A mining company is acquired and a shareholder who preferred the company’s long-term prospects to its short-term sale price exercises its appraisal rights. Fast forward to the appraisal exercise in court: the company’s primary asset to be valued is a gold mine that the company had acquired pre-merger but only first began to actively extract ore from post-merger. In assessing the mine’s fair value as of the merger date, is the court confined to examine only pre-merger projections or can it resort to post-merger evidence of actual results?
When a court sets out to determine just what a company’s “fair value” is as of the time of the merger, the judge generally avoids relying on transactions or events that occur after the merger takes place. While at first blush the rule barring post-merger evidence seems to deprive the court of all available evidence — sometimes the ostensively best evidence of just how accurate the pre-merger expectations were — the wisdom of the rule cannot be overstated.
In an appraisal proceeding, the Court of Chancery shall appraise “the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger . . . .” 8 Del. C. § 262(h). The underlying assumption in an appraisal proceeding is that the dissenting shareholder would be willing to maintain his equity position in the company had the merger not occurred. To fully compensate the stockholder for having his shares taken away from him involuntarily, those shares are to be valued as his proportionate interest in the company as a going concern. Likewise, fair value is to be determined as of the effective date of the merger, so post-merger evidence — that is, what actually happens after the closing — is irrelevant to the valuation exercise.
As a result, the Delaware courts generally base their appraisals on projections prepared by company management before the merger. The other side of this coin is that courts are highly skeptical of companies that try to disclaim their own pre-merger projections through their valuation experts. Delaware courts thus reject hindsight-driven, after-the-fact views of the company’s pre-merger prospects:
Contemporary pre-merger management projections are particularly useful in the appraisal context because management projections, by definition, are not tainted by post-merger hindsight and are usually created by an impartial body. In stark contrast, post hoc, litigation-driven forecasts have an “untenably high” probability of containing “hindsight bias and other cognitive distortions.”
Prescott Group Small Cap, L.P. v. Coleman Co., Inc., 2004 WL 2059515, at *21 (Del. Ch. 2004). Delaware courts thus prohibit a merged company from using post-merger data to undermine pre-merger projections, as “any other result would condone allowing a company’s management or board of directors to disavow their own data in order to justify a lower valuation in an appraisal proceeding.” Gray v. Cytokine Pharmasciences, Inc., 2002 WL 853549, at *8 (De. Ch. 2002). While on rare occasions a court might consider post-merger evidence for the limited purpose of validating what was known or knowable and susceptible of proof as of the time of the merger, that exception reinforces the rule that post-merger evidence generally may not be used to adjust or change pre-merger data.
So in our mining company example, the value of that gold mine is to be determined based only on facts known or knowable as of the merger date; what happens after then is immaterial to the appraisal action. After the acquisition is consummated, there could be a huge spike or a sudden drop in the price of gold; mining technology could improve, or miners could go on a prolonged strike, but none of these post-merger events is permitted to override the purity of the valuation of the shares as of the date that they were forcibly removed from the shareholder’s hands: the shareholder is not required to share in the company’s unanticipated future loss just as he is not permitted to enjoy participation in an unexpected future gain.
Such a rule preserves the integrity of the valuation exercise, however removed from actual post-merger reality. After all, the policy underlying appraisal rights recognizes that the shareholder would continue to hold stock in the company absent the merger; once the shareholder is thus deprived by merger of the chance to share in the company’s future risks and rewards, he is to be effectively appraised and cashed out on a going concern basis, as of the merger date, without regard to how those future risks and rewards actually turn out.