John O’Toole writes:

In In re Appraisal of DFC Global Corp., the Court of Chancery conducted an in-depth analysis of three common valuation methodologies—discounted cash flow analysis, multiples-based comparable company analysis, and deal price.  After discussing how each methodology was and should be applied, Chancellor Bouchard ultimately determined that although “all three metrics suffer from various limitations” the fair value of the merger in question was best ascertained by weighting all three methods equally.

The Court’s opinion serves a number of useful purposes.  First, it provides a comprehensive overview of each the methodologies discussed.  Second, given the context in which the Court’s analysis was done, it offers guidance on how to best determine the fair value of a company following a deal consummated in a “tumultuous environment” where a company’s “future profitability and…viability” are at issue.


John O’Toole is a summer associate, resident in the firm’s Wilmington office.

On January 10, 2012, in the case of In Re Appraisal of the Aristotle Corporation, the Delaware Court of Chancery addressed an issue of first impression with respect to the standing of stockholders, who dissented to a short form merger under Section 253 of the Delaware General Corporation Law (“DGCL”) and perfected their appraisal rights, to bring an additional claim alleging that the directors breached their fiduciary duty to disclose the material facts necessary for the stockholders to determine whether to seek appraisal.

In connection with a short form merger, the petitioners filed an appraisal action under Section 262 of the DGCL seeking the fair value of their shares. Despite the fact that the appraisal action was pending, on the eve of trial and eighteen months into their appraisal case, the petitioners filed a separate complaint for breach of fiduciary duty of disclosure in connection with the merger seeking the difference between the fair value of their shares and the price of the merger.  The defendants moved to dismiss the fiduciary complaint for lack of standing.

Because there were no prior cases that squarely addressed this issue, the Court relied on its prior decision of Andra v. Blount, 772 A.2d 183 (Del. Ch. 2000) by analogy.  There, the Court was faced with an action for breach of the duty of disclosure in connection with a tender offer, which culminated in a cash out of remaining shareholders through a short form merger.  The plaintiff initially moved for expedited proceedings to enjoin the consummation of the tender offer until corrective disclosures were issued.  Thereafter, the plaintiff withdrew her request to enjoin the tender offer and instead waited to bring a post-closing action for money damages in the form of an appraisal proceeding.  After the short form merger was consummated, in which plaintiff refused to accept the merger consideration and preserved her appraisal rights, plaintiff renewed her fiduciary duty challenge to the disclosures.  The Court ruled that plaintiff did not have standing to pursue her disclosure claim because she did not tender her shares and thus, could not have been injured by the allegedly misleading disclosures.

Importantly, the Andra Court noted that a different result might have been obtained if the plaintiff had timely sought to enjoin her disclosure claim before her decision to tender.  This would have given the Court an opportunity to order corrective disclosures, a remedy that would inure to the benefit of all the stockholders contemplating the decision to tender.  The Court refused to look at the potential injury to the other shareholders because the plaintiff withdrew her injunction motion through which she could have sought to demonstrate collective injury to other investors. Instead, plaintiff chose to press her disclosure claim only after the merger closed. As a result, the Court held plaintiff to the traditional standing requirement that she show individual injury as a result of the misleading disclosures—a burden plaintiff could not satisfy, because she chose not to tender.

“When a litigant files a new claim that, if proven, would not entitle it to any relief that it does not already have a right to receive, that litigant in my view has no proper standing.”

Relying on the reasoning in Andra, the Chancellor in the instant case ruled that the petitioners did not have standing to pursue their disclosure claim because the petitioners never sought to represent other investors, did not promptly seek to enjoin the merger and thus, did not suffer any cognizable individual injury that could be redressed by the Court of Chancery. The Court further found this to be particularly true because the relief sought in the fiduciary duty action is the same as the exclusive remedy afforded in a Section 262 appraisal action—a fair value determination.

The Chancellor reasoned that “when a litigant files a new claim that, if proven, would not entitle it to any relief that it does not already have a right to receive, that litigant in my view has no proper standing.”  In other words, the alleged disclosure inadequacies did not in any way impair the petitioners’ ability to seek appraisal, and addressing the fiduciary duty claim could at best result in the petitioners’ “right to a ‘quasi’ version of something they already possess in its actual form.”  Such a moot court determination, according the Chancellor, would result in an advisory opinion, against which the Delaware Supreme Court has warned.

The Court further found that there was no need to evaluate the possibility of nominal damages in connection with the fiduciary duty action, because the petitioners’ voting interests were not harmed, and they will receive a fair value determination in connection with the appraisal action.

This case is important to shareholders who seek appraisal in connection with a short form merger but also choose to bring a subsequent action for breach of the duty of disclosure in connection with merger.  If the stockholder refuses to tender in connection with the short form merger, thereby preserving their appraisal rights, but fails to seek an injunction of the merger, he will not be able to demonstrate cognizable injury to bring a fiduciary action for breach of the directors’ duty of disclosure after the closing of the short form merger transaction.

In the case of Glenn B. Showell v. William H. Pusey, et al., C.A. No. 3970-VCG (Del. Ch., Sept. 1, 2011), the Court of Chancery construed the provisions of an operating agreement of Robert M. Hoyt and Company, L.L.C. to determine what value, if any, Plaintiff was due upon his voluntary retirement from the company.

Analysis

Plaintiff, who owned 29% of the company at the time of his retirement, argued that he was entitled to 29% of the fair value of the company as a going concern at the time of his retirement pursuant to 6 Del. C. § 18-604. To the contrary, Defendants asserted that Plaintiff was entitled to zero distribution, or alternatively, 29% of the liquidation value of the company at the time of his retirement.

The Court first made clear that the relationship between members of a limited liability company, and their rights and duties, are governed by the operating agreement for such a company, and also stated that limited liability companies exist pursuant to the Delaware Limited Liability Company Act, 6 Del. C. Section 18–101, et seq.

The Court next found that the Operating Agreement at issue did not allow for the withdrawal or resignation of its members, stating that “no Member shall be entitled to withdraw or resign from the Company.” However, the parties entered into a Supplemental Agreement which addressed the repurchase of a member’s interest in the company upon a “Retiring Event”.  However, such a “Retiring Event” was not defined in the Supplemental Agreement to include the voluntary retirement of a member, and the parties agreed that nothing in the Operating Agreement or Supplemental Agreement allowed for, nor set forth the company’s obligation to a member upon, a voluntary retirement.

The Court declined to apply the “default” provision of 6 Del. C. § 18-604 in determining the appropriate distribution to Plaintiff, given that through the Operating Agreement and the Supplemental Agreement, the members had carefully planned for the obligations of the company upon a member’s retirement.

Despite the fact that a member’s voluntary retirement was not included as a “Retiring Event” in the Supplemental Agreement, the Court found that the members had orally agreed to amend the  agreement to that effect, and therefore, the Court held that Plaintiff was entitled to the distribution provided to members who qualified for a “Retiring Event”, which was the liquidation value of their respective shares in the company, as opposed to the fair value of such shares pursuant to the default provision of section 18-604.

Conclusion

As is clear from this decision, it is imperative that an operating agreement for a limited liability company provide as much clarity as possible, and that ambiguity will only lead to increased litigation costs should a dispute ultimately arise between members of such company.