Delaware Supreme Court Decision Addresses Critical "Fair Value" Issues
in Appraisal Litigation
August 2, 2017
On August 1, 2017, the Delaware Supreme Court issued an en banc opinion in DFC Global Corporation v. Muirfield Value Partners, L.P., et al., reversing the Delaware Court of Chancery's decision regarding the fair value of DFC Global, and remanding for a reassessment of the fair value of DFC Global.1 This decision has been highly anticipated because it addresses two important issues in appraisal actions: (1) the role of the merger price in appraisal proceedings brought by stockholders under Delaware law following a merger in order to adjudicate the "fair value" of their shares; and (2) the Court of Chancery's discretion to weigh multiple valuation methodologies to determine a company's fair value.
In a July 2016 post-trial opinion,2 Chancellor Bouchard of the Court of Chancery found that the fair value of DFC Global, a payday loan company, was $10.21 per share—7.5 percent higher than the merger price actually paid by the private equity buyer—based on an equal one-third weighting of the merger price, a discounted cash flow (or DCF) valuation, and a comparable companies analysis. The sale process leading up to the merger lasted approximately two years, involved a pre-signing market check of dozens of financial sponsors and several strategic buyers, and culminated in a conflict-free purchase of DFC Global by a third-party buyer in an arm's-length sale. Despite Chancellor Bouchard's factual findings supporting the sale process, which he acknowledged "appeared to be robust," he nonetheless gave the merger price only one-third weight in determining the fair value of DFC Global because the sale process coincided with a period of significant company turmoil and regulatory uncertainty, and the private equity buyer's pricing was driven by its desired internal rate of return rather than the "fair value" of DFC Global.
On appeal, the Delaware Supreme Court rejected the buyer's request to establish, by "judicial gloss," a presumption that the merger price is the best estimate of fair value in certain appraisal actions involving arm's-length mergers. The Supreme Court reasoned that such an "act of creation" had "no basis in the statutory text," and was best left to the Delaware legislature. Instead, the Supreme Court relied upon its prior holding in Golden Telecom,3 where a similar argument was presented and rejected on the ground that the language of the relevant Delaware statute—Section 262 of the Delaware General Corporation Law—requires that the Court of Chancery consider "all relevant factors" in determining the fair value of shares.
Regarding the specific value of DFC Global, however, the Supreme Court concluded that the merger price was the "best evidence" of the fair value of DFC Global despite the Court of Chancery's finding to the contrary. As a result, the Supreme Court remanded the case to the Court of Chancery to reconsider the weight it gave the merger price in its valuation analysis. In particular, the Supreme Court noted several "objective factors" that supported the fairness of the merger price, including the failure of other buyers to pursue the company despite the lengthy sale process, the unwillingness of lenders to help finance the acquisition at a higher price, the company's failure to meet its own projections, and the absence of any conflicts of interest in the sale process. In light of these factors, the Supreme Court was critical of the Court of Chancery's decision to give only one-third weight to the merger price, concluding that limited weight was unsupported by the record.
In addition, the Delaware Supreme Court declined to prospectively limit the Court of Chancery's ability to fashion a valuation analysis suited to the facts of a given case. Noting that the Court of Chancery has "considerable discretion" to determine the appropriate methods to calculate the fair value of a company or the weight to give indicia of value, the Supreme Court emphasized that the Court of Chancery must nonetheless articulate its reasoning for doing so based on the record before it. The Supreme Court found that the Court of Chancery failed to do so in this case.
The Delaware Supreme Court was also critical of the Court of Chancery's decision—in response to a motion for reargument identifying a clerical error that would have resulted in a judgment lower than the merger price—to increase the long-term growth rate in its DCF model from 3.1 percent to 4.0 percent. The Supreme Court observed that the original growth rate was already "bullish" and "generous" to the stockholder-petitioners, and that the 4.0 percent long-term growth rate would exceed even the risk-free rate. The Court of Chancery's adjustment to the long-term growth rate upon reargument was therefore not supported by the record.
Finally, the Delaware Supreme Court rejected the stockholder petitioners' cross-appeal, in which they argued that the Court of Chancery abused its discretion by giving weight to a comparable companies analysis instead of primary weight to the discounted cash flow model. The Supreme Court explained that there was "ample evidence" in the record to support the Court of Chancery's comparable companies analysis, such that giving weight to that analysis was within the Court of Chancery's discretion.
As one of the more significant decisions to come out of the Delaware Supreme Court in the area of appraisal litigation in several years, DFC Global will no doubt be highly scrutinized by practitioners in the coming months. We see several important takeaways:
- Although the Delaware Supreme Court refused to adopt a general presumption that the merger price is the best indication of fair value, the decision strongly signals that the merger price should be viewed as a robust measure of fair value in the context of a third-party, arm's-length transaction. The Supreme Court emphasized that its decision "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." This guidance may help discourage the trend in recent years of appraisal petitions challenging third-party mergers.
- The Delaware Supreme Court's criticism of the two factors cited by Chancellor Bouchard in deciding not to defer to the merger price is also significant. Disposing of the regulatory uncertainty issue, the Supreme Court commented that the payday loan industry, like other closely regulated industries, "is hardly unusual in being subject to regulatory risks," and that all of the market players took these risks into account when pricing DFC Global. Applied more broadly, the decision indicates that the timing of a merger—even if it correlates to a business or market trough—is of no moment when considering merger price as an indication of fair value, so long as the market was aware of the headwinds.
- The Delaware Supreme Court's rejection of the Court of Chancery's concern about the private equity buyer's pricing model is also noteworthy. The Supreme Court observed that "all disciplined buyers, both strategic and financial, have internal rates of return that they expect in exchange for taking on the large risk of a merger," and a buyer's focus on a desired 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." This language touches upon an issue similar to that presented in the Court of Chancery's decision in Dell (which has been appealed and will be heard by the Supreme Court on September 27, 2017),4 where Vice Chancellor Laster rejected the merger price as evidence of fair value, in part, because the buyers used a pricing model based on their desired internal rate of return.
For more information about the Delaware Supreme Court's decision or any related matter, please contact David Berger, Brad Sorrels, Amy Simmerman, or any member of the securities and governance litigation practice at Wilson Sonsini Goodrich & Rosati.