In its recent decision in Carlock v. ExxonMobile Canada Holdings ULC, 2020 YKCA 4, the Yukon Court of Appeal (Court of Appeal) overturned an order that set the fair value of shares held by dissident shareholders at a 43 per cent premium above the agreed transaction price between ExxonMobil Canada Holdings ULC's and InterOil Corporation. The Court of Appeal held that the negotiated transaction price reflected the fair value of the dissidents' shares. This decision serves to confirm that objective market evidence should guide the determination of fair value in public mergers and acquisitions (M&A) appraisal proceedings.
The appeal arose from an order of the Supreme Court of Yukon (Trial Court) that set the fair value of shares owned by shareholders who exercised their dissent rights in relation to a court-approved plan of arrangement.
In 2015, InterOil began exploring the possibility of a whole company transaction and later accepted an acquisition offer from Oil Search. ExxonMobil subsequently tendered a superior bid to buy all the shares of InterOil, by way of plan of arrangement, for US$45 per share, plus a contingent resource payment (Initial Arrangement). The Initial Arrangement was approved by a substantial majority of shareholders and the Trial Court. However, the Court of Appeal overturned the Trial Court's final order that approved the Initial Arrangement. ExxonMobil and InterOil successfully completed a second plan of arrangement with a similar transaction price totaling US$49.98 per share, including the contingent resource payment (Second Arrangement). The Second Arrangement was endorsed by over 90 per cent of the voting shareholders and approved by the Trial Court.
Fewer than 0.5 per cent of shareholders exercised their dissent and appraisal rights and applied to have the Trial Court set the fair value of their shares. In an opinion issued in February 2019, the Trial Court agreed with the dissident shareholders that the transaction price did not represent fair value and appraised their shares at US$71.46 per share.
COURT OF APPEAL DECISION
The Court of Appeal concluded that the Trial Court erred in its appraisal of the dissidents' shares. Specifically, the Trial Court erred giving insufficient weight to the transaction price in assessing the fair value of the dissidents' shares. This led to the Trial Court incorrectly relying on theoretical discounted cash flow (DCF) evaluation that was contrary to reliable and objective market evidence of fair value. As a result, the Court of Appeal set the fair value of the dissidents' shares at US$49.98, the transaction price of the Second Arrangement.
Appraisal of Fair Value
In the Court of Appeal's view, the objective market evidence compelled the conclusion that the transaction price reflected the fair value of the dissidents' shares. Several factors led to this conclusion:
The transaction price reflected a negotiated price in a competitive market consisting of well‑informed and sophisticated parties
There was no indication that any other process could have led to a higher price
All potential purchasers or partial investors were fully informed
There was no impediment to higher bids by other potential purchasers
The transaction price was at a substantial premium to the pre‑deal stock price
The shares were widely traded and held by large and sophisticated investors, expert in assessing value, none of whom dissented
Share value was driven by an asset in the early stages of development, for which the future prospects were highly uncertain
In contrast to the objective market evidence, theoretical derivations of value reflected uncertainty and speculation
In addition to these factors, the Court of Appeal discussed the Trial Court's criticism that there was no planned sales process or public auction. The Court of Appeal pointed out that there was no evidence that such processes would have produced a higher transaction price. Accordingly, such processes are not necessarily a condition to using the deal price to assess the fair value of shares in public M&A transactions.
Finally, the Court of Appeal recognized the limitations of the DCF method of evaluating share value, which it characterized as an “inherently frail valuation technique” that depends on its assumptions. The Court of Appeal was careful, however, to note that a DCF assessment is commonly used to analyze values and perspective transactions. It was not critical of using DCF to assess potential transactions, only of the potential frailties when DCF valuation does not align with the actions of sophisticated market participants acting in their own self-interest during public company M&A. In the Court of Appeal’s assessment, the behavior of the real market is better evidence than a theoretical measure of value.
This decision confirms that a transaction price negotiated by sophisticated arm’s length parties in the context of a widely-held and broadly-traded company may be the best indicator of fair value. When deficiencies are not apparent in the transaction process or when deficiencies have been corrected, objective market evidence should guide the appraisal analysis arising from public M&A transactions.