On January 14, 2011, the Court of Chancery issued a post-trial decision in the case of In Re: John Q. Hammons Hotels Inc. Shareholder Litigation, C.A. No. 758-CC (Jan. 14, 2011), addressing the issues concerning: (i) whether John Q. Hammons, JQH’s controlling shareholder, breached any fiduciary duty in connection with the merger and (ii) whether the third-party acquirers aided and abetted any breach of fiduciary duty. Read opinion here.
In the end, the Court concluded that: (i) the merger price of $24 per share was entirely fair, (ii) the process that led to the transaction was fair; (iii) Hammons breached no fiduciary duty; and (iv) as a result of no breach of fiduciary duty, plaintiffs’ claim for aiding and abetting against the third-party acquirers must fail.
This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.
Standard of Review– Entire Fairness or Business Judgment
In the Court’s September 2009 decision on summary judgment, the Court determined that entire fairness would be the standard of review applicable to the merger. See, In re John Q. Hammons Hotels Inc. S’holder Litig., 2009 WL 3165613 (Del. Ch. Oct. 2, 2009). See blog summary of that decision here. The Court based its determination in part on plaintiffs’ allegation that Hammons used his controlling position to divert merger consideration disproportionately to himself. However, at trial the plaintiffs presented no evidence to support this assertion. Based on that lack of evidence, the Court noted: “[w]hile the JQH board (a majority of whom are concededly independent and disinterested) may actually have been entitled to business judgment rule protection, I have nonetheless applied the more exacting entire fairness standard of review because defendants easily satisfy it.”
Under the entire fairness test, the defendants must show fair dealing (which addresses the timing and structure of negotiations as well as the method of approval of the transaction) and fair price. While the “initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction,” the Court here said that “plaintiffs bear the ultimate burden to show the transaction was unfair given the undisputed evidence that the transaction was approved by an independent and disinterested special committee of directors.”
In discussing the negotiations and approval of the transaction, the plaintiffs argued that that “the Special Committee was ‘coerced’ into accepting [the bidder’s] offer to avoid ‘worse outcomes’ that the minority stockholders might face.” The Court disagreed find that that “no credible evidence was introduced at trial demonstrating improper self-dealing by Hammons or illicit ‘strong-arming’ type conduct that would have coerced the Special Committee or the stockholders into supporting the [m]erger.” The Court also found that the transaction was entirely fair based on the fact that the Special Committee: (i) was independent and disinterested; (ii) was highly qualified and experienced; (iii) understood their authority and duty to reject any offer that was not fair to the minority stockholders; and (iv) were thorough, deliberate, and negotiated at arm’s length to achieve the best deal available for the minority stockholders.
Fair Price — Battle of the Valuation Experts
The plaintiffs’ expert used the discounted cash flow (“DCF”) analysis and at the outset the Court acknowledged that “this Court has recognized that ‘the DCF valuation has featured prominently in this Court because it is the approach that merits the greatest confidence within the financial community.’” The plaintiffs’ expert also used a comparable companies’ analysis and a comparable transactions analysis to conclude that the fair value of the common stock on the date of the merger was $49 per share which is twice the merger consideration of $24 per share. The $24 price (which represented a more than 300% premium to the unaffected stock price) was the result of a competitive nine-month process in which the Special Committee negotiated between two bidders (Barceló and Eilian) and pushed the bids from $13 up to $24 per share.
The plaintiffs’ expert relied on management’s projections in performing his DCF analysis which is permissible as long as the projections are reliable. As a general matter, projections made in the ordinary course of business are considered to be reliable. However, in this case, the plaintiffs failed to show that management’s projections were created in the ordinary course of business. In addition, the expert performed no independent analysis of the assumptions underlying management’s projections. In addition to unrealistic assumptions, the Court found fault with the expert’s methodology in implementing his DCF analysis. In the comparable companies approach, the Court noted that to be a reliable indicator of value, the companies selected must be comparable to the company being valued. However, in this case, the companies selected by the plaintiffs’ expert differed significantly from JQH. Finally, the Court noted that the plaintiffs’ expert offered no analysis with respect to the consideration Hammons received in the merger.
The defendants’ expert also used a DCF analysis but his analysis used a capital cash flow approach, which the Court noted was “particularly appropriate for valuing companies like JQH where the leverage ratios are expected to change over time.” However, the defendants’ expert did not use a comparable companies’ analysis because he concluded that was not a reliable basis for estimating the value of JQH because of a lack of comparable companies. The defendants’ expert concluded that the value of the shares at the date of the merger ranged from $14.97 to $18.71 per share. The defendants’ expert also analyzed certain aspects of the consideration received by Hammons and concluded that the total amount of consideration Hammons received was less than $15.80 per share. Because the plaintiffs’ expert did not value Hammons’ consideration, the Court accepted the valuation of the defendants’ expert.
Approval by Minority Stockholders
While it was undisputed that the minority stockholders “overwhelmingly supported” the transaction, the plaintiffs argued that the minority stockholders support could not be considered because they were not fully informed. They alleged that the directors failed to disclose that: (i) an employee of the Special Committee’s financial advisor had contacted one of the bidders about the possibility of underwriting a security offering planned by the bidder for after the merger: (ii) the Special Committee’s legal advisor also represented an entity providing financing for one of the bidders with respect to the drafting and negotiation of the line of credit provided to Hammons; and (iii) at a November 2004 presentation by one of the bidders to the Special Committee, the bidder estimated that JQH could be worth $35.37 to $43.01 per share.
The Court concluded that each of the plaintiffs’ alleged disclosure claims involved facts or circumstances immaterial to the stockholders’ decision to vote on the merger and was not required to be disclosed under Delaware law. As to the potential offering after the merger, none of the directors were aware of the contact and under Delaware law there is no obligation to disclose facts that the directors are not aware of. As to the Special Committee’s legal advisor, the plaintiffs presented no evidence that this other representation had any affect on the legal advice given to the Special Committee or had any affect on the Special Committee’s decision to approve the merger. Finally with respect to the November 2004 presentation, the Court found that it was not necessary for the directors to disclose this information since the estimated value at that presentation was based on a hypothetical scenario.
Based on all of the above, the Court concluded that the plaintiffs had failed to show that the transaction was unfair and “[e]ven if the burden of proof had not shifted to the plaintiffs, [the Court] would find defendants had demonstrated the fairness of both the process and the price.”
No Breach of Fiduciary Duty; No Aiding and Abetting
In assessing Hammons’ conduct with respect to the plaintiffs claim for breach of fiduciary duty, the Court found no breach of fiduciary duty for the following reasons: (i) Hammons did not participate in the approval of the Merger as a director of JQH, and he did not participate in the Special Committee process; (ii) he did not stand on both sides of the Merger; (iii) he did not make an offer as a controlling stockholder; (iv) he did not engage in any conduct that adversely affected the merger consideration obtained by JQH’s minority stockholders; (v) there was no evidence to support any finding that Hammons used his influence to “divert” any of the merger consideration from the minority stockholders to himself; and (vi) the merger consideration Hammons received was worth less per share than the merger consideration JQH’s minority stockholders received. Finally, having found that neither Hammons nor the JQH board members breached a fiduciary duty, the Court noted that the plaintiffs’ claim of aiding and abetting must fail.