Analysis & Opinion | Alison Frankel

Dela. Supreme Court upholds market price as proxy for value in appraisals

By Alison Frankel  |  February 12, 2015

Breaking news from the Delaware Supreme Court: Chief Justice Leo Strine does not like Beck, the indie musician who won the 2015 Grammy for best rock album. At oral arguments Wednesday in Huff Fund Investment Partnership’s appeal of the judgment in an appraisal action it brought against CKx – the company that, among other things, owns rights to the television show “American Idol” – Strine offered a very Strinian riff, referring obliquely to Kanye West’s antics when Beck accepted his Grammy award on Sunday night. “Beck is not an artist at all,” Strine said. “Beck has no talent.”

Now that that’s settled, let’s move on to the actual news, which is that on Thursday, the Delaware Supreme Court affirmed without an opinion the judgment Vice Chancellor Sam Glasscock of Delaware Chancery Court entered in the CKx appraisal case. Glasscock concluded in 2013 that the most reliable indicator of the fair value of CKx shares was the price that the private equity firm Apollo agreed to pay for the company after CKx tested the market and conducted an auction. By affirming Glasscock without adding to the discussion, the Supreme Court effectively confirmed that Chancery Court judges have the discretion to rely on market prices as a proxy for fair value in appraisal cases.

These actions – in which shareholders of an acquired company refuse to cash out their stock in the merger and call upon the court to set a fair price for their stake – are on the rise. In the burgeoning field of “appraisal arbitrage,” as I’ve reported recently, sophisticated investors bring valuation experts to court to argue that the fair value of the share price of an acquired company is higher than what the acquirer agreed to pay. If the judge agrees, the arbitrageur wins: The company has to pay it that higher per-share price. The risk for appraisal arbitrageurs, however, is that the judge will conclude the fair value of their shares is actually less than the acquisition price, which means they can be cashed out for less money than other investors were paid.

The key question, of course, is how the court reaches a determination of fair value. In his 2013 CKx opinion, Vice Chancellor Glasscock rejected the valuation models proposed by both Huff and CKx. He said their competing cash flow projections were unreliable and that he could not rely on transactions involving comparable companies because CKx’s assets are so unusual. (In addition to “American Idol” rights, which were up for renegotiation at the time of the Apollo deal, CKx’s assets include Elvis Presley Enterprises and Muhammad Ali Enterprises.) Glasscock also found that CKx had conducted a thorough and disinterested sales process. So without a better alternative, he said, “merger price must be the primary factor in determining fair value.” He ruled that Huff’s shares were worth the price Apollo agreed to pay.

On appeal, Huff’s lawyers at Lowenstein Sandler argued that the vice chancellor had “abdicated” his responsibility under the appraisal statute to reach an independent assessment of the intrinsic value of the company. “The appraisal remedy is illusory,” they wrote, “if the standard for ‘fair value’ applied by the Court of Chancery amounts to nothing more than deferring to the price to which negotiating parties agreed.” (They also argued that the sales process for CKx was flawed.)

CKx, represented by Paul Weiss Rifkind Wharton & Garrison, countered that Glasscock had done what the statute requires and weighed all of the valuation evidence presented at trial. “The Chancery Court did not defer to the merger price as the presumed fair value of CKx but rather concluded it was the most reliable indicia of fair value after carefully analyzing and rejecting several other valuation methods,” the company’s brief said. (Interestingly, both briefs asserted that the Delaware Supreme Court’s most recent opinion on determining fair value in an appraisal action, the 2010 decision in Golden Telecom v. Global GT, backed their position.)

It was obvious in Wednesday’s oral argument that Strine holds both the market and Chancery Court judges (though not Beck) in high regard. If a Chancery judge concludes the market had a robust opportunity to set a fair value on a company, he asked Huff counsel Lawrence Rolnick of Lowenstein, why should the court opt instead to rely on an expert’s valuation theory? “The best indicator of value is a market check,” Strine said. (If I seem to be harping on Strine’s comments, that’s because he utterly dominated the court’s questioning.)

The justices’ summary rejection of Huff’s appeal, Rolnick said in an interview Thursday, is a lost opportunity for the court to provide clarity. “We were looking for the Supreme Court to talk about the underlying economic rationale of fair value,” Rolnick said. “This winds up being a very narrow case.” Under this decision, he said, the deal price is only an proxy for fair value if there’s no alternative methodology to determine a fair price. (Glasscock actually used exactly that reasoning in a Jan. 30 decision in an appraisal action against Ancestry.com, holding that when neither side meets the burden of proving a more reasonable alternative, the most reliable indicator of value is the share price set at a well-run auction.)

My first instinct was that the Supreme Court order in the CKx case underlines the risk of appraisal litigation. Apollo completed its acquisition of CKx in 2011. Almost four years after Huff refused to cash out its shares, with all the trouble and expense of litigation, those shares have been determined to be worth exactly what Apollo paid other investors in 2011. Huff, in other words, lost its four-year bet that Apollo underpaid for CKx shares.

But then I remembered statutory interest, which came up in oral arguments in the Huff case on Wednesday. Under Delaware law, investors are entitled to 5.75 percent interest on the payouts they receive after appraisal actions. That’s such a nice return in these days of low interest rates that Huff refused to accept any money from CKx until the case was over, even when CKx offered to pay the entire judgment.

In fact, if you read the Supreme Court order in CKx as setting the market price as a floor in appraisal litigation, rather than a ceiling, the decision actually incentivizes appraisal arbitrage for big investors. If shareholders know judges will default to using market price as an indicator of fair value, their only risk in bringing an appraisal case is time and litigation costs. The upside, meanwhile, is that 5.75 percent interest – and the possibility that they will reap a bonanza if the judge agrees with their higher valuation. That’s a bet that a lot of appraisal arbitrageurs will take.

I left a message with CKx counsel Lewis Clayton of Paul Weiss but didn’t hear back.