Fair Value as Windfall? Not So Fast.

February 14, 2020

The Yukon Court of Appeal overturned the Supreme Court of Yukon’s reliance on a speculative discounted cash flow proxy for fair value in favour of the more commonly used market transaction price.  

  • The Yukon Court of Appeal (“YKCA”) released its reasons overturning the trial judgement of the Yukon Supreme Court on February 7, 2020.
  • As previously noted by the authors, the trial court’s undue emphasis on prior, otherwise rectified, governance flaws to justify the unsuitability of the transaction price as a proxy for fair value was problematic and ultimately determined to be in error.
  • The prior governance shortcomings supported the conclusion only that the fairness and reasonableness of the transaction had not been demonstrated, not that the transaction itself was actually unfair or unreasonable. As such, the transaction value borne of a flawed governance process could still be resurrected as a proxy for fair value to the extent the flaws were addressed, as they were.

A Brief Refresher

We refer readers to our previous summary of the judgements leading to the Yukon Court of Appeal’s decision.

By way of brief background, the central dispute dealt with the proper fair market valuation to be attributed to the acquisition of InterOil Corporation (“InterOil”) by Exxon. Exxon initially sought to acquire Interoil by way of plan of arrangement under the Yukon Business Corporations Act, for an approximate 30% premium, which consisted of a basic payment and a capped contingent payment (the “First Arrangement”). The First Arrangement was approved by over 80% of voting InterOil shareholders and subsequently approved by Chief Justice R.S. Veale of the Yukon Supreme Court. Following this approval, a group of dissenting shareholders successfully appealed to the YKCA to overturn and require a reassessment of the fair market valuation due to a number of governance and process concerns surrounding the valuation utilized for the First Arrangement.

Exxon successfully remedied these flaws and proposed a second arrangement (the “Second Arrangement”) which was approved by over 90% of InterOil’s shareholders. However, following the completion of the Second Arrangement, dissenting shareholders were successful in obtaining an order that the fair value for their securities should be set at 59% above Exxon’s successful offer.  The decision of the Yukon Supreme Court was rendered by Chief Justice R.S. Veale, the same judge as presided over the First Arrangement. 

Central to the Chief Justice’s decision was the argument that, as a result of the process flaws in the First Arrangement, the fair market value determination was prima facie unable to be based on the actual market transactions which took place. Instead, the Chief Justice adopted the dissenting shareholder’s discounted cash flow (“DCF”) methodology, despite a number of theoretical and evidentiary flaws which rendered the DCF valuation subject to potential error.

YKCA: Arm’s-length Market Value Remains Fundamental FMV Valuation Method

Given the significant value swing resulting from the fair value determination of the Supreme Court of Yukon, Exxon unsurprisingly appealed to the YKCA, where a unanimous panel determined that Chief Justice Veale had materially erred with respect to the application of the underlying principles of fair market valuation.

In overturning the lower court judgement, the YKCA noted two primary errors which permitted the YKCA to re-evaluate the factual record:

  • Insufficient weight was placed on the objective market evidence of value, which resulted in an inappropriate contest of experts as the primary determinate of InterOil’s en bloc fair market value; and
  • Chief Justice Veale misinterpreted key comments made by the YKCA in vitiating the First Arrangement.

Although these mistakes in principle were tied together, each is addressed in turn below.

The “insufficient weighting” error

The YKCA reaffirmed the primacy of objective market indicators of fair market value, and confirmed that in rectifying the procedural issues of the First Arrangement, the market’s objective evaluation of fair market value was most reliable, stating:

The transaction price reflects a negotiated price in a competitive market consisting of well-informed and sophisticated parties. There is no indication that any other process could have led to a higher price. All potential purchasers or partial investors were fully informed. There was no impediment to other potential purchasers outbidding Exxon. The deal price was at a substantial premium to the pre-deal stock price. The shares were widely traded and held by large and sophisticated investors, expert at assessing value, none of whom dissented. Share value was driven by an asset in the early stages of development, the future prospects of which were highly uncertain. Theoretical derivations of value were rife with uncertainty and speculation. Such assumptions were surely factored into the decision by institutional investors to accept the deal price.

As a result of this primacy, in reviewing the transaction record, the YKCA strongly dismissed the dissenting shareholder’s argument that to rely on the market evidence would eviscerate dissenting shareholder rights. Although the Court acknowledged that each case turns on its own facts, it found that in this case, there was compelling objective market evidence and other evidence of value that better reflected fair market value than theoretical assumptions.

The misinterpretation of the YKCA’s prior decision

Regarding the misinterpretation by Chief Justice Veale of the YKCA’s prior decision, the Court strongly clarified that its prior decision did not establish a principle that a flawed process preventing an assessment of fairness and reasonableness in relation to a transaction meant that the transaction itself could not be fair and reasonable. Furthermore, the YKCA also noted that in its prior decision, it had said nothing about the openness or competitiveness of the bidding and negotiations leading to the determination of the transaction price.  

Given that InterOil remedied these deficiencies in pursuing the Second Arrangement, Chief Justice Veale was required to grapple with the substantially different record in determining whether the original transaction price was objectively unfair. It was not open to the Honourable Justice to simply rely on the YKCA’s previous factual findings on a substantially different record to vitiate the market determination of fair market value.

The Result: Balance Returns to Fair Market Valuation

With this decision, the final chapter in the Exxon-InterOil saga may have been written. Thankfully, with the decision of the YKCA, the concepts applicable to, and the authority of, longstanding fair market valuation principles remain.

DISCLAIMER: This publication is intended to convey general information about legal issues and developments as of the indicated date. It does not constitute legal advice and must not be treated or relied on as such. Please read our full disclaimer at www.stikeman.com/legal-notice.

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