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Huff Fund Investment Partnership v. CKx, Inc., C.A. No. 6844-VCG (Del Ch. May 19, 2014)

This decision, in essence, reaffirmed the Court of Chancery’s prior appraisal decision that the merger price was the correct number for the appraised value of the company. The court gave the parties the opportunity after its prior ruling to submit additional data, but the parties declined. Instead they reargued their positions without additional evidence. The net result is that the court upheld its prior holding to use the merger price for the appraised value for the reasons explained in its prior opinion highlighted on these pages here.

Laidler v. Hesco Bastion Environmental, Inc., C.A. No. 7561-VCG (Del. Ch. May 12, 2014).

This is an appraisal decision based on DGCL Section 262.  The challenge to the Court in this matter included the absence of management financial projections and somewhat unique characteristics of the company involved which had, in essence, one primary product.  The product was used to assist in containing flood waters and was therefore subject to the unpredictable number of natural disasters that might occur in the future.

The Court began its analysis with the fundamental principle that the Court may consider “proof of value by any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in Court.”

In this case, due to the lack of comparable transactions and comparable companies’ metrics, the Court determined that the appropriate valuation method should be the direct capitalization of cash flow method of valuation (“DCCF”).  The Court described how this method differed from the more common income approach of a discounted cashflow analysis (“DCF”).

The Court distinguished a recent Chancery opinion in which the merger price was adopted in the short form merger as the appraised value of the stock of the target company.  In this case, however, there was no arms’ length transaction as in the Chancery decision in Huff Fund Investment Partnership v. CKx Inc., C.A. No. 6844-VCG (Del. Ch. Nov. 1, 2013).

For those interested in the minutiae of the financial considerations addressed by the Court in the nature of terms more commonly used by valuation experts as compared to lawyers, see pages 33 to 40 for reference to tax rates and depreciation, cost of debt, size premium and industry risk premium.  For the reference by the Court to Weighted Average Cost of Capital calculation, pages 34 and 39 should be consulted.

Huff Fund Investment Partnership v. CKx, Inc., C.A. No. 6844-VCG (Del. Ch. Feb. 12, 2014).dollar_sign.jpg 

Why this case is noteworthy: The Court of Chancery addresses the issue of potential “rent-seekers” who may seek to benefit from the application of statutory interest on the amount the Court determines to be the value of stock in a statutory appraisal, and the limited ability of the respondent company (or the Court), to “toll” the accrual of that interest–even if the respondent company were to offer payment pending post-trial motions and prior to a final settlement.

This pithy Court of Chancery letter ruling addresses the public policy behind the legal rate of interest that applies in statutory appraisal proceedings, to the value of stock determined by the Court, based on DGCL Section 262(h). The Court explained that Section 262(h) expresses the General Assembly’s determination that the:

… appropriate way to compensate appraisal petitioners for their lost investment opportunity, and to prevent the respondent corporation from being unjustly enriched by the use of petitioner’s capital … is to award them interest in the amount of five percent over the Federal Reserve discount rate through the payment of a final judgment.

The statute gives the Court very limited discretion to deviate from the application of that rate, absent unusual circumstances not present in this case. Prior Chancery decisions that provide background facts in this case (involving the popular American Idol TV show), were highlighted on these pages.

The Court’s discussion arose in the context of its rejection of the equivalent of an “offer of judgment” to pay the petitioner pursuant to the court’s prior appraisal ruling (which is the subject of pending motions) in order to “stay” the accrual of interest while pending motions are being considered by the court. The statute did not give the Court that type of discretion based on the facts of this case–in addition to the reality that the Court of Chancery does not have the equivalent of Rule 68 of the Superior Court which allows a party to limit the adverse effects of a final judgment. That option is not available, as a matter of right, in the Court of Chancery.

Huff Fund Investment Partnership v. CKx, Inc., C.A. No. 6844-VCG (Del. Ch. Nov. 1, 2013).

This opinion addresses the statutory appraisal remedy and the method used to determine “fair value” which is not the same as “fair market value”, in part because Delaware law does not include the synergies expected from merger as part of “fair value”. This opinion also addresses the admonition in the Delaware cases that the actual merger price, even if the result of a fair procedure, is not necessarily the presumptive upper limit of fair value–however, this opinion did conclude that the merger price was the correct appraised value for purposes of this appraisal action.

Professor Larry Hamermesh provides erudite insights on this decision.

Huff Fund Inv. P’ship v. CKx Inc., C. A. No. 6844-VCG (Del. Ch.) (August 15, 2012).

Issue Presented:

In this appraisal action, is the relevance of the financial information of Fox Broadcasting, a non¬party to the litigation and the merger, regarding American Idol outweighed by the potential harm the disclosure of that information would cause for future contract negotiations?

Short Answer: Yes. The Court found that the marginal relevance of the internal Fox information is outweighed by the potential harm the disclosure of that information would cause Fox and the presence of non-confidential, more probative information already in the record.

Background:

In an appraisal action arising out of the merger between CKx and an affiliate of Apollo Global Management, LLC, Petitioners moved to enforce a subpoena issued to a non-party, Fox Broadcasting Company.  Fox has an existing agreement with a subsidiary of CKx, 19TV Limited, for the right to broadcast the American Idol television program, which provided substantial revenues to CKx before the Merger. The Petitioners wanted information related to American Idol, Fox’s contracts and contract negotiations with 19TV and FremantleMedia North American, and the merger. In particular, one request would require Fox to produce documents relating to Fox’s internal valuation and financial information regarding its negotiations with CKx in connection with an agreement to broadcast American Idol.

Parties Positions:

In opposing the subpoena, Fox argued that: (i) this information is of minimal relevance to an objective valuation of CKx’s stock given that the parties already know the actual, negotiated contract price (because it was executed in January 2012); (ii) the internal information is highly confidential and its disclosure would be harmful to Fox in future business dealings; and (iii) the requested information is overly broad and that its production would impose a significant expense on Fox, a burden particularly unjustifiable given Fox’s non-party status.

In support of the subpoena, the Petitioners argued that: (i) the amount Fox was subjectively willing to pay for American Idol broadcast rights is relevant to a valuation of CKx, as American Idol provided CKx with its largest source of revenue; (ii) confidentiality concerns can be addressed with a modification to the existing confidentiality order; and (iii) the potential burden on Fox is justifiable given that the requested information cannot be obtained from any other source.

Analysis:

The only litigable issue in an appraisal action is the value of the petitioner’s shares on the date of the merger. Weighing in favor of disclosure, the Court noted that there was some marginal relevance in the value Fox assigned to the contract. The Court noted that the value of the Petitioners’ shares on the date of the merger is dependent in part on the value of CKx’s rights in American Idol.  The Court went on to note that CKx’s and Fox’s subjective valuations—i.e., how much Fox was willing to pay and how much CKx was willing to take—would seem to establish a range within which an objective valuation might be located.  Weighing against the disclosure, the Court stated that in addition to the substantial expense Fox would incur in production, there is the potential harm the disclosure of that information would cause to Fox in future negotiations with CKx over American Idol broadcast rights if CKx were to learn precisely how Fox valued those rights in the past.  Moreover, the ability of a confidentiality order to prevent such harm is doubtful. CKx would have difficulty responding to the Petitioners’ arguments and characterizations regarding Fox’s valuations and internal information without access to the information itself.  Finally, the Court stated that superior information already exists regarding the objective value of CKx’s rights in American Idol—the actual agreement CKx reached with Fox in January 2012.

Motion to enforce subpoena denied.

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.              

The full Delaware Supreme Court recently reversed the dismissal of a shareholder challenge to a private equity consortium’s acquisition of Inovalon HoldingsInc. after finding the cloud-based healthcare industry support provider’s directors did not fully reveal to investors the conflicted roles of the deal’s financial advisors, as the high court’s seminal MFW ruling requires, in City of Sarasota Firefighters Pension Fund et al. v. Inovalon Holdings Inc., Del. Supr., No. 305, 2023 (May 1, 2024).

The justices unanimously reversed the Court of Chancery’s decision that the transaction met the standard Khan v. M & F Worldwide Corp. 88 A.3d 635 (Del. 2014) demands of controller-dominated deals to qualify for review under the defendant-friendly business judgment standard. The high court said MFW required Inovalon’s special committee of directors that negotiated the merger terms to reveal the full extent of their financial advisors’ involvement with counterparties in this transaction.  Without that information, the Inovalon minority shareholders could not cast the informed merger vote that would justify business judgment review and dismissal of the suit, Justice Karen Valihura wrote.

The decision marked the second time in as many months that the high court overturned a Chancery Court merger ruling on grounds that, the justices found, too little was required of the challenged deal’s proponents under MFW.  In the case styled In re Match Group Inc. Derivative Litigation, Del. Supr., No. 368, 2022 (April 4, 2024), Chancery had allowed an asset reshuffle that allegedly dealt less value and more debt to pension fund investors compared to IAC insiders. The high court said, in a controller-dominated deal, all the directors of the negotiating committee—not just a majority—had to be independent to avoid review under the exacting entire fairness standard.

Background

Three pension funds challenged the Nordic-led acquisition of Inovalon claiming it was a controller transaction that failed to qualify for protection under MFW because the deal did not have the benefit of a fully independent review committee from the outset and did not get a completely informed approval vote from a majority of the minority shareholders.

The suit claimed that Inovalon CEO Kieth Dunleavy and director Andre Hoffmann controlled a majority of Inovalon’s stock through multiple vote shares but did not establish a functioning, fully-independent negotiating committee from the outset of bidding. And it charged that the minority knew only part of the conflicts involving Inovalon’s investment banker financial advisors.

The trial court ruling

In a bench ruling, the Chancery Court dismissed, finding that the deal and disclosures about it to investors met MFW’s requirements. Concerning the ab initio requirement for the special committee, it found that the alleged conflicts did not arise until Nordic “formally requested that Dunleavy participate in an equity rollover as part of its written offer on July 21, 2021,” which marked the official beginning of the negotiations.   The trial court found that the conflicted roles of the advisors was adequately revealed.

The appeal ruling

On appeal, the high court focused on the plaintiffs’ contention that “judicial cleansing under the MFW framework is unavailable because the Proxy omitted material information that rendered the minority stockholders’ vote to approve the Transaction uninformed.”  The full court agreed.

The justices noted that MFW requires of controller buyouts that the business judgment standard of review will be applied “if and only if:”

(i)     the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;

(ii)    the Special Committee is independent;

(iii)   the Special Committee is empowered to freely select its own advisors and to say no definitively;

(iv)    the Special Committee meets its duty of care in negotiating a fair price;

(v)     the vote of the minority is informed; and

(vi)    there is no coercion of the minority.

Full disclosure required

The high court said, “the trial court’s due care analysis concerning the retention and management of the advisors did not sufficiently address all of the disclosure issues and “Delaware courts have required full disclosure of investment banker compensation and potential conflicts.”

Conclusion

It was not enough to simply disclose to investors that the advisors might have received fees from counterparties to the transaction, the high court  said, because, “when a board chooses to disclose a course of events or to discuss a specific subject, it has long been understood that it cannot do so in a materially misleading way, by disclosing only part of the story, and leaving the reader with a distorted impression.” Rather, “[d]isclosures must provide a balanced, truthful account of all matters they disclose.”

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The full Delaware Supreme Court recently revived part of an investor challenge to IAC/InterActive Corp’s spinoff of its internet dating subsidiary after finding that the deal that controller IAC imposed on minority shareholders did not meet the exacting standards of the high court’s seminal MFW ruling, in In re Match Group Inc. Derivative Litigation, Del. Supr., No. 368, 2022 (April 4, 2024).

The en banc high court partially reversed a Court of Chancery decision that the derivative suit must be dismissed because IAC met the requirements of independence set by the milestone opinion in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014).  The asset reshuffle allegedly dealt less value and more debt to pension fund investors compared to IAC insiders.  MFW famously said a controller-engineered deal could get business judgment protection if the negotiating committee was independent and disinterested–and the properly-disclosed transaction was endorsed by a majority of the minority shareholders.

The ruling’s importance

But the pivotal issue in this high court appeal concerned the proper standard to determine whether this unique corporate transaction was the product of fully independent, disinterested fiduciaries.  At one extreme, in the case of a freeze-out merger–where the corporate machinery is allegedly used to deprive investors of their shares and/or voting rights–all deal negotiators must be completely independent and disinterested. The high court said the key question in the appeal was: since the Match spinoff did not involve a freeze-out, could the IAC defendants qualify for the protection of the deferential business judgement standard even though one of three deal negotiators was not independent? 

The Court of Chancery said “yes”, agreeing with defendants that a majority of independent directors was enough to trigger the business judgment standard.  The high court said, ‘no“  and reversed. “If the controlling stockholder wants to secure the benefits of business judgment review, it must follow all MFW’s requirements,” the justices said.  In the MFW setting, to replicate arm’s length bargaining, all separation committee members must be independent of the controlling stockholder.

 Background

 The challenged 2020 transaction involved the creation of two new corporations out of the former IAC and Match.com businesses and a reshuffling of the assets and liabilities of those two entities that was engineered by a “separation committee” composed of three IAC directors.  The old Match was later dissolved into the new ICA.

Three pension funds that owned that eliminated stock sued alleging that the separation was a conflicted transaction in which Old IAC, as Old Match’s controlling stockholder, stood on both sides of the transaction. The plaintiffs claimed that Old IAC obtained significant “non-ratable” benefits in the Separation to the detriment of Match and its minority stockholders, and argued that the Separation Committee was conflicted and the proxy disclosures misled the Old Match minority stockholders.

The trial court ruling

Although the Court of Chancery found that the plaintiffs successfully pleaded facts creating a reasonable inference that one director was not independent of Old IAC, it ruled that a plaintiff must nonetheless show that “either (i) 50% or more of the special committee was not disinterested and independent,” or “(ii) the minority of the special committee ‘somehow infect[ed]’ or ‘dominate[ed]’ the special committee’s decision-making process.“  Finding that plaintiffs failed to do that, the vice chancellor dismissed.

The appellate ruling

Defendants argued that the vice chancellor correctly applied a less exacting standard than the one used in MFW and other freeze-out merger cases.  But the Supreme Court  said, in those key cases, “the common thread running through our decisions: a heightened concern for self- dealing when a controlling stockholder stands on both sides of a transaction.’”

In addition, the high court noted that, longstanding business affiliations, particularly those based on mutual respect, are of the sort that can undermine a director’s independence. Directors who owe their success to another will conceivably feel as though they owe a “debt of gratitude” to the individual. The plaintiffs have adequately pleaded that Director Thomas McInerney may have such a relationship with IAC.

The justices said, a controlling stockholder’s influence is not “disabled” when the special committee is staffed with members loyal to the controlling stockholder. “We stated in MFW that the special committee must be independent, not that only a majority of the committee must be independent,” the high court said’,  “A special committee created to secure the protections of MFW should function “in a manner which indicates that the controlling stockholder did not dictate the terms of the transaction and that the committee exercised real bargaining power at an arm’s length.

The unanimous Supreme Court reversed the dismissal, finding the plaintiffs’ claims of an unfair deal by non-independent directors are supported by the facts that:

1) the minority stockholders received a slightly higher percentage of ownership of New Match;

(2) Old Match was capitalized in a vastly different way, with limited cash, much higher debt, and restrictive governance provisions; and

(3) the boards were different

Supplement: One of Delaware’s favorite corporate law scholars, Professor Stephen Bainbridge, provides additional insights about this case on his eponymous blog here and here.

An Eckert Seamans associate prepared this overview.

A recent Chancery opinion held that stockholder approval and the business judgment rule barred fiduciary duty claims against a board that dissolved the company. The Huff Energy Fund, L.P. v. Gershen, C.A. No. 11116-VCS (Del. Ch. Sept. 29, 2016)

Background: The Delaware Court of Chancery recently dismissed a stockholder’s breach of contract and fiduciary claims against a dissolving company. This action stems from Defendant Longview Energy Company’s (“Longview”) decision to dissolve Longview after the company sold a significant portion of its assets.  Plaintiff, The Huff Energy Fund (“Huff”), was the largest Longview stockholder, holding approximately 40% of Longview’s common stock. Huff brought suit to challenge the dissolution.

A Shareholders Agreement (the “Agreement”) between Huff and Longview required a unanimous vote of the Board for any act having “a material adverse effect on the rights of [Longview’s stockholders], as set forth in” the Agreement. The Agreement also provided Longview with the right of first offer if Huff were to transfer any shares, and provided that the company would continue to exist and remain in good standing under the law.

The sale and dissolution plan at issue was approved by the Longview Board and shareholders, over the abstention of one Huff board designee.

Huff’s Allegations: Huff alleged that Longview breached the Agreement because the dissolution had “a material adverse effect” on its right to transfer its Longview stock to Longview. Accordingly, Huff alleged that the Board’s decision was subject to the unanimity requirement. Additionally, Huff asserted that dissolution violated the obligation to “continue to exist.” Finally, Huff brought a fiduciary claim against the Board for adopting the dissolution plan without exploring more favorable alternatives in violation of Revlon, and as an unreasonable response to a perceived threat in violation of Unocal.

Court’s Analysis: The court first held that the individual Board defendants could not be liable for breach of contract because they signed the Agreement as company representatives, and not in their individual capacities. Additionally, Huff failed to adequately plead a tortious interference claim, as the allegations were improperly raised for the first time in briefing.

Next, the Court held that Huff failed to plead breach of contract against the Board. Huff argued that the unanimity requirement applied to any act effecting any right referenced in the contract. However, the Court found that Huff’s interpretation contradicted common sense. Huff’s interpretation would unreasonably subject all extra-contractual “rights” to the unanimity requirement, solely because they were referenced in relation to another right actually created by the Agreement. Therefore, because the Agreement did not create a “right of transferability” for Huff, but instead allowed Longview the right of first offer, the Court rejected Huff’s argument that the dissolution vote violated the Agreement.

The Court also found that dissolution itself did not breach the Agreement’s provision requiring Longview to “continue to exist and [] remain in good standing under [the law].” The provision was merely a commitment to remain in good standing as a Delaware corporation, and not a “commitment to exist ‘come what may,’” as Huff asserted. Huff’s interpretation was also unreasonable in light of other contract provisions referencing a potential merger or sale.

Next, the Court found that there was no fiduciary violation in approving the transaction. Huff failed to plead that the Board was not disinterested and independent. That the dissolution plan provided severance pay to certain directors, that some members had personal friendships, and that one member acted with alleged “animosity” towards Huff did not indicate that the Board was “interested” in the transaction to a degree that would rebut the business judgment rule. Regardless, despite Huff’s allegations toward individual Board members, Huff failed to plead that a majority of the Board that approved the transaction were not independent. Thus, entire fairness did not apply.

The Court next turned to Huff’s Revlon and Unocal arguments. Revlon did not apply because the applicable policy concerns were absent. Specifically, the adoption of the plan did not constitute a “final stage” transaction or effect a “change of control.” Similarly, Unocal did not apply. The Court noted that Huff “cite[d] no cases…indicating either that (1) the adoption or filing of a certificate of dissolution or (2) the board’s ‘perception’ that a shareholder posed a threat to any individual director’s ‘power’ over the corporation implicates the ‘omnipresent specter’ lingering in those instances where Unocal scrutiny has been invoked.”

Conclusion

Therefore, the Court held that Huff failed to plead any contractual breach or fiduciary violations. The Court also noted the significance of the shareholder vote in addition to Board approval. Even if enhanced scrutiny applied, “the Longview stockholders’ [informed] approval cleansed the transaction thereby irrebuttably reinstating the business judgment rule.” Accordingly, the Court invoked the business judgment rule and dismissed Huff’s complaint in its entirety.