outwit the larger universe of equally avid capitalists with an incentive to reap rewards by buying the asset if it is too cheaply priced.”

In this case, the Supreme Court ruled, Chancellor Andre Bouchard abused his discretion when he gave the deal price a private equity buyer agreed to pay for DFC only the same weight as two other factors. The court said the record of the case didn’t support the relative weight Chancellor Bouchard accorded the deal price. It remanded the case so the chancellor can reconsider his valuation, grounding his assessment “in the record and reliable principles of corporate finance and economics.”

The chief justice didn’t stint on offering the chancellor helpful guidance about exactly what those economic principles are. “The best evidence of fair value was the deal price, as it resulted from an open process, informed by robust public information, and easy access to deeper, non-public information, in which many parties with an incentive to make a profit had a chance to bid,” he wrote. “Established corporate finance theories suggest that the collective judgment of the many is more likely to be accurate than any individual’s guess.” (These quotes are just a sampling. There are plenty more just like them in the opinion.)

As the Supreme Court pointed out, most appraisal decisions in recent years have, in fact, concluded the sale price was a proxy for fair value, especially for publicly-traded companies. There has been some pushback from Chancery judges in deals involving private equity acquisitions, like the DFC deal, because private equity funds are not strategic buyers and have to worry about hitting their rate-of-return targets. The DFC opinion specifically rejected that theory, which it called the “private equity carve-out,” as unfounded in economic literature. “That a buyer focuses on hitting its internal rate of return has no rational connection to whether the price it pays as a result of a competitive process is a fair one,” the opinion said.

The important consideration, according to the Supreme Court, is the quality of the market check. There are, of course, deals in which the sale price is not adequately market-tested. Historically, Chief Justice Strine wrote, appraisal actions have been most useful when shareholders challenge valuations of deals involving private companies or public companies involved in conflicted buyouts. The DFC opinion noted in a footnote that outside of Delaware, in states that use the Model Business Corporation Act, shareholders cannot even bring appraisal actions against public companies unless those companies go private or sell to a conflicted buyer.

Obviously, Delaware isn’t there yet and may never be. Appraisal arbitrageurs can still petition Chancery Court to determine the fair value of their shares, and - despite the best efforts of DFC and its lawyers from Gibson Dunn & Crutcher – Chancery judges still have discretion to consider factors other than the sale price in appraisal decisions.

But after the Supreme Court’s DFC opinion, Chancery judges are going to think extra-hard about deviating from well-tested sale prices lest they be overturned by the justices. My assumption is that in the long run, appraisal arbitrageurs will focus on deals in which the sales process wasn’t pristine. As the chief justice said, shareholders’ right of appraisal has historically been most useful in tainted deals. In DFC, the Delaware Supreme Court seems to be returning appraisal to its roots.

DFC was represented at oral argument by Gibson’s Joshua Lipshutz. Stuart Grant of Grant & Eisenhofer argued for the shareholders who brought the appraisal action.