Campbell, Iridium, and the Future of Valuation Litigation
Michael W. Schwartz and David C. Bryan, 67(4): 939 - 956 (August 2012)
Five years ago, two landmark federal court valuation decisions, Campbell and Iridium, held that market evidence—rather than the testimony of paid litigation experts—should be relied on to value corporations for purposes of litigation. While a number of decisions have followed Campbell and Iridium, their full potential to make business valuation litigation less costly and less susceptible to hindsight bias has yet to be realized.
Trademark Licensing in the Shadow of Bankruptcy
James M. Wilton and Andrew G. Devore, 68(3): 739-780 (July 2013)
When a business licenses a trademark, transactional lawyers regularly advise that if the trademark licensor files for bankruptcy, the licensee could be left without a right to use the mark and with only a bankruptcy claim for money damages against the licensor. Indeed, the ability of a trademark licensor to reject a trademark license and to limit a licensee’s remedies to a dischargeable claim for money damages has been a significant risk for licensees for twenty-five years based on the Fourth Circuit case, Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. This result is grounded in the Bankruptcy Code prohibition on remedies of specific performance for non-debtor parties to rejected contracts and is in accord with Bankruptcy Code policy of affording debtors an opportunity to reorganize free of burdensome contracts. In the summer of 2012, however, the Seventh Circuit, in its decision Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, held that a non-debtor trademark licensee retains rights to use licensed trademarks following rejection of the contract by the debtor-licensor. The decision, derived from a pre-Bankruptcy Code paradigm for understanding the rights of non-debtors under rejected executory contracts that convey interests in property, creates a circuit split over the implications of trademark license rejection. This article asserts that the Sunbeam Products case misconstrues the rights of a trademark licensee as a vested property right and is therefore incorrect under both the holding of the Lubrizol case and the pre-Bankruptcy Code paradigm on which the Sunbeam Products case relies.
Market Evidence, Expert Opinion, and the Adjudicated Value of Distressed Businesses
Robert J. Stark, Jack F. Williams, and Anders J. Maxwell, 68(4): 1039-1070 (August 2013)
One year ago, The Business Lawyer published an article arguing that courts, when adjudicating the value of distressed businesses, should predominantly defer to “market” evidence, rather than expert opinion. In Campbell, Iridium, and the Future of Valuation Litigation, authors Michael W. Schwartz and David C. Bryan contended that near-universal judicial deference to market data: (1) is supported by recent developments in the case law; (2) would obviate judicial “hindsight bias”; and (3) would enable a more efficient valuation process. Messrs. Schwartz and Bryan further argued that, to solidify the paradigm change, courts should start imposing a pretrial obligation on any litigant intending to present expert valuation opinion to move specially, under Federal Rule of Evidence 702(a), for allowance to do so. This article offers an opposing viewpoint and argues that Messrs. Schwartz and Bryan interpret applicable case law selectively, outside of a broader jurisprudential context, and in a manner that disregards deeply ingrained legal principles. The authors here further contend that: (a) Messrs. Schwartz and Bryan have not presented a compelling case of widespread judicial “hindsight bias”; (b) they have also failed to make a persuasive showing that their proposal will lead to meaningful process efficiencies; and (c) their thesis fails to appreciate the complexity of market dynamics. This article concludes that market evidence tends to require expert interpretation, especially when used to value troubled businesses.
A Further Comment on the Complexities of Market Evidence in Valuation Litigation
Gregory A. Horowitz, 68(4): 1071-1082 (August 2013)
This comment offers another view in the dialogue concerning the use of market evidence in valuation litigation initiated in these pages one year ago. In Campbell, Iridium, and the Future of Valuation Litigation, Michael Schwartz and David Bryan argued that an understanding of the importance of market evidence, and of costs and vagaries of a battle of valuation experts, should lead courts to adopt a rebuttable presumption against the admissibility of expert valuation testimony. Like Messrs. Stark, Williams, and Maxwell, whose views are forcefully advanced in a separate article here, I find this proposal ill-advised, but for somewhat different reasons. I agree with Messrs. Schwartz and Bryan that market evidence is central to any question of value, but argue that the market never speaks for itself, indeed never speaks with a voice capable of lay interpretation. By way of example, I present a “debt discount test” for determining whether the market deems an enterprise to be insolvent (the question at issue in both Campbell and Iridium) and show that, even while this test substantially simplifies the interpretation of market data, expert opinion is inevitably required in its application. The increasing recognition of the importance of contemporaneous market information will improve valuation litigation and narrow areas of good-faith dispute without the need for radical procedural limitations on the adversarial process.
Putting Stockholders First, Not the First-Filed Complaint
Leo E. Strine, Jr., Lawrence A. Hamermesh, and Matthew C. Jennejohn, 69(1): 1-78 (November 2013)
The prevalence of settlements in class and derivative litigation challenging mergers and acquisitions in which the only payment is to plaintiffs’ attorneys suggests potential systemic dysfunction arising from the increased frequency of parallel litigation in multiple state courts. After examining possible explanations for that dysfunction and the historical development of doctrines limiting parallel state court litigation—the doctrine of forum non conveniens and the “first-filed” doctrine—this article suggests that those doctrines should be revised to better address shareholder class and derivative litigation. Revisions to the doctrine of forum non conveniens should continue the historical trend, deemphasizing fortuitous and increasingly irrelevant geographic considerations, and should place greater emphasis on voluntary choice of law and the development of precedential guidance by the courts of the state responsible for supplying the chosen law. The “first-filed” rule should be replaced in shareholder representative litigation by meaningful consideration of affected parties’ interests and judicial efficiency.
Standing at the Singularity of the Effective Time: Reconfiguring Delaware’s Law of Standing Following Mergers and Acquisitions
S. Michael Sirkin; 69(2): 429-474 (February 2014)
This article examines the doctrine of standing as applied to mergers and acquisitions of Delaware corporations with pending derivative claims. Finding the existing framework of overlapping rules and exceptions both structurally and doctrinally unsound, this article proposes a novel reconfiguration under which Delaware courts would follow three black-letter rules: (1) stockholders of the target should have standing to sue target directors to challenge a merger directly on the basis that the board failed to achieve adequate value for derivative claims; (2) a merger should eliminate target stockholders’ derivative standing; and (3) stockholders xi of the acquiror as of the time a merger is announced should be deemed contemporaneous owners of claims acquired in the merger for purposes of derivative standing. Following these rules would restore order to the Delaware law of standing in the merger context and would advance the important public policies served by stockholder litigation in the Delaware courts.
The Evolving Role of Special Committees in M&A Transactions: Seeking Business Judgment Rule Protection in the Context of Controlling Shareholder Transactions and Other Corporate Transactions Involving Conflicts of Interest
Scott V. Simpson and Katherine Brody, 69(4): 1117-1146 (August 2014)
Special committees of independent, disinterested directors have been widely used by corporate boards to address conflicts of interests and reinforce directors’ satisfaction of their fiduciary duties in corporate transactions since the wave of increased M&A activity in the 1980’s. In 1988, The Business Lawyer published an article titled The Emerging Role of the Special Committee by one of this article’s co-authors, examining the emerging use of special committees of independent directors in transactions involving conflicts of interest. At that time, the Delaware courts had already begun to embrace the emergent and innovative mechanism for addressing corporate conflicts. Now, after over thirty years of scrutiny by the Delaware courts, it is clear that the special committee is a judicially recognized (and encouraged) way to address director conflicts of interest and mitigate litigation risk. This article will examine the role of the special committee in the context of conflict of interest transactions, with a particular focus on transactions involving a change of control or a controlling stockholder, from a U.S. perspective (in particular, under the laws of the State of Delaware), and will briefly consider international applications of the concepts discussed. To this end, this article will examine recent case law developments and compare the special committee processes at the heart of two high-profile Delaware decisions, and, finally, provide guidance to corporate practitioners on the successful implementation of a special committee process.
Massey Prize for Research in Law, Innovation, and Capital Markets Symposium—Foreword
70(2): 319-320 (Spring 2015)
Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.
As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.
As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.
As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.
Consequential Damages Redux: An Updated Study of the Ubiquitous and Problematic “Excluded Losses” Provision in Private Company Acquisition Agreements
Glenn D. West; 70(4): 971-1006 (Fall 2015)
An “excluded losses” provision is standard fare as an exception to the scope of indemnification otherwise available for the seller’s breach of representations and warranties in private company acquisition agreements. Sellers’ counsel defend these provisions on the basis of their being “market” and necessary to protect sellers from unreasonable and extraordinary post-closing indemnification claims by buyers. Buyers’ counsel accept such provisions either without much thought or on the basis that the deal dynamics are such that they have little choice but to accept these provisions, notwithstanding serious questions about whether such provisions effectively eviscerate the very benefits of the indemnification (with the negotiated caps and deductibles) otherwise bargained for by buyers. For buyers’ counsel who have given little thought to (or who need better responses to the insistent sellers’ counsel regarding) the potential impact of the exclusion from indemnifiable losses of “consequential” or “special” damages, “diminution in value,” “incidental” damages, “multiples of earnings,” “lost profits,” and the like, this article is intended to update and supplement (from a practitioner’s perspective) the legal scholarship on these various types of damages in the specific context of the indemnification provisions of private company acquisition agreements.
Appraisal Arbitrage—Is There a Delaware Advantage?
Gaurav Jetley and Xinyu Ji; 71(2): 427-458 (Spring 2016)
The article examines the extent to which economic incentives may have improved for appraisal arbitrageurs in recent years, which could help explain the observed increase in appraisal activity. We investigate three specific issues. First, we review the economic implications of allowing petitioners to seek appraisal on shares acquired after the record date. We conclude that appraisal arbitrageurs realize an economic benefit from their ability to delay investment for two reasons: (1) it enables arbitrageurs to use better information about the value of the target that may emerge after the record date to assess the potential payoff of bringing an appraisal claim and (2) it helps minimize arbitrageurs’ exposure to the risk of deal failure. Second, based on a review of the recent Delaware opinions in appraisal matters, as well as fairness opinions issued by targets’ financial advisors, we document that the Delaware Chancery Court seems to prefer a lower equity risk premium than bankers. Such a systematic difference in valuation input choices also works in favor of appraisal arbitrageurs. Finally, we benchmark the Delaware statutory interest rate and find that the statutory rate more than compensates appraisal petitioners for the time value of money or for any bond-like claim that they may have on either the target or the surviving entity.
Our findings suggest that, from a policy perspective, it may be useful to limit petitioners’ ability to seek appraisal to shares acquired before the record date. We also posit that, absent any finding of a flawed sales process, the actual transaction price may serve as a useful benchmark for fair value. We conjecture that, while the statutory interest rate may not be the main factor driving appraisal arbitrage, it does help improve the economics for arbitrageurs. Thus, the proposal by the Council of the Delaware Bar Association’s Corporation Law Section to limit the amount of interest paid by appraisal respondents—by allowing them to pay appraisal claimants a sum of money at the beginning of the appraisal action—seems like a practical way to address concerns regarding the statutory rate. However, paying appraisal claimants a portion of the target’s fair value up front is akin to funding claimants’ appraisal actions, which may end up encouraging appraisal arbitrage.