In re Sunbelt Beverage Corp. Shareholder Litigation, C.A. No. 16089-CC (Del. Ch. Jan. 5, 2010)
In this consolidated breach of fiduciary duty and appraisal proceeding, the Court of Chancery held that the defendants, the directors and controlling stockholders of Sunbelt Beverage Corp., a privately owned wholesale alcohol distributor (“Sunbelt”), did not meet their burden to establish the entire fairness of a merger designed to cash out the plaintiff, a minority stockholder of Sunbelt. Noting that the fair price prong of the entire fairness standard of review relates closely to the determination of fair value under Section 262 of the DGCL, the Court discussed various methods of valuing companies and ultimately relied on a discounted cash flow analysis to appraise the fair value of plaintiff’s shares at more than twice the merger consideration.
The Court applied the entire fairness standard of review because the defendants stood on both sides of the merger. Noting that no procedural protections were employed, the Court found that the controlling stockholder group of Sunbelt “jerryrigged” the cash-out merger process to accomplish its goal of eliminating plaintiff’s position in Sunbelt’s stock. Thus, the Court determined that the process was “anything but fair.”
Addressing the appraisal statute fair value and entire fairness fair price claims as one, the Court decided it would not consider a prior transaction in Sunbelt’s stock or a comparable transaction analysis in its determination of Sunbelt’s fair value. In the prior transaction, which was completed one month before the merger, the controlling stockholder group purchased shares of Sunbelt from other stockholders for the same price as the merger consideration. The Court held that this transaction was not evidence of fair value because the price was controlled by a formula that had been negotiated three years before the merger. The Court emphasized that there is no bright-line rule delineating when prior transactions become so stale that a Delaware court will discount their weight as evidence of fair value, but held that, in this case, three years was too long to accept the formula as a reliable indicator of fair value. For this reason, and because the Court found fault with the formula itself based upon specific characteristics of Sunbelt’s business, the Court did not consider the formula in determining fair value.
The Court chose not to accord any weight to the comparable transaction analysis performed by plaintiff’s expert because the companies the expert examined were not sufficiently comparable to Sunbelt. The Court also questioned the methodology of the expert’s analysis because the expert had relied on the multiple median approach instead of accounting for certain variations in specific transactions. The Court stated that when, as in this case, there were known and measurable variations in a small sample size, the median multiple approach cannot be the sole justification for a failure to account for such variations.
Having rejected the other proposed valuation methods, the Court relied upon a discounted cash flow analysis and appraised the fair value of plaintiff’s shares at $114.04 per share. The Court determined the appropriate small-firm risk premium to be used in such an analysis by adhering to the method promulgated by Ibbotson Associates, a leading authority on asset allocation. The Court declined to apply a company-specific risk premium to the discounted cash flow analysis because the defendants could not overcome judicial skepticism of a company-specific risk premium and failed to meet their burden to demonstrate that Sunbelt faced risks not shared by all businesses in its industry. The Court also invalidated adjustments each party made to its valuations to account for Sunbelt’s conversion to an S-corporation after the merger because plaintiff owned shares in a C-corporation at the effective time of the merger, and stockholders seeking appraisal are entitled to be paid only for that which is taken from them.
The Court rejected plaintiff’s request for rescissory relief (in the form of awarding plaintiff rights for certain states within Sunbelt’s alcohol distribution portfolio) because such relief would present significant issues related to complexity and implementation. The Court awarded the plaintiff interest at the statutory rate of 5% over the Federal Reserve Discount Rate from the date of the merger through the date of payment, compounded quarterly, and directed that the parties adjust appropriately for each and every change in the Federal Reserve Discount Rate that had occurred over the course of the lengthy litigation. The Court also awarded to plaintiff all court costs and expert witness fees, but declined to shift attorneys’ fees because defendants’ actions did not rise to a high level of egregiousness.