Who is Entitled to a Fair Price? — Aditi Bagchi

Post by Aditi Bagchi

Making waves recently was a ruling by the Delaware Court of Chancery that Michael Dell and the private equity firm Silver Lake paid too little for Dell when they bought the company in 2013 in a leveraged buyout. See http://courts.delaware.gov/Opinions/Download.aspx?id=241590. Vice Chancellor J. Travis Laster concluded in an appraisal proceeding that shares were worth about $17.62 rather than the $13.75 that shareholders were paid.

The court arrived at this result without finding that Mr. Dell and management breached their fiduciary duties. To the contrary, they appear to have taken many “praiseworthy” steps in the sales process. No one else came forward with a clearly better offer. The court found, however, that there were structural problems with the accuracy of the market valuation of the company, including some inherent conflicts of interest but, more importantly, limitations in the valuations by potential classes of buyers, including shareholders (short-termism), private equity (high return expectations), and strategic acquirers (integration risk). The result is that the company was found to be worth more than anyone was willing to pay for it.

Reviewing the case, one might sigh with relief that courts do not review ordinary contracts for sufficiency of consideration. Thus, courts do not usually need to decide what a fair price in a sales contract would be. Nevertheless, contract scholars can take the Dell case as an occasion to consider just what justifies court oversight of the substantive terms of exchange.

One might argue that even if fiduciary duties are not violated, the terms of any sale controlled by fiduciaries should be subject to scrutiny. Fiduciaries might act contrary to beneficiaries’ interests without committing any observable wrong that rises to the level of a breach of fiduciary duty. But most of the arguments for why price was inadequate in the Dell case did not have to do with deficiencies in the principal-agent relationship between managers and shareholders. They turned instead on deficiencies in the market for the firm. One can imagine comparable reasons to explain why other sales, controlled on both sides by principals, take place at the “wrong” price. Why not have the court substitute its judgment in those cases, offering the remedy of rescission or even damages for the difference between the contract and “correct” price?

Perhaps the trigger for substantive oversight is instead the involuntary nature of a sale. The sale of a public corporation could be involuntary from the standpoint of individual shareholders. Although Dell shareholders voted whether to approve the sale, some were outvoted and in fact only those shareholders are entitled to recover in an appraisal lawsuit. (This requirement bars recovery for T. Rowe Price, a major proponent of the suit which mistakenly voted in favor of the transaction.) If involuntariness is the trigger, quite a lot turns on our assessment of what qualifies as true consent to a sale. We might doubt that a range of consumer purchases and employee sales meet a robust standard of voluntariness.

Shying away from a philosophical analysis of voluntariness in this context, we are tempted to ask the more limited (but still quite tricky) question of whether judicial oversight is likely to do more harm than good. No doubt that is the main question corporate lawyers will ask.

Note that there is an important difference between deferring to parties’ contract terms on the basis of judicial incompetence (or humility), on the one hand, and party autonomy, on the other. Neither is a sound basis for categorical deference. (See my article, Contract as Procedural Justice (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2691849), for a longer discussion of fundamental differences in the normative bases for contract enforcement.) Although in the usual case we have a variety of good reasons for not even asking whether someone paid a fair price, we should also strive to identify systematically the market conditions under which those reasons are not good enough.

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