William W. Davis
Prof. Palmiter
Law & Valuation
Cede & Co. v. Technicolor, Inc. IV
INTRODUCTION
An important goal of corporations law is to protect
minority shareholders and the legislature and courts have
developed several techniques to accomplish this.
Delaware’s
appraisal remedy, 8 Del. C. § 262 is one tool for minority
shareholders to use in protecting there interests. Over the
years the scope and use of this remedy has changed through
interpretation by the courts.
One such case that highlights
some of these changes are Cede & Co. v. Technicolor, Inc.
line of cases.
These cases are a good example of many of
the benefits and short comings of the Delaware’s appraisal
remedy.
This paper will attempt to critique the latest
decision from the Supreme Court of Delaware on this long
running case and its implications for the appraisal remedy,
Cede & Co. v. Technicolor, Inc., 684 A.2d 289 (1996).
THE APPRAISAL REMEDY
Minority Shareholders can be subject to abuse by the
majority because of their lack of control.
This concern is
at its greatest when one company is about to merge or
consolidate with another, especially when the majority
forces out the minority in a cash-out merger.
In a cash-out
merger the majority can force out the minority for a price
lower than the stocks true value.
The Delaware Code, in 8
Del. C. § 262, allows minority shareholders who did not vote
for the merger to petition the court for an appraisal
hearing.
If all of the requirements of the statute are met
and the procedures are followed, the court, after hearing
evidence from both the merged corporation and the dissenting
shareholders, will determine the fair value of the minority
shares.
Originally the court was required to value
companies via the “Delaware Block Method”, but because of
the methods rigidity the courts are now free to use “any
techniques or methods which are generally considered
acceptable in the financial community and otherwise
admissible in court.”
1
Historically, the appraisal remedy served a liquidity
function allowing minority shareholders to exit an
investment which no longer resembled their original
investment because of the merger or consolidation.2
appraisal remedy serves a different purpose.
Now the
Because cash-
out mergers have become commonplace and the nature of
corporate transactions has changed the remedy serves as a
way to protect minority shareholder from abuses by the
majority.3
Wertheimer v. UPO, 457 A.2d 701, 713 (1983).
Barry M. Wertheimer, The Shareholders’ Appraisal Remedy
and How the Courts Determine Fair Value, 47 Duke L.J. 613,
615 (1988).
3 Id. at 616.
1
2
THE CASE
The Cede v. Technicolor line of cases originated from
the acquisition of Technicolor by MacAndrews and Forbes
Group, Inc (“MAF”) in a two step merger in 1983.
First in
November of 1982, MAF made a tender offer for $23 a share
acquiring control with over eighty-two percent of
Technicolor’s shares.4
Then about three months later, at a
special shareholders meeting, 89 percent of the shareholders
approved a cash-out merger with MAF, making Technicolor a
wholly-owned subsidiary of MAF.5
After the merger a shareholder (“Cede”) not only
brought an action for the appraisal remedy (“appraisal
action”) but also attacked the transaction by bringing a
rescissory damages lawsuit for fraud and unfair dealing
(“fraud action”).6
The first appeal concerned an
interlocutory judgment in the fraud action.
The court held
“that [Cede] was entitled to pursue its appraisal action and
its [fraud] action concurrently, through trial.”7
Ultimately Cede lost the fraud action and was left with the
appraisal remedy.
The opinion in focus here is the last Delaware Supreme
Court ruling concerning the appraisal remedy, Cede v.
Cede & Co. v. Technicolor, 634 A.2d 345, 357 (1993).
Id. at 358.
6 Cede & Co. v. Technicolor, 684 A.2d 289, 290 (1996).
7 Id. at 290 (quoting Cede & Co. v. Thechnicolor, Inc., 542
A.2d 1182, 1192 (1988)).
4
5
Technicolor, Inc., 684 A.2d 289 (1996).
The issue is
whether to include in the valuation “MAF’s new business
plans and strategies, which the Court of Chancery found not
speculative but had been adopted and implemented between the
date of the merger agreement and the date of the final
merger.”8 Citing Weinberger v. UOP, the Delaware Supreme
Court held the it was proper to value Technicolor using the
new management’s plans.9
The appraisal remedy statute states that the appraised
value must be on the date of the merger and “exclusive of
any element of value arising from the accomplishment or
expectation of the merger”.10
In this case and in most two-
step mergers these two requirements conflict.
If you chose
the date of the merger it would be proper to value
Technicolor under the new business plan.
If you excluded
any value from new management the court would be valuing
Technicolor under the old management’s plans, three months
before the final merger.
happening.
Two factors kept this from
First, citing Weingberger v. UOP, the court
construed the statutory phrase narrowly, excluding “[o]nly
the speculative elements of value that may arise from the
‘accomplishment or expectation’ of the merger” and “elements
of future value…which known or susceptible of proof as of
Id. at 290.
Id. at 295.
10 8 Del. C. § 262.
8
9
the date of the merger and not the product of speculation,
may be considered.”11
Second, in an earlier decision the
Delaware Court of Chancery found that between the time of
the merger offer and the completion of the merger, new
management had already formulated and begun implementing
their new plan.
JUSTIFICATION
The first question is whether his decision is justified
under the purposes of the Delaware appraisal statute.
Under
the old justification, where the appraisal remedy had a
liquidity purpose only allowing minority shareholders to
exit investments they no longer wanted, this decision is
weak.
By allowing a valuation that includes the new
management’s plans the minority shareholders are receiving a
windfall.
First, they were exiting the investment whether
the new management had any plans or not and, second, the
investement they entered was Technicolor run by old
management.
Under current rational, where the appraisal
remedy is meant to protect minority shareholder rights, the
decision is much more justifiable.
The minority shareholder
in this transaction and other cash-out mergers do not want
to exit the investment.
This can be inferred in this case
by the fact that many of the shareholders did not sell their
shares during the original tender offer. (The first step in
11
Id. at 295 (quoting Weinberger v. UOP, Inc., 457 A.2d
the two step merger.)
The minority shareholders kept their
shares because they felt that the new management, who had
just gained control of the firm will have a positive
influence on the profitability of the company and the value
of the shares were greater than the original tender offer.
(The acquiring firm also has this opinion or they would not
have acquired the company in the first place.)
By allowing
the new majority to cash-out the minority without factoring
in their new plan of management, which at this time would be
more than speculative, the court is undervaluing the
minorities shares and giving the new majority a windfall.
IMPLICATIONS
This decision could have wide ranging implications both
on the Delaware appraisal remedy and management’s decision
on how mergers are structured in Delaware.
Legal Implications
First, this decision now makes the implementation of
the Delaware appraisal statute different for one and two
step mergers.
In one-step mergers where the minority is
cashed-out all it once, the valuation is determined without
looking at any of the effects the merger could have on
profitability.
This happens, no matter how well known and
concrete the new management’s plans are, because at the time
of the merger they do not have any control to implement
701, 713 (1983)).
them.
Under a two-step merger the valuation is made
incorporating the effects of the new management’s plans, as
long as they are not speculative.
It seems inequitable to
allow a benefit to be conferred on one group of minority
shareholders and not another based on a factor the minority
has no control over, how the merger is structured.
I
believe that in the future the Delaware courts will apply
this decision regardless of how the merger is structured as
long as the information about the new management’s plans are
concrete and not speculative.
But currently this inequity
could effect how mergers and acquisitions are implemented in
Delaware.
Second, although it was very clear in this case,
potential problems exist in determining when new
management’s plans are not speculative.
The court set out
two requirements for making this decision, both of which are
vague and ill-defined: 1) the value from the new plans can
not be speculative and 2) that the plans have become part of
the “operating reality” by the completion of the merger.12
It is safe to assume that most acquiring companies when
attempting to buy a company that is under performing would
have some sort of plan to turn the company around or they
Justin B. Wienburgh, Cede & Co. v. Technicolor, Inc.:
Appraising Dissenters’ Shares: The “Fair Value” of
Technicolor, 22 Del. J. Corp. L. 293, 306 (1997).
12
would not be making the acquisition.13
Now, if this issues
comes up it will be up the Delaware Court of Chancery and
the parties involved to determine if these vague
requirements are fulfilled on a case by case basis.
If this
determination becomes a problem the Supreme Court of
Delaware will have to clarify this decision.
Business Implications
First, it may discourage two-step mergers from being
implemented.
Second, it might force acquiring companies
using the two-step merger to make a tender offer in the
first step at a substantial premium.14
Unless this premium
is offered shareholders could perceive a disincentive in
tendering their shares during the first step, hoping for a
substantial increase in value during the second step.15
Third, new management could, to avoid having their plans
incorporated into the valuation during a two-step merger,
refrain for implementing their plans until the second step
of the merger is complete.
Recent law review articles have analyzed these possible
business implications and concluded they are unlikely.
They
argue that this decision although ripe with possible
implications will have little impact on how mergers are
See Id.
Jesse A. Finklestein and Russell C. Silberglied,
Technicolor IV: Appraisal Valuation in a Two-Step Merger, 52
Bus. Law 801, 809 (1997).
15 Id.
13
14
structured.
First, the procedural and financial burdens of
the appraisal remedy make it a very inefficient for
plaintiffs.16
The Delaware appraisal remedy statute forces
plaintiffs to jump through extensive procedural hoops and
does not allow any money to be paid for the outstanding
shares until the proceeding is complete.
This case is a
great example, it has taken over 15 years and four appeals
to come to any concussion and or for Cede & Co. to get any
money for their shares.
Second, the strategic factors for
structuring a two-step merger will likely outweigh the
implications of this decision.17
Third, if management was
to refrain from implementing their plan until after the
merger it could have legal implications on their “fair
dealings” as to the minority shareholders and increase the
likelihood of further litigation.18 The authors do feel that
one impact will be that acquiring companies will emphasize
the first step of the two-step merger by keeping the
original tender offer open longer or increasing the tender
offer.
By doing this the majority reduces the potential
pool of appraisal claims.
See Justin B. Wienburgh, Cede & Co. v. Technicolor, Inc.:
Appraising Dissenters’ Shares: The “Fair Value” of
Technicolor, 22 Del. J. Corp. L. 293, 308-09 (1997); Jesse
A. Finklestein and Russell C. Silberglied, Technicolor IV:
Appraisal Valuation in a Two-Step Merger, 52 Bus. Law 801,
807-08 (1997).
16
17
18
See Id.
See Id.
CONCLUSION
The latest decision in the saga of Cede & Co. v.
Technicolor exemplifies many of the benefits and problems
with the Delaware appraisal remedy.
The problems include
first, the time and cost involved in using the remedy.
Second, the courts do not evenly apply the remedy and are
not completely clear on many of its implications.
But it
currently is a good way to protect minority shareholders
without adversely affecting the course of business.
Because
of the recent prevalence of cash-out mergers the appraisal
remedy is currently being used more often.
Over time the
courts should iron out many of the problems in the appraisal
remedy and make it more efficient.