DealLawyers.com Blog

Last month, in a post-trial opinion in Jacobs v. Akademos, Inc. (Del. Ch.; 10/24), the Delaware Chancery Court addressed the sale of a distressed company to a controlling stockholder where the common stockholders received no consideration. Vice Chancellor Laster’s 93-page decision finding for the defendants addressed the plaintiffs’ petition for appraisal and their fiduciary duty challenges — and, in doing so, compared the techniques used to evaluate the fair price dimension of the entire fairness analysis and those used in an appraisal proceeding.

The case involved a struggling company operating online college and university bookstores. It hired an investment banker to run a dual-track process seeking outside investment or an acquisition proposal, with disappointing results. The best third-party proposals valued the company at $10 million. The company’s largest investor — a venture capital fund — then proposed a cash-out merger that valued the company at $12.5 million, which it closed after a 3-week go-shop period. Given the liquidation preferences and repayment premiums associated with the fund acquirer’s preferred stock and promissory notes, none of the consideration was allocated to the common stockholders. (The opinion notes that the valuation would have had to be greater than $40 million for the common stockholders to receive any consideration.)

In the appraisal proceeding, VC Laster found that the fair value of the shares of common stock was zero — even after resolving that the preferred stock’s deemed liquidation provision should be ignored in determining fair value. That’s because the provision did not apply when the company was operating as a going concern, and the Delaware Supreme Court has interpreted the language of the appraisal statute to require the court to determine the stockholder’s “proportionate interest in a going concern.”

In addressing the breach of fiduciary duty claims, VC Laster reviewed the transaction under the entire fairness standard of review since the transaction was not conditioned on MFW procedural protections — which defendants argued was because the company lacked the funds to support a full-blown MFW process. In addressing the fair price component of the entire fairness review, VC Laster distinguished this analysis from the appraisal proceeding:

In this case, the common stockholders received no consideration in the Merger. Notwithstanding that stark result, the Merger provided the common stockholders with a fair price. Before the Merger, the common stockholders were so far underwater in the capital stack that they had no prospect of receiving value from the Company. The Merger provided the stockholders with the substantial equivalent of what they had before.

Evaluating whether the minority stockholders received the substantial equivalent of what they had before requires accounting for the fact that the KV Fund already controlled the Company. Unlike in an appraisal proceeding, where the going concern standard looks to the value of the corporation without considering issues of control, a claim for breach of fiduciary duty that challenges the fairness of a squeezeout transaction must account for the implications of control. … That control meant that the KV Fund could veto any transaction that did not first satisfy the $6 million due on the KV Notes, then pay the $6 million repayment premium due on the KV Notes, and then attribute value to the Preferred Stock’s liquidation preference of $32 million.

The common stock thus had no value before the Merger. The common stockholders received nothing in the Merger, but that was the substantial equivalent of what they had before. The Merger therefore offered a fair price.

On the fair dealing component, VC Laster simply said:

Here, the fair price evidence is sufficiently strong to carry the day without any inquiry into fair dealing. Even if the KV Fund had implemented the Merger unilaterally, without any process whatsoever, the defendants proved that the common stock was so far out of the money that the Merger was entirely fair.

For more, see this post on the Delaware Corporate & Commercial Litigation Blog, which calls this opinion a “scholarly work of art.” Indeed, it’s worth a full read for its review of the principles of Delaware appraisal law and its discussion of the fair price dimension of the entire fairness standard.

– Meredith Ervine