The Dec. 16 opinion in Merion Capital v. Lender Processing Services is 75 pages long, with many of those pages dedicated to a detailed recounting of the years-long process that led to Fidelity’s 2014 acquisition of the mortgage services company Lender Processing for $37.14 per share, or about $2.9 billion. You’d be forgiven, in other words, if you didn’t read all the way to the end.
But it’s worth taking a look at the last nine pages of the LPS decision, in which Vice-Chancellor Travis Laster of Delaware Chancery Court discusses the last 10 decisions he and his colleagues have issued in appraisal litigation by shareholders dissatisfied with acquisition prices. The vice-chancellor goes to considerable trouble to explain why M&A lawyers and bankers should not be panicked about the risk of their clients owing tens or hundreds of millions of dollars to renegade shareholders. If companies drum up real competition in their sales processes, Laster suggested, then judges will give great weight to the market price.
As you know, appraisal litigation – which asks Delaware judges to determine a fair value for shares in acquired companies on behalf of shareholders who refuse to participate in the sales – has become an investment niche for extremely sophisticated hedge funds betting that they can spot acquisition targets sold too cheaply. (Appraisal arbitrageurs also historically took advantage of a favorable statutory interest rate, although Delaware’s legislature has acted to limit that upside edge.)
In a string of five decisions between 2013 and 2015, as Vice-Chancellor Laster explains in the LPS opinion, Chancery judges concluded that as long as the sale process was robust, arm's-length and untainted by conflicts, the overriding consideration in determining fair value should be the actual price the acquirer agreed to pay. The appraisal statute instructs judges to reach an independent determination of fair value, and the Delaware Supreme Court said in 2010’s Global Telecom v. Global GT that judges don’t have to defer in appraisal actions to the market price for a company. But as appraisal litigation spread, companies in M&A deals were reassured by the weight Chancery judges seemed to be willing to give to deal prices achieved in well-run, well-advised sales.
Their confidence was shaken by two Chancery Court opinions earlier this year. First, in May, Vice Chancellor Laster held that the 2013 buyout price for Dell shares undervalued the stock by about 22 percent, or nearly $4. The vice-chancellor identified specific flaws in the Dell going-private deal, but, more ominously for M&A professionals, he seemed to suggest that the negotiated price in leveraged buyouts doesn’t deserve deference because LBO players all use the same financial models and those models are based on their own profitability, not necessarily the “intrinsic value” of the target company.
Then in July, Chancellor Andre Bouchard ruled that Lone Star Capital underpaid by about 70 cents per share when it acquired the payday lender DFC Global. In that appraisal action, the chancellor actually found DFC had conducted a full and fair sale but he discounted the weight of the market price because of regulatory uncertainty about DFC’s business model. Bouchard used two financial methodologies to evaluate DFC shares, then averaged the numbers, giving equal weight to the two financial models and the market price Lone Star agreed to pay.
The Dell and DFC decisions introduced uncertainty to M&A deals, especially if Vice-Chancellor Laster meant what he seemed to imply about the untrustworthiness of the market in going-private deals and if even market prices obtained in well-executed auctions were not going to be accorded deference. DFC’s lawyers at Gibson Dunn & Crutcher, as I reported last week, have called on the Delaware Supreme Court to restore clarity to the appraisal process by requiring such deference if transactions meet the high standard of being robust and conflict-free. They argue in the DFC appeal that the appraisal system, which calls for judges to rely on their own financial instincts instead of the collective wisdom of the market, is arbitrary and imprecise.
Vice-Chancellor Laster’s opinion in the LPS appraisal is seeded with references to the Dell and DFS decisions, with about 20 citations in its 75 pages to the judge’s own previous decision in Dell. Laster also mentioned Chancellor Bouchard’s Nov. 10 opinion in Dunmire v. Farmers & Merchants Bancorp, although in that case the deal raised conflict questions because a controlling shareholder dictated the exchange ratio in a stock-for-stock merger with another company it controlled. (“The only surprising aspect of Dunmire is (that) the respondent argued in favor of deference to the deal price,” Vice-Chancellor Laster wrote.)
But many of the judge’s references to prior decisions rejecting complete deference to the market price served to distinguish LPS’s sale from the transactions examined in the Dell and DFS cases, as if to provide reassurance that Dell and DFS are outliers. The vice-chancellor did not explicitly say that. In fact, he emphasized the inherent subjectivity of appraisal actions. “The relevant factors can vary from case to case depending on the nature of the company, the overarching market dynamics, and the areas on which the parties focus,” Laster wrote. Even the quality of each side’s advocacy, he said, makes a difference in how judges decide these cases – a point I’m sure LPS’s lawyers at Weil Gotshal & Manges and Ross Aronstam & Moritz particularly appreciated.
The judge nevertheless emphasized why the sale price LPS obtained is a fair measure of its value. The company engaged with an array of both strategic and financial bidders before it reached a deal with Fidelity. It (mostly) isolated insiders with potential conflicts from the process. It rejected Fidelity bids several times over the course of two years before coming to terms. It engaged management consultants, as well as two sets of financial advisers, to analyze its options. It resolved regulatory overhang and enhanced its market position by reaching a settlement with the government before it received final offers. It also accepted Fidelity’s offer even though most LPS senior executives expected to lose their jobs if the deal went through.
“Because the company contacted a reasonable number of heterogeneous bidders during the pre-signing phase, its argument for reliance on the deal price (all else equal) is more persuasive,” Vice-Chancellor Laster wrote. “Another factor supporting the effectiveness of the sale process in this case was that adequate and reliable information about the company was available to all participants, which contributed to the existence of meaningful competition,” he said, contrasting LPS’s process to those in the Dell and DFC cases. “The record in this case lacked persuasive evidence of factors that would undermine the reliability of information that bidders received, such as a regulatory overhang or a significant disconnect between the company’s unaffected market price and informed assessments of fair value by insiders.”
Delaware fiduciary law is all about deference to the judgment of corporate boards. Appraisal litigation, by statute, is not. But the LPS opinion tells companies that if they run an unimpeachable sales process, Chancery judges will trust the market. If the policy goal of shareholder M&A litigation is to assure that corporations make deals that maximize value for their shareholders, Vice-Chancellor Laster’s opinion will help.