Steiner Corporation v. Benninghoff
An Analysis of the Court’s Valuation Process
Introduction
Scholars in the field of valuation claim that the modern purpose of the appraisal statutes is to prevent misconduct by majority shareholders. However, an analysis of Steiner reveals that even when a corporation’s actions reveal aspects of fair dealing this has little impact on the judicial valuation process.
Summary of the Court’s Findings of Facts and Conclusions of Law
To avoid the potential imposition of an accumulated earnings tax, Steiner Corporation, a privately owned company, merged with Steiner Holding Corporation and offered to repurchase the minority shares at $1200 per share. Steiner Corporation v. Benninghoff, 5 F.Supp.2d 1117, 1121 (Nev. D.C. 1998). The merger was conditioned on an approval vote by a majority of the minority. Id. at 1121. Before determining the purchase price, the board of directors appointed a Special Committee of outside board members to represent the interests of the minority. Id. at 1122. The Special Committee retained independent counsel and hired J.P. Morgan Securities (JPM) to perform the valuation. Id. JPM assigned a value for the corporation between $1100-$1500. Id. In turn, the Special Committee reported the range of $1100-$1400 to the board of directors (without providing an adequate reason for the devaluation from $1500). Id. Negotiations between the Special Committee and the board resulted in the $1200 offer to the shareholders. Id.
Although 83% of the minority shareholders as well as nine members of the Steiner family surrendered their shares, seven members of the Benninghoff family (17%) dissented from the merger. Id. at 1121. With limited success, the Benninghoff’s attempted to obtain information regarding the method of valuation performed by JPM. Id. at 1122. Given that notice of the merger and the day of the vote were only a month apart, the Benninghoff’s lacked the opportunity to obtain their own professional advice as to the value of the corporation. Id. At trial the corporation offered both JPM and Dr. Allan Kleidon as experts, and the Benninghoff’s offered David Nolte of Arthur Anderson. Id.
N.R.S. § 78.476 gives dissenting shareholders the right to the “fair value” of their shares. The court identified the following four factors as determinative of “fair value”:
1) Pre-merger market value discounted for illiquidity;
2) Pre-merger enterprise value as a whole;
3) Pre-merger net asset value, and;
4) Any other factor bearing on value. Id. at 1123.
For the first prong of the four-prong test the court used a “market comparable” approach by comparing the company’s subsidiaries to a number of similar publicly traded companies to arrive a market multiple with which to multiply Steiner’s earnings. Id. at 1126. With this method the court determined a market value of $515,534. It discounted the market value 25% for illiquidity, subtracted the corporation’s debt, added excess cash and divided by shares outstanding for a final value of $1191 per share for prong one. Id. The second prong of the analysis included a discounted cash flow (DCF) analysis and an acquisition method. Id. at 1129-37. The debt-free DCF method resulted in a value of $1273 per share and the acquisition method produced a value of $1958 per share. Id. The two results in step two were weighted 70% and 30%, respectively, to arrive at a total value for the second prong of $1479 per share. Id. at 1137. The third prong consisted of the pre-merger net asset value of the company and the fourth prong consisted of weighing other evidence of fairness. Id. at 1138. Neither prongs three nor four were assigned a value due to the court finding that these methods lacked credibility. Finally, the court assigned a weight to the four methods, 25%, 75%, 0%, 0%, respectively, and arrived at a final valuation for the corporation of $1407 per share. Id.
Role of Evidence of Fair Dealing
According to Barry M. Wertheimer, “The Shareholder’s Appraisal Remedy and How Courts Determine Fair Value,” 47 Duke L.J. 613 (1998), the modern purpose of the appraisal statute is to “protect minority shareholders from unfair fundamental transactions involving conflicts of interest.” Id. at 712. Wertheimer further states that…
in cases where the dissenting shareholders achieve a favorable result, there almost invariably is evidence that the acquiring party acted inequitably or engaged in overreaching… On the other hand, in appraisal cases where the acquiring party achieves a favorable result, there is evidence that the acquiring party did not act inequitably. These cases typically involve a third-party arms-length transaction, or other indicia of fair dealing. In short, there is a strong correlation between the particular equities of each case and the result reached. Given the purpose of the appraisal remedy, this is a desirable outcome. Id. at 678-79.
Citing a number of cases, Wertheimer identifies factors of unfair dealing such as offering an obviously unfair price, providing inadequate disclosures to the shareholders, failing to provide independence in the valuation process, refusing independent representation of the minority on the board and other such indications self-dealing. Id. at 679-684. The appearance of these factors, according to Wertheimer, results in the courts rightly determining the value of a minority’s shares in excess of the company’s offering price. Id. Wertheimer’s comments and observations seem to indicate that the behavior of the majority shareholders is a factor in determining “fair value” and plays a significant role in the judicial valuation process.
Likewise in Ryan v. Tad Enterprises, Inc. the court applied an “entire fairness analysis” which included, as its first step, an evaluation of the “fairness of the negotiation and the approval process in the transaction.” 709 A.2d 682, 689 (Del. Ch. 1996). In Ryan, there was ample evidence of self-dealing such as failing to obtain independent valuations, including high non-compete payoffs to the majority shareholders, and lack of bargaining for optimal shareholder buy-out prices. Id. at 691-93. After examining the merger and valuation procedures, the Ryan court concluded, “the defendants failed to carry their burden of proving the Asset Sale and the Merger were the product of fair dealing.” Id. at 693. Only after making a determination about the fairness of the merger proceedings did the court undertake to actually begin its valuation of the company. Like Wertheimer, the Ryan court seemed to believe that indicators of fairness or unfairness in the initial merger transaction are important factors in determining “fair value”.
Major aspects of “fair dealing” the Ryan court looked for are described by Alan Palmiter, Corporations: E&E, chapter 17, page 13 and include “negotiation by a team of the subsidiary’s outside directors…, full disclosure, approval by minority shareholders by conditioning the vote on a majority of the minority shareholders…, and not timing the merger to avoid an obligation to pay a higher contract price.” As noted, Steiner conditioned the merger on a majority vote by the minority shareholders, of which 83% approved the merger. Steiner also appointed a Special Committee to represent the interest of the minority, and the committee in turn retained independent legal counsel and an outside valuation firm. Negotiations took place between the Special Committee and the majority shareholders to determine a final price. Additionally, the Steiner court ruled that neither side acted in bad faith regarding the events surrounding the merger or the litigation. 5 F.Supp.2d 1117,1138-39 (D. Nev. 1998). Even though the District Court in Nevada is not bound by Delaware decisions, Nevada, having few appraisal cases on which to rely, cites to many of Delaware’s cases. However, unlike the Delaware court, the court in Steiner completely disregarded the aspects of fairness in the Steiner merger.
The Nevada court could have used the aspects of fairness in the merger in at least three different ways. First, similar to the Ryan case, it could have used the aspects of fairness to decide in a summary judgment-like fashion if the company met its initial burden of proving that its valuation was fair. This entry-level method rightly allows the company to avoid a judicial valuation by engaging in fair dealing in its business practices. In addition, given that courts traditionally refrain from interfering with business judgments, it is consistent to impose this justification on the court ordered valuation process.
Second, the court could have used the lack of bad faith on the corporation’s part as evidence of the credibility of the assumptions used by the independent valuation performed by JPM. However, out of the approximately ten conflicts between the parties on the valuation assumptions, the court accepted only two of JPM’s, one of which already agreed with Nolte’s. Part of this rejection by the court of JPM’s assumptions may be explained by JPM’s inability to reproduce all the related documents it used in its original valuation of the company. JPM claimed that it “routinely” destroys such documents despite the standard of practice in the appraisal industry prohibiting such destruction. Id. at n3. Nevertheless, the court did rely on JPM despite the lack of corroborating data when JPM’s assumptions closely approximated or matched those of Nolte’s.
For example, in the first prong of the fair price analysis the parties performed a “market comparable” valuation. JPM and Kleidon produced a range of value of $514,290—$551,030 and $364,500—$579,000, respectively. Nolte gave one value of $515,534. Id. at 1128. The court chose Nolte’s value because it fell comfortably between the two ranges offered JPM and Kleidon. Id. Not relying on JPM’s higher range would have forced the court to better justify its choice. Likewise in determining the market risk premium for the CAPM equation, the court again used JPM’s numbers to the detriment of the company. Kleidon and Nolte disagreed on the proper method to determine the market risk premium, but JPM used the same method as Nolte. Id. at 1134. Here the court used “the preponderance of the evidence” test to support its use of Nolte’s and JPM’s lower numbers. Id. It should be noted that nowhere else in the opinion in the multitude of conflicts is “the preponderance of the evidence” test evoked. Therefore, the court’s use, or lack thereof, of the corporation’s assumptions tends to show that aspects of fair dealing in the merger process provided little weight in establishing the credibility of the corporation’s assumptions.
Finally, the court could have used evidence of fair dealing in its fourth prong of the fair price analysis. The fourth prong of the “fair price” test included consideration of “any other factor bearing on value.” Id. at 1123. The court defined this prong as going “more to the credibility or reliability of the results achieved under the other prongs than to any independent method of valuation.” Id. at 1137. This language evokes the use of fairness in the Ryan case. Unlike Ryan, instead of an entry-level analysis, this prong contributes it own weight to the entire valuation. However, the court only considered and rejected the evidence that some members of the Steiner family cashed in their shares for $1200. Id. The court argued that the willingness of Steiner family members to take a tax hit by cashing in their shares, as opposed to passing the shares in their estates, was not evidence that the price was “an absolutely super, once-in-a-lifetime deal.” Id. at 1137-38. Although the court should have only been considering if this was evidence of a “fair price”, the court refused to give any weight to this evidence based on the court’s lack of belief that is was a “super, once-in-a-lifetime deal.” Id.
The Steiner court’s failure to use any one of these three methods to weigh in fair-play indicates that dissenter’s rights, at least in this court, entitle the dissenter to an accounting of value regardless of the terms of the merger. In this way any minority shareholder, whether nine or one, is entitled to a judicial determination of value. Additionally, if the courts apply favoritism consistent with this opinion, the valuation achieved will always be greater than that offered by the company. This use of the appraisal statute does not encourage a corporation to use equitable methods in determining shareholder price in a cash-out merger. Likewise it encourages dissenter actions regardless of the price offered by the company. In the limit, the appraisal statute in Nevada could make normally sound economic decisions such as mergers too expensive for small independent companies since, to satisfy minority shareholders, it would have to offer prices obviously above any reasonable enterprise value.
Inconsistencies in the Methods of Valuation
While the court took pains to be as precise in its valuations as possible, it overlooked three major inconsistencies, all of which favored the dissenters. Before the court undertook the valuation process it addressed several areas of conflict. One of these areas involved the imposition of either imposing a control premium or a minority discount to the market comparable method in prong one of the fairness test, and the DCF and acquisition methods in prong two, respectively. Id. at 1124.
The court recognized that the market comparable approach had an inherently minority value and the DCF and acquisition approach were control values. Id. To resolve the issue, the court opted to add neither a discount nor a premium to any of the methods. Id. This seemed equitable given the controversy surrounding this issue and since the court would arrive at it’s final price using a weighted average of both types of values, minority and control. However, when the court arrived at its results in all the prongs of the test, it applied a 30% weight to prong one and a 70% weight to prong two. Id. at 1138. The only reason the court gives for the difference in weighting is that the DCF method was “stress[ed]” at trial. Id. There is no real evidence that the DCF method achieved a more reliable valuation given the conflicts between the parties in determining the appropriate assumptions to use and the seemingly arbitrary choices of the court. In effect, this difference in weighting applied a premium to the market comparable’s approach by giving the lower result less weight in the final analysis. This result seems inconsistent with the arguments presented by the court in its refusal to impose any discount or premium. Since the court cited a number of different authoritative sources in justifying the use of the market comparable method, it seems inconsistent that it would weigh this recognized method lower than any other valuations.