Case #1:
Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. (April 2019)
THE SUPREME COURT OF DELAWARE REJECTED THE CHANCERY COURT’S DEPENDENCE ON THE 30-DAY AVERAGE UNAFFECTED STOCK PRICE IN DETERMINING FAIR VALUE AND ENDORSED DEAL-PRICE-MINUS-SYNERGIES AS THE FOUNDATIONAL METHOD IN DETERMINING FAIR VALUE OF ARUBA’S STOCK.
A valuation corresponding to an acquisition determined that the fair value of the shares for Dissenting Shareholders was $19.10 per share based on the deal price minus synergies method. The Chancery Court determined that the fair value of shares was $17.13 per share based on the 30-day average unaffected stock price. The Supreme Court of Delaware vacated this decision and reaffirmed that the deal price in an arm’s-length deal in an efficient market is the strongest indicator of the fair value of a company’s stock.
Two funds managed by Verition Fund Management (“Verition” or the “Dissenting Shareholders”) sought appraisal of the fair value of shares held in Aruba Networks, Inc. (“Aruba” or the “Company”) when the Company was acquired by Hewlett-Packard Company (“HP”).
Aruba’s business focused on wireless networking, with an emphasis on security and mobile devices. Four years after its IPO on the Nasdaq exchange in 2007, Aruba exceeded $1 billion in revenue and was growing rapidly. In early 2015, HP announced its intent to acquire Aruba for approximately $3 billion in an all-cash deal, or $24.67 per share. The 30-day average unaffected stock price of Aruba was $17.13 per share. Verition Fund Management, an appraisal arbitrage hedge fund, sought statutory appraisal for shares worth more than $56 million (valued at the deal price of $24.67 per share). Verition argued that, using a discounted cash flow analysis, their shares were worth $32.57 per share. Aruba initially valued their stock by subtracting anticipated synergies from the deal price, which came out to $19.10 per share. However, after the Supreme Court ruling in Dell and DFC, Aruba changed its methodology and argued that the 30-day average unaffected trading price of the shares was the best evidence of the company’s fair value. The Court of Chancery agreed and ruled the fair value of the Aruba shares was $17.13 per share. Verition appealed, and on review, the Supreme Court of Delaware ruled that the deal price minus synergies method was the best evidence to determine the fair value of Aruba’s stock and held that the fair value was $19.10 per share.
Deal-Price Minus Synergies
The Chancery Court argued that using the deal-price minus synergies approach fails to account for the additional value created by a merger in reduction of agency costs. It believed that in order to fully capture value realized by the transaction, it would need to account for both synergies and expected agency cost reductions to arrive at Aruba’s fair value. The Supreme Court disagreed, stating that there was no basis for concluding that reduced agency costs were not already incorporated in the calculated synergies.
Use of 30-Day Average Unaffected Share Price
The Chancery Court agreed with Aruba’s use of a 30-day average unaffected share price to be the best indication of its fair value. However, the Supreme Court disagreed, stating that although the unaffected stock price in an efficient market is an important indicator that should be given weight, stock price does not invariably reflect the company’s fair value in an appraisal. Further, the Chancery Court used a 30-day period prior to the transaction’s closing date, which in this case was several months prior due to the time lag between the transaction being announced and closed. The Supreme Court ruled that the stock price used was not reflective of Aruba’s developments subsequent to the news of the deal being released. The deal price also reflected that HP had access to material non-public information, which gave it an informational advantage over the market.
The ruling confirmed, like Dell and DFC, that when an efficient market or an arm’s-length deal generates evidence of a company’s fair value, that evidence must be given significant weight.
Case #2
In re Xura, Inc. Stockholder Litigation (December 2018)
THE DELAWARE COURT OF CHANCERY DECLINED TO DISMISS CLAIMS AGAINST XURA, INC.’s CEO FOR HIS ACTIONS IN NEGOTIATING THE SALE OF THE COMPANY. THE COURT REJECTED THE CEO’S CLAIM THAT HE SHOULD BE HELD TO THE DEFERENTIAL BUSINESS JUDGMENT RULE AND NOT THE HIGHER ENTIRE FAIRNESS STANDARD BECAUSE SHAREHOLDERS WERE NOT FULLY INFORMED ABOUT ASPECTS OF THE NEGOTIATIONS WHEN THEY APPROVED THE DEAL.
A valuation corresponding to an acquisition led to litigation against the former CEO of Xura, Inc. for breach of fiduciary duty. The Chancery Court concluded that the deferential business judgment rule did not apply under Corwin v. KKR Financial Holdings LLC because shareholders were not fully informed of certain aspects of the negotiations that took place when they approved the transaction. The Court also held that the Plaintiff pled a viable claim that the CEO favored his own interests over those of the shareholders and therefore may be personally liable for a breach of his duty of loyalty.
Obsidian Management LLC (“Obsidian” or the “Plaintiff”) sough appraisal of the fair value of shares held in Xura, Inc. (“Xura” or the “Company”) when the Company was acquired by an affiliate of Siris Capital Group (“Siris”).
During the discovery portion of the petition, Obsidian uncovered evidence that Xura’s former CEO, Philippe Tartavull, breached his fiduciary duties to Xura stockholders in the sale process leading up to the merger. Obsidian soon after initiated a petition of breach of fiduciary duty and aiding and abetting action against Tartavull and Siris.
In August 2016, an affiliate of Siris Capital Group, LLC and two co-investors acquired Xura for $25 per share in a transaction that was approved by Xura’s shareholders. Despite the board forming a strategic committee to evaluate and negotiate the deal, Xura’s CEO oversaw negotiations almost exclusively. The CEO did not keep the Xura board or the company’s financial advisor fully informed regarding developments (despite repeated requests from the financial advisor to do so) and defied the board’s requested negotiating strategy on at least one occasion. The nondisclosure agreement executed between Xura and Siris required Siris to communicate through the CEO and to obtain his permission before communicating with others, and the board reaffirmed this authorization. Siris did communicate almost exclusively through the CEO, even though Xura’s financial advisor made requests to Siris that communications go through the advisor.
The circumstances also suggested that the CEO tipped off one potential bidder regarding Siris’ offer for the company, leading the potential bidder not to make its own offer to acquire Xura, but instead to co-invest with Siris. Throughout the process, the CEO faced job uncertainty, with the board considering management changes if there was no deal and major shareholders openly questioning his performance. Siris, however, indicated its willingness to work with existing management (including the CEO). Further, after closing, the CEO negotiated a $25 million long-term incentive, although he never realized on this plan because he was terminated before its implementation. None of the issues surrounding the negotiations process were disclosed to shareholders voting on the transaction.
Shareholder Approval
In 2015 the Delaware Supreme Court case of Corwin v. KKR Financing Holdings held that a transaction that would be subject to enhanced scrutiny under Revlon would instead be reviewed under the deferential business judgment rule after it was approved by a majority of disinterested, fully informed and uncoerced stockholders. In addition to federal securities law requirements imposed on public companies, Delaware law requires disclosure of all material facts when stockholders are requested to vote on a merger. Corwin provides a strong incentive for companies to ensure full disclosure and as discussed below, based on the new case of In re Xura, Inc. Stockholder Litigation the failure to provide such disclosure may nullify the otherwise strong Corwin defense.
Following the Corwin decision, several Delaware courts enhanced the ruling, finding that the business judgment rule becomes irrebuttable if invoked as a result of a stockholder vote; Corwin is not limited to one-step mergers and thus also applies where a majority of shares tender into a two-step transaction; the ability of plaintiffs to pursue a “waste” claim is exceedingly difficult; even interested officers and directors can rely on the business judgement rule following Corwin doctrine stockholder approval; and if directors are protected under Corwin, aiding and abetting claims against their advisors will also be dismissed.
Once the business judgment rule is invoked, a shareholder generally only has a claim for waste, which is a difficult claim to prove. Corwin makes it difficult for plaintiffs to pursue post-closing claims (including those that would have nuisance value) because defendants will frequently be able to dismiss the complaint at the pleading stage based on the stockholder vote. It is thought that Corwin will help reduce M&A-based litigation which has become increasingly abusive over the years and imposes costs on companies, its stockholders and the marketplace.
Corwin should also be considered in conjunction with the Delaware Supreme Court’s 2014 decision in Cornerstone Therapeutics Inc. Shareholder Litigation in which the Supreme Court held that directors can seek dismissal even in an entire fairness case unless the plaintiff sufficiently alleges that those directors engaged in non-exculpated conduct (i.e., disloyal conduct or bad faith). Cornerstone generally allows an outside, independent director to be dismissed from litigation challenging an interested transaction unless the plaintiff alleges a breach of the duty of loyalty against that director individually. The Corwin case goes further by providing that if there is an informed stockholder vote, then directors who are interested or lack independence can obtain dismissal without having to defend the fairness of the transaction.
Although following Corwin a string of cases strengthened and expanded its doctrine, the recent (December 2018) case of In re Xura, Inc. Stockholder Litigation reminded the marketplace that in order for Corwin to provide its protections, the stockholder approval must be fully informed. In Xura the court found that the disclosures made by the CEO to the board of directors and shareholders and that ultimately were included in the company’s proxy statement were so deficient as to preclude a fully informed, uncoerced decision. The takeaway from Xura is that despite growing officer/director protections in an M&A transaction, process and disclosure remain the bedrock of any defense.
