A "fairness opinion"
is a statement from a financial expert that a transaction is "fair
from a financial point of view" to certain parties at interest. In theory, such opinions
should protect minority shareholders who are diffuse and cannot have a direct voice
in transactions. Fairness opinions serve two primary purposes: 1) to assist and justify
the decision making of directors and 2) to persuade shareholders to tender shares or
to agree to approve the terms of a transaction.
The issues of fairness and the
need for fairness opinions generally arise where actual
or potential conflicts of interest exist among parties involved in a transaction. A fairness
opinion attempts to provide a posture maintaining arm's length standards where they
do not otherwise exist.
Officers, directors and majority
shareholders of a corporation owe a fiduciary
responsibility to minority shareholders. Dissident minority shareholders may
seek injunctive relief, rescission, damages or a statutory appraisal, and may
allege the transaction involves inadequate disclosure, breach of duty, or
There are many reasons for fairness
opinions, most of which deal with transactions
involving securities of both closely held and publicly traded companies. An
independent opinion of fairness concerning the exchange of values involved can
provide substantial support for such exchanges. Furthermore, independent fairness
opinions are useful as a defense against dissident shareholder claims.
Fairness opinions are most useful
when they are the product of thorough research
by independent financial advisers, and not simply "rubber stamp" endorsements of
decisions previously made in the corporate boardroom. Their purpose is to provide
an objective standard against which directors, shareholders, and other interested
parties may measure proposals and opportunities concerning their company.
Business Judgment Rule
With the power to oversee the
business and affairs of a corporation, granted by
state law and corporate charter, comes the duties of care and loyalty to the
corporation (as well as to shareholders). In other words, the board must act in a
prudent manner and avoid, where possible, conflicts of interest.
Fairness opinions are designed
to assist directors in making reasonable business
judgments, and to provide protection under the business judgment rule. This
rule generally requires that when a business decision is made: (a) the board
exercised due care in the process of making that decision; (b) the board acted
independently and objectively (as a disinterested party might have acted);
(c) the board's decision was made in good faith; and (d) there was no abuse of
discretion in making the decision.
However, there must be objective
evidence of the directors' attempts to be fair.
The courts make detailed inquiries into how a decision was made, with a great
deal of emphasis on the processes involved. Clearly, there is a heightened duty
of care in a transaction where management has a significant self-interest.
An expert valuation opinion
may be one of the factors taken into account in
determining whether the directors possessed sufficient information concerning
the transaction and whether they critically examined the information available
Fairness opinions are generally
not required, but have evolved from state
corporate laws requiring boards of directors to approve transactions affecting
shareholders and express their views on fairness. An independent opinion will
help the board satisfy its obligation to exercise sound business judgment in
It is not the valuation expert's
job to determine whether the business judgment
rule applies in borderline situations. Therefore, there may be some elements
of the fairness process on which the valuation expert is not competent to render
an opinion because they require legal judgments.
The ultimate purpose of a fairness
opinion is to help the board of directors of the
seller satisfy its obligation to exercise sound business judgment in approving the
transaction. This judgment is required of the directors even when no conflicts of
Under most state corporation
statutes, directors can rely, to a large extent, on
opinions expressed by outside experts within the range of their expertise. Under
Delaware law, for example, a member of the board of directors is fully protected
in relying in good faith upon the books of account or reports made to the corporation
by any of its officers, or by an independent certified public accountant, or by an
appraiser selected with reasonable care by the board of directors.
Usually, a number of different
parties must consider the fairness of the transaction to
them or to a constituency they represent. In most transactions of any size or complexity,
the following parties generally play a role:
A special committee of the board
of directors is generally the key participant
attempting to have the transaction meet applicable legal standards. Courts will
look for objective indications of compliance with the duty of care. Therefore,
where a board establishes a special committee to evaluate a proposed course
of conduct, retains independent legal and financial experts, takes its time in
addressing the matters before it, and questions its advisors rather than passively
receiving information, the board will have taken significant steps toward having
made an informed decision.
Breaches of the duty of care
are usually characterized by either a board's failure
to obtain adequate information before acting or a board's failure thoroughly to
consider a decision. Although the establishment of a special committee does not
satisfy the duty of care standard, the use of a special committee should minimize
the risk of breaching the duty of care. This is because the special committee is
likely to be a smaller and more objective group that can more effectively monitor
and assist the information gathering and deliberative functions of the board.
Courts' Concept: Entire Fairness
What does "fairness"
mean if it is more than simply fair market value? The
broader concept of fairness in transactions involving potential conflicts of
interest was brought into focus in the Delaware courts. In the Singer v.
Magnavox Company decision, the Delaware Supreme Court held that
majority stockholders owed minority stockholders a duty of "entire fairness."
The concept of entire fairness, initially highlighted in Singer and discussed at
length in Weinberger v. UOP, Inc.,encompasses two tests: 1) fair dealing
(or procedural fairness) and 2) fair price (or substantive fairness).
Partly because of the difficulty
of determining the substantive fairness of the
price in any transaction, Delaware decisions emphasize procedural fairness as
a safeguard. The issue of what constitutes "fair procedures" in a particular
transaction is driven by the facts of that transaction.
Procedural fairness requires
that the majority not use their control of the
corporate machinery to effect a transaction without regard for the rights
of the minority. In Weinberger, the court indicated that fair dealing
"embraces the questions of when the transaction was timed, how it was
initiated, structured, negotiated and disclosed to the directors, and how
the approvals of directors and stockholders were obtained." Unfair
dealing includes fraud, overreaching, hurried transactions that deny
directors an opportunity for careful deliberations, lack of arm's length
negotiation, and nondisclosure of pertinent information.
One of the possible indications
of procedural fairness, which also provides
support for the determination of price fairness, is the existence of an opinion
from an independent expert, such as a valuation consultant. Delaware courts
have suggested that, while it is not absolutely necessary for the board to have
the assistance of a financial adviser passing on a transaction, failure to do so is
at the board's own peril.
The burden of proof, at least
in Delaware, depends upon the use of fair
procedures. In general, in a transaction with conflicts of interest, the burden
of proving fairness will rest initially on the party with the conflict. If that party
can show that fair procedures were followed that in substance, neutralized the
conflict, then the burden of proving unfairness may shift to the plaintiff.
Substantive fairness encompasses
the economic and financial aspects of a
proposed transaction. While a fairness opinion issued by a financial expert
usually addresses only the issue of fair price, obtaining a fairness opinion
provides an indication of procedural fairness. The determination of fair price
itself remains an elusive concept. Despite the literature of financial analysis
and the abilities of valuation experts, values are difficult to determine. This
has led the courts also to consider the non-financial, procedural elements of
the transaction in assessing fairness.
Since fair dealing and fair
price are examined as a whole, the financial expert
should be informed of all material facts and circumstances of the transaction,
even if the opinion does not directly address the aspect of fair dealing.
Weight Given to Fairness Opinions
The expert's opinion is not
conclusive on the issue of fairness unless it is a
negative opinion. It is highly unlikely that a transaction found by the expert
to be unfair from a financial point of view could go forward successfully.
If the expert's opinion is positive
as to financial fairness, a variety of other
factors bear on the question of how much weight, if any, a court will give
to that opinion.
(a) Independence: A person
who attempts to express an opinion on the fairness of
a transaction such as a merger or reorganization to be acted upon by stockholders
having divergent interests, should be in a position of absolute impartiality. Fairness
opinions are often provided by the very same investment bankers who are
structuring the deal in question and whose compensation is often or predominantly
contingent on the deal's success. In such a situation, the investment bank faces a
serious conflict of interest that can compromise the credibility of the fairness opinion.
(b) Time and Fees: Careful
consideration should be given to the nature of the fee
arrangements for the valuation opinion. If a material portion of the fee is dependent
upon the success of the transaction or any factor other than the mere delivery of the
opinion, the independence of the person giving the opinion is likely to be called into
question. Currently, the standard practice is to give valuation experts as much time
as they indicate they need to reach their decisions primarily because of the adverse
commentary in many recent Delaware decisions.
(c) Information Available:
The amount of information made available to the
valuation expert also has had significant bearing on the weight a court gives
to the work product. A failure to make available essential information to the
appraiser, needed by the appraiser if his appraisal were to have any meaning,
has been held to be a breach of fiduciary duty.
In addition, fiduciaries must
take the time to understand the analysis and assumptions
underlying the opinion. Finally, fiduciaries should examine the text of the opinion
carefully and understand any disclaimers or limiting assumptions that may weaken
or dilute the opinion.
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