August 3, 2015

Delaware Chancery Critical of Valuations Performed by Valuation Firms

In this decision – Fox v. CDX Holdings – the Delaware Court of Chancery was extremely critical of the valuation work of two valuation firms working on behalf of the seller. Significantly, this litigation relates to the sale of a private company – David Halbert, the founder of Caris, owned 70.4% of its fully diluted equity and JH Whitney VI, L.P. (“Fund VI”), a private equity fund, owned another 26.7%. Most of the remaining approximately 2.9% of Caris‘s fully diluted equity took the form of stock options that were cancelled in connection with the Merger. The plaintiff, Kurt Fox, sued on behalf of a class of option holders.

This decision highlights the potentially significant commercial, reputational and – if they had been named as defendants – legal and financial risks that financial advisors/valuation firms can face even when advising privately held companies with only a small percentage of the equity held by persons outside the control group. Luckily for the valuation firms, because the plaintiffs were option holders and not stockholders, this was a contract claim and Delaware law does not recognize a claim for aiding and abetting a breach of contract.

Separately, the opinion contains interesting dicta regarding providing aggressive projections (as opposed to fraudulent projections):

“During a sales process, a company may provide optimistic or bullish projections to bidders, even ‘extremely optimistic valuation scenarios for potential buyers in order to induce favorable bids.”16 There is an important line, however, between responsibly aggressive projections and outright falsehoods: “Pushing an optimistic scenario on a potential buyer is to be expected; shoveling pure blarney at that stage is another.”
Pennaco Energy, 787 A.2d at 713. “An optimistic prediction regarding a company‘s future prospects” may rise to the level of a “falsehood” if accompanied by “evidence that it was not made in good faith (i.e., not genuinely believed to be true) or that there was no reasonable foundation for the prediction.”
16 In re Pennaco Energy, Inc., 787 A.2d 691, 713 (Del. Ch. 2001) (Strine, V.C.) (citations and internal quotation marks omitted); see also In re Topps Co. S’holders Litig., 926 A.2d 58, 76 (Del. Ch. 2007) (Strine, V.C.) (“[O]ne of the tasks of a diligent sell-side advisor is to present a responsibly aggressive set of future assumptions to buyers, in order to extract high bids.”).