Delaware Courts Skeptical When Cos. Create Fair Value Projections During Litigation

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By Michael Greene

June 18 — Companies looking to cash out stockholders in mergers should be advised that Delaware courts are skeptical of expert projections created during litigation and that a company's earnings should be tax affected to adequately compensate shareholders being deprived of certain tax advantages, according to a June 17 Delaware Chancery Court ruling.

In a 79-page opinion, Chancellor Andre G. Bouchard held that using the proper inputs for a discounted cash flow analysis, Energy Services Group Inc.'s former president's shares were worth about $42.2 million at the time of a cash-out merger, instead of the $26.3 million the company gave him a right to receive.

In addition to determining the fair value of company stock, Bouchard also found that company's two other directors, and largest shareholders, breached their fiduciary duties by approving a self-interested transaction that was not entirely fair. However, the court declined to award any additional compensation for these claims because the damages were equivalent to the properly appraised stock value.

Reliable Projections

After being cashed-out out of his Energy Services' stock, Nathan Owen, the company's former president and largest shareholder, petitioned the court under 8 Del. C. §262 to determine the fair value of his stock at the time of the merger.

Although the parties agreed that the court should use discount cash flow methodology, they disagreed on certain key inputs, including the source for projecting the company's future performance.

Even though the company derived its merger price from five-year projections created in 2013 under the direction of its new president Lynn Cannon, the defendants insisted the court use a set of 10-year projections that their financial expert created during the litigation.

Siding with Owen, Bouchard concluded that the company's earlier projection best estimated the company's future performance. In doing so he, he found that the record reflected that top executives “engaged in a deliberate, iterative process over a period of three years to create, update and revise multi-year projections for the Company.”

The court also noted that if anything, the 2013 projections were revised significantly downward because Cannon knew he was forcing Owen out of the company.

“Cannon was motivated in my view to make the assumptions in the 2013 Projections as conservative (i.e., reliable) as possible because he knew full well when they were created that they could set the price to force [Owen] out of the Company involuntarily, which was an invitation to litigation,” Bouchard wrote.


The court also found that the 10-year projections created for the purpose of litigation were not reflective of management's best estimates.

“Delaware courts are generally skeptical of projections created by an expert during litigation,” Bouchard wrote, adding that the after-the fact projections were “tainted by hindsight” and were not reliable sources in determining the fair value of Owen's shares.

Tax Affect

Bouchard also ruled that the company's valuation incorrectly failed to compensate Owen for being deprived of his Supchapter S stockholder status.

S-Corp. stockholders are only taxed once at the investor level.

After addressing several other disputed inputs, the court concluded that the fair value of Owen's sock as of the merger was about $42.2 million.

Fiduciary Duties

The court also addressed claims that two company directors breached their fiduciary duties by approving the merger.

Because the two defendant directors conceded that they were conflicted because of their material interest in paying Owen as little as possible, the court reviewed the merger under the entire fairness standard.

Finding not only that the merger price was inadequate, but also that the transaction was a product of unfair dealing, Bouchard concluded that the defendants had breached their fiduciary duties.

However, the court declined to award any compensation for these breaches because Owen failed to show that the damages were greater than the fair value of his shares.

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To contact the editor responsible for this story: Ryan Tuck at

The opinion is available at