The Delaware Supreme Court’s recent decision in Fir Tree v. Jarden[1] marks an important milestone in the law of appraisal, making clear that unaffected market price can and should be decisive in some appraisal actions. Because the court’s opinion relied on the proposed methodology we advocated in our recent article, Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets, published in the 2019 edition of the Business Lawyer, [2] we here offer some observations about the Jarden opinion and the future of the law of M&A appraisal.
Jarden involved the not-so-uncommon situation where an acquirer bids well above the unaffected market price of a target on the theory that the merger will produce synergies that make it worthwhile to pay such a high premium. Specifically, while the target (Jarden) had traded at $48.31 per share on the closing date of the merger, the bidder offered cash and non-cash compensation ultimately worth $59.21 per share at closing. There was no question in Jarden that the premium the bidder (Newell) was willing to pay was driven by synergies – in fact the Delaware Court of Chancery went so far as to characterize such synergies as the “logic for the deal”[3] and specifically found that “Jarden stockholders probably did [] receive the value of the synergies that were created by the deal.”[4]
There is no question that synergies are excluded by law from the appraisal award to which a dissenting shareholder is entitled due to the operation of section 262 of the Delaware General Corporation Law. Section 262(h) expressly defines fair value as excluding “any element of value arising from the accomplishment or expectation of the merger or consolidation,” and synergies by definition arise from accomplishment of the merger. In its prior decision in Dell, the Delaware Supreme Court stated unequivocally that “the court should exclude ‘any synergies or other value expected from the merger giving rise to the appraisal proceeding itself.’”[5] The rationale for excluding synergies is straightforward: Shareholders who exercise their appraisal rights wish to reject the proposed merger deal and therefore should not receive those elements of value arising solely from that transaction.
Thus, at least when the target underwent a robust deal process, the Delaware courts have seemed to favor an appraisal valuation methodology which begins with the deal price and subtracts synergies.[6] But what to do when the deal process was flawed in some way? Here courts and commentators have diverged, with some advocating the use of a discounted cash flow (DCF) analysis while others – like us – suggesting that, in those deals in which the target is a public company whose shares trade in an efficient capital market, the unaffected market price is a far more reliable measure of fair value, provided that appropriate adjustments are made. It is altogether too common for DCF valuations to diverge wildly in appraisal litigation. In Jarden, the petitioner’s expert valued the firm at $70.36-$70.40 per share while the respondent’s expert arrived at $48.01 per share – a $5 billion difference![7]
Our article proposes an approach that is less vulnerable to the highly speculative assumptions underlying DCF models –specifically, starting with the unaffected market price and adjusting for material nonpublic information.[8] This is a straightforward way to measure the fair value of a company whose shares trade in an informationally efficient market. The Jarden court embraced this methodology, concluding that the “the court did not abuse its discretion when it found that the market did not lack material nonpublic information about Jarden’s financial prospects”[9] and thus upholding the trial court’s conclusion that the “market was well informed and the Unaffected Market Price reflects all material information.”[10]
Critically, there is no justification to depart from the unaffected market price even in the presence of a flawed deal process. Plaintiffs who vote against a transaction and exercise their appraisal rights forego the synergies or other gains from trade associated with the merger transaction itself. A flawed deal process means that the selling shareholders did not receive what they would have received in a flawless deal process. But the dissenters seeking appraisal were not entitled to those gains from trade in the first place by virtue of the fact that they are seeking an alternative to the deal price, i.e., the “fair value” of their shares prior to the run-up in value caused by the deal itself. For this reason, there is no basis for asserting that a flawed deal-making process harms dissenters. Flawed deal-making may harm non-dissenters, who are entitled to pursue a claim for breach of fiduciary duty, but a flawed deal process cannot harm dissenters who seek not the best deal but the fair value of their shares, excluding synergies and other gains from trade.
Some may worry that the publicly traded market price of a firm’s shares reflects the lowest price that a shareholder is willing to sell shares of the firm and thus fails to capture optimistic valuations of the firm held by shareholders who refuse to sell at the current market price. But the appraisal remedy seeks to award shareholders the fair value of their shares, not their idiosyncratic valuations. And while scholars have persuasively shown that DCF valuations are likely superior to deal prices if the goal is to maximize the expected gains to target shareholders,[11] the Jarden court reiterated that Delaware case law has never embraced that normative goal, quoting DFC for the proposition that “fair value is just that, fair. It does not mean the highest possible price that a company might have sold for.”[12]
We close with a slightly broader point. At their core, academic debates over appraisal often turn on whether market prices undercompensate shareholders for elements of existing value that are “unlocked” through M&A. The notion that prices in publicly traded markets might be artificially depressed is an argument that one of us (Mitts) is particularly sympathetic to, having written about downward market manipulation by short sellers.[13] But it does not follow that DCF valuations in appraisal litigation are well-suited to remedy the modest shortcomings of public markets. A robust anti-fraud and anti-manipulation regime under the securities laws[14] will ensure that the assumption of informational efficiency central to appraisal post-Jarden in fact occurs in practice.
ENDNOTES
[1] Fir Tree v. Jarden, slip op., 2020 WL 3885166 (Del. July 9, 2020), available at https://courts.delaware.gov/Opinions/Download.aspx?id=307900.
[2] Jonathan Macey & Joshua Mitts, Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets, 74 Bus. Law. 1015, 1021 (2019).
[3] Jarden, 2019 WL 3244085, at *25.
[4] Id. at *26 n.324.
[5] Dell, 177 A.3d at 21 (quoting Global GT LP v. Golden Telecom, Inc., 993 A.2d 497, 507 (Del. Ch. 2010), aff’d, 11 A.3d 214 (Del. 2010)).
[6] See Jarden, 2020 WL 3885166 at *13.
[7] The trial court also conducted its own DCF analysis, which yielded a value of $48.13 per share, despite petitioners arguing that the court erred in its calculation of Jarden’s terminal investment rate, which would have yielded a value between $61.59 and $64.01 per share – yet another example of how wildly divergent DCF valuations can be.
[8] Macey & Mitts, supra note 1, at 1038-39.
[9] Jarden, 2020 WL 3885166 at *26.
[10] Jarden, 2020 WL 3885166 at *27 (quoting Jarden, 2019 WL 3244085, at *30).
[11] Albert H. Choi & Eric L. Talley, Appraising the “Merger Price” Appraisal Rule, 35 J.L. Econ. & Org. 543 (2019).
[12] Jarden, 2020 WL 3885166 at *28 (quoting DFC, 172 A.3d at 370).
[13] See, e.g., Joshua Mitts, Short and Distort, J. Leg. Stud. (forthcoming, 2020), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3198384.
[14] See, e.g., John C. Coffee, et al., Petition for Rulemaking on Short and Distort, available at https://www.sec.gov/rules/petitions/2020/petn4-758.pdf.
This post comes to us from Jonathan Macey, the Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale Law School and a professor at the Yale School of Management, and from Joshua Mitts, associate professor of law and Milton Handler Fellow at Columbia Law School.