Navigating change: US M&A H1 2018

Decision time for M&A in Delaware

Noteworthy rulings out of the Delaware Supreme Court and the Court of Chancery in the past six months are already having consequences for M&A activity

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Dell and DFC Global: Market value may mean fair value

Two high-profile Delaware appraisal rulings from last year are already making waves in 2018.

In December 2017, the state's Supreme Court reversed an earlier ruling by the Delaware Court of Chancery, which found the 2013 buyout of computer maker Dell Inc. to be underpriced. Similarly, in August 2017 the Delaware Supreme Court ruled that the acquisition of payday lender DFC Global Corp. had not been undervalued, reversing another earlier Delaware Court of Chancery appraisal decision.

In both cases, the state's Supreme Court found that deal price should have been given significant weight in the determination of fair value under the appraisal statute.

These rulings were front of mind in this year's appraisal decision regarding Hewlett-Packard Company's 2015 acquisition of Aruba Networks, Inc. The Court of Chancery determined Aruba's fair value to be the 30-day average unaffected market price of US$17.13 per share—a discount from the US$24.87 deal price paid in the transaction.

The Court of Chancery held that the Dell and DFC reversals endorsed using, in addition to share price, the market price of a widely traded firm as an indicator of fair value, if the market for the shares of the firm aligned with the attributes underlying the Efficient Markets Hypothesis (EMH). These include: many stockholders; no controlling stockholder; highly active trading; and information about the company being widely available and easily disseminated to the market.

In addition, the Court of Chancery found that the Dell and DFC decisions endorsed using deal price in a third-party, arm's-length transaction as an indicator of fair value, but only after deducting synergies from the deal price.

Finally, the Court of Chancery found that these reversals urged caution against discounted cash flow analyses prepared by adversarial experts when reliable market indicators are available. Accordingly, the Court of Chancery declined to give any weight to expert valuations of Aruba that relied on discount cash flow analyses.

Finding Aruba's common stock to exhibit attributes consistent with the premises of the EMH, the Court of Chancery considered Aruba's 30-day average unaffected market price of US$17.13 per share to be a reliable indicator of value.

And while the Court of Chancery also considered the US$24.87 deal price to be a reliable indicator of fair value, adjustments would be required to exclude the value of synergies arising from the transaction as required by the appraisal statute.

As a result, the Court of Chancery concluded that the unaffected market price of US$17.13 was the most persuasive evidence of Aruba's fair value. Subject to the Delaware Supreme Court confirming this approach on appeal, dealmakers can expect unaffected market price to be fundamental to appraisal proceedings in the future.


Determining the existence of a "controlling stakeholder" has become increasingly important.


Corwin: Controlling stockholders and adequate disclosure

The Delaware Supreme Court's 2015 decision in Corwin v. KKR Financial Holdings LLC has become a powerful tool for boards of directors defending against breach of fiduciary duty claims with regards to acquisitions.

Under this ruling, director approval of a transaction that is not subject to an entire fairness review is entitled to business judgment deference when the transaction is later approved by an uncoerced, fully informed majority of disinterested stockholders,either by vote or acceptance of a tender offer.

The "cleansing" effect of such stockholder approval is that fiduciary duty claims will be dismissed unless there is a showing of waste.

This defense can be defeated, however, if the transaction involves a conflicted controlling stockholder—subjecting the transaction to an entire fairness review. As a result, determining the existence of a "controlling stockholder" has become increasingly important.


Tesla: Who is a controlling stockholder?

In the case of In re Tesla Motors, Inc. Stockholder Litigation, for example, the Delaware Court of Chancery sided with plaintiffs who argued that, in connection with Tesla's 2016 acquisition of SolarCity Corporation, Elon Musk was a controlling stockholder of Tesla, Inc. even though he held only 22 percent of its common stock.

As a consequence, breach of fiduciary duty claims against the Tesla board of directors and Musk, as a controlling stockholder, survived a motion to dismiss, even though the transaction had been approved by a majority of Tesla stockholders.

The Court of Chancery noted that Tesla's bylaws contained several supermajority voting requirements, allowing Musk significant control while only owning approximately 22 percent of Tesla's common stock.

In addition, the Court of Chancery cited Musk's alleged domination of the Tesla board in the lead-up to the SolarCity acquisition, including bringing the SolarCity proposal to the board three times, leading board discussions and being responsible for engaging the board's advisors.

Finally, the Court of Chancery noted alleged conflicts in the Tesla board that diminished its potential resistance to Musk's influence, as well as Tesla's and Musk's own acknowledgments of Musk's outsized influence.

Parties should be mindful of factors such as these, in addition to stock ownership, in determining whether a "controlling stockholder" exists and whether the "cleansing" effect of a stockholder vote will be available.


Appel: What's does "fully informed" mean?

A second defense to the cleansing effect of Corwin is to establish that stockholder approval was not fully informed. In Appel v. Berkman, in February of this year, the Delaware Supreme Court reversed a Court of Chancery dismissal of a stockholder challenge to the sale of Diamond Resorts International.

The chairman of Diamond's board of directors abstained from voting to approve a sale of the company, but Diamond did not disclose why. The Delaware Supreme Court held this to be material information without which Diamond's stockholders could not have made a fully informed tender into the deal.

Failure to make such material disclosures denied Diamond's board the "cleansing" effect of stockholder approval for the transaction. At the pleading stage, this precluded the invocation of the business judgment rule standard. As a result of this decision, boards must carefully consider how dissenting opinions of directors are discussed in disclosures to stockholders.


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Navigating change: US M&A H1 2018


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