Recent Cases of Interest

October 22, 2008
Deer Creek Energy Ltd. v. Paulson & Co., Inc. and Wayne County Employees' Retirement System v. Corti et al.

Alberta judge holds market valuation soundest basis for deciding fair value of dissenters' shares; dissenters not permitted to take advantage of spike in market price after first stage of two-step transaction

Also rejects dissenters' claim for far higher valuation based on future possibilities, even though some of these had been touted by company in its marketing efforts

Deer Creek Energy Ltd. v. Paulson & Co., Inc.

Court of Queen's Bench (Alberta)
June 13, 2008 . 2008 ABQB 326
Romaine J.

In this long anticipated ruling, Madam Justice Romaine of Alberta's Court of Queen's Bench found that "market value" was the primary consideration in valuing the shares of dissenting shareholders of Deer Creek Energy Ltd., an ABCA corporation involved in an oil sands project near Fort McMurray, Alberta.


While promising, Deer Creek's project was still in its early stages when, on August 2, 2005, Total E&P Canada Ltd. announced a bid for the company's outstanding shares at $25 per share, a 39% premium over the trading price. The $25 bid was subsequently hiked to $31 when Total exercised its right of first refusal with respect to a competing offer in that amount by Shell Canada Ltd. All of this occurred after Total and Deer Creek had spent the first half of 2005 discussing the possibility of a joint venture or asset sale.

After extending its offer, Total took up and paid for the 82.4% of outstanding Deer Creek shares that had been tendered. The Deer Creek board, now made up of Total nominees, scheduled a special shareholder meeting for December 12, 2005 to approve a going-private transaction. At that meeting the majority of the minority voted to approve the transaction. Those that remained exercised their dissent and appraisal right under the ABCA rather than accept the $31 that had been offered, arguing that the shares were worth much more - at least $110 and perhaps as much as $200. Their argument was based on the company's future prospects (which had been touted to some extent by the company itself in marketing presentations).

Thus, the court was required to determine the fair value of their shares at the close of business on December 9, 2005. After a trial, a two-year wait, and 132 pages of detailed reasons, the answer turned out to be $31.

The board's process

Several significant process concerns were addressed in the reasons in response to the dissenters' complaint that the process adopted by the Deer Creek board was inadequate. Romaine J. accepted the testimony of a number of witnesses that negotiations between Deer Creek and Total had been vigorous. She also agreed that the Deer Creek board was within its rights to decide that no independent committee was needed: the CEO held a sufficient equity position to ensure that he would not be conflicted by his management role and the board had reasonably satisfied itself that two nominee directors representing the minority interest of a private equity firm were not under any pressure to accept a bid as a means of cashing out the firm's investment.

Romaine J. concluded that "Deer Creek engaged in a deliberate and organized process of considering alternatives for the future development of the [project]" and that its attempts to test the market were "more than adequate".  That the board was not outmanoeuvred in negotiations was shown by the fact that it negotiated a soft lock-up with fiduciary out (allowing for a post-market check) and a reasonable 3% break fee. It also got Total to cut its 90% tender requirement to 66 2/3%. In addition, the $31 price represented a premium of 72% on Deer Creek's prior trading price.

Business judgment in appraisal situations

Deer Creek argued that, in the absence of fraud, bad faith and self-dealing, the board's decisions about process and valuation should be deferred to under the "business judgment rule". Romaine J. noted the difficulty inherent in allowing a company to take recourse to the "rule" in a dissent situation. In her view, the rule should not be applied in such situations so as to add to the dissenter's burden of proof. In this case, however, the board's decision was the right one, even in hindsight, so the application of the business judgment rule was unnecessary.

Investor presentations

High on the list of the dissenters' complaints were presentations made by Deer Creek to potential investors and industry groups prior to the take-over bid. The presentations had sugges¬ted high potential values for the project, with minimal discounting of execution, financing or other forms of risk. The high valuations put forward by the dissenters were allegedly based on dividing the potential values discussed at these seminars by the number of shares outstanding.

Romaine J. rejected as "unrealistic and self-serving" the argument that the dissenters, who were highly sophisticated investors and arbitrageurs, had been misled by what in her view were industry-standard presentations relating to the potential of an early-stage development. She found that the presentations did not breach TSX disclosure rules and that the two fairness opinions supporting the $31 offer should have dispelled any doubt the shareholders had about the presentations' completeness. She also found as a matter of fact that at least some of the dissenters had clearly not relied on the valuation information communicated in the presentations.

Market valuation preferred

Under the ABCA, the court was required to come up with a "fair value" for the shares. The meaning of "fair" in this context is often disputed, of course. Here, Deer Creek preferred the market value method and the dissenters the discounted cash flow method. As Romaine J. noted, the duty of the court is to take everything that is relevant into account, so a combination of these methods (and possibly of other considerations) is another alternative.

That having been said, the court strongly preferred the market value approach in the circumstances. Three factors were considered: (i) whether there was an open and unrestricted market for Deer Creek shares, (ii) whether the board and management acted in a prudent and informed manner, and (iii) whether the fact that this was a two-step going-private transaction affected the validity of the market valuation approach.

Does it matter that this was a two-stage transaction?

The first two questions were quickly answered in the affirmative, while the third required more consideration. The argument was essentially that, during the period in which Total was a majority shareholder, Deer Creek's value increased (i.e. because it had a deep pockets backer with access to financing, top-flight management, etc., eliminating the "execution risk" that existed when the company was simply an unproven junior player).

Romaine J. held that where, as here, the intention to carry out a two-stage transaction is clear, dissenters cannot capitalize on a spike in value in the interim period between the two stages. While she could find no Canadian authority on the point, she referred to Delaware law which has treated the issue inconsistently. In Cede & Co. v. Technicolor, Inc., 684 A.2d 289 (Del. 1986), it was held that post-merger (but pre-squeeze-out) developments should be factored into the valuation. However, Romaine J. noted that cases such as Grimes v. Vitalink Communications Corp., [1997] WL 538676 (Del. Ch.) have distinguished Technicolor and in any event Delaware law must (in Romaine J.'s opinion) be applied with caution because dissent rights in that state's corporations statute do not apply as broadly as those of the ABCA and other similar Canadian statutes.

The 2001 Delaware ruling in Allenson v. Midway Airlines Corp., 789 A.2d 572 (Del. Ch. 2001) stated that the rule for the interim period is that there must have been, in Romaine J.'s words, "actual implementation of a new plan or activity" before the fair value would be affected by it. Here, Deer Creek had followed the same business plan before and after Total became the majority shareholder.

Finally, Romaine J. noted that under Canadian law (and probably under U.S. law as well), it is a general principle that "a dissenting shareholder cannot benefit from an increase in underlying share value created by a corporate transaction from which that shareholder dissented." This is particularly true in the case of a two-step transaction, a form of transaction that is widely recognized, in law and in the business community, as a "single complete change of control transaction."

Thus the fact that it was a two-stage transaction did not affect the validity of the market valuation approach. On the Allenson test described above, the second stage did not constitute the "actual implementation of a new plan" because it was clear from the beginning (and certainly should have been plain to investors as sophisticated as the dissenters) that Total was interested in a two-stage transaction.

Valuation methods

Romaine J. held that in general the discounted cash flow method of valuation tends to be less appropriate for early stage companies (and that it is less common in Canada than under Delaware law). She further held that the fact that virtually 100% of the long-term shareholder base of the company (as opposed to the dissenting arbitrageurs) tendered to the $31 offer constituted significant evidence that the shareholders received fair value. She also found that the net asset value approach, another alternative valuation method, supported the $31 figure.

No "expropriation premium"

One group of dissenting shareholders, who argued for a $200 share value, claimed that the court should include an "expropriation" or "forcible taking" premium. They relied on Domglas Inc. v. Jarislowski, Fraser & Co. (1980), 13 B.L.R. 135 (Que. S.C.), aff'd (1982), 22 B.L.R. 121 (Que. C.A.) for the proposition that such premiums are available, but Romaine J. held that Domglas has been rejected in numerous subsequent cases, notably LoCicero v. B.A.C.M. Industries Ltd., [1988] 1 S.C.R. 399 and Ford Motor Co. of Canada v. OMERS (2006), 12 B.L.R. (4th) 198 (Ont. C.A.).


In light of the board's diligent efforts to ensure shareholder value and the liquidity of the stock, and in light of the inappropriateness of discounted cash flow as a valuation method for an early-stage resource company, it was clear that the market price accepted by the vast majority of the shareholders under conditions in which there was ample information about the company was determinative of "fair value" for the purposes of the ABCA dissent provisions. That value was accordingly set at $31.

Delaware court won't stop shareholder meeting to approve merger from going ahead, holding that disclosure issues cited were not material

Unless unhappy shareholders make a really strong case, Delaware courts appear reluctant to issue injunctive relief against proposed transactions in a weak M&A market.


Wayne County Employees' Retirement System v. Corti et al.

Court of Chancery (Delaware)
July 1, 2008 . Civil Action No. 3534-CC
Chancellor Chandler

This ruling was part of what was essentially a battle over the popular "massively multiplayer" online role-playing game World of Warcraft. The plaintiffs were shareholders of Activision, Inc., whose board had recommended a merger with the Vivendi Games (VG) unit of the giant multinational Vivendi S.A. Among the affiliates of VG are well-known electronic gaming brands Sierra and Blizzard, the owner of World of Warcraft.

The deal

Under the deal, Vivendi S.A. would purchase new shares of Activision at $27.50 per share, would contribute Vivendi Games to the new "Activision Blizzard" entity (AB) and, upon closing, would commence a tender offer at the $27.50 price for up to 50% of the shares of the current Activision shareholders. This would give Vivendi a controlling interest in AB. The $27.50 price represented a 25% premium on the closing price the day before the announcement.

Shareholders seek to prevent vote on merger

The plaintiff shareholders were attempting to obtain an injunction that would prevent a July 8, 2008 shareholder meeting called to approve the transaction. They argued that the board had failed to disclose information material to the shareholders' decision about how to vote. Their complaint seems to have been based in suspicions that Activision's CEO and Co-Chairman had engineered an improvident deal to save their own jobs, an analysis confirmed (in their minds) by the failure of the board to reconsider the deal when the company's share price rose sharply (to $35/share in June 2008). But for the purposes of the injunction they sought, they based their argument entirely on disclosure issues.

The decision

Chancellor Chandler rejected their claim in its entirety, holding that the omissions complained of "would not significantly alter the mix of information that is already available in the nearly 300-page definitive proxy released by the Company." Thus there was little likelihood of success on the merits and no preliminary injunction.

Not every document seen by the board needs to be disclosed as "material"

The first of the shareholders' three specific disclosure complaints had to do with an April 29, 2008 meeting at which the Activision board decided to reaffirm its December 1, 2007 recom¬mendation of the deal. The shareholders argued that the board should have to disclose the VG internal projections on which it allegedly relied (ahead of the December 2007 fairness opinion from its financial advisor) in coming to this decision.

Chancellor Chandler rejected this argument, both on the ground that there was no evidence the board had relied on the VG internal projection or that the 2007 fairness opinion was in any way stale just seven months later. In Lewes v. Leaseway Transp. Corp., C.A. No. 8720, 1990 WL 67383 (Del. Ch. 1990), the Chancery had ruled that there is no "per se rule that such documents must be updated after a certain time". Moreover, even if the Activision board had looked at the VG internals, "not every document reviewed by the board is material". Finally, because the plaintiffs themselves had admitted that the VG internal projections were in line with those relied on for the 2007 fairness opinion, it could not meet the basic test of materiality under Delaware (and U.S. federal) law, i.e. that they would "significantly alter the total mix of information already provided" (Skeen v. Jo-Ann Stores, Inc., 750 A.2d 1170, 1174 (Del. 2000)). There is no requirement under Delaware law to "inundate" shareholders with information. (Arnold v. Society for Savings Bancorp, 650 A.2d 1270, 1280 (Del. 1994).

Board reaffirming earlier recommendation need not offer new justification

The second complaint was that the Activision board had omitted to disclose the reasons and bases for its continued recommendation. Chancellor Chandler held that it was enough to state that upon examination of the proposed transaction the board "determined that there was no need to change its December 1, 2007 recommendation."

"Fixed ratio" valuation issues

The plaintiffs' final complaint had to do with the parties' agreement to employ a fixed ratio to simplify the valuation process. In other words, the agreement deemed VG to have a value of 47.5% of that of Activision so that the mechanics of the transaction could be worked out to ensure that Vivendi ended up with the controlling interest it was paying for. When Activision had better than anticipated results for 2007, the original $24.75 price was renegotiated to the $27.50 figure mentioned above. The plaintiffs noted that because of the fixed ratio, this adjustment implied a $1 billion increase in the valuation of VG. They then argued, first, that this should have been mentioned in the proxy statement, and second, that the basis of the financial advisors' (and Activision management's) acceptance of the billion-dollar increase should have been disclosed.
Chancellor Chandler rejected both arguments, stating that while it might have been "helpful" to have disclosed the billion-dollar figure, there is no rule that everything helpful is material, particularly where, as in this case, "a middle school algebra student could plug in the numbers and determine precisely how the November 2007 increase in Activision's valuation affected the implied value of [VG]." As for the second and more serious issue, the Chancellor held as follows:

In an exchange utilizing a fixed valuation ratio, it is implicit that an increase in the valuation of one company will necessarily lead to a corresponding increase in the value of the other company.

Therefore, the fairness statement appended to the proxy statement, which disclosed the basis for adopting the fixed ratio in the first place, constituted acceptable disclosure. This was especially true here, where even the increased value of VG lay at the low end of a valuation range that had been prepared by the financial advisor. The increased valuation did not affect the "total mix" of information available to share¬holders.

Weak M&A market makes a difference

Perhaps the most noteworthy aspect of the ruling is Chancellor Chandler's stated reluctance to disrupt a deal and prevent shareholders from exercising "a potentially value-maximizing opportunity" in a "decidedly unstable market". Where an injunction is sought, a "particularly strong showing" that the plaintiff has a reasonable likelihood of success will be required in light of "current market conditions". He noted that no other bid had emerged in the interim despite the absence of any substantial deal protection mechanisms and that leading invest¬ment advisors have urged shareholders to vote in favour of the deal.

It is also worth noting that Chancellor Chandler rejected the argument that the CEO and Co-Chairman were simply protecting their own jobs, both on the basis of a lack of evidence for the claim and because they were also owners of 7.5% of Activision's stock, "thereby aligning their interests with those of the shareholders."

M&A as a massively multiplayer game?

We would be remiss not to mention the court's comparison of M&A to World of Warcraft:

In some ways, perhaps, the world of Mergers and Acquisitions is a massively multiplayer role playing game as well. Like in World of Warcraft and other games, the participants in the M&A field take on certain roles, interact in their own community, hone specialized skills, and even develop a unique, somewhat curious vernacular. One particular quest in the world of M&A is disclosure litigation..

In this case, despite the fact that "both sides have played the game well", Chancellor Chandler ended the proceedings by telling the plaintiffs that it was unfortunately "Game Over" for their quest.



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