The year 2015 proved to be an active and interesting year for M&A cases in the Delaware Chancery Court and the Dole case was among the most significant.

March 01, 2016

Damages of $148 million1 were awarded to shareholders in the case, one of the largest awards ever to shareholders in an M&A deal-related lawsuit.

David Murdock, CEO and chairman of Dole — who owned approximately 40 percent of the outstanding Dole shares and who initiated a going private transaction that closed on November 1, 2013, at $13.50 per share (approximately $1.6 billion) — was found liable for breaching his fiduciary duty of loyalty in connection with the deal. Michael Carter, a director of Dole and its president and COO, was also found liable for breaching his fiduciary duty of loyalty. He was accused of committing fraud in the going private transaction for, among other actions, manipulating information released to the public markets, canceling an open-market stock repurchase program (thus, negatively affecting the stock price), and aiding Murdock in buying Dole stock at a lower price. This article discusses the M&A process and valuation-related issues pertaining to the Dole case.

Many structural process issues in this matter were seemingly handled according to best practices for managing related-party transactions; however, in the end a strong M&A process was not a panacea for the violations and breaches of fiduciary duty. When the Dole going private transaction was under negotiation in 2013, the MFW Delaware court case2 had recently been decided. The decision essentially protected the M&F Worldwide (MFW) board from liability under the business judgment rule in a related-party transaction. Prior to the MFW decision, a typical related-party merger transaction was subject to the higher entire fairness standard, shifting to the related party the burden of proof that it had executed the transaction according to fair process and fair price.

MFW was a significant case because the board and the controller were insulated from liability in a related-party merger transaction by taking two steps in combination: 1) the board formed a special committee of disinterested directors, and 2) a vote of the “majority of the minority” of disinterested shareholders was held. Under the business judgment rule, a board is generally allowed much more latitude to operate when negotiating a merger transaction as long as the transaction price falls within a range of reasonableness of fair market value. The Dole transaction followed a process and structure similar to MFW’s: a special committee was formed, and the transaction was subject to a vote of the “majority of the minority” of disinterested shareholders. In addition, the Special Committee retained a separate financial advisor and legal counsel that negotiated a higher price with the related party. The financial advisor was praised by the Chancery Court for its advice to the Special Committee and for helping negotiate the $13.50 merger price — an increase from the original $12.00 offer, implying a 20 percent premium over the price traded in the stock market.

Process

A number of issues in the Dole matter became problematic from a process perspective, beginning with the formation of the Special Committee. The Chancery Court found Carter restricted the Special Committee’s mandate to meet to “specifically consider Murdock’s proposal and for no other purpose,” thereby not allowing the special committee to entertain transactions with other bidders. Carter, the court also found, interfered with the Special Committee’s process by attempting to influence selection of the Committee’s advisors, insisting on controlling the terms of any nondisclosure agreements the committee could enter into with other potential bidders, and improperly granting data room access to Murdock’s advisors.

The financial projections for Dole that were used in the going private transaction were another crucial issue. The Chancery Court found that the revenue and profit forecasts provided to the Special Committee lacked credibility because they were constructed using a “top down” instead of the usual “bottom up” process that Dole normally undertook, involving line business managers in the estimates. Moreover, the Chancery Court said, the projections “inexplicably” showed flat EBITDA estimates for 2016 and 2017, except for a small adjustment for new cargo ships. The Special Committee and its financial advisor recognized that the projections as originally presented were not reliable; those “lowball” projections were substantially below the projections that had been used about six months earlier to finance Dole’s sale of its Asian fresh produce and global packaged food business to ITOCHU International Inc. The Special Committee and its financial advisor recognized the inconsistencies in the projections provided by Dole management and apparently made “Herculean” efforts, as noted by the Chancery Court, to overcome the information deficit by creating their own projections.

Cost savings estimates became a point of contention in Chancery Court as well. Cost savings from the sale of Dole’s Asian operations were initially estimated to be $50 million annually, which was communicated to the markets as $20 million to be implemented immediately in 2012 and another $30 million to be realized in 2013. Carter, however, changed the cost savings estimate to suggest that only the original $20 million of cost savings would be achieved. After the announcement of the lower estimate, Dole’s stock price dropped 13 percent. Meanwhile, analysts covering Dole’s debt were told the company had already achieved a $30 million run rate of savings. Murdock’s advisors and the banks looking to provide Murdock with financing for his buyout proposal were told a different, and significantly more positive, story on the cost savings. The inconsistencies about the level of cost savings communicated to the market and to the Special Committee by Dole executives were perceived as deceptive.

Murdock had been advocating for a self-tender as a step toward going private. The Board was divided about whether to pursue open-market purchases or a self-tender for Dole’s shares. The self-tender would have allowed for larger volume purchases and would have been executed more quickly, with Dole purchasing shares at a premium to market price. The open-market purchase option would have been executed at the market price without a premium. Given Murdock’s large block of stock, a self-tender would have been more beneficial to his shares. Murdock tried to influence the board members toward a self-tender; the issue became so contentious that two board members resigned over it. In the end, Murdock did not get approval for a self-tender. The Board voted instead to begin open-market purchases. Two weeks after the open-market purchase program began, Carter canceled the program without consulting the board, citing, in a press release, the need to purchase vessels.

The Special Committee also obtained a go-shop provision in the transaction with a small breakup fee (by industry standards). In a fair process, a go-shop provision that allows outside bidders to bring topping bids gives a level of assurance that the transaction in question has achieved a fair price through a fair process. Despite a market go-shop provision in the Dole case, Murdock’s refusal to sell to Chiquita or any other buyer rendered the go-shop provision ineffective. Moreover, any alternative bids would have been based on public disclosures that the Chancery Court found “lacked material information about planned cost savings.” Further, the Chancery Court found that the same lack of disclosure of material information impaired the majority of the minority vote and “foreclosed the ability of the stockholders to protect themselves by voting down the deal.”

Despite attempts by the Special Committee and its legal and financial advisors to ensure a fair process, the Special Committee’s efforts did not provide a cure for the “antithesis of a fair process.” The majority of the minority vote was rendered, as the Chancery Court said, “inherently unknowable” since there was “no way to learn what the Special Committee would have done in the absence of a fiduciaries’ disloyal conduct.”

Price

Unlike in the MFW case, the Dole transaction was held to the higher, entire fairness standard, requiring fair price and fair process. In cases where the entire fairness standard applies and where fair price is being evaluated, the Chancery Court considers whether the transaction was one “that a reasonable seller, under all of the circumstances, would regard as within a range of fair value; one that such a seller could reasonably accept.” The fair price analysis as part of the entire fairness review suggests that the value of a company is not a “point on a line.” Instead it is a range of value that by its nature suggests a wider spectrum of acceptable transaction prices and is most relevant when a related party establishes a process that simulates arm’s-length bargaining supported by appropriate procedural protections. If the Dole structural process had effectively ensured a fair process, the merger price of $13.50 might have been determined as fair. Given the Dole executives’ actions in driving down the stock price and withholding certain information, however, the Chancery Court thought the Special Committee was prevented from achieving a “fairer” price.

In determining damages, the Chancery Court adjusted the projections and valuation of the Special Committee to reflect the areas where the Dole executives misled the Special Committee, including cost savings and benefits from farm purchases, which had been underestimated. These adjustments resulted in a damage award of $2.74 per share and implied a fair value for Dole of $16.243 per share, which was meant to approximate the result had an arm’s-length negotiation taken place between parties having equal information.

The Chancery Court found Murdock and Carter jointly and severally liable for breaches of fiduciary duty for $148 million, representing damages of $2.74 per share. Since breach of fiduciary duty is not exculpable or indemnifiable under Delaware law, Murdock and Carter were personally liable for the damages.

Key Takeaways:

  • Related-party mergers can be subject to the higher legal standard of entire fairness, requiring fair process in addition to fair price. Meeting the MFW tests of forming a special committee of disinterested directors and facilitating a vote of the majority of the minority doesn’t guarantee that a related-party transaction will be viewed under the business judgment rule (i.e., fair price alone).
  • Proper formation of the special committee is critical. The process of selecting special committee members must be objective, and the special committee must be allowed the full freedom necessary to select an unbiased financial advisor and legal counsel.
  • Officer actions in a related-party transaction must support a fair process and show that officer loyalty is to the corporation and its shareholders, not the related party. The actions of certain corporate officers in the Dole case were deemed unbecoming and unfair to shareholders by the Delaware Court.
  • Projections must be consistent with those used by the board in the normal course of business and for other financing or transactional purposes. The process of constructing the projections (top down versus bottom up) should also be evaluated for consistency.
  • A meaningful control premium is not evidence of a fair deal price. This is an old concept from the 1980s landmark case Smith v. Van Gorkom4, in which a control premium of over 40 percent was achieved, but in the end was deemed unfair. In Dole, the 20 percent control premium was deemed insufficient value for shareholders.
  • A true, unfettered market check with full and transparent information can help with a defense in shareholder litigation. If there is a market go-shop provision and no other constraints on bidders and no bidders materialize, then it is hard to argue that a fair process was violated.

  1. The Dole executives that were found liable for the damages subsequently settled for a payment of $114 million.
  2. In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. 2013).
  3. It is interesting to note that the court initially calculated the damages at $6.84 per share but subsequently reduced the amount because, in its view, the cost-savings initiatives and purchases of new farms “were riskier and less certain than Dole’s established business.”
  4. Smith v. Van Gorkom, 488 A.2d 858, 879 (Del. 1985)
  5. Sources: Memorandum Opinion, In the Court of Chancery of the State of Delaware, In Re: Dole Food Co., Inc., Stockholder litigation and In Re: Appraisal of Dole Food Company; Wall Street Journal.