Delaware Chancery Court Update

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In Re: Sunbelt Beverage Corporation, 2010 Consol. C.A. No.16089-CC (Del. Ch.)(Jan. 5, 2010)

Sunbelt Beverage Corporation merged into SBC merger Corporation in August 1997. One consequence, and specific goal, of the merger was to cash-out shareholder Jane Goldring’s 14.9% interest. Goldring brought suit for a fair value appraisal as of the time of the merger, arguing that the cash-out price of $45.83 per share was unfair. Chancellor Chandler agreed and ruled that the fair value of Sunbelt was $114.04 per share. At issue was a formula price, the relevance of a contemporaneous fairness opinion, comparable transactions, small-firm risk premium, company specific risk premium, and a Subchapter S conversion.

Formula Price

Sunbelt had calculated the cash-out price of $45.83 via a share price formula set forth in a 1994 Shareholders Agreement and had asked the court to recognize previous transactions made with its sophisticated investors at the price set forth in the formula. The court concluded that previous transactions under the formula had been made three years prior to the 1997 merger and therefore were not relevant to the fair value at the time of the merger.

Fairness Opinion Relevance

Sunbelt argued for the consideration of a fairness opinion performed at the time of the merger that found the $45.83 cash-out price was fair. The court found the fairness opinion “highly suspect” and “pure window dressing intended by defendants to justify the preordained result” and refused to place any weight on it. The court noted that the opinion had been prepared in only one week’s time, just prior to the board of directors meeting approving the merger, and the practitioner was unable to work extensively and meaningfully with Sunbelt representatives in part because he was busy working on other matters.

Comparable Transactions

Goldring’s expert had used a comparable transactions analysis as part of his work. The court assigned no weight to the analysis, finding little comparability due to differences in size, products and geography, the comps were privately held in a tightly controlled market, and other factors. Further, Goldring’s expert had taken the median multiples of his comp group in order compensate for shortcomings related to particular companies and transactions. The court ruled that the use of median multiples was “at its best” when used to smooth unknown and immeasurable errors and differences in an analysis, but that it was not appropriate to use as justification for a failure to account for known errors and variations as was the case here.

Small-firm Risk Premium

Both experts used a DCF method and included small-firm risk premiums. Goldring’s expert selected a 3.47% premium using Ibbotson 9th and 10th deciles. Sunbelt’s expert selected a 5.78% premium based on Ibbotson’s 10th decile. The court sided with Goldring’s approach as the value of Sunbelt was close to the dividing line between the deciles.

Company Specific Risk Premium (CSRP)

Sunbelt argued that a 3% CSRP was appropriate based on the at-will termination provisions of supplier agreements, competition from specific industry participants and the company’s use of optimistic sales and profit projections. The court cited other cases in reminding us that the proponent of a CSRP bears the burden of convincing the court of the premium’s appropriateness and ruled that Sunbelt had not met its burden. In support of its conclusion, the court noted that Sunbelt’s justifications for a CSRP affected the entire industry and not just Sunbelt, that there wasn’t sufficient evidence that Sunbelt’s projections were overly optimistic, and that there was no rigorous quantitative explanation for why 3% was the appropriate magnitude.

Subchapter S Conversion

Experts for both parties adjusted their valuations to take into account the impact of a Subchapter S conversion which occurred after the merger. Sunbelt’s expert selected a 26% premium which was accepted by Goldring’s expert. Despite the agreement, the court rejected the premiums, stating that the stockholder is only entitled to be paid for that which has been taken and that the fair value should not include speculative elements of value that may arise from the accomplishment of the merger, noting that Sunbelt did not complete the Subchapter S conversion until after the merger.

Berger v. Pubco Corporation, et. al., 2010 C.A. No.3414-CC (Del. Ch.)(May 10, 2010)

In 2007, Pubco Corporation completed a short-form merger and Pubco’s minority shareholders received $20 per share. Minority shareholder Berger sought appraisal. Chancellor Chandler ruled that the fair value of Pubco was $38 per share. At issue between the parties were the appropriate control premium and capital gains tax treatment.

Control Premium

Both experts used a DCF and book value method to value Pubco and neither used a public company comparable method. The court ruled that the addition of a control premium is appropriate under Rapid-American Corp. v. Harris (603 A.2d 796 (Del. 1992)) only under specific circumstances in a comparable company methodology and not under a DCF approach. The court cited Shannon Pratt’s The Lawyer’s Business Valuation Handbook (2000) as support that it was “improper and illogical to add a control premium to a discounted cash flow valuation.”

Capital Gains Tax Liability

Pubco owned a portfolio of securities on the merger date, some of which had market prices that exceeds purchase prices. Pubco’s expert reduced the valuation of Pubco by $4.00 per share to reflect the expected capital gains tax that would be due were those securities sold. The court rejected this approach for a number of reasons:

• The Delaware Supreme Court had ruled that it was “improper to apply a deduction to an asset valuation based on speculative future tax liabilities attributable to sales that were not specifically contemplated at the merger date” Paskill Corp. v. Alcoma Corp., 747 A.2d 549 (Del. 2000);

• Delaware appraisal law entitles a dissenter to receive a proportionate share of fair value in the going concern on the date of the merger, and not the share of value obtained upon a liquidation; and

• There was nothing in the record indicating that securities were planned for sale or that Pubco had a particular schedule to sell any securities.

Implications

These