On January 14, 2011, the Court of Chancery issued a
post-trial decision in the case of In Re: John Q. Hammons Hotels Inc.
Shareholder Litigation, C.A. No. 758-CC (Jan. 14, 2011), addressing the
issues concerning: (i) whether John Q. Hammons, JQH's controlling shareholder,
breached any fiduciary duty in connection with the merger and (ii) whether the
third-party acquirers aided and abetted any breach of fiduciary duty. Read
opinion here.
In the end, the Court concluded that: (i) the merger
price of $24 per share was entirely fair, (ii) the process that led to the
transaction was fair; (iii) Hammons breached no fiduciary duty; and (iv) as a
result of no breach of fiduciary duty, plaintiffs' claim for aiding and
abetting against the third-party acquirers must fail.
This summary was prepared by Kevin F. Brady of Connolly
Bove Lodge & Hutz LLP.
Standard of Review-- Entire Fairness or
Business Judgment
In the Court's September 2009 decision on summary
judgment, the Court determined that entire fairness would be the standard of
review applicable to the merger. See, In re John Q. Hammons
Hotels Inc. S'holder Litig., 2009 WL 3165613 (Del. Ch. Oct. 2, 2009). See
blog summary of that decision here.
The Court based its determination in part on plaintiffs' allegation that
Hammons used his controlling position to divert merger consideration
disproportionately to himself. However, at trial the plaintiffs presented
no evidence to support this assertion. Based on that lack of evidence, the
Court noted: "[w]hile the JQH board (a majority of whom are concededly
independent and disinterested) may actually have been entitled to business
judgment rule protection, I have nonetheless applied the more exacting entire
fairness standard of review because defendants easily satisfy it."
Under the entire fairness test, the defendants must show
fair dealing (which addresses the timing and structure of negotiations as well
as the method of approval of the transaction) and fair price. While the
"initial burden of establishing entire fairness rests upon the party who stands
on both sides of the transaction," the Court here said that "plaintiffs bear
the ultimate burden to show the transaction was unfair given the undisputed
evidence that the transaction was approved by an independent and disinterested
special committee of directors."
Fair Dealing
In discussing the negotiations and approval of the
transaction, the plaintiffs argued that that "the Special Committee was
'coerced' into accepting [the bidder's] offer to avoid 'worse outcomes' that
the minority stockholders might face." The Court disagreed find that that
"no credible evidence was introduced at trial demonstrating improper self-dealing
by Hammons or illicit 'strong-arming' type conduct that would have coerced the
Special Committee or the stockholders into supporting the [m]erger." The
Court also found that the transaction was entirely fair based on the fact that
the Special Committee: (i) was independent and disinterested; (ii) was highly
qualified and experienced; (iii) understood their authority and duty to reject
any offer that was not fair to the minority stockholders; and (iv) were
thorough, deliberate, and negotiated at arm's length to achieve the best deal
available for the minority stockholders.
Fair Price -- Battle of the Valuation Experts
Plaintiffs' Expert
The plaintiffs' expert used the discounted cash flow
("DCF") analysis and at the outset the Court acknowledged that "this Court has
recognized that 'the DCF valuation has featured prominently in this Court
because it is the approach that merits the greatest confidence within the
financial community.'" The plaintiffs' expert also used a comparable
companies' analysis and a comparable transactions analysis to conclude that the
fair value of the common stock on the date of the merger was $49 per share
which is twice the merger consideration of $24 per share. The $24 price
(which represented a more than 300% premium to the unaffected stock price) was
the result of a competitive nine-month process in which the Special Committee
negotiated between two bidders (Barceló and Eilian) and pushed the bids from
$13 up to $24 per share.
The plaintiffs' expert relied on management's projections
in performing his DCF analysis which is permissible as long as the projections
are reliable. As a general matter, projections made in the ordinary course
of business are considered to be reliable. However, in this case, the
plaintiffs failed to show that management's projections were created in the
ordinary course of business. In addition, the expert performed no
independent analysis of the assumptions underlying management's
projections. In addition to unrealistic assumptions, the Court found fault
with the expert's methodology in implementing his DCF analysis. In the
comparable companies approach, the Court noted that to be a reliable indicator
of value, the companies selected must be comparable to the company being
valued. However, in this case, the companies selected by the plaintiffs'
expert differed significantly from JQH. Finally, the Court noted that the
plaintiffs' expert offered no analysis with respect to the consideration
Hammons received in the merger.
Defendants' Expert
The defendants' expert also used a DCF analysis but his
analysis used a capital cash flow approach, which the Court noted was
"particularly appropriate for valuing companies like JQH where the leverage
ratios are expected to change over time." However, the defendants' expert
did not use a comparable companies' analysis because he concluded that was not
a reliable basis for estimating the value of JQH because of a lack of
comparable companies. The defendants' expert concluded that the value of
the shares at the date of the merger ranged from $14.97 to $18.71 per
share. The defendants' expert also analyzed certain aspects of the
consideration received by Hammons and concluded that the total amount of
consideration Hammons received was less than $15.80 per share. Because the
plaintiffs' expert did not value Hammons' consideration, the Court accepted the
valuation of the defendants' expert.
Approval by Minority Stockholders
While it was undisputed that the minority stockholders
"overwhelmingly supported" the transaction, the plaintiffs argued that the
minority stockholders support could not be considered because they were not
fully informed. They alleged that the directors failed to disclose that:
(i) an employee of the Special Committee's financial advisor had contacted one
of the bidders about the possibility of underwriting a security offering
planned by the bidder for after the merger: (ii) the Special Committee's legal
advisor also represented an entity providing financing for one of the bidders
with respect to the drafting and negotiation of the line of credit provided to
Hammons; and (iii) at a November 2004 presentation by one of the bidders to the
Special Committee, the bidder estimated that JQH could be worth $35.37 to
$43.01 per share.
The Court concluded that each of the plaintiffs' alleged
disclosure claims involved facts or circumstances immaterial to the
stockholders' decision to vote on the merger and was not required to be
disclosed under Delaware law. As to the potential offering after the merger,
none of the directors were aware of the contact and under Delaware law there is
no obligation to disclose facts that the directors are not aware of. As to
the Special Committee's legal advisor, the plaintiffs presented no evidence
that this other representation had any affect on the legal advice given to the
Special Committee or had any affect on the Special Committee's decision to
approve the merger. Finally with respect to the November 2004
presentation, the Court found that it was not necessary for the directors to
disclose this information since the estimated value at that presentation was
based on a hypothetical scenario.
Based on all of the above, the Court concluded that the
plaintiffs had failed to show that the transaction was unfair and "[e]ven if
the burden of proof had not shifted to the plaintiffs, [the Court] would find
defendants had demonstrated the fairness of both the process and the price."
No Breach of Fiduciary Duty; No Aiding and
Abetting
In assessing Hammons' conduct with respect to the
plaintiffs claim for breach of fiduciary duty, the Court found no breach of
fiduciary duty for the following reasons: (i) Hammons did not participate in
the approval of the Merger as a director of JQH, and he did not participate in
the Special Committee process; (ii) he did not stand on both sides of the
Merger; (iii) he did not make an offer as a controlling stockholder; (iv) he
did not engage in any conduct that adversely affected the merger consideration
obtained by JQH's minority stockholders; (v) there was no evidence to support
any finding that Hammons used his influence to "divert" any of the merger
consideration from the minority stockholders to himself; and (vi) the merger
consideration Hammons received was worth less per share than the merger
consideration JQH's minority stockholders received. Finally, having found that
neither Hammons nor the JQH board members breached a fiduciary duty, the Court
noted that the plaintiffs' claim of aiding and abetting must fail.
Read more Delaware business
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Pileggi, of Fox Rothschild LLP.