Measuring Valuation Damages for Breach of Fiduciary Duty Claims in Shareholder Disputes During the COVID-19 Pandemic

Degree of Precision in Selecting the Valuation Date

Generally, business valuation is forward-looking and a function of expected cash flows, risk, and growth. Furthermore, the date of value for damage measurement is usually predetermined by the contract, legal counsel, or the company. Business valuation professionals do not select the valuation date.

In the United States, the first mandatory work-from-home directives of the COVID-19 pandemic began in the third week of March 2020. During the pandemic, increased fluctuations occurred in financial results, financial forecasts, pricing multiples, and volumes of acquisitions for both private and public companies.

Since December 31, 2019, the prices of many public stocks and the expectations of many businesses have each varied. In fact, between February 19, 2020, and March 23, 2020, the S&P 500 Stock Index suffered one of its largest percentage declines in history (34 percent), and oil prices collapsed, before eventually starting to recover.

In addition, the pandemic has caused increased variability in financial results (illustrated by the last 12 months’ EBITDA, earnings before interest, depreciation, and taxes), forward-looking financial forecasts, and pricing multiples.

Furthermore, acquisition activity also declined during this period. From July 2019 through March 31, 2020, the average monthly total of announced merger and acquisition transactions in the United States was about $105 billion but declined sharply below that average in March 2020 through June 2020 before recovering later in 2020.

Interestingly, the number of transactions and degree of impact from the pandemic varied among different industry sectors.

As can be seen in the charts above, selection of the valuation date can significantly affect the then available financial results, relevant forecasts, and components of a quantified valuation multiple. Therefore, when the situation changes as rapidly as it has during the pandemic, the impact on valuation damages on the degree of precision of the selected valuation date may be significant.

Adequacy of the Financial Forecast

In evaluating business valuation damages for breach of fiduciary valuation claims in shareholder litigation, the discounted cash flow method, based on an appropriate forecast or projection for the company, is often considered one of the potential established techniques. It is not unusual for courts to deem the discounted cash flow method a superior technique when the appropriate information is available.

In addition to matching relevant industry and company forecasts to the selected valuation date, the robustness of the company’s financial forecast is also a factor. Each valuation of damages is fact-specific, and financial projections that do not reflect the operative reality relevant to the valuation date may be disregarded by a court. Some of the factors that have been considered by courts when evaluating the relevance and reliability of financial forecasts and projections for breach of fiduciary duty claims—such as factors considered in ACP Master, Ltd. v. Sprint Corp., Nos. 8508-VCL, 9042-VCL, 2017 Del. Ch. LEXIS 125 (Del. Ch. July 21, 2017), and In re PLX Technology Stockholders Litigation, 2018 Del. Ch. LEXIS 336 (Del. Ch. Oct. 16, 2018)—are whether they

• were made in the ordinary course of business by the company’s management;
• were made by management with a track record of missing its projections;
• reflect the buyer’s actual plans for the subject acquisition;
• were for a proposed new line of business with a different type of customers;
• were deemed not sufficiently reliable by other potential buyers; and
• were unrealistic or speculative.

The availability of an appropriate forecast, or appropriate inputs to develop a forecast, can significantly affect the weight accorded to a discounted cash flow method if it is used to quantify valuation damages. In addition, market valuation approaches often use estimates of forward valuation multiples to be applied to appropriate forecasts for the subject company. Accordingly, the availability of an appropriate forecast can also significantly affect the weight otherwise accorded a market approach based on forward multiples.

Also, when the situation changes rapidly as it has during the pandemic, the forecasts, if available, may also be changing. This is seen in the charts discussed above. Therefore, the selection of valuation date may affect both the nature and the availability of an appropriate forecast. Consequently, the selection may have an impact on both the amount quantified by and the weight accorded to available valuation damage measurement methods.

Conclusion

In measuring valuation damages for breach of fiduciary duty claims in shareholder disputes, the degree of precision in selecting the valuation date and the adequacy of the financial forecast are important contemporary considerations. When the situation changes rapidly as it has during the pandemic, these items may have a comparatively greater impact on the resulting quantification of valuation damages.

John Levitske is senior managing director, Disputes & Economics—Valuation & Transaction Disputes, with the Chicago, Illinois, office of Ankura Consulting Group, LLC. 

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