Chancellor Strine’s December 17, 2012 bench ruling in In re Ancestry.com Inc. Shareholder Litigation attracted immediate attention from M&A practitioners and scholars regarding the Chancellor’s comments on so-called “Don’t Ask, Don’t Waive” standstill provisions.[1]  That attention, however, overshadowed the Chancellor’s equally important guidance regarding the materiality—and, therefore, need to disclose to shareholders—of qualitative facts surrounding fairness opinions prepared by a target’s financial advisor.  This post attempts to highlight that guidance, now that some of the proverbially dust kicked up by the Chancellor’s commentary on “Don’t Ask, Don’t Waive” standstills has begun to settle.

Background to the Ancestry.com Dispute

Beginning in January 2012, Ancestry.com Inc. (“Ancestry” or the “Company”) received a number of unsolicited, private expressions of interest from various private equity firms, including Permira Advisers, LLC (“Permira”).  After ongoing deliberation throughout the Spring, the Company’s board of directors (the “Board”) formally engaged Qatalyst Partners LLP (“Qatalyst”) as its financial advisor on May 15 and authorized Qatalyst to initiate a full sales process.  Although Ancestry did not prepare long-term financial projections in its ordinary course of business, the Board also approved a set of management-prepared, five-year projections at that same time.

Despite early indications of interest to acquire the Company for as much as $38 per share, the auction dragged on into October 2012 as the various bidders either lowered their bids or outright stopped negotiating due to concerns uncovered during the due diligence process.  Eventually, Ancestry’s largest shareholder—Spectrum Equity Investors (“Spectrum”), which held approximately 30% of the Company’s shares—offered to roll $100 million worth of its existing equity into the surviving company to facilitate the only remaining bidder’s—Permira’s—ability to make an all-cash offer for the remaining, outstanding shares.  Senior management made a similar offer of approximately $80 million.  Relieved of the need to acquire 100% of Ancestry, Permira made a firm offer of $32 per share in cash on October 10.

Qatalyst, however, had informed the Board on October 3 that it likely could not provide a favorable fairness opinion at $32 per share based on the financial projections management had prepared in May.  Between October 3 and 16, management revised its long-term projections to reflect, in the defendants’ account, more current financial information and adjustments for the various diligence issues bidders had raised.  Based on those revisions, Qatalyst provided a favorable fairness opinion on October 18.  That same day, the Board approved a definitive merger agreement with Permira at $32 per share, which was publicly announced on October 21.

Shareholders challenged the merger agreement in the Delaware Court of Chancery, alleging breach of the Board’s Revlon duties to maximize Ancestry’s sale price and seeking to enjoin the shareholder vote scheduled for December 27.  Among other things, the plaintiffs argued that Spectrum and management disloyally gave preferential treatment to Permira, including by revising the May projections to justify retroactively the tainted deal already reached, to ensure their ability to participate in the buyout at an unfair price and at the expense of the unaffiliated shareholders.

The Court of Chancery’s Decision Regarding the Fairness Opinion

Although the Court did not find a breach of the Board’s Revlon duties, it did find the last-minute projections “troubling.”[2]  For example, various defendants testified at their depositions that the original May projections were deliberately bullish and prepared only to facilitate a sale, whereas the revised projections reflected a more honest picture of the Company’s prospects, and the Court admitted that that story “makes a lot of sense.”[3]  Nevertheless, Chancellor Strine also said that story was “vexing to deal with” because, if Ancestry and Qatalyst had known all along that the May projections were “just sell-side puffery,” Qatalyst likely would not have even attempted to rely on the May projections.  That it did, and even formally informed the Board of its concerns in this regard, however, created what the Court called a “cognitive dissonance.”[4]  Furthermore, nothing in the board minutes or other meeting materials corroborated the defendants’ account that the May projections always were understood to be more aspirational than actual.  As an aside, Chancellor Strine criticized the minutes for being overly “hygienic” in this respect, noting that omitting details “actually told to the directors that might be valuable” can undermine the record on which “the directors are actually supposed to be entitled to rely.”[5]

In the final analysis, the Court could not conclude on the existing evidence that management had merely reverse-engineered the projections to confirm the fairness of Permira’s existing bid.  The Court also found evidence of the Board’s good faith from the fact that the proxy statement distributed to shareholders recommending the merger agreement contained both the original May projections provided to bidders and the revised October projections on which Qatalyst based its fairness opinion.  Nevertheless, the Court faulted the proxy statement for not disclosing the circumstances surrounding “this powerful point where the advisor to the board says, I can’t give a fairness opinion based on these [projections].”[6]  That is, the Court found the objective fact that the revised projections were prepared in response to Qatalyst’s affirmative statement that it was unable to give a fairness opinion to be material information improperly omitted from the Company’s proxy statement.  Accordingly, the Court enjoined the shareholder vote pending corrective disclosure of Qatalyst’s hesitancy to issue a fairness opinion based on the original projections.

Implications of the Ancestry.com Ruling

Although Delaware law generally requires disclosure of management-prepared projections that have been relied on by a financial advisor to render a fairness opinion,[7] the Court of Chancery also has been explicit that the proxy must disclose only “management’s best estimates [of future performance] at the time.”[8]  Indeed, based on this reasoning, the Court of Chancery in In re BioClinica, Inc. Shareholder Litigation[9] recently denied a motion to expedite, which requires the existence of only a “colorable” disclosure claim.  Essentially, that is, the Court of Chancery ordinarily rules that shareholders are entitled to nothing else than the financial information actually relied on by the financial advisor.  Furthermore, in the analogous context of appraisal proceedings under 8 Del. C. § 262, the Court repeatedly has emphasized that management projections prepared in the ordinary course of business are preferable to projections prepared solely for the challenged transaction (i.e., where management, in advancing shareholders’ best interests, are motivated to exaggerate the future value of the company).

Yet, in Ancestry, Chancellor Strine required disclosure of the qualitative, process-based fact that the financial advisor informed the Board that it could not issue a fairness opinion based on nearly 6-month-old projections prepared outside the ordinary course of business.  In doing so, this case is an important reminder to M&A transaction planners that, while the general rules in Delaware are (1) only financial information both prepared by management and actually relied on in rendering the final fairness opinion must be disclosed and (2) the Court of Chancery considers projections prepared outside of the ordinary course of business to be inherently less credible, Delaware law requires thorough disclosure of any deal-specific facts that might affect the reliability of a fairness opinion.  Here, the “powerful point” where the financial advisor actually warned that it could not provide a fairness opinion based on the only existing projections at that time constituted such a fact.

The Court’s aside about the “hygienic” board minutes also should serve as an invaluable reminder to corporate counsel and others involved in drafting corporate records that, while sensitivity to the risks of over disclosure is important, excessive caution in recording the decisions made and events that transpired at the board level can produce countervailing risks.  In this case, the starkness of the board minutes and materials may have deprived the defendant directors of valuable evidence demonstrating their good faith efforts to advance shareholders’ best interests.