Deal Price is King in Appraisal Rights Actions in North Carolina Where Merger Process Bears “Objective Indicia of Fairness”
In the first trial of its kind in North Carolina, the North Carolina Business Court has determined the fair value of dissenters’ shares in a large, publicly-traded company under the North Carolina Appraisal Rights statute, N.C. Gen. Stat. § 55-13, et seq., holding that the dissenters were not entitled to recover more than the “deal price” in the merger.
The case, Reynolds American Inc. v. Third Motion Equities Master Fund Ltd., et al., 2020 NCBC 35 (April 27, 2020), arose out of the acquisition of Reynolds American Inc. (“RAI”) by British American Tobacco plc (“BAT”) (the “Merger”) in an almost $50 billion transaction that created the world’s largest listed tobacco company.[1] Prior to the merger RAI was a public company with approximately 1.4 billion shares of common stock outstanding. BAT was a shareholder of RAI, owning approximately 42% of RAI’s common stock.
The defendants are former shareholders of RAI who asserted statutory appraisal rights. RAI filed suit after the parties failed to agree on the fair value of the defendants’ shares. RAI sought a judgment that the defendants’ shares were worth no more than $59.64 a share, which was equal to the value of the merger consideration on the date the merger was announced. Defendants contended that the fair value of their shares was $92.17 a share and alleged that they were entitled to a judgment for the difference–approximately $312 million in the aggregate, plus interest.
The defendants’ assessment of fair value was based entirely on a discounted cash flow (DCF) analysis prepared by their experts. Defendants argued that a DCF analysis was the only allowable method for determining value under the facts of the case and that their expert’s DCF analysis was the only one that should be given weight. Defendants urged the court to ignore all other evidence of value presented by RAI and to reject the deal price entirely on the grounds that the merger process was purportedly flawed, among other reasons, because it had not involved an auction or a pre-closing market check to identify other potential buyers.
The court declined to adopt this restrictive approach, finding that, under N.C.G.S. § 55-13-01(5), fair value is to be assessed (i) “using customary and current valuation concepts and techniques,” (ii) “excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable” and (iii) “without discounting for lack of marketability or minority status.” The court noted that the statute does not limit or prescribe the specific “valuation concepts and techniques” that may be used, and requires only that they be “customary and current” and “generally employed for similar business in the context of the transaction requiring appraisal.”
The court found that, in the merger context, courts, economists, and valuation professionals customarily and currently use a wide range of valuation concepts and techniques, including but not limited to assessing market evidence of the value of the shares, assessing whether the transaction process was one in which the resulting deal price is a reliable indicator of value, reviewing internal valuations performed by the company prior to consideration of the merger, estimating the net present value of the company’s expected future cash flows (a DCF analysis), comparing the company’s trading multiples to the trading multiples of similar firms, and comparing the multiples paid in the merger to the multiples paid in similar transactions.
The court rejected defendants’ argument that the North Carolina appraisal statute did not permit consideration of the deal price in determining fair value, finding that defendants’ contention “has no support in North Carolina case law and is squarely refuted by the legislative history reflected in the Model Business Corporation Act commentary.” Further, the court concluded that, in an arm's-length merger transaction negotiated by an independent and well-informed transaction committee, the “deal price” is entitled to substantial, if not determinative, weight. This is consistent with the views expressed in a number of recent Delaware cases, many of which were cited by the court, such as Verition Partners Master Fund, Ltd. v. Aruba Networks, Inc., 210 A.3d 128, 135 (Del. 2019) and Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd., 177 A.3d 1, 20 (Del. 2017).
Applying these concepts to RAI, the court found that the merger was “negotiated at arm’s length by independent, fully informed, and deeply knowledgeable directors with the assistance of independent and experienced advisors, all of whom had extensive experience in the tobacco industry and a deep and impeccable knowledge of RAI and its potential opportunities, challenges, and future prospects.” Further, given RAI’s size and industry position, there were few, if any, likely bidders other than BAT and there was nothing in the record to suggest that increased competition would have produced a better result. “The Court thus concludes that, under the circumstances present here, even without more aggressive outreach and a competitive auction, the resulting deal price is reliable evidence of RAI’s fair value.”
While giving greatest weight to the deal price, the court found significant additional evidence supporting its conclusion that fair value did not exceed $59.64 a share, including RAI’s unaffected stock price prior to the merger and the independent valuations conducted by the financial advisors in determining that the merger was fair to RAI’s shareholders. The court determined that it was unreasonable “both as a matter of common sense and fact-finding under North Carolina law” for defendants’ to insist that “the only reliable evidence of value is their expert’s litigation-generated DCF valuation, which is starkly inconsistent with all other evidence of value including the market evidence, contemporaneous DCFs, and various sanity checks that Dissenters’ experts agree are a typical part of the valuation process.”
The court’s emphasis on the primacy of the deal price, and its rejection of defendant’s made-for-litigation DCF analysis in the absence of other credible evidence of higher value, represents a practical and reasoned approach to determining fair value in shareholder appraisal cases. Although the Delaware courts have reviewed similar issues, with generally similar results, the decision plows new ground in North Carolina and should be required reading for all companies facing potential shareholder appraisal claims in this state.
Key Takeaways
- As the notes to the Model Business Corporation Act, on which North Carolina’s appraisal statute is based, explain, “A court determining fair value under chapter 13 should give great deference to the aggregate consideration accepted or approved by a disinterested board of directors for an appraisal-triggering transaction.” Even when the deal price is not given controlling weight, it remains a relevant indicator of fair value that should not be ignored, particularly when independent and well-informed directors negotiated with the buyer at arm’s length.
- An auction or pre-closing market check to identify other potential bidders is not necessary in every case to establish the reliability of the deal price and is not required simply because the proposed acquirer is a significant existing shareholder of the target company. RAI’s failure to solicit competing bidders did not undermine the reliability of the deal price as evidence of fair value, where there was no credible evidence at trial that any third party was interested in purchasing RAI with or without BAT’s support.
- The wide variability and susceptibility to manipulation attendant to a DCF analysis raises questions about its reliability as a valuation tool in appraisal litigation. Courts in North Carolina are likely to cast a skeptical eye on appraisal claims that rely solely on an expert’s made-for-litigation DCF analysis, particularly when it results in a value that is far out of line with all other relevant evidence. “Even where the parties have retained credible experts, the court should consider ‘factual evidence relating to valuation as a cross-check, or reality-check, on the litigation-driven figures generated by [those] experts.’”
- Where a company’s shares trade in a semi-strong efficient market at the time of the merger, evidence of the unaffected stock price is relevant in determining fair value. There is no legal or evidentiary rule in North Carolina requiring a court’s determination of market efficiency to reflect a consideration of expert testimony. Expert testimony on market efficiency was not necessary where there was undisputed evidence establishing that the market for RAI’s shares was semi-strong efficient at the time of the merger.
- The court rejected defendants’ arguments that RAI’s stock price implicitly contained a minority discount and, therefore, could never show fair value. While the NC appraisal statute directs the court to determine fair value “without discounting for lack of marketability or minority status,” that requirement did not affect the value determination in this case where RAI was a large actively-traded public company, there was no evidence that RAI’s stock traded at a “discount,” and BAT was not a majority shareholder of RAI.
- Fair value does not include a control premium. A control premium is the additional value that a buyer ascribes to an asset under the assumption that the buyer will be able to derive more value from that asset. The value of “control” is irrelevant in determining fair value for appraisal purposes, which is based on the value the company would have as an ongoing enterprise if the corporate action at issue did not occur.
- Interest under the NC appraisal statute runs from the effective date of the corporate action until the date that dissenters receive “payment” for the fair value of their shares. Prior to the filing of the action, RAI paid defendants $59.64 a share for their stock plus interest through the payment date. Because the court determined that “fair value” was equal to or less than $59.64 a share, defendants were not entitled to any further interest on the judgment amount.
Concluding Notes
Appraisal cases involving public companies like RAI are relatively unusual in North Carolina. The North Carolina appraisal statute does not create a general right to appraisal for companies with stock that is traded in an organized market and that has at least 2,000 shareholders and a market value of twenty million dollars. There is an exception for “interested transactions,” which includes certain corporate actions involving “interested persons” as defined in the statute. Interested persons include a person who is a beneficial owner of 20% or more of the voting power of the corporation, other than as owner of excluded shares. Because BAT owned 42% of the outstanding common stock of RAI at the time of the merger, the merger fell within this exception.
Prior to the court’s decision in RAI, fair value determinations under the North Carolina appraisal statute were mostly a “blank canvas,” with little judicial direction as to how the statute should be applied in particular cases. The RAI decision fills in some of those important gaps. Although much of the court’s analysis of the “fair value” issue is specific to RAI and its status as a large, publicly-traded company, the court’s opinion also offers useful instruction for privately held companies, including closely-held corporations. In particular, the court’s discussion of the wide variety of valuation methodologies that a court properly may consider in determining issues of fair value, including but not limited to the deal price, should provide helpful guidance to shareholders who may be evaluating the utility of a future appraisal demand and to companies who seek to defend such demands.
[1] Smith Anderson served as North Carolina counsel to BAT in the merger transaction and serves as North Carolina counsel for RAI in the appraisal action. A copy of the Court’s decision is linked here.
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