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More on Berger v. Pubco: Disclosure in Notices of Appraisal Rights and Merger Proxies

From Kevin Miller of Alston & Bird: Most commentators on Berger v. Pubco are focusing on the Delaware Supreme Court’s holding granting quasi appraisal rights as the appropriate remedy for faulty disclosure in connection with a short-form merger.

“[T]he exclusive remedy for minority shareholders who challenge a short form merger is a statutory appraisal, provided that there is no fraud or illegality, and that all facts are disclosed that would enable the shareholders to decide whether to accept the merger price or seek appraisal. But where, as here, the material facts are not disclosed, the controlling stockholder forfeits the benefit of that limited review and exclusive remedy, and the minority shareholders become entitled to participate in a “quasi-appraisal” class action to recover the difference between “fair value” and the merger price without having to “opt in” to that proceeding or to escrow any merger proceeds that they received.”

While the Berger decision highlights the need to include all appropriate disclosure in a notice of appraisal rights to ensure that statutory appraisal will be the exclusive remedy for minority shareholders in a short form merger, the decision may also indicate that the level of required disclosure is not as detailed as certain Chancery Court decisions suggest.

In Berger, the Notice of Appraisal Rights at issue only provided unaudited historical financial statements for the subject company and a five sentence description of the company. The notice of appraisal rights did not contain any disclosures regarding the company’s plans or prospects (e.g., projections), a meaningful discussion of its current operations or any financial disclosures by division or line of business. Nevertheless, the only disclosure violation found by the Chancery Court relating to the company was the failure to disclose how the controlling stockholder determined the merger consideration. Though not the focus of its decision, following a careful summary of the Chancery Court’s disclosure findings, the Delaware Supreme Court did not take issue with the Chancery Court’s disclosure holdings.

This is consistent with the Delaware Supreme Court’s prior decision in Skeen v. Jo-Ann Stores. In Skeen, a 2000 decision of the Delaware Supreme Court, the Delaware Supreme Court considered and rejected a claim that the board of the target breached its fiduciary duties by failing to disclose (i) management’s projections and (ii) a summary of the methodologies used and the ranges of values generated by the financial analyses performed by its financial advisor in a Notice of Appraisal Rights. In Skeen, the Delaware Supreme Court also confirmed that the standard of disclosure for Notices of Appraisal Rights was the same as for merger proxies.

Nevertheless, several subsequent Chancery Court decisions, including Pure Resources and Netsmart, have sought to establish more detailed disclosure requirements regarding target company projections and the financial analyses performed by financial advisors/opinion providers.

– Netsmart (3/07) – “It would therefore seem to be a genuinely foolish (and arguably unprincipled and unfair) inconsistency to hold that the best estimate of the company’s future returns, as generated by management and the Special Committee’s investment bank, need not be disclosed when stockholders are being advised to cash out. . . . Indeed, projections of this sort are probably among the most highly prized disclosures by investors. Investors can come up with their own estimates of discount rates or (as already discussed) market multiples. What they cannot hope to do is replicate management’s inside view of the company’s prospects.” 

– Pure Resources (10/02) – holding that a summary of the methodologies used and the ranges of values generated by the financial analyses performed by the client’s financial advisor was required .

But see:

– CTI Molecular Imaging (E.D. Tenn) – see transcript of 2005 federal court decision denying temporary restraining order (Court stated that it was capable of interpreting the law of the State of Delaware as espoused in Skeen without the assistance of the Chancery Court’s interpretation in Pure Resources)

The Chancery and Supreme Court opinions in Berger do not specifically address whether a Notice of Appraisal Rights must include disclosure of financial projections or a detailed description of the financial analyses performed by a financial advisor or opinion provider. Given that a short form merger is effected by a 90%+ stockholder without action by the target, the target didn’t hire a financial advisor and it is not clear that the 90%+ stockholder engaged a financial advisor to advise on the price it determined to pay in the merger. Nevertheless, the Chancery Court and Supreme Court opinions in Berger may provide an indication of the views of certain members of the Chancery Court and members the Delaware Supreme Courts regarding the level of disclosure required in Notices of Appraisal Rights and merger proxies.

In Berger, the only disclosure violation relating to the company or the transaction was the failure to disclose how the 90%+ stockholder determined the merger price. The Chancery Court did not find that the failure to disclose the company’s plans or prospects was a disclosure violation, nor did the Chancery Court find that the failure to provide meaningful disclosure regarding company’s actual operations or finances by division or line of business was a disclosure violation.

In fact, it appears that the disclose of unaudited historical financial statements, together with a five sentence description of the company provided adequate disclosure regarding the company and its finances even where the company was privately held and was not required to file detailed financial and other information with the SEC. According to the Chancery Court “Plaintiff’s other arguments about alleged disclosure violations are less persuasive. Although plaintiff correctly notes that the description of the Company left much to the imagination, plaintiff has not explained why additional details about the products and services Pubco offered would have been materially relevant to the decision of whether or not to seek appraisal.”

Furthermore, if the 90%+ stockholder is not required to disclose “picayune details” about the process he used to set the price in a freeze out merger of a private company effected by the 90%+ stockholder without action by the subject company where the question is “can the minority shareholder trust that the price offered is good enough,” it is not clear why more detailed disclosure regarding projections and a financial advisor’s analyses would be required in connection with an arm’s length merger involving a public company with detailed business and financial information on file with the SEC – i.e., consistent with the Delaware Supreme Court decisions in Skeen and McMullin, should it not be sufficient for the disclosure regarding a fairness opinion upon which the board of directors is entitled to rely to disclose “in a broad sense what the process was” – i.e., the methodologies employed (e.g., selected companies, selected transactions and discounted cash flow analyses) – without necessarily disclosing the results of those analyses.