Summary
following Paskill in refusing to deduct capital gains taxes
Summary of this case from Reis v. Hazelett Strip-Casting Corp.Opinion
Civil Action No. 3414-CC.
Submitted: April 16, 2010.
Decided: May 10, 2010.
Ronald A. Brown, Jr., Prickett, Jones Elliott, P.A., Wilmington, Delaware.
Allen M. Terrell, Jr., Meredith M. Stewart, Lisa M. Pietrzak, Richards, Layton Finger, Wilmington, DE.
Dear Counsel:
The parties have agreed by stipulation to submit the two following valuation issues to the Court: the capital gains tax issue and the control premium issue. This is my decision regarding those two issues.
First, as to the control premium issue, I conclude that the addition of a control premium in this case is not appropriate. Both appraisers used the discounted cash flow and book value methodologies. Under Delaware law, it is appropriate to add a control premium when appraisers use a comparable public company methodology. This has been the teaching of cases following the Delaware Supreme Court's decision in Rapid-American Corp. v. Harris. Since the comparable public company methodology was not a methodology used by either appraiser in this case, I decline to extend the rule of Rapid-American in these circumstances. Even the Court in Rapid-American held that the inclusion of a control premium was required "under the unique facts" of that case, which was based on comparable values using the market price of similar shares of stock. Cases decided in the Court of Chancery since Rapid-American have clearly held that the addition of a control premium to a discounted cash flow valuation, as here, is not appropriate. Authoritative commentators have likewise observed that it is improper and illogical to add a control premium to a discounted cash flow valuation. Accordingly, the value of Pubco's shares should not be increased by a control premium because no such premium was implicit in any valuation methodology used by the appraisers.
603 A.2d 796 (Del. 1992).
Id. at 806.
See Montgomery Cellular Holding Co. v. Dobler, 880 A.2d 206 (Del. 2005); In re Toys "R" Us, Inc. S'holder Litig, 877 A.2d 975 (Del. Ch. 2005).
See SHANNON PRATT, THE LAWYER'S BUSINESS VALUATION HANDBOOK 359 (2000).
Second, as to the capital gains tax issue, I conclude it is not appropriate to reduce the value of Pubco's securities portfolio based on projected capital gain tax liability that might (or might not) be incurred if the securities portfolio is in fact ever sold. Pubco owned a significant portfolio of securities on the merger date, some of which had market prices that exceeded their purchase prices. It was improper, in my opinion, for the appraisers to subtract the expected capital gains taxes that would be due in the event these appreciated assets were sold to determine an "adjusted" value on the merger date. All that was known and capable of proof on the merger date is the market value of the securities Pubco owned. Nothing in the record indicates that any particular securities were earmarked for sale or that Pubco had a particular schedule regarding the disposition of any securities in its portfolio. Viewed in that light, I believe this issue is controlled by Paskill Corp. v. Alcoma Corp., where the Supreme Court held that it was improper to apply a deduction to an asset valuation based on speculative future tax liabilities attributable to sales that were not specifically contemplated at the merger date. The Paskill holding was based on the bedrock principle of Delaware appraisal law that entitles "[t]he dissenter in an appraisal action . . . to receive a proportionate share of fair value in the going concern on the date of the merger, rather than value that is determined on a liquidated basis." Adjusting the value of Pubco's entire portfolio of securities for the taxes Pubco would have to pay if those securities were sold caused plaintiff to receive her proportionate share of the liquidated value of the portfolio, rather than the going concern value of the portfolio.
747 A.2d 549 (Del. 2000).
Id. at 552.
Id. at 554.
See id. at 553 ("The underlying assumption in an appraisal valuation is that the dissenting shareholders would be willing to maintain their investment position had the merger not occurred. Consequently, this Court has held that the corporation must be valued as an operating entity."). Reducing the value of the securities portfolio by the capital gains taxes that have theoretically encumbered the unrealized gains in the portfolio effectively treats the portfolio as if (1) it was sold at market value on the merger date, (2) the sales proceeds were used to pay the capital gains tax, and (3) the net proceeds were distributed to shareholders, including plaintiff. This is the liquidated value that an investor would realize upon exiting her investment in the portfolio. The assumption under Delaware law, however, is that plaintiff was willing to maintain her investment in the portfolio; albeit indirectly through her investment in Pubco. In this case, the going concern value of plaintiff's investment in the portfolio is better measured by market value; because that is the amount investors desiring to enter the investment are willing to pay for it. In an efficient market, the market value of the portfolio reflects the market's best estimate of the portfolio's present value to an investor who plans to hold the portfolio into the foreseeable future; precisely the position the law presumes plaintiff would have been in had the merger not occurred. See Tri-Continental Corp. v. Battye, 74 A.2d 71, 72 (Del. 1950) ("the stockholder is entitled to be paid for that which has been taken from him, viz., his proportionate interest in a going concern. By value of the stockholder's proportionate interest in the corporate enterprise is meant the true or intrinsic value of his stock which has been taken by the merger.").
Although defendants insist that it had a history of selling the securities in its portfolio and that the "operative reality" on the merger date was that all of the portfolio would be sold at some point in the future, this is not evidence that a particular asset would be sold on the merger date or on any particular date thereafter and that a tax liability would necessarily be created upon such sale. What is known on the merger date is the value of the securities that defendants owned, and that is the value that must be factored into a valuation under 8 Del. C. § 262. Accordingly, I hold that $4 per share must be added to the $34 per share base valuation in order to adjust for the appraiser's improper calculations regarding the capital gains tax issue.
See Paskill, 747 A.2d at 552. Defendants argue that it would be inconsistent to include Pubco's net operating loss tax asset (the "NOL") in the valuation while simultaneously excluding estimated capital gains taxes on Pubco's securities portfolio from the valuation. Defendants argue that if the capital gains taxes are "speculative," then the NOL is likewise "speculative." Unlike the two valuation issues considered in this Opinion, the parties did not agree by stipulation that this Court should consider whether inclusion of Pubco's NOL in the valuation was appropriate. Accordingly, I decline to perform an extensive legal analysis of — or render a formal judgment on — the NOL question. I note, however, that at the merger date Pubco had a definite plan to apply the NOL prospectively (and as soon as possible) to the income from its operating subsidiaries. Thus, unlike the securities in its portfolio, at the merger date Pubco had planned "transactions" involving the NOL, thereby making the NOL's tax benefits part of the "operative reality" of Pubco. On this reasoning, the NOL's value appears to have been appropriately included as a component of Pubco's going concern value. According to defendants, the NOL's value was partly calculated on the assumption that it would be used to offset capital gains on Pubco's securities sales. If I had been asked to rule on the NOL issue I would explore this assertion further, as it may not be appropriate to increase the NOL's value by the taxes it would save Pubco on securities sales when such sales are not part of Pubco's operative reality. Having said that, the NOL would still have going concern value, independent of any securities gains, because Pubco also had a plan to apply the NOL to income from the operating subsidiaries. Thus, it is possible the full value of the NOL would have been realized solely by applying it to income from the operating subsidiaries.
In sum, I find in favor of defendants with respect to the control premium issue, and I find in favor of plaintiff with respect to the capital gains tax issue. In light of this determination, the $34 per share base valuation, which is the agreed compromise of the parties regarding the fair value of Pubco stock as of the merger date, must be adjusted upward by an additional $4, for a total of $38 per share base valuation.
I ask counsel for plaintiff to prepare an implementing order and, upon approval and consent by defendants' counsel, I will enter the order accordingly.