June 13, 2017
Statutory appraisal rights under Delaware law continue to be the focus of intense discourse among M&A practitioners. Many are rightfully concerned that the rise of appraisal arbitrage by hedge funds, combined with efforts by the plaintiffs’ bar to use appraisal proceedings as an alternative route to try traditional breach of director fiduciary duty claims, may be adding unwarranted uncertainty to public M&A transactions at a time when Delaware courts have issued decisions that have cut back on frivolous and wasteful M&A litigation through the Corwin and Trulia lines of cases.
Two Delaware appraisal decisions in the last year have in particular captured practitioners’ attention as "poster children" for the dangers of appraisal rights: In re: Appraisal of Dell Inc. and In re Appraisal of DFC Global Corp. In both cases, the Delaware Court of Chancery determined that the "fair value" of the target company’s shares was above the deal price negotiated by sophisticated parties. Appeals under both cases are currently pending before the Delaware Supreme Court, and practitioners hope that the Delaware Supreme Court will offer clear guidance concerning the extent to which the Delaware Court of Chancery should defer to the deal price in appraisal proceedings in public M&A transactions, particularly where the target company’s board of directors has executed an adequate sale process. Gibson Dunn is representing DFC in its appeal before the Delaware Supreme Court. A replay of the oral argument, which took place last week, can be accessed by clicking here.
While we await the outcomes of the DFC and Dell appeals, two recent Delaware Court of Chancery appraisal opinions have provided some welcome news for potential public sellers and their advisors: In re Appraisal of PetSmart, Inc. and In re Appraisal of SWS Group, Inc. In PetSmart, the Court assessed the robustness of the sales process and determined that the "deal price" constituted the best evidence of fair value, rather than valuing the company using the post-hoc discounted cash flow (DCF) analysis proposed by the petitioners. In SWS Group, the Court agreed with both parties that the deal price did not constitute the best evidence of fair value, conducted its own DCF analysis and determined the fair value to be below the deal price. Both decisions have favorable implications for buyers in future appraisal actions.
In PetSmart, the Court’s principal rationale for rejecting the petitioners’ proposed valuation was that the management projections upon which the DCF analysis was conducted were not reliable indicators of the company’s expected cash flows. The Court found the management projections presented in PetSmart’s proxy statement to be unreliable because (1) PetSmart management did not have a history of creating (or any experience with) long-term projections, (2) PetSmart management’s short-term projections were frequently inaccurate, (3) the management projections presented in the proxy statement were not created in the ordinary course of business but rather for use in the auction process and (4) PetSmart management created the projections while under pressure to be aggressive, on the expectation that potential bidders would discount such projections.
In SWS Group, where the target company’s stockholders had received a mix of cash and stock, both the dissenting stockholders and the target company took the position that the deal price did not constitute fair value, albeit for different reasons—the stockholders argued that the sales process was fundamentally flawed, while the target company argued that the deal price was inflated due to synergies that, under the Delaware appraisal statute, should not be included in determining fair value. The Court agreed that it was improper to give effect to such synergies and determined (using its own DCF analysis) that the fair value was below the deal price. Importantly, the Court noted that "the fact that [its] DCF analysis resulted in a value below the merger price not surprising: the record suggests that this was a synergies-driven transaction whereby the acquirer shared value arising from the merger with SWS."
The SWS Group decision suggests that the concerns that have developed around the risk of appraisal rights following the Dell and DFC decisions might be less relevant in the context of mixed cash/stock consideration deals, particularly when value creation is driven by anticipated synergies. Further, in the context of cash deals, including private equity buyouts, PetSmart suggests that target companies and their advisors should be mindful of preserving a clear record of the assumptions and circumstances surrounding the preparation of management forecasts utilized in the transaction so that they can be viewed in the proper context by the Court in a potential appraisal proceeding. Both decisions are certainly welcome news as target companies and their advisors await the outcome of the Dell and DFC appeals.
 In re Trulia, Inc. S’holder Litig., 129 A.3d 884 (Del. Ch. 2016); Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015). See our discussion of Corwin here.
 In re Appraisal of SWS Grp., Inc., C.A. No. 10554-VCG, 2017 WL 2334852 (Del. Ch. May 30, 2017); In re Appraisal of PetSmart, Inc., Consol. C.A. No. 10782-VCS, 2017 WL 2303599 (Del. Ch. May 26, 2017).
 For further discussion of the key takeaways from the PetSmart and SWS Group opinions, please see here.
The following Gibson Dunn lawyers assisted in preparing this client update: Barbara Becker, Jeffrey Chapman, Stephen Glover, Eduardo Gallardo, Brian Lutz, Adam Offenhartz, Meryl Young, Jonathan Corsico, Joshua Lipshutz, Colin Davis, and Daniel Alterbaum.
Gibson Dunn’s lawyers are available to assist with any questions you may have regarding these issues. For further information, please contact the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following leaders and members of the firm’s Mergers and Acquisitions practice group:
Mergers and Acquisitions Group / Corporate Transactions:
Barbara L. Becker – Co-Chair, New York (+1 212-351-4062, firstname.lastname@example.org)
Jeffrey A. Chapman – Co-Chair, Dallas (+1 214-698-3120, email@example.com)
Stephen I. Glover – Co-Chair, Washington, D.C. (+1 202-955-8593, firstname.lastname@example.org)
Dennis J. Friedman – New York (+1 212-351-3900, email@example.com)
Jonathan K. Layne – Los Angeles (+1 310-552-8641, firstname.lastname@example.org)
Eduardo Gallardo – New York (+1 212-351-3847, email@example.com)
Jonathan Corsico – Washington, D.C. (+1 202-887-3652), firstname.lastname@example.org
Mergers and Acquisitions Group / Litigation:
Meryl L. Young – Orange County (+1 949-451-4229, email@example.com)
Brian M. Lutz – San Francisco (+1 415-393-8379, firstname.lastname@example.org)
Aric H. Wu – New York (+1 212-351-3820, email@example.com)
Paul J. Collins – Palo Alto (+1 650-849-5309, firstname.lastname@example.org)
Michael M. Farhang – Los Angeles (+1 213-229-7005, email@example.com)
Joshua S. Lipshutz – Washington, D.C. (+1 202-955-8217, firstname.lastname@example.org)
Adam H. Offenhartz – New York (+1 212-351-3808, email@example.com)
© 2017 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.