Normally a judge will not get involved in the sale of the business as long as there was no fraud and there was fair dealing with the purchase. In May the Delaware Court of Chancery did something out of the ordinary in a decision with potentially broad implications for the future of corporate takeovers, according to the New York Times. The judge decided that the board of directors of Dell Inc. under priced the company by $6 billion when the formerly public company was taken private by a buyout group led by company founder Michael Dell in 2013 for $24.4 billion.
Vice Chancellor J. Travis Laster stated in his decision there had been no higher offer and the board “and its advisors did many praiseworthy things.” However he ruled that shareholders had been short changed and Dell had to pay the plaintiff shareholders their portion of the difference. The decision got Wall Street’s attention because Laster essentially decided the free market didn’t set the right price.
Under the decision a board of directors doesn’t just have a fiduciary duty to find a buyer willing to pay the highest price, but it needs to operate knowing that a judge may finally decide later what that price should have been. Not surprisingly the decision was applauded by shareholder advocates and it may spark future lawsuits involving other companies.
There are dangers of conflicts of interest and self-dealing when management buyouts take a public company private but in this case the decision found no wrongdoing by Dell or its board. Laster decided that based on the “fair price” of the company, incorporated in Delaware, it was simply sold for too little. This case is part of a growing trend where investors buy a company’s stock after a takeover bid has been made public planning to sue the company claiming the price was too low (known as appraisal arbitrage).
“The concept of fair value under Delaware law is not equivalent to the economic concept of fair market value,” he wrote. “Rather, the concept of fair value for purposes of Delaware’s appraisal statute is a largely judge-made creation…” Laster explained that a board’s actions “might pass muster for purposes of a breach of fiduciary claim and yet still generate a sub-optimal process for purposes of an appraisal.”
The rules concerning Delaware’s appraisal rights of “fair value” are designed to aid long-term investors who may end up getting burned by management self-dealing or other corporate misdeeds. Recently using the court system to set “fair value” has become a major strategy for investment funds and lawyers hoping for a quick profit.
The decision raises a number of questions. What’s the best way to decide a purchase price? If the highest offer is not deemed “fair” by a judge, assuming the auction is run competently, what is a “fair” price?
Like most court rulings there are potential benefits and costs, depending on where you stand. The ruling is likely to make it more difficult for boards of directors to complete buyouts.
- That might be good for shareholders who may lose out if the company goes private and finds ways to later do substantially better.
- The decision may also have a chilling effect since a judge, not the market, decides the final price. It might make the sale of the business much more complex, uncertain, time consuming and increase legal costs.
If you’re the shareholder of a company that has been purchased and your feel your rights have been violated and have suffered financially, or are part of management of a business being purchased or are buying another business, if you have questions or concerns about the process and how to protect your rights, contact our office so we can discuss what’s going on, how the law may apply and the best steps you should take moving forward.