December 4, 2013

Delaware Reigns in Shareholder Attacks on Weak Fairness Opinions

In the “AG Deal Diary,” C.N. Franklin Reddick III & Asma Chandani of Akin Gump note:

Financial advisors should remain keenly aware that, in recent years, plaintiffs and courts have been more carefully scrutinizing fairness opinions rendered in the context of public M&A transactions. Post-Great Recession, the trend in fairness opinions has been toward more robust disclosure on projections and deal economics, in part due to decisions of the Delaware Courts and urging by the Securities and Exchange Commission. The plaintiff’s bar has thus taken to attacking aspects of the fairness opinion that are more tangential. Accordingly, the Delaware Courts are demonstrating an increased sensitivity to the risk of their fact-specific decisions being exploited for claims sounding in principles of general liability. Some of the biggest pressure points that remain the target of shareholder claims include: (i) conflicts of interest, (ii) the analysis used by the financial advisor and (iii) management’s projections.

The Netspend case from earlier this year demonstrated the scrutiny imposed upon a fairness opinion when it is being relied upon as the sole ‘market check’ in the transaction i.e., in a single-bidder process for sale of a company when neither the stockholders nor the court have any market-based indication for the adequacy of the price). The Netspend Board forewent a pre-agreement market check; acquiesced to strong deal protections, including, most notably, ‘don’t ask, don’t waive’ provisions against private equity bidders; and relied upon a weak fairness opinion. The financial advisor who rendered the opinion relied upon the stock price as a basis for valuation, when, in fact, the stock price was highly volatile, resulting in the Court’s finding that the fairness opinion was a” particularly poor simulacrum of a market check’. Vice Chancellor Glasscock criticized the investment bank for using dissimilar comparables, most of which were old and predated the financial crisis. The Court also criticized the investment bank for using projections that exceeded the customary practices of management — highlighting the importance for a financial advisor to ensure that the valuation methods used, and the projections made, are those normally utilized by the company.

Glasscock recently distinguished the Netspend decision in Bioclinica, rejecting plaintiff’s claims against the Bioclinica directors alleging breach of the directors’ duties to the stockholders and against the private equity buyer for aiding and abetting the directors. The case involved the sale of a company to a private equity consortium after a lengthy bidding process participated in by both private equity bidders and strategic acquirers. The merger agreement contained several deal-protection devices in favor of the private equity buyer, including a non solicit clause, termination fee, information rights, a top-up option and an exclusive waiver of the poison pill.

Glasscock emphasizes in Bioclinica that the scrutiny placed by the court on the weakness of the fairness opinion in the Netspend case was heightened in the absence of a market check, and that such review is necessarily “contextual”. He explicitly clarified that his decision in Netspend does not create a new basis to challenge every sales process. The deal-protection devices employed by the Board in Bioclinica were deemed non preclusive, where the sales process was otherwise reasonable.

The recent holding in Bioclinica notwithstanding, given the trend in recent case law, it is advisable for investment banks preparing fairness opinions to take cognizance of whether a company’s board is conducting a thorough market check, or has solicited multiple bidders. A financial advisor should also ascertain the reliability of its basis for valuation and confirm such reliability with management. It is also relevant for an advisor to consider the extent of any deal-protection devices in the merger agreement. The fairness opinion is less likely to be singled out as ‘weak’ if other “contextual” factors in the Board’s process are strong.