The Third Circuit Court of Appeals recently upheld the dismissal of a suit by the shareholders and creditors of Vlasic Foods International, Inc., a former Campbell Soup subsidiary that had been “spun out” of the parent. The case, VFB, LLC v. Campbell Soup Co. (March 30, 2007), upholds the broad discretion of trial courts to determine valuation issues in the context of corporate transactions and, more specifi cally, gives great weight to market capitalization as a measure of value.

The plaintiff, VFB, was created in the wake of Vlasic Foods’ bankruptcy to prosecute the claims of Vlasic’s shareholders and creditors against Campbell, Vlasic’s former parent. The claims arose out of a March 1998 “leveraged spin” transaction in which Vlasic was formed to own certain businesses in Campbell’s Specialty Foods Division, which Campbell viewed as underperforming. The transaction basically involved Campbell’s incorporation of a new wholly owned subsidiary (Vlasic), the subsidiary’s assumption of bank debt to purchase the Division for $500 million, and then Campbell’s issuance of stock in the subsidiary to Campbell shareholders as an in-kind dividend. Vlasic’s life was short lived and it fi led for bankruptcy in 2001. In SEC fi lings as early as June 1998, it was disclosed that the pre-transaction operating results of the Specialty Foods Division had been infl ated to increase short term earnings. Over the next two years, the reduced earnings forecast, the burden of the acquisition debt and declining food sales all contributed to Vlasic’s failure. Between 1999 and May 2001, Vlasic sold off the former Specialty Foods Division for some $115 million less than it had paid in 1998.

VFB sued Campbell alleging that the original purchase price was infl ated and, therefore, the “spin out” was a fraudulent transfer as to Vlasic’s shareholders and creditors. VFB also claimed that Campbell breached a fi duciary duty to the future creditors of Vlasic. The district court rejected both arguments and VFB appealed.

The Court of Appeals reprised the testimony before the district court, including the expert testimony on the issues of Vlasic’s valuation at the time of the transaction. VFB had presented testimony from three different experts that, under a market approach or a discounted cash fl ow analysis, Vlasic had a value substantially less than the purchase price on the date of the “spin out” transaction. The district court viewed these opinions as “hindsight evaluations” that did not refl ect the assumptions made by the public markets as of the time of the spin and for months thereafter. The district court emphasized that the market capitalization of Vlasic as of March 1998 was approximately $1.6 billion and it did not drop below $1.1 billion until 1999, even though by that time the market knew about Vlasic’s infl ated pre-spin earnings.

As the appeals court put it, “nobody claims that [Vlasic’s] fortunes were improving, so the market’s valuation of [Vlasic] as solvent in FY 1999 was strong evidence that [Vlasic] was solvent at the time of the spin, and therefore received reasonably equivalent value for its $500 million.” Rejecting VFB’s argument that the district court had improperly disregarded its experts’ valuations, the circuit court stated: “Absent some reason to distrust it, the market price is ‘a more reliable measure of the stock’s value than the subjective estimates of one or two expert witnesses.’”

The Third Circuit also rejected VFB’s claim that Campbell had aided and abetted a breach of the Vlasic directors’ duty of loyalty to the subsidiary when they approved the spin transaction. VFB’s argument rested on the fact that the Vlasic directors were simultaneously directors of Campbell. The appeals court found that, because Campbell was the sole shareholder of Vlasic, there was only one substantive interest to be protected and, thus, “it makes no sense to impose a duty on the director of a solvent, wholly owned subsidiary to be loyal to the subsidiary as against the parent company.” The appeals court noted that the situation would be different if the subsidiary were not wholly owned or if the subsidiary were insolvent at the time of the transaction. In those cases, the directors would have duties to act fairly toward minority shareholders and creditors, respectively.