Thursday, May 28, 2015
Fair Process and Fair Price, Except When Fair Price Is Enough
Under Delaware law, with respect to a conflict of interest transaction, it is required that there be (a) a fair process and ultimately that (b) there be a fair price. This pair of requirements is referred to as the “entire fairness” test. The combination of procedural and substantive safeguards is intended to protect the interests of minority participants in the transaction. By way of example, if the 51% shareholder of a business corporation desires that the company undergo a merger in which the 49% shareholder will be cashed out, the fair process/fair price requirements should ensure that the minority shareholder receives the appropriate value for his or her shares. A recent decision from the Delaware Chancery Court considered the treatment of a situation in which the process was manifestly flawed from a prototypical “fair” process, but objectively a price that was more than a fair price was achieved. In re Nine Systems Corporation Shareholders Litigation, Consol. C.A. No. 3940-VCN, 2014 WL 4383127 (Del. Ch. Sept. 4, 2014).
The Court neatly summarized the challenge presented as follows:
The board decisions and stockholder actions at the heart of this lawsuit present one of the long-standing puzzles of Delaware corporate law: for a conflicted transaction reviewed by this Court under the entire fairness standard, “[t]o what else are shareholders entitled beyond a fair price?” The entire fairness standard of review has long mandated a dual inquiry into “fair dealing and fair price” that this Court should weigh as appropriate to reach a “unitary” conclusion on the entire fairness of the transaction at issue. Delaware courts have contemplated this issue before. What unites the resulting range of explications of this area of Delaware law is the principle that the entire fairness standard of review is principally contextual. That is, there is no bright-line rule on what is entirely fair.
Here, the Court concludes that a price that, based on the only reliable valuation methodologies, was more than fair does not ameliorate a process that was beyond unfair. At least doctrinally, stockholders may be entitled to more than merely a fair price, but the difficulty arises in quantifying the value of that additional entitlement. A more challenging question thus arises: what damages may stockholder plaintiffs receive where the transaction at issue was approved and implemented at a fair price? This memorandum opinion contemplates one practicable—and contextual—answer to that question. (Slip op. at 1 (footnotes omitted)).
In a subsequent decision, the Chancery Court would award $2,000,000 to the plaintiff’s attorneys. See In re Nine Systems Corporation Shareholders Litigation, C.A. No. 3940-VCN, 2015 WL 2265669 (Del. Ch. May 7, 2015). Admittedly, plaintiff’s counsel did request nearly $12,000,000.
My question is where this decision leaves the “entire fairness” test and it’s elements of fair process and fair price. In this instance, notwithstanding that the process was manifestly flawed, the plaintiffs were granted no relief because they had already been compensated in an amount higher than they would have been had the process been entirely fair. Does this mean that a “fair price” is, in effect, a defense to the failure to employ a “fair process”? Alternatively, are we now at the place where the entire fairness test is really one that looks to fair process for the purposes of dismissal on either a 12(b)(6) or summary judgment motion, but on the merits requires a demonstration of damages by the plaintiffs in order to recover on what had been the “fair price” element? But then what does that do to the requirement that, in a transaction subject to the entire fairness test, the defendant Board of Directors demonstrate a fair price? Is a burden being shifted? Again, is fair price a defense to flawed process?