Court decides on fair value determination in merger case

The Cayman Islands Grand Court has for the first time decided on how to value the shares of investors who disagree with the merger of the company they have invested in. 

The first decision of its type under Section 238 of the Cayman Islands Companies Law sets a precedent for the interpretation of merger transactions under Cayman Law by the courts.  

According to Section 238, members of a Cayman company are entitled to be paid the fair value of their shares provided they submit in writing that they oppose the merger before the vote is held and demand payment in case the merger is approved. 

If the company and dissenting investors fail to agree a price for the shares, both can appeal to the court to determine their fair value. 

The Cayman case concerned Russian oil field services producer Integra, which completed its management buyout transaction through a merger in February 2014. A group of related institutional investors, representing 17 percent of the company’s shares, rejected the deal and challenged the merger price of US$10 per share that had been approved by the majority of shareholders and which represented a 45 percent premium on the share price on the London Stock Exchange at the time.  

The offer had been examined by a committee of independent directors and supported by a fairness opinion by Deutsche Bank. 

While it is not unusual for investors in North America to appeal to the court to determine the fair value of the merged company, it is a new concept in Cayman. 

However, the unique circumstances of the Integra merger led the court to conclude that there is no universal approach and that each case must be specifically examined on its own facts. 

While the Grand Court relied on approaches taken by Delaware and Canadian courts, it decided that the valuation methodology should be selected on a case-by-case basis and could be a market-, income- or asset-based approach.  

To determine the fair value, the court said, it would take a detailed and objective approach to valuation, taking into account all of the available evidence.  

Valuation cases typically rely on expert witnesses who assess the value on the basis of the company’s records and books.  

In the present case, Justice Andrew Jones QC noted that in view of the disagreement by the parties’ expert witnesses, a discounted cash flow methodology was the most appropriate because the stock was comparatively thinly traded and the stock market valuation therefore was not a reliable indicator.  

One expert witness had put the value of the company at $70 million to $100 million, the other at $125 million to $135 million. 

Offshore law firm Walkers, which advised Integra on its management buyout and later on the merger price, said in a client notice that it will often not be possible or economical for companies to perform a full forensic valuation of their operations before a merger. 

Because valuations are imprecise, the statutory right of dissent becomes a powerful tool, the note said. 

“It is not the purpose of the statute to act as a disincentive to commercial activity, to have a Board paralyzed into inaction, or a transaction supported by the majority of shareholders held hostage by a minority. Nevertheless, the leverage that may be exerted through the exercise of these rights may in some cases be significant.”  

But the court reasoned that the right of dissent is a safeguard to protect minority shareholders from oppressive action; it should not become a bonus.  

It followed therefore that any effect of the merger, positive or negative, on the price should be disregarded and the date of the extraordinary general meeting at which the merger was approved and the dissent was expressed should be the valuation date.  

The court awarded the dissenters US$11.70 per share as opposed to the merger price of US$10 per share. In addition, the court awarded a “fair rate of interest” based on the midpoint between the company’s assumed rate of return on cash and its assumed U.S. dollar borrowing rate. 

Walkers concluded in its client notice: “[T]he tenor of the authorities from all jurisdictions is that the courts will be willing to examine questions of fair value in a detailed and forensic way as opposed to adopting a broad brush approach which might be more reflective of the commercial realities of a deal.  

The approach to disclosure on dissent should act as a strong reminder to a company considering a merger transaction of the importance of full and accurate disclosure – a lack of candor may well lead to serious adverse consequences in the event that the Court is called upon to examine the fairness of the merger price.”