Jacobs v. Akademos, Inc. ( 2024 )

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
BRIAN JACOBS, ALAN JACOBS, THE )
BERNARD B. JACOBS AND SARA JACOBS )
FAMILY TRUST, JEAN-LOUIS VELAISE, )
DALE KUTNICK, TOREN KUTNICK, )
EDWARD B. ROBERTS, JOHN DENNIS, )
SHLOMO BAKHASH, and JOAN RUBIN, )
)
Plaintiffs, )
)
v. ) C.A. No. 2021-0346-JTL
)
AKADEMOS, INC., KOHLBERG )
VENTURES, LLC, BAY AREA HOLDINGS, )
INC., JOHN EASTBURN, GARY SHAPIRO, )
JAMES KOHLBERG, RAJ KAJI, BILL )
YOUSTRA and BURCK SMITH, )
)
Defendants. )
POST-TRIAL OPINION
Date Submitted: July 12, 2024
Date Decided: October 30, 2024
Elizabeth A. Sloan, BALLARD SPAHR LLP, Wilmington, Delaware; Jason C. Spiro,
Thomas M. Kenny, Marissa DeAnna, SPIRO, HARRISON & NELSON, Montclair,
New Jersey; Attorneys for Plaintiffs.
Geoffrey G. Grivner, Kody M. Sparks, BUCHANAN INGERSOLL & ROONEY PC,
Wilmington, Delaware; Attorneys for Defendants Akademos, Inc. John Eastburn,
Gary Shapiro, James Kohlberg, Raj Kaji, Bill Youstra and Burck Smith.
Geoffrey G. Grivner, Kody M. Sparks, BUCHANAN INGERSOLL & ROONEY PC,
Wilmington, Delaware; Gavin J. Rooney, LOWENSTEIN SANDLER LLP, New York,
New York; Attorneys for Defendants Kohlberg Ventures LLC and Bay Area Holdings,
Inc.
LASTER, V.C.
A privately held corporation pursued a seemingly promising business model:
contract with educational institutions like colleges and universities to operate their
online bookstores. Yet during more than two decades of operations, the company
failed to produce a single profitable year.
Throughout the company’s first decade, the founder bridged the company’s
annual cash shortfall by raising funds from friends, family, and the occasional angel
investor. In return, those investors received common stock.
Around the halfway mark, the company secured an investment from a venture
capital fund. The fund received shares of preferred stock that carried a liquidation
preference triggered under specified circumstances.
During the company’s second decade, the fund made supplemental
investments to cover the company’s shortfalls. Initially, the fund bought more
preferred stock. Later, the fund received promissory notes that carried a repayment
premium triggered under specified circumstances.
The company maintained that if it could achieve sufficient scale, then its
business model would become profitable. By 2020, the company had not achieved its
goals, and the company’s low margins cast doubt on whether it ever could. A new
CEO proposed starting two new, higher-margin businesses, but the company needed
at least $2 million to continue operating its core business and another $6 million to
start the new, higher-margin businesses.
During the first half of 2020, the company and its investment banker ran a
dual-track process seeking either outside investment or an acquisition proposal. No
one expressed any interest in an investment. The company received a few indications
of interest in an acquisition, but none at values greater than $10 million.
In July 2020, having shown patience far beyond what one might generally
expect from a homerun-ardent venture capitalist, the fund proposed to acquire the
company’s remaining shares through a cash-out merger. The fund was willing to put
more capital into the company, but only if it owned all of the equity.
The proposed transaction valued the company at $12.5 million on a cash-free,
debt-free basis. In a change of control at that valuation, the liquidation preferences
associated with the fund’s preferred stock and the repayment premiums associated
with its debt would garner all of the consideration. Taking those claims into account,
the company’s valuation would have to reach $40 million before the common
stockholders would receive anything. There was no market evidence that anyone
believed the company was worth that much.
The fund did not condition its offer on the twin MFW requirements—approval
from both an independent special committee and a majority of the unaffiliated
stockholders. At trial, the defendant directors explained persuasively that the
company lacked the funds to support a full-blown MFW process.
The fund did condition the merger on the prior approval of the company’s three
unaffiliated directors. The fund also proposed a comparatively open post-signing go-
shop. The company could shop the offer freely, the fund would not have any match
rights, and the fund would be obligated to sell into any bid that the unaffiliated
directors deemed superior. The only knock was the go-shop’s duration. At only three
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weeks, it was short, and the company was not a high-profile entity. On the other
hand, the go-shop followed an exhaustive pre-signing outreach, and during the go-
shop, the company focused on those few potential counterparties who had expressed
some level of interest in a transaction.
The unaffiliated directors voted in favor of the merger by a two-to-one vote.
The company’s founder, who remained on the board, voted against. The fund had
sufficient voting power to approve the merger at the stockholder level, and it did.
The merger closed initially in September 2020, but the deal had not been
structured optimally for the fund from a tax perspective. Fortuitously, the lawyers
had neglected to have the acquisition vehicle’s stockholders—namely the fund—vote
on the merger. The company and the fund declared the initial closing void,
restructured the deal to meet the fund’s tax objectives, then closed a second time in
in December 2020.
A group of common stockholders led by the company’s founder sought
appraisal. They also asserted plenary claims for breach of fiduciary duty against the
directors and a claim for aiding and abetting by the fund. The plaintiffs challenged
not only the merger but also a two of the preceding debt financings where the fund
supplied the company with desperately needed capital.
In the appraisal proceeding, each side had the burden of proving its valuation
position. The plaintiffs did not present a credible valuation. The defendants made a
convincing case that the fair value of the plaintiffs’ shares at the time of the merger
was zero.
3
For purposes of the plenary claims, the defendants bore the burden of proving
that the financing transactions and the merger were entirely fair. They carried that
burden.
Judgment will be entered against the plaintiffs and in favor of the defendants.
I. FACTUAL BACKGROUND
Trial lasted four days. The parties introduced 692 exhibits, including thirteen
deposition transcripts. Five fact witnesses and two experts testified live.1
When cases go to trial, there are invariably at least two plausible ways to view
the evidence. One side generally has an account that is shorter, tighter, and reads
well on paper. The other side proffers an account that takes longer to unfold, requires
drawing inferences from combinations of documents, testimony, and events, and
turns on credibility determinations. Here, the plaintiffs benefitted from the shorter,
tighter story. They pointed to a squeeze-out transaction, cited some internal
documents that sounded bad for the defendants, and claimed that the defendants had
sought to take them out at too low a price. The defendants proffered the more complex
account, and it depended on the court rejecting the founder’s assessment of the
company’s prospects.
1 The parties agreed to seventy stipulations of fact, cited as “PTO ¶ _.” Citations
in the form “[Name] Tr.” refer to witness testimony from the trial transcript. Citations
in the form “[Name] Dep.” refer to witness testimony from a deposition transcript.
Citations in the form “JX — at —” reference trial exhibits. Citations in the form
“Argument Tr.” refer to the post-trial argument.
4
The court did not find the founder credible. While he did not affirmatively lie,
his assertions about the company and its prospects for success were Panglossian in
the extreme. He also had difficulty accepting any responsibility for his own role in the
company’s demise. When presented with evidence challenging his assertions, he
generally fell back on the retort that he simply knew better than anyone else. Where
the company was concerned, he was too close to his creation to be objective.
Having evaluated the witnesses and weighed the evidentiary record as a whole,
the court makes the following factual findings.
A. The Company
Akademos, Inc. (the “Company”) described itself as an education-technology
firm. Its principal business involved operating virtual bookstores for educational
institutions like colleges and universities. Plaintiff Brian Jacobs founded the
Company in 1999 and served initially as its Chief Executive Officer and sole board
member.
During the more than two decades from 1999 to 2020, the Company never had
a profitable year. Not surprisingly, the Company suffered regular cash shortfalls.
Virtually every spring, the Company needed outside financing to continue as a going
concern.
Initially, Jacobs raised the additional capital from friends and family. He also
found angel investors through investment forums. In return for their capital, they
received common stock. Some investors bought stock at prices as high as $26 per
share.
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B. The Fund
In 2009, Jacobs sought venture capital financing. Despite the Company’s
decade-long record of losses, Jacobs could tell a compelling story. After all, Amazon
started as an online bookstore, and operating online bookstores for educational
institutions seemed like a good niche. Jacobs stressed that although selling books was
a low margin business, the Company could be immensely profitable if only it could
achieve sufficient scale.
One of the firms Jacobs approached was Kohlberg Ventures, LLC (the “KV
Fund”), the venture capital affiliate of Kohlberg & Company. Jerome Kohlberg, Jr.
and his son James Kohlberg founded Kohlberg & Company after their departure from
Kohlberg Kravis Roberts & Co., now the private equity behemoth known as KKR.
In July 2009, the KV Fund invested $2.5 million in the Company. 2 In return,
KV Holdings received shares of Series A Preferred Stock. The Series A Preferred
carried a liquidation preference. The Company was obligated to pay the liquidation
preference upon a “Deemed Liquidation Event.” JX 692 at ’751. More on that later.
As part of the investment, the Company’s board of directors (the “Board”)
expanded from one seat to three. The KV Fund had the right to appoint a director,
2 Technically, James Kohlberg invested the funds through Bay Area Holdings,
Inc. (“Bay Holdings”), one of his personal investment vehicles. The distinction
between the KV Fund and Bay Holding is not important for purposes of this case, and
it makes the factual account unnecessarily complex. For simplicity, this decision
treats the KV Fund as having provided all of the capital, even though Bay Holdings
made some of the investments.
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and it designated Bill Youstra, a partner in the KV Fund. The third seat was reserved
for a mutually acceptable independent director, and Jacobs and the KV Fund agreed
on Scott Eagle.
C. The 2010 Cash Crisis
The capital from the KV Fund did not last long. In March 2010 and again in
April 2010, the KV Fund invested another $500,000. In exchange, the KV Fund
received additional shares of Series A Preferred.
That capital did not last long either. In August 2010, Jacobs approached John
Eastburn, a co-founder of the KV Fund, with an urgent request for additional cash.
The KV Fund agreed to provide another $200,000 in exchange for a promissory note.
The Company’s chief financial officer—not Jacobs—also provided $200,0000 in
exchange for a promissory note.
D. The KV Fund Acquires Control.
The Company’s serial demands for capital caused the KV Fund to lose
confidence in Jacobs. In 2011, the KV Fund invested $1,831,160 in exchange for
shares of Series A-1 Preferred Stock. Together with its earlier investments, those
shares gave the KV Fund majority voting control.
The KV Fund conditioned its investment on a CEO transition. Jacobs agreed
to step down, and he supported the search for a new CEO. In April 2011, the Company
hired John Squires. Jacobs transitioned to a new role as President, charged with
focusing on the Company’s big-picture strategy.
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Squires recommended expanding the Board, and the KV Fund agreed. They
added Eric Fingerhut as an outside director. Fingerhut was the former head of the
Ohio State Board of Regents, and Squires thought he could provide introductions that
would help drive sales.
The Company continued to burn cash. By fall 2012, the Company faced a
budget shortfall of approximately $1 million. Jacobs began sharply criticizing Squires
during board meetings. Faced with a choice between Jacobs and Squires, the Board
chose Squires.
In December 2012, Jacobs left the management team. He remained a member
of the Board. Jacobs stipulated in the Pre-Trial Order that he resigned. PTO ¶ 34.
But at trial, he claimed he was terminated. Consistent with the stipulated fact in the
Pre-Trial Order, Eastburn testified that Jacobs resigned to focus on a new business,
called panOpen. Jacobs began planning that new business while still at the Company,
and when Jacobs departed, he agreed to provide the Company with a 10% equity
stake in panOpen in return for waiving his noncompete clause.
E. The Barnes & Noble Deal
In 2015, the Company seemed to be making some headway, and its gross sales
passed $33 million. See JX 643. Seeking funding to support further growth, the
Company hired a boutique investment bank to find an investor willing to buy a
minority position. The effort generated little interest, and after six months, the
Company terminated it.
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Despite failing to raise capital, the Company did receive an unsolicited
indication of interest from Barnes & Noble Booksellers, Inc. to acquire the Company
for approximately $30 million. The Board authorized Squires to negotiate, and the
two sides agreed in principle to a stock-for-stock transaction at the $30 million
valuation. The Board, including Jacobs, approved the transaction in principle, and
the Company and Barnes & Noble executed a term sheet.
In November 2015, however, the Company learned that one of its largest
customers—City College of Chicago—might seek to rebid the Company’s contract.
Squires told Barnes & Noble, and they lowered the purchase price to $20 million.
Squires tried to get City College to commit to its contract, but City College refused.
Meanwhile, Youstra asked Jacobs for help securing consents approving the
deal from the common stockholders. See JX 12. Jacobs responded by expressing
concern that at the $30 million valuation, some common stockholders would take a
loss. Jacobs asked the KV Fund to reduce its liquidation preference by approximately
half to make the common stockholders whole.
Later that month, Jacobs and Eastburn met at a coffee shop. Jacobs reiterated
his request that the KV Fund make the common stockholders whole. He also asked
for stock grants for three of the Company’s executives. Jacobs Tr. 18–19. Jacobs
testified that he offered to contribute some of own proceeds. Id. at 19. He recalled that
Eastburn reacted with “hostility,” became irate, and told Jacobs “so sue us.” Id. at 20.
Eastburn recalls responding differently. He remembers pointing out that “the
only common that’s making money here is named Jacobs.” Eastburn Tr. 274. He also
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recalled proposing to share the make-whole amounts pro rata. And he recalled that
Jacobs refused, saying “[t]hose are my founder shares, no way.” Id.
Regardless of what happened, Eastburn and Jacobs walked away distrusting
each other. Eastburn testified that after this meeting, “every time that [Jacobs] said
he was looking out for the rest of the common, I was skeptical.” Id.
The dispute about sharing value proved premature. In December, Barnes &
Noble terminated discussions.
F. The Going Concern Qualification
Starting in 2015, the Company’s audited financial statements began including
a going concern qualification. The auditors noted that the Company’s “significant
operating losses and working capital and shareholders’ deficiency raise substantial
doubts about its ability to continue as a going concern.” JX 14 at ’836. In a later
footnote in each financial statement, the auditors elaborated on the qualification. Id.
at ’843–44. In 2017, they wrote:
The Company’s primary financing sources include a line of credit with
Avidbank, promissory notes payable to the State of Connecticut and
certain financial institutions, and periodic debt and equity infusions
from its largest shareholder. Management believes the Company’s
ability to continue as a going concern is uncertain without the ability to
both renew and obtain new financing from all these sources, or new ones.
. . . [S]o, management has concluded, under the standards of Financial
Accounting Standards Board Accounting Standards Update 2014-15,
that doubt exists regarding the Company’s ability to continue as a going
concern.
JX 244 at ’801. The Company’s audited financials carried similar warnings in 2016,
2017, 2018, 2019, and 2020. JX 14; JX 75; JX 243; JX 244; JX 356.
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G. The KV Fund Invests More.
Despite improved performance in 2015, the Company remained unprofitable.
In 2015, the KV Fund loaned the Company another $4.6 million.
In 2016, the management team projected that the Company was two years
away from profitability. Eastburn Tr. 269. To bridge the gap, the KV Fund invested
another $1 million in return for Series B Preferred Stock (together with Series A
Preferred Stock and Series A-1 Preferred Stock, the “Preferred Stock”). The KV Fund
also converted $3 million of its loan into Series B Preferred. JX 18; Eastburn Tr. 269.
The KV Fund wanted shares of Series B Preferred valued at two times the converted
debt. Jacobs negotiated them down to 1.5 times. The investment implied an equity
value for the Company of $34 million. On a fully diluted basis, that equated to a value
of $26.75 per share. JX 18.
The KV Fund believed the Series B round would be “the last money going in.”
Eastburn Tr. 269. In connection with the Series B investment, Fingerhut and Eagle
left the Board. Eastburn replaced Fingerhut. After a director search, Gary Shapiro
replaced Eagle. Shapiro was an industry veteran who served in various roles in the
college store space since 1968. Shapiro and his wife, though his wife’s firm, had served
as consultants to the Company since the beginning of 2016. The Company agreed to
pay Shapiro $25,000 per year for his Board service.
H. The 2018 Note
In spring 2018, the Company again needed financing. The KV Fund provided
it, this time in the form of a $2 million convertible promissory note. In the event of a
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change in control, the Company would redeem the note for one-and-a-half times the
unpaid principal and interest (the “2018 Note”). The 2018 Note would become due in
March 2019, one year later. The KV Fund offered to let any of the common
stockholders participate in the loan on the same terms, but all declined. The Board,
including Jacobs, unanimously approved the 2018 Note.
Also during March 2018, Jacobs emailed Eastburn about the KV Fund buying
some of his shares so Jacobs could use the capital for a new venture. Eastburn told
him that they might want to buy all of his stock, but not part of it. He also said that
valuing the stock would be tricky. JX 43.
Later that day, Jacobs and Eastburn spoke by phone. Jacobs recalled an offer
of $10 per share for total consideration of $1.4 million, implying a value of $40 million
for the Company. JX 41; Jacobs Tr. 31. Eastburn testified that he only had authority
to offer up to $350,000 for Jacobs’s stock and did not exceed his authority. Eastburn
Tr. 289–294. Regardless, Jacobs came away believing the KV Fund had offered $10
per share, which he rejected as too low.
The Board decided to seek out additional third-party financing. The Company
had secured some new contracts, and Follett Higher Education Group (“Follett”) had
told Squires that they might be interested in a deal. This time, the Company hired a
different boutique investment bank to seek investors for a $5-10 million round. The
result was the same. No one wanted to invest.
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In parallel, Squires and the investment bank approached Follett and proposed
an acquisition at a valuation of $50 million. Eastburn thought a transaction in range
of $20–30 million was more realistic and told Jacobs that. JX 59 at 12:30–13:00.
Jacobs came to believe that Follett made an offer to acquire the Company for
$30 million and the KV Fund rejected the offer without presenting it to the Board.
While Jacobs may have thought that, the evidence does not support it. It seems as if
at some point, Follett may have floated the possibility of a potential acquisition in the
range of $30 million, but there is nothing in writing suggesting any conviction behind
the figure, and it was clearly not an actionable proposal.
I. The Board Hires A New CEO.
In May 2018, the Board terminated Squires and hired Raj Kaji as the
Company’s new CEO. Jacobs contends that the KV Fund terminated Squires and
hired Kaji without involving the Board, but the record does not support that
assertion.
It is true that Eastburn and Youstra led the replacement process. They
obtained a list of potential candidates from an executive recruiter, and they spoke
with Shapiro about a change in leadership. After Shapiro agreed that a change would
be beneficial, Eastburn and Youstra involved him in the process, and he interviewed
the potential candidates.
It is also true that Eastburn and Youstra excluded Jacobs from the process
until they were ready to present a candidate for Board approval. Eastburn, Youstra,
and Shapiro all thought that involving Jacobs would be detrimental: Jacobs had
13
previously disclosed confidential information learned during a Board meeting, and he
was starting a new firm that was a quasi-competitor.
Ultimately, the other directors did involve Jacobs. On May 4, 2018, Eastburn
met with Jacobs in person and told him about the plan to replace Squires with Kaji.
JX 59 at 9:10–10:00; JX 60; JX 61. Jacobs did not object, and he agreed that a change
of management was beneficial. JX 59 at 13:00–14:00. A week later, Eastburn emailed
Jacobs about the CEO-replacement plan. JX 64. Again, Jacobs did not object. Id. at
’699.
At Jacobs’ request, Eastburn facilitated a call between Kaji and Jacobs. JX 65.
Jacobs had a relatively favorable impression of Kaji, noting that he had “[a] lot of
experience in Education [sic].” JX 67 at ’715. There is no contemporaneous evidence
that Jacobs raised any objection to hiring Kali.
The Board approved Kaji’s appointment as CEO on May 16, 2018. Jacobs
abstained, stating, “I was not informed nor did I participate in any aspect of the
decision to change the CEO. I said that, while I wasn’t necessarily against a change
I should have been part of the discussion and process and that I could have
contributed to both . . . .” . JX 74 at ’136. At trial, Jacobs portrayed the CEO selection
process as evidence of the KV Fund’s control over the Company. The KV Fund did
control the Company, but there is no reason to think that the selection of Kaji was
unfair or could otherwise constitute a breach of duty.
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During the same period, Eastburn approached Jacobs about the KV Fund
buying his shares and having him resign from the Board. Having seen Jacobs criticize
Squires, Eastman wanted Kaji to have a “clear path” to succeed. JX 59 at 19:00–24:00.
Jacobs reacted defensively and asked why the KV Fund didn’t just buy the
Company. Eastburn noted that Jacobs previously had suggested valuations around
$70 million, which was not realistic, and that at present, the common was worth
nearly zero given the capital structure. See id. at 23:00–25:00. Eastburn noted that
the Company was likely to need additional investment that would further dilute the
common stockholders, otherwise the Company might liquidate. Id. at 25:00.
Jacobs dug in, stating
I am going to stay on the board until there is some reasonable exit after
all these years and years of work and trying to support this company in
every way that I could. I would hope that you’d understand that I am
just trying to protect myself, my family, . . . and to the extent that I can
the other common holders.
Id. at 25:45–26:06. Becoming irritated, Eastburn told Jacobs that he had been
“obstructionist from day one” and had not been “working in good faith.” Id. at 26:10–
26:55. Jacobs then attacked the decisions that Squires and his team had made over
the past seven years. Eastburn reiterated that there could be a recapitalization in
which “the common gets significantly diluted” and that it was Jacobs’s choice if he
wanted “to be on the board when that happens.” Id. at 31:45–32:10.
The conversation ended in frustration for both sides. Jacobs then tried to go
over Eastburn’s head by sending a letter to James Kohlberg and asking him to replace
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Eastburn on the Board. Jacobs blamed Eastburn for the Board’s disfunction and the
Company’s lack of progress. The KV Fund ignored the letter.
J. The September 2018 Board Meeting
Kaji spent his first few months assessing the Company. During a board
meeting on September 6, 2018, he provided his impressions.
Kaji thought the Company needed to strengthen the management team and
increase its scale to make a thin-margin business profitable. Kaji then laid out a plan
to develop two new lines of business. He also proposed to recruit two advisors with
experience in the education technology industry.
Kaji also noted that the Company had regularly missed its revenue forecasts.
On average, the Company overestimated revenue for new accounts by 24.3% and for
existing accounts by 3.4% to 9.7%. Based on that history, Kaji reported that
management had reduced the Company’s projected revenue. Given the new figures,
he projected that the Company would need another $1.25 million to avoid insolvency.
After the meeting, Jacobs and Eastburn had another heated conversation, this
time about the upcoming annual meeting. Eastburn criticized Jacobs for “juvenile”
conduct and asked again that he leave the Board. JX 90 at ’723. Jacobs responded
that Eastburn should leave and “Jim Kohlberg should come in.”
JX 89. After the call, Jacobs pulled together a group of common stockholders who
wrote to Kohlberg and asked to him to replace Eastburn. JX 93; JX 94.
This time, Kohlberg agreed to join as an additional director. Meanwhile, Kaji
looked for two advisors who might later join the Board. He found one: Burck Smith,
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who joined the Board in September 2019. When Smith accepted the position, he
refused to take his compensation in stock options and asked for a cash retainer. Smith
did not think the common stock would have any value short of a deal at $41 million
or more, and he doubted that a transaction could achieve more than $20–$30 million.
JX 183 at ’253–54. The Company rejected his request, and Smith ultimately agreed
to accept $25,000 and a small option package. Smith Tr. 590.Jacobs objected to Smith
joining the Board because of his refusal to take stock options as compensation.
K. Potential New Lines Of Business
Under Kaji’s leadership, management began developing potential new lines of
business. Kaji also successfully negotiated a $700,000 increase in the Company’s
revolving line of credit, plus $800,000 in trade credit from its venders.
In December 2018, Kaji presented the Board with ideas for two new businesses.
One was Courseware Integration Software (“Courseware”), which would help
educational institutions and publishers exchange data and work together on course
content. The Company envisioned monetizing the concept by charging publishers a
fee.
The other was Edge Equitable Access (“Edge”), which would allow institutions
to deliver course materials to students and bill them directly. The Company
envisioned monetizing this service by charging a fee to colleges and universities.
Management hoped the new offerings would be high margin businesses. But
management also estimated that developing them would require approximately $11
million in additional capital. JX 105 at ’118. Although that figure was daunting,
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management believed that there was a “bigger risk [in] not doing anything.” Id. The
Board authorized management to proceed.
L. The 2019 Note
In January 2019, management contacted the same boutique investment bank
that had led the most recent process. But the Company’s contact there had left, and
the investment bank did not want to make another attempt. Four other banks
declined as well. The bankers all thought that the Company needed to identify
significant new accounts to raise more capital, or it needed a letter of intent for a
promising acquisition that the new investors could back. After hearing the report, the
Board pushed off the fundraising effort until late March or early April, after the
Company hopefully secured new customers.
In the meantime, the Company needed $2.25 million to fund its operations
through August. Kaji asked Eastburn about the KV Fund providing the money.
Eastburn suggested a loan that only would be repayable in the event the company
was sold, at which point the Company would owe two times the unpaid balance of
principal and interest. Eastburn thought the terms were market, and Kaji thought
the request was reasonable. JX 113.
On March 6, 2019, the KV Fund sent the Company a term sheet for a
convertible note in the amount of $2 million (the “2019 Note”). JX 114; JX 115. The
term sheet tracked Eastburn’s proposal and also contemplated extending the
maturity date for the 2018 Note in exchange for updating its terms to match the 2019
Note. Id.
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Kaji circulated the term sheet to the non-KV Fund directors. Kaji then had
calls with Shapiro and Jacobs to discuss the terms. He also noticed a special meeting
of the Board to discuss the term sheet from KV Fund. Before the meeting,
management proposed revisions to KV Fund’s original term sheet, including
increasing the amount of the loan to $2.25 million and allowing any current investor
in the Company to participate in the financing up to $750,000.
During a board meeting on March 26, 2019, Jacobs objected to the term sheet.
He proposed different terms, but Kaji explained that the KV Fund had already
rejected a similar counteroffer. Jacobs then asked management to search for better
financing from other lenders. Jacobs Tr. 160–61. But management had already tried
to hire an investment bank to accomplish that, and no one would take on the
assignment.
With Jacobs abstaining, the Board approved the amendment to the 2018 Note.
JX 124 at ’523–24. The directors also approved the 2019 Note, subject to management
making a further effort to secure better financing. Management complied and
contacted thirteen additional parties over a six-week period. PTO ¶ 49
That limited process resulted in two alternatives. Concise Capital offered a
$2.5 million loan with a mid-double-digit interest rate conditioned on a guarantee
from the KV Fund. Avidbank, one of the Company’s existing lenders, offered bridge
financing, conditioned on both a guarantee from the KV Fund and an escrow account
containing funds earmarked to repay the loan. JX 145; JX 146. During a meeting on
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April 25, 2019, the Board considered the alternatives but did not make any decisions.
JX 144 at ’489.
Meanwhile, Jacobs and a group of common stockholders hired counsel. On
April 16, 2019, their lawyer wrote the Board expressing concerns about 2019 Note
and accusing the directors of failing to fulfill their fiduciary duties. JX 138. The
Company responded two weeks later and denied the allegations. JX 147.
During a meeting on May 2, 2019, Kaji provided an update on the financing
effort. JX 148. He reported that none of the stockholders who were accredited
investors expressed interest in participating in the proposed 2019 Note. He also
reported on the two financing proposals and noted that the KV Fund was willing to
provide a guarantee, but not to put cash in escrow. That meant the Avidbank deal
was a non-starter. Concise Capital wanted Avidbank to subordinate its existing debt,
which was also a non-starter.
Jacobs then proposed that the Company accept the 2019 Note, but only if it
matured on September 30, 2019 and only required repayment at 1.5x face value.
Management did not believe the KV Fund would accept. After further discussion, the
Board voted to approve the 2019 Note, with Jacobs abstaining.
With the 2019 Note added to the capital structure, the KV Fund was entitled
to receive the first $29.7 million from any change-of-control transaction. JX 180 at
12. A deal would have to exceed that amount before the common stockholders received
anything.
20
M. Jacobs Attempts To Rally The Stockholders.
After the Board approved the 2019 Note, the Company sent a notice to the
common stockholders soliciting their consent. E.g., JX 150 at ’587. Jacobs sought to
rally the common stockholders against the financing, and a group of common
stockholders vocally objected. E.g., JX 150; JX 151. Jacobs led a call to explore legal
options during which he claimed the Company’s value was around $40 million. JX
158. But not all the common stockholders supported him. At least one stockholder
thought the value of the Company was far less. See JX 159.
On June 24, 2019, the lawyer Jacobs had retained sent another letter to the
Company objecting to the 2019 Note. JX 167. The Board met the next day. JX 170;
JX 171. The record does not contain minutes for the meeting, but Jacobs’ took notes
documenting several heated exchanges. JX 166. Two weeks later, the Company
responded to the attorney’s letter and denied its allegations.
N. The Loss Of Customers
During the June 2019 Board meeting, management reported that the Company
might lose City College as a customer, which would cost the Company about 25% of
its revenue. Kaji Tr. 546. To offset the projected loss, management engaged in cost-
cutting.
Management also prepared a set of projections showing that the Company
could replace the revenue attributable to City College, but only through a “Herculean
effort” that would require “a lot of sales and marketing effort and dollars.” Kaji Tr.
547–48. Even then, the Company would run out of cash in May 2020. JX 171 at ’516.
21
On September 17, 2019, the Board convened a regular board meeting. While
in executive session, the Board unanimously approved a valuation for purposes of
granting equity compensation in accordance with Internal Revenue Service Rule
409A. The valuation put the Company’s enterprise value at $38.5 million and valued
the common stock at $13.41 per share. JX 179. After applying a 35% discount for the
stock’s lack of marketability, the valuation landed at $8.71 per share (the “2019 Rule
409A Valuation.”). The Board unanimously approved the valuation. JX 188.
O. The Dual-Track Process
In late 2019, management began working in earnest on a potential acquisition
or strategic combination that could be used to justify raising new capital. Initially,
management reached out to potential strategic partners where they had contacts.
Two contacts—RedShelf, Inc and Kivuto Solutions—had no interest. Two others did:
Ambassador Education Solutions (“Ambassador”) and Nebraska Book Company
(“Nebraska Book”), where Shapiro had been a director since 2017.
On November 5, 2019, Ambassador expressed interest in a stock-for-stock
transaction that valued the Company at between $5,400,000 and $17,200,000. After
discussions with Company management, Ambassador proposed a transaction that
valued the Company at $10.3 million with consideration consisting of 25% stock and
a promissory note for the other 75%, to be paid off over the two years after closing.
JX 213 at ’652; JX 211 at tab 2, cells D14–28.
On November 24, 2019, Nebraska Book expressed interest in acquiring the
Company based on a total enterprise value of approximately $17 million. The
22
proposal implied an equity value of $10.3 million, to be paid shares of Nebraska Book
stock. Nebraska Book was not publicly traded, so it was offering its own illiquid
securities. PTO ¶ 55; JX 202. As an alternative, Nebraska Book and the Company
discussed having the Company acquire one of Nebraska Book’s business lines.
The Board discussed the proposals during a meeting on December 5, 2019. JX
213; JX 215. Shapiro recused himself because of his role at Nebraska Book.
Both proposals were far below the implied valuations that Barnes & Noble and
Follett had put on the Company in 2015. Kaji suggested hiring an investment banker
to conduct a dual-track process, with one track focusing on fundraising and another
on M&A. Kaji reported that management had contacted a range of investment
bankers and only two were interested: Parchman Vaughn & Company L.L.C. and
Cherry Tree & Associates LLC. He discussed their qualifications and proposed fee
structures. The Board signed off on hiring an investment banker and directed
management to negotiate final proposals. Jacobs abstained from the vote. JX 215.
The Board met again on December 10, 2019. JX 218. Kaji described the
Company’s existing college store business as “an unprofitable core business that
needs scale to be profitable” but emphasized that the Company was “at the cusp of
profitability.” JX 219 at ’767. Kaji then discussed options the Company could pursue
to improve profitability. He did not think additional personnel cuts were viable. Id.
at ’768. He also advised that even at scale, the core business “will produce low
margins and [would] not result in substantial EBITDA gains even after growing
23
materially.” Id. at ’769. He recommended that the Company needed to focus on new
initiatives. Id. at ’770–79.
On January 10, 2020, the Board held a special meeting to hire an investment
bank to hire and review management’s projections. JX 245. Cherry Tree did not seem
truly interested in the engagement, so management contacted two other firms.
Neither seemed like a good fit. By contrast, Parchman Vaughan was both eager and
qualified, having worked in the education space for over twenty years. Id. The Board,
including Jacobs, approved engaging Parchman Vaughan.
Management’s forecasting indicated that the Company need to raise $9–10
million. After meeting with Parchman Vaughn, management opted to seek $8 million:
$1.5 million to launch Edge, $4.5 million to launch Courseware Integration Software,
and $2 million to sustain existing operations. JX 280 at ’481.
Parchman Vaughn led a process that started in February 2020 and ended in
September 2020 (the “2020 Process”). PTO ¶ 57. In total, Parchman Vaughan and the
Company contacted 120 different parties, including contacted 31 strategic buyers and
66 financial investors. The list included Barnes & Noble and Follett. JX 440 at ’205.
The response was underwhelming. The Company received only one acquisition
proposal before the original bid deadline of March 31, 2020: A firm doing business as
eCampus proposed to buy the Company for $6 million. The Company received three
proposals after the bid deadline, but no one expressed interest in an investment.
The Board met twice in March 2020 to discuss the COVID-19 pandemic and
review the results of the 2020 Process. Everyone agreed that the COVID-19 pandemic
24
had a negative effect. In addition, by the time of trial, no one thought that Parchman
Vaughn did a great job. Kaji described the effort as “satisfactory” and thought it could
have been better. Kaji Tr. 466.
The plaintiffs claim Parchman Vaughan marketed the Company as a
distressed asset. Jacobs Tr. 82–85. Parchman Vaughan admittedly did not include a
target valuation for the Company in its materials. The lead banker testified that Kaji
had discussed a $20 million valuation, but that figure was hard to support for a
company that had always lost money, so Parchman Vaughn decided to emphasize the
Company’s story and let the market set the valuation. Rowan Tr. 669–70. In
hindsight, not providing a target valuation may have been a mistake, but it was a
reasonable approach.
P. The 2020 Note
By April 2020, as expected, the Company was again running out of cash.
Meanwhile the 2020 Process had failed to generate any interest.
In early April 2020, Eastburn, Youstra, and Kohlberg discussed what the KV
Fund should do. JX 310. Options included selling the Company, providing bridge
financing, or letting the Company file for bankruptcy. They decided on a bridge loan
of $1–1.5 million to cover the Company through the fall, when they hoped to market
the Company for sale again. They did not consider acquiring 100% of the equity.
On April 8, 2020, the KV Fund sent the Company a term sheet for another
convertible note financing transaction, this time in the amount of $1 million with the
potential for another $500,000 if the Company hit certain targets (the “2020 Note,”
25
together with the 2018 Note and 2019 Note, the “KV Notes”). JX 312; PTO ¶ 53. The
terms were nearly identical to the 2018 and 2019 Notes. The one major difference
was that the 2020 Note was secured and would mature in six-months. That was also
when the 2018 and 2019 Notes would mature.
Kaji responded by asking the KV Fund to extend the deadline on all of the
notes. The KV Fund declined.
The Board met on April 15, 2020 to review the 2020 Process and consider the
KV Fund’s term sheet. JX 319. By this point, management and Parchman Vaughan
had contacted 101 parties, Parchman Vaughn contacted 97 and Kaji contacted 4.
Discussions with eCampus led to a revised acquisition proposal that increased the
consideration by $1 million to $7 million. PTO ¶ 57. Parchman Vaughan
recommended against further discussions with eCampus because the offer was so low.
JX 319.
Kaji reported that he had a promising conversation with the CEO of RedShelf,
and the Board authorized Kaji to offer to sell the Company for $20 million, half in
cash and half in RedShelf stock. Id. at ’345. Kaji also reported on his dialogue with
Kivuto, which was finishing a fundraising process and suggested re-engaging after
that ended. The Board authorized Kaji to continue those discussions. Id.
After that, the Board turned to the 2020 Note. Kaji reviewed the terms, then
moved to accept the offer. Jacobs objected, arguing that the terms were too onerous.
He also wanted new leadership. With Jacobs abstaining, the Board voted to move
26
forward. JX 319 at ’346. At a meeting one week later, the Board approved the 2020
Note, with Jacobs again abstaining. JX 323.
Just as the COVID-19 pandemic ended up helping other technology firms, the
pandemic also benefitted the Company. The shift to online education increased
demand for the Company’s services, and in June 2020, Kaji reported to the Board
that the Company had signed a record-high twenty-two new deals. JX 353. But
despite adding new institutions, the Company remained unprofitable for the year.
The dual-track process continued to yield disappointing results. Since the
original March 31 bid date, the Company received only one new offer: A distressed
debt investor offered $5 million in senior-secured, super-priority debtor-in-possession
financing if the Company filed for bankruptcy. The conversations with RedShelf and
Kivuto did not yield any offers.
During a Board meeting on June 18, 2023, all of the directors except for Jacobs
believed a merger or sale of the Company was the best outcome. Jacobs wanted the
Company to remain independent, arguing it would “thrive in the current environment
with revision to its strategy and Board composition.” JX 345 at ’847. Jacobs claimed
that management’s “lack of vision” would lead the Company into bankruptcy. Id.
Q. The Kohlberg Ventures Term Sheet
On July 13, 2024, the KV Fund offered to acquire the Company based on a
cash-free, debt-free valuation of $12.5 million. PTO ¶ 57. The term sheet did not
condition the transaction on the twin MFW protections of special committee approval
and a favorable majority-of-the-minority vote. The three Kohlberg-affiliated directors
27
did commit to recuse themselves from meetings when the Board discussed the
proposal. JX 373. The term sheet contemplated a go-shop period, and the KV Fund
committed to support any transaction that the non-KV Fund directors deemed
superior. The term sheet treated the transaction as a Deemed Liquidation Event,
triggering the liquidation preference on the KV Notes and the Preferred Stock.
The Board met on July 15, 2024. JX 435. Parchman Vaughan reported that
they had contacted sixteen additional parties, all of whom focused on distressed
businesses. Three expressed potential interest and two started diligence. No one
suggested a valuation, but Parchman Vaughan expected any offer to be well below
the Company’s target of $20 million. Id. In response to a question from Jacobs,
Parchman Vaughn explained why the valuations were so low despite the Company’s
strong revenue numbers, citing
(i) general market conditions, including the competitive nature of the
Company’s business and the low valuation of comparable companies
such as Barnes & Noble, (ii) the impact that COVID-19 has had, and is
continuing to have, on higher education broadly, and (iii) even though
the Company’s core business is growing, it has not been profitable after
20 years of operation, and its new software-based initiatives are too
young to rely on or be able to adequately forecast against.
Id. at ’597.
The Board then turned to the KV Fund’s offer. Kaji asked the KV Fund
directors to remain to answer questions. Eastburn expressed support for the go-shop.
Jacobs asked whether the term sheet was confidential because he had a personal
interest in seeking a better bid. Kaji said that Jacobs could talk with third parties as
long as there were confidentiality agreements put in place.
28
The KV Fund directors left the meeting, and the remaining directors discussed
the term sheet. Jacobs said he could not support the deal because none of the common
stockholders would receive any value. Kaji said the same thing would happen in any
deal. After further discussion, Kaji, Smith, and Shapiro voted to have Kaji negotiate
with the KV Fund over the term sheet, Jacobs abstained.
Between July 15, 2020 and July 28, 2020, Company management negotiated
the term sheet with support from Parchman Vaughan and Company counsel. The
terms did not materially change. See JX 400.
While the negotiations were underway, Ames Watson LLC, a financial
investor, offered to buy a 75% stake in the Company for $500,000. JX 379. Ames
Watson also offered to provide another $500,000 in return for additional equity.
The Board met on August 3, 2020. JX 402. Parchman Vaughan reported that
no one other than Ames Watson had been responsive. The directors discussed the KV
Fund’s term sheet. Jacobs proposed his vision for the Company and envisioned deals
with different strategic partners. Jacobs asked Eastburn whether the KV Fund would
give him until December 31, 2020 to find a different deal. Eastburn refused.
The KV Fund directors left the meeting so that the unaffiliated directors could
deliberate and vote. Jacobs objected to Shapiro and Smith voting, claiming that they
were conflicted. The unaffiliated directors then voted two-to-one in favor of the KV
Fund’s term sheet, with Jacobs voting no.
29
R. The Go-Shop
From August 4–25, 2020 Parchman Vaughan ran the go-shop. They did not
recanvas everyone contacted during the 2020 Process. Instead, they contacted the
four parties who had showed interest: eCampus, Ambassador, Ames Watson, and
RedShelf.
Ambassador reiterated its interest in the deal it had proposed in December
2019—a $10.3 million valuation with the consideration consisting of 25% stock and a
promissory note for the other 75%, to be paid off over the two years after closing.
RedShelf’’s CEO sent Kaji a text message expressing potential interest in a deal in
the range of $10 million. Ames Watson responded that if the Company “can get
anything close to [$12.5 million] they should run to closing.” JX 410. eCampus did not
respond.
On September 4, 2020, the non-KV Fund directors met to review the results of
the go-shop. JX 415. They determined that none of the counterparties had made a
superior proposal. Kaji then reported on a proposal by the KV Fund to provide some
consideration to the common stockholders. At that point, the KV Fund held
approximately $40 million in preference through its notes and preferred stock,
leaving the common far out of the money. Nevertheless, the KV Fund offered to
provide aggregate consideration to the common holders $0.24 per share, or total
consideration of $51,234, but only if a majority of the common stockholders executed
support agreements in favor of the deal, waived appraisal rights, and released any
claims. Jacobs refused, saying the price was too low. Shapiro and Smith wanted to
30
ask for more for the common. The Board members authorized Kaji to negotiate with
the KV Fund, resulting in the KV Fund increasing its offer for the common to $0.35
per share, or total consideration of $76,986.
The KV Fund sent the offer to the common stockholders on September 8, 2024.
JX 416. Jacobs campaigned against it. Dale Kutnick, an angel investor who had
invested $600,000 in the Company, responded to Jacobs and all of the common
stockholders by saying that his “fatigue with your rants has now reached exhaustion.
For 15 years you promised the moon, changed directions numerous times, burned
cash, burned investors, exaggerated minor successes, obfuscated some major
problems, and failed to ever make a profit.” JX 420 at ’328. After Jacobs reached out
to Kutnick separately, Kutnick told Jacobs that he was “fantasizing again.”
The baby is now a 20-something year old indigent (or worse) that can’t
make its own way, and it’s no longer cute and cuddly. Before we talk,
what is your PLAN to raise the necessary capital in a short period
of time, because the company is running on fumes based on the
numbers I’ve seen? Who is going to put up the capital if KV doesn’t
do it.
JX 421 at ’338. Kutnick nevertheless became a plaintiff in this action.
The KV Fund’s offer did not receive sufficient support from common
stockholders. Some common stockholders accepted it, but Jacobs and his supporters
did not.
S. The Merger
From August 25 through September 29, 2020, the Company and the KV Fund
negotiated the final deal documents. On September 29, Jacobs caused the attorneys
representing a group of dissenting common stockholders to send another letter
31
objecting to the proposed Merger and representing that they would pursue their
appraisal rights.
The Board met that same day to consider the Merger. Parchman Vaughan
reviewed the 2020 Process, summarized the expressions of interest the Company
received, and flagged that none of the four parties contacted during the go-shop made
a meaningful bid. JX 549 at ’113.
The directors then discussed the proposed Merger. After some discussion, the
KV Fund directors left the meeting. After additional discussion, the unaffiliated
directors approved the Merger by a two-to-one vote, with Smith and Shapiro voting
in favor and Jacobs voting against. The KV Fund directors then rejoined the meeting
and held a second vote. Everyone except Jacobs voted in favor. Jacobs voted against.
In November 2020, the KV Fund realized that the structure of the original
Merger had negative tax consequences that could have been avoided. Conveniently,
the Company also determined that Merger was technically defective under Section
251(c) of Delaware General Corporation Law (the “DGCL”) because the stockholders
of original merger subsidiary failed to properly approve the transaction.
The KV Fund proposed a redo. In response, the Board asked for and received
an assurance that if the Company agreed to nullify the Merger, then the KV Fund
would close a restructured transaction on the same terms and pay all the legal fees
associated with the redo. The Board did not seek any additional consideration for the
common stockholders. The KV Fund agreed, and on December 15, 2020, the Company
32
filed a Certificate of Correction with the Delaware Secretary of State through which
Company cancelled the original Merger.
On December 22, 2020, the Board met to consider the restructured Merger.
Parchman Vaughan gave its presentation again. Kaji explained that the stockholders
could either ratify the Merger or redo the transaction. But because the redo conferred
a tax benefit on the KV Fund, the KV Fund preferred that path. JX 493 at ’963.
Jacobs implored the Board not to approve the do-over. The KV Fund directors
left the meeting, and the unaffiliated directors discussed the Merger. Smith and
Shapiro stated that “regardless of what had happened in the past, if the deal had
been presented . . . today,” he would vote to approve it. Id. at ’964. The unaffiliated
directors then voted, with Smith and Shapiro voting in favor and Jacobs voting
against. The KV Fund directors returned, and the entire Board voted. Five directors
voted in favor; Jacobs voted against.
The Company distributed the proceeds as if the Merger was a Deemed
Liquidation Event. That meant the common stockholders received nothing.
T. After The Merger
The KV Fund operated the Company for roughly two years after the Merger.
The Company gained some additional scale but remained unprofitable. The KV Fund
invested another $3.5 million to pursue Edge, but it too remained unprofitable.
In late 2022, the KV Fund decided to pull the plug. Eastburn informed Kaji
that the KV Fund would not provide any additional financing. The Company hired
another investment banker and ran a dual-track process similar to the 2020 Process.
33
That process resulted in a sale of the Company to Vital Source Technologies, LLC
(“VitalSource”) for approximately $20 million. The sale closed on March 17, 2023 (the
“2023 Sale”).
The $20 million price from the 2023 Sale exceeded the Merger consideration
by $7.5 million. After backing out the KV Fund’s additional investment of $3.5
million, the 2023 Sale exceeded the Merger consideration by $4 million. For the KV
Fund, its investment in the Company was a disaster, representing a loss of $18
million in invested capital.
U. This Litigation
On January 8, 2021, the plaintiffs demanded appraisal. On April 22, 2021, the
plaintiffs filed a joint petition for appraisal and complaint asserting claims for breach
of fiduciary duty. The parties then conducted discovery and litigated the case through
trial.
II. THE APPRAISAL CLAIM
Jacobs and his group of common stockholders (the “Jacobs Group”) sought
appraisal under Section 262 of the DGCL. Technically, the Company is the
respondent for purposes of the appraisal claim, but the Company emerged from the
Merger as a wholly owned subsidiary of the KV Fund. The KV Fund controlled the
positions the Company took in this litigation, and this decision therefore refers to the
KV Fund as the real party in interest.
34
This decision finds that the fair value of Jacobs Group’s shares is zero. Given
the rights of the Preferred Stock, the common stock would not receive any value from
the Company as a going concern.
A. Legal Principles Governing An Appraisal Proceeding
“An action seeking appraisal is intended to provide shareholders who dissent
from a merger, on the basis of the inadequacy of the offering price, with a judicial
determination of the fair value of their shares.”3 The appraisal statute states that
“the Court shall determine the fair value of the shares”4 and requires that the court
“take into account all relevant factors.”5 The valuation must be “exclusive of any
element of value arising from the accomplishment or expectation of the merger.”6
Those statutory standards have significant implications. First, the statutory
mandate that “the Court shall determine the fair value of the shares” results in a
different allocation of the burden of proof than a standard liability proceeding. In an
appraisal proceeding, “both sides have the burden of proving their respective
valuation positions by a preponderance of the evidence.”7 “No presumption, favorable
3 Cavalier Oil Corp. v. Harnett, 564 A.2d 1137, 1142 (Del. 1989).
4 8 Del. C. § 262(h).
5 Id.
6 Id.
7 Fir Tree Value Master Fund, LP v. Jarden Corp., 236 A.3d 313, 322 (Del. Ch.
2020) (cleaned up) (citing M.G. Bancorporation, Inc. v. Le Beau, 737 A.2d 513, 520
(Del. 1999).
35
or unfavorable, attaches to either side’s valuation.”8 “Each party also bears the
burden of proving the constituent elements of its valuation position . . . , including
the propriety of a particular method, modification, discount, or premium.”9
Second, the statutory mandate that “the Court shall determine the fair value
of the shares” means that the court has to arrive at a valuation, even if none of the
parties’ attempts are persuasive.10 “In discharging its statutory mandate, the Court
of Chancery has discretion to select one of the parties’ valuation models as its general
framework or to fashion its own.”11 The Court of Chancery may “adopt any one
expert’s model, methodology, and mathematical calculations, in toto, if that valuation
is supported by credible evidence and withstands a critical judicial analysis on the
record.”12 Or the court “may evaluate the valuation opinions submitted by the parties,
select the most representative analysis, and then make appropriate adjustments to
8 Pinson v. Campbell-Taggart, Inc., 1989 WL 17438, at *6 (Del. Ch. Feb. 28,
1989).
9 In re Appraisal of Stillwater Mining Co. (Stillwater Trial), 2019 WL 3943851,
at *18 (Del. Ch. Aug. 21, 2019) (internal quotation marks omitted), aff’d sub nom.
Brigade Leveraged Cap. Structures Fund Ltd. v. Stillwater Mining Co., 240 A.3d 3(Del. 2020).
10 See Gonsalves v. Straight Arrow Publ’rs, Inc., 701 A.2d 357, 362 (Del. 1997)
(“[T]he Court of Chancery may ‘select one of the parties’ valuation modes as its
general framework, or fashion its own.’”).
11 Id.12 M.G. Bancorporation, 737 A.2d at 526 (emphasis added).
36
the resulting valuation.”13 If neither party satisfies its burden, “the court must then
use its own independent judgment to determine fair value.”14
Third, the language of the appraisal statute requires a specific approach to
valuation. The Delaware Supreme Court has interpreted “the fair value of the shares
exclusive of any element of value arising from the accomplishment or expectation of
13 Jesse A. Finkelstein & John D. Hendershot, Appraisal Rights in Mergers
and Consolidations, 38-5th C.P.S. § V(A), at A-31 (BNA, 2010 & 2017 Supp.)
(collecting cases).
14 Gholl v. eMachines, Inc., 2004 WL 2847865, at *5 (Del. Ch. Nov. 24, 2004);
accord In re Orchard Enters., 2012 WL 2923305, at *5 (Del. Ch. July 18, 2012) (“After
considering the parties’ arguments and the respective experts’ reports and testimony
in support of their valuation positions, this court has discretion to select one of the
parties’ valuation models or to create its own.”); Del. Open MRI Radiology Assocs.,
P.A. v. Kessler, 898 A.2d 290, 310–11 (Del. Ch. 2006) (“I cannot shirk my duty to
arrive at my own independent determination of value, regardless of whether the
competing experts have provided widely divergent estimates of value, while
supposedly using the same well-established principles of corporate finance.”); Cooper
v. Pabst Brewing Co., 1993 WL 208763, at *8 (Del. Ch. June 8, 1993) (“When . . . none
of the parties establishes a value that is persuasive, the Court must make a
determination based upon its own analysis.”); see Gonsalves, 701 A.2d at 361
(emphasizing the trial court’s responsibility to “independently determine the value of
the shares that are the subject of the appraisal action”). The Aruba decision could be
read to overrule precedent on this point and require a trial judge to use a valuation
methodology that one of the party’s advanced and which was subject to discovery and
cross-examination at trial. See Verition P’rs Master Fund Ltd. v. Aruba Networks,
Inc., 210 A.3d 128, 139–40 (Del. 2019) (per curiam). But Aruba can also be read as a
situationally specific ruling that did not intend to depart from the appraisal statute’s
command or overrule longstanding precedent. See Hyde Park Venture P’rs Fund III,
L.P. v. FairXchange, LLC, 2024 WL 3579932, at *17 (Del. Ch. July 30, 2024). The
latter reading is preferable, because the Aruba decision “does not suggest an intent
to overrule prior precedent and set out a new framework for appraisal cases in which
the trial court lacks the power to make its own valuation determination.” Id.37
the merger”15 to mean the stockholder’s “proportionate interest in a going concern.”16
To apply this standard, the court must first “envisage the entire pre-merger company
as a ‘going concern,’ as a standalone entity, and assess its value as such.” 17 Valuing
the corporation as a standalone entity means valuing its “operative reality” at the
time of merger, albeit in a but-for world where the merger did not take place.18
Valuing the corporation’s operative reality means using the business plan the
company would have continued to pursue but for the merger. 19 It also means using
15 8 Del. C. § 262(h).
16 Brigade Leveraged Cap. Structures Fund Ltd. v. Stillwater Mining Co., 240
A.3d 3, 10 (Del. 2020) (explaining that a stockholder should be awarded “his
proportionate interest in [the] going concern.” (alteration in original) (quoting Dell,
Inc. v. Magnetar Glob. Event Driven Master Fund Ltd, 177 A.3d 1, 21 (Del. 2017));
Montgomery Cellular Hldg. Co. v. Dobler, 880 A.2d 206, 222 (Del. 2005); Paskill Corp.
v. Alcoma Corp., 747 A.2d 549, 553 (Del. 2000); Rapid-Am. Corp. v. Harris, 603 A.2d
796, 802 (Del. 1992); Cavalier Oil Corp., 564 A.2d at 1144; Bell v. Kirby Lumber Corp.,
413 A.2d 137, 141 (Del. 1980); Universal City Studios, Inc. v. Francis I. duPont & Co.,
334 A.2d 216, 218 (Del. 1975). But see DFC Glob. Corp. v. Muirfield Value P’rs, L.P.,
172 A.3d 346, 371 (Del. 2017) (describing fair value inquiry as examining whether
stockholders “receive fair compensation for their shares in the sense that it reflects
what they deserve to receive based on what would fairly be given to them in an arm’s-
length transaction”).
17 Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd , 177 A.3d 1, 20
(Del. 2017).
18 Id.19 Cede & Co. v. Technicolor, Inc. (Technicolor IV), 684 A.2d 289, 299 (Del.
1996) (holding that a fair value determination must account for the company’s
business plan “on the date of the merger”); see Glob. GT LP v. Golden Telecom, Inc.
(Golden Telecom Trial), 993 A.2d 497, 507 (Del. Ch. 2010) (“The entity must be valued
as a going concern based on its business plan at the time of the merger.”), aff’d, 11
A.3d 214 (Del. 2010); Del. Open MRI, 898 A.2d at 314–15 (“Here, the business plan
of Delaware Radiology involved the strategy of opening additional MRI Centers in
38
the company’s actual capital structure but for the merger. 20 Valuing the corporation
exclusive of value attributable to the merger means disregarding “those elements of
value (which may be either positive or negative) that arise out of the Merger—as
contrasted with those elements of value associated with the ongoing business
Delaware with Edell. This strategy was part of what the Supreme Court would call
the ‘operative reality’ of Delaware Radiology on the merger date and must be
considered in determining fair value.”).
20 See IQ Hldgs, Inc. v. Am. Com. Lines Inc., 2013 WL 4056207, at *3 (Del. Ch.
Mar. 18, 2013) (“The cost of debt will be the weighted average of the actual cost of the
Notes and American’s revolving credit facility . . . , as of the Merger Date.”), aff’d, 80
A.3d 959 (Del. 2013); In re U.S. Cellular Operating Co., 2005 WL 43994, at *15 (Del.
Ch. Jan. 6, 2005) (“The Court’s task is to determine the fair value of the Companies
as a going concern. Therefore, a potential, or even an actual, acquirer’s cost of debt is
not as informative to the Court as the surviving company’s cost of debt, when that
cost is available.” (footnote omitted)); Gilbert v. M.P.M. Enters., Inc., 1998 WL
229439, at *2 (Del. Ch. Apr. 24, 1998) (“In keeping with the Court’s goal of
determining with as much accuracy as possible the fair value of petitioner’s shares
on the merger date, the parties should use MPM’s actual cost of debt when calculating
the discount rate.”), aff’d, 731 A.2d 790 (Del. 1999); In re Radiology Assocs., Inc. Litig.,
611 A.2d 485, 493 (Del. Ch. 1991) (“Even if Ms. Danyluk’s hypothetical capital
structure represents a debt to equity ratio that is closer to the industry average,
defendants argue (and I agree) that the use of the industry average rather than
Radiology’s actual capital structure was improper. The entire focus of the discounted
cash flow analysis is to determine the fair value of Radiology. I am not attempting to
determine the potential maximum value of the company. Rather, I must value
Radiology, not some theoretical company.”); see also Hintmann v. Fred Weber, Inc.,
1998 WL 83052, at *5 (Del. Ch. Feb. 17, 1998) (“I agree that, if known, it is desirable
to use a company’s actual cost of debt.”).
39
venture.”21 The corporation cannot be valued based on what a third party would pay
in an acquisition.22
The valuation date in an appraisal is the date when the merger closes, not
when the merger agreement was signed.23 If the company’s business plan changes
between signing and closing, then the court must use the business plan in place at
closing.24 If the corporation’s business plan includes known plans for expansion or
value-enhancing changes to its capital structure, then its value as a going concern
includes “non-speculative” elements of value attributable to those plans that are
“susceptible of proof.”25 If the value of the corporation increases or decreases between
21 Cede & Co. v. MedPointe Healthcare, Inc., 2004 WL 2093967, at *7 (Del. Ch.
Sept. 10, 2004).
22 M.P.M. Enters., Inc., 731 A.2d at 795 (explaining that the trial court must
determine “the value of the company . . . as a going concern, rather than its value to
a third party as an acquisition”); accord Golden Telecom, Inc. v. Global GT LP, 11
A.3d 214, 217 (Del. 2010) (“[T]his Court has defined fair value as the value to a
stockholder of the firm as a going concern, as opposed to the firm’s value in the context
of an acquisition or other transaction.”).
23 Stillwater, 240 A.3d at 17.
24 See Technicolor IV, 684 A.2d at 299; MedPointe Healthcare, 2004 WL
2093967, at *8 (“The challenge for the Court is to determine the fair value of the going
concern at the time of the Merger. By the time of the Merger, Carter-Wallace had sold
the Consumer Products Division; it had incurred the capital gains tax liabilities and
it had incurred the transaction costs. In short, the Court in an appraisal action values
the stock that is merged with regard to its ‘operative reality’ as of the Merger.”
(footnote omitted)); ONTI, Inc. v. Integra Bank, 751 A.2d 904, 910 (Del. Ch. 1999)
(“[T]he EquiMed Transaction was effectively in place at the time of the Cash-Out
Mergers, as Cede requires.”).
25 Technicolor IV, 684 A.2d at 299; accord Del. Open MRI, 898 A.2d at 314–15
(“Obviously, when a business has opened a couple of facilities and has plans to
40
signing and closing due to external events, then the court must take those changes
into account.26
Finally, the statutory requirement to “consider all relevant factors” 27 means
that the court can consider
all factors and elements which reasonably might enter into the fixing of
value. Thus, market value, asset value, dividends, earning prospects,
replicate those facilities as of the merger date, the value of its expansion plans must
be considered in the determining fair value. To hold otherwise would be to subject our
appraisal jurisprudence to just ridicule. The dangers for the minority arguably are
most present when the controller knows that the firm is on the verge of break-through
growth, having gotten the hang of running the first few facilities, and now being well-
positioned to replicate its success at additional locations—think McDonald’s or
Starbucks.”); see Ng v. Heng Sang Realty Corp., 2004 WL 885590, at *6 (Del. Ch. Apr.
22, 2004) (“In determining fair value, this court cannot consider speculative future
tax liabilities.”), modified, 2004 WL 1151980 (Del. Ch. Apr. 22, 2004), aff’d, 867 A.2d
901 (Del. 2005). Conversely, expansion plans or changes in capital structure that
depend on the merger cannot be considered. See Cede & Co. v. JRC Acq. Corp., 2004
WL 286963, at *7 & n.71 (Del.Ch. Feb. 10, 2004) (excluding debt incurred to finance
the merger); Allenson v. Midway Airlines Corp., 789 A.2d 572, 585–86 (Del. Ch. 2001)
(excluding business concessions conditioned on merger).
26 BCIM Strategic Value Master Fund, LP, v. HFF, Inc. , 2022 WL 304840, at
*1 (Del. Ch. Feb. 2, 2022) (“In an appraisal, however, the court must determine the
fair value of the Company at the time of closing, and the record evidence supports a
finding that the value of the Company increased by the time of closing. Quantifying
the magnitude of that change is an admittedly difficult task. Based on changes to the
implied market price methodology advocated by JLL’s expert, this decision finds that
the value of the Company increased between signing and closing by $2.30 per share.”);
In re Appraisal of Regal Ent. Gp., 2021 WL 1916364, at *1 (Del. Ch. May 13, 2021)
(“The appraisal statute obligates the court to determine the fair value of Regal when
the Merger closed. The parties agreed that some adjustment was necessary because
after signing but before closing, Regal’s value increased when the Tax Cuts and Jobs
Act . . . reduced the corporate tax rate from 35% to 21%. To reflect that valuation
increase, this decision adds $4.37 per share to the value of the deal price minus
synergies.”).
27 8 Del. C. § 262(h).
41
the nature of the enterprise and any other facts which were known or
which could be ascertained as of the date of the merger and which throw
any light on future prospects of the merged corporation are not only
pertinent to an inquiry as to the value of the dissenting stockholders’
interest, but must be considered . . . .28
Although both the statute itself and this passage make consideration of “all relevant
factors” mandatory, every possible factor will not be relevant to every case. Not only
that, but the parties to the appraisal proceeding create the record on which the court’s
fair value determination depends. The appraisal statute states that “the appraisal
proceeding shall be conducted in accordance with the rules of the Court of Chancery,
including any rules specifically governing appraisal proceedings.” 29 Because the
determination of fair value follows a litigated proceeding, “the issues that the court
considers and the outcome it reaches depend in large part on the arguments advanced
and the evidence presented.”30 “An argument may carry the day in a particular case
if counsel advance it skillfully and present persuasive evidence to support it. The
same argument may not prevail in another case if the proponents fail to generate a
similarly persuasive level of probative evidence or if the opponents respond
effectively.”31 Likewise, the approach that an expert espouses may have met “the
28 Tri-Cont’l Corp. v. Battye, 74 A.2d 71, 72 (Del. 1950).
29 8 Del. C. § 262(h).
30 Stillwater Trial, 2019 WL 3943851, at *20.
31 Merion Cap. L.P. v. Lender Processing Servs., L.P., 2016 WL 7324170, at *16
(Del. Ch. Dec. 16, 2016).
42
approval of this court on prior occasions,” but may be rejected in a later case if not
presented persuasively or if “the relevant professional community has mined
additional data and pondered the reliability of past practice and come, by a healthy
weight of reasoned opinion, to believe that a different practice should become the
norm.”32
B. Determining Standalone Value
The first step in determining the fair value of the Jacobs Group’s shares is to
determine the standalone value of the Company as a going concern, using the
operative realty at the time of the Merger that the Company would have continued
pursuing but for the Merger.
1. The Expert Valuations
Both sides introduced testimony from valuation experts who reached
dramatically different valuation conclusions. The Jacobs Group’s expert valued the
Company at $31.6 million. JX 569 at 21. The KV Fund’s expert valued the Company
at $4.3 million. JX 568 at 54. Even in an appraisal proceeding, that is a prodigious
gap.
a. The Jacobs Group’s Expert
The Jacobs Group’s expert determined the Company’s value using the
discounted cash flow methodology.33 He conducted a generally sound valuation with
32 Golden Telecom Trial, 993 A.2d at 517.
33 The Jacobs Group’s
expert considered but did not rely on a comparable
company approach, which he called the guideline public company method, after
43
one key flaw: his reliance on projections from the Company’s Confidential
Information Presentation. See JX 569 at 5.
“Without reliable . . . projections, ‘any values generated by a DCF analysis are
meaningless.’”34 The projections from the Confidential Information Presentation were
overly optimistic for the Company’s core business. They showed high revenue growth
and increasing margins, resulting in a projected 2024 adjusted EBITDA margin of
10.8% compared to a negative 3.8% adjusted EBITDA margin in 2020. See JX 568 at
33; accord JX 280 at 38.
The projections from the Confidential Information Presentation also included
projections for the not-yet launched Edge and Courseware business lines. See JX 280
at 38–40. The projections for those brand-new businesses were too speculative to be
reliable.
The projections from the Confidential Information Presentation also could not
support a meaningful valuation because the first year of the projection period showed
a negative EBITDA of $3,259,959, and the second year showed a negative EBITDA
of $596,872. JX 280 at 40; see also JX 569 at 28. In the halls of academe where
determining that there were a lack of sufficiently comparable public companies. He
also considered a comparable acquisitions approach, which he called the mergers and
acquisitions method, but failed to find sufficiently comparable transactions. He did
not identify any arm’s-length transactions in the Company’s stock, and he did not
believe that an asset valuation would reflect the Company’s value as a going concern.
JX 569 at 6.
34 LongPath Cap., LLC v. Ramtron Int’l Corp., 2015 WL 4540443, at *18 (Del.
Ch. June 30, 2015).
44
economics professors ply their trade, a net-present-value-positive project can always
secure funding on the basis of its future cash flows. As a matter of theory, therefore,
it is always possible to cross the valley of near-term losses to reach the out-year
summits of profitability. In the real world, finding funding is not so easy.
Here, the Company had no ability to fund its existing operations or launch the
new business lines. The Company had raised financing from every source it could
find. It had even secured venture debt financing. It had no options left.
The Confidential Information Presentation stated that the Company needed
$6 million in outside investment to launch the Edge and Courseware business lines,
plus $2 million to fund the existing business’s operating needs. JX 280 at 9. No one
was willing to provide that capital. The DCF valuation that the plaintiffs’ expert
provided assumed that the Company’s plans could be funded. The evidence showed
they could not.
The projections from the Confidential Information Presentation were also
unreliable because they sought to anticipate the results of brand new businesses that
the Company had yet to start. Projecting results for a new business is inherently
speculative. “Because of that fact, courts generally reject efforts to prove lost-profits
damages for a new business that has no history of making profits. This court has
45
followed a similar practice in appraisal proceedings by declining to credit projections
for a new business without any operating track record.”35
At trial, the plaintiffs’ expert conceded that the Courseware business had not
started, but he believed that Edge “had been operational.” Ultz Tr. 845. Edge had
secured a contract for a single pilot project charging $5,000 in annual service fee. JX
687 at 7; accord Kaji Tr. 516. That was it. Edge needed $1.5 million just to get off the
ground.
The new business projections that management created are too speculative to
use. “They represent [the Company’s] hoped-for reality, not its operative reality.”36
The plaintiffs’ DCF analysis had other flaws, but the speculative nature of the
projections is sufficient to reject it. The plaintiffs’ DCF valuation was not credible.
b. The KV Fund’s Expert
The KV Fund’s expert valued the Company using a discounted cash flow
methodology and a comparable public company analysis.37 He concluded that under
the discounted cash flow method, the Company’s value was $2.4 million. JX 568 at
54.
35 See Hyde Park, 2024 WL 3579932, at *22 (footnote omitted) (collecting
authorities).
36 Id. at *22.
37 The KV Fund’s expert attempted to value the Company using the value of
the Merger. The Jacobs Group successfully moved for an order striking those parties
of his report. Dkt. 122.
46
The KV Fund’s expert started by addressing the Company’s inability to sustain
itself as a going concern:
While the Company on average has operated with negative working
capital, there are times during the annual business cycle when funds
are needed to bridge working capital needs, and, every year, the
Company needs to fund these outlays. As a result, Akademos has and
must borrow these funds or raise equity capital. Without these
additional funds, the Company cannot continue to operate, let alone
grow and eventually reach scale, at which point it believes it will be able
to fund these cyclical working capital needs from its current operating
profits.
Id. at 5. During the five years leading up to the valuation date of December 23, 2020,
the Company “was almost entirely dependent” on the KV Fund for financing, and it
was only with that financing that the Company was able to operate as a going
concern. In each year from 2015 through 2020, the Company’s auditors included a
going-concern qualification on its audited financial statements. Id.
The Company’s financial statements revealed its condition. Between 2015 and
2020, the Company suffered an operating loss in every year, ranging from −$2.4
million in 2017 to −$1.1 million in 2020. JX 14; JX 243; JX 244; JX 356. Net sales
increased from $18.2 million in 2015 to $19.5 million in 2020, reflecting a compound
annual growth rate of just 1.4%.38 See JX 14 at 6; JX 356 at 5. As of June 30, 2020,
the Company’s balance sheet reflected total equity of negative $8.6 million. JX 356 at
38 KV Fund’s expert report states that “$19.3 million” was the 2020 net sales
number. JX 568 at 16. This was a misquote. The Company’s 2020 financial statement
has the number as “$19.5 million.” JX 356 at 5. KV Fund’s misquote nevertheless
represents an incidental typographic error, because KV Fund’s expert still calculated
the correct compounded annual growth rate, 1.4%.
47
6. Total liabilities were $13.1 million, and current liabilities were $12.5 million,
including $6.8 million in short-term debt coming due in September 2020. Id. at 4; see
also JX 568 at 17.
Like the Jacobs Group’s expert, the KV Fund’s expert valued the Company
using a discounted cash flow method. He started with the projections from the
Confidential Information Presentation, but he excluded the amounts attributed to
the two new lines of business. The Company needed to raise $6 million to fund those
businesses, rendering them too speculative to value.39
The KV Fund’s expert thus only valued the cash flows from the Company’s
existing business. The projections showed a loss of $1.162 million in 2021, but the KV
Fund’s expert assumed that could be financed, even though that was “an optimistic
assumption given the Company’s inability to raise capital from outside parties.” Id.
at 33. He also treated the Company’s near-term debt of $5.937 million as an
adjustment to equity value, rather than as a near-term obligation that the Company
lacked the funds to meet. See id. at 47. With those and other favorable assumptions,
he concluded that under the discounted cash flow approach, the Company had a value
of $2.4 million. Id. at 49.
39 The KV Fund’s expert report states that “[t]he Emerging Business Offerings
assume the successful raise of $8 million in new equity in 2020 to fund these emerging
business offerings.” JX 568 at 32. The Confidential Information Presentation shows
the Company needed $6 million to launch Edge and Courseware and $2 million “to
fund operating needs to become cash flow positive.” JX 280 at 9. The KV Fund’s expert
mistakenly combined these two numbers to reach $8 million.
48
The KV Fund’s expert separately prepared a comparable companies analysis
using four guideline companies. Id. at 49–51. He derived a valuation multiple of 0.69x
based on their latest twelve months of revenue and a multiple of 0.55x based on the
projected next twelve months of revenue. Id. at 52. Applying the latest-twelve-month
revenue multiple to the Company’s results generated a value of $7.3 million. Using
the next-twelve-month multiple generated a value of $4.8 million. He then added a
10% premium to offset the KV Fund’s control and the value of cash, resulting in a
value of $8.4 million based on latest-twelve-month revenue and $5.7 million based on
next-twelve-month revenue. Id. at 53. He averaged the two for an implied valuation
of $7.1 million.
To reach this valuation conclusion, the KV Fund’s expert gave 60% weight to
the DCF valuation of $2.4 million and 40% to the comparable company valuation of
$7.1 million. That weighing resulted in a valuation of $4.3 million. Id. at 54.
2. Other Valuation Indicators
The court must consider all relevant factors and should test the soundness of
the expert valuation conclusion against corroborative evidence from the record. 40
40 8 Del. C. § 262(h); accord Le Beau v. M.G. Bancorporation, Inc. (M.G.
Bancorporation Trial), 1998 WL 44993, at *12 (Del. Ch. Jan. 29, 1998), aff’d, M.G.
Bancorporation, 737 A.2d at 526; see Cede & Co. v. Technicolor, Inc. (Technicolor
Appraisal III), 2003 WL 23700218, at *4 (noting that a valuation supported by
“several independent indicia of value” is more reliable and preferred), aff’d in part,
rev’d in part on other grounds, 884 A.2d 26 (Del. 2005); In re Appraisal of Shell Oil
Co., 607 A.2d 1213, 1220 (Del. 1992) (“When a court is faced with a lack of reliable
direct evidence of value, or when doubt exists as to the accuracy of its findings, it is
appropriate for the court, as a fact-finder, to test its conclusions against other
evidence in the record before it.”). The court has tested parties’ valuations by looking
49
a. Transaction Value
The Delaware Supreme Court has instructed the Court of Chancery to
prioritize market evidence when determining value in an appraisal, observing that
“[i]n economics, the value of something is what it will fetch in the market. That is
true of corporations, just as it is true of gold.”41 The justices have also stated that
“[m]arket prices are typically viewed [as] superior to other valuation techniques
because, unlike, e.g., a single person’s discounted cash flow model, the market price
should distill the collective judgment of the many based on all the publicly available
information about a given company and the value of its shares.”42
But the cases in which the Delaware Supreme Court has called for deferring
to the deal price have involved third-party transactions subject to sufficiently
competitive and informed market forces. Unsurprisingly, this court has eschewed
using market evidence in an appraisal following a controller squeeze-out
at various factors. See, e.g., Highfields Cap., Ltd. v. AXA Fin., Inc., 939 A.2d 34, 52
(Del. Ch. 2007) (considering market price data); Cede & Co. v. Technicolor, Inc.
(Technicolor I), 1990 WL 161084, at *32 (Del. Ch. Oct. 19, 1990) (Allen, C.)
(considering the decision of knowledgeable insiders), rev’d in part on other grounds,
634 A.2d 345 (Del. 1993); Andaloro v. PFPC Worldwide, Inc., 2005 WL 2045640, at
*19 (Del. Ch. Aug. 19, 2005) (considering views of the analyst community); Highfields
Cap., 939 A.2d at 59 (considering a party’s contemporaneous decision-making).
41 DFC Glob. Corp., 172 A.3d at 368–69.
42 Id. at 369–70; see also In re Tesla Motors, Inc. S’holder Litig. (Tesla I)., 2022
WL 1237185, at *42 (Del. Ch. Apr. 27, 2022) (“Market evidence is a reliable indicator
of fair price, however, only when ‘the evidence reveals a market value forged in the
crucible of objective market reality.’”), aff’d, 298 A.3d 667 (Del. 2023).
50
transaction.43 But even when not deferring to the deal price as primus inter pares,
this court has sought to “test the soundness of its valuation conclusion against
whatever reliable corroborative evidence the record contains.”44
In this case, the market evidence tends to undermine the valuation of $31.6
million advanced by the Jacobs Group. First, before the 2020 Process began,
management reached out to potential strategic partners. That effort yielded only the
offer from Ambassador that valued the Company at $10.36 million, with 25% of the
consideration taking the form of Ambassador’s illiquid common stock and the other
75% taking the form of a promissory note payable over two years.
Next, the Company hired Parchman Vaughan to run a dual-track process
seeking either financing or an M&A deal. During the first phase of that process,
management and Parchman Vaughan contacted a total of 101 including two firms—
Barnes & Noble and Follett—who previously expressed interest in the Company.
43 See HBK Master Fund L.P. v. Pivotal Software, Inc., 2023 WL 10405169, at
*23 (Del. Ch. Aug. 14, 2023) (“Unsurprisingly, no appraisal decision of a Delaware
court has given weight to deal price when determining fair value in the context of a
controller squeeze-out, which lack the competitive dynamics that render deal price
reliable.”); Orchard, 2012 WL 2923305, at *5 (“Orchard makes some rhetorical hay
out of its search for other buyers. But this is an appraisal action, not a fiduciary duty
case, and . . . an appraisal must be focused on Orchard’s going concern value.”).
44 M.G. Bancorporation Trial, 1998 WL 44993, at *12, aff’d, 737 A.2d; see Shell,
607 A.2d at 1220 (“When a court is faced with a lack of reliable direct evidence of
value, or when doubt exists as to the accuracy of its findings, it is appropriate for the
court, as a fact-finder, to test its conclusions against other evidence in the record
before it.”); Cooper, 1993 WL 208763, at *10 (same); Technicolor I, 1990 WL 161084,
at *31 (Del. Ch. Oct. 19, 1990) (using market price “as corroboration of the judgment
that [the expert’s] valuation is a reasonable estimation”).
51
That effort generated no interest in a financing transaction and only one indication
of interest in an M&A deal before the initial bid deadline of March 31. The latter was
a proposal from eCampus to acquire the Company for $6 million dollars, with 50% of
the consideration in cash and no specification as to the other 50%.
Because the results were so disappointing, management and Parchman
Vaughan continued the effort and reached out to another nineteen parties. That
additional effort yielded three new indications of interest and a revised proposal from
eCampus:
• Invictus Global, an investor in distressed companies, submitted a non-binding
letter of intent offering $5 million in senior-secured, super-priority debtor-in-
possession financing, but only if the Company declared bankruptcy.
• Ames Watson offered $500,000 for a 75% stake in the Company, plus another
$500,000 for additional equity.
• eCampus increased its proposal by $1 million to $7 million in total, still with
no more than 50% payable in cash and the balance undefined without saying
what form of consideration the balance would take.
None of those indications of interest bear any resemblance to the valuation advanced
by the Jacobs Group’s expert. They are more consistent with the valuation prepared
by the KV Fund’s expert.
Third, the Merger contemplated a go-shop process during which the KV Fund
did not have any matching rights and was obligated to support any transaction that
the non-KV Fund directors concluded offered more value to the KV Fund in its
capacity as a debtholder. See JX 400 at 4–5. Because the Merger would pay off $6
million in debt, any superior proposal had to clear that bar.
52
That comparatively open go-shop could have provided some degree of price
validation for the transaction price, but the process had shortcomings. At three
weeks, it was comparatively short. And given the Company’s small size and risky
prospects, the business was not one that would attract attention easily. Nor did
Company management and Parchman Vaughan reach out widely during the go-shop.
They chose instead to contact the four parties they believed had the most interest:
Ambassador, eCampus, Ames Watson, and Red Shelf. None of these parties made a
superior offer, and Ames Watson told Parchman Vaughan that if the Company “can
get anything close to that price [$12.5 million] they should run to closing.” JX 410
at 1.
The plaintiffs argue that the Company should have contacted Barnes & Noble,
Follett, and VitalSource. Company management and Parchman Vaughan did contact
Barnes & Noble and Follett, but at the outset of the 2020 Process. Neither had any
interest in the Company. See JX 440 at 4–5. And Kaji and Eastburn testified credibly
that the Company ruled out VitalSource because they expected VitalSource to want
to acquire the Company through a Section 363 sale in bankruptcy. See Eastburn Tr.
382–83; Kaji Tr. 464–65. The defendants proved they had good reasons for not
contacting VitalSource.
Last, the plaintiffs argue that Kaji undercut the go-shop process by not telling
the Board about a text from RedShelf’s CEO floating a $10 million figure or
Ambassador’s reiteration of its proposal from December 2019. Those were missteps,
and Kaji should have disclosed those contacts to the Board so the non-KV Fund
53
directors could decide how to proceed. But the RedShelf CEO’s text was little more
than a trial balloon, and the Board had previously rejected Ambassador’s offer. The
plaintiffs argue that Ambassador had been willing to go as high as $18.3 million, but
they base that on an initial proposal from mid-2019. Ambassador withdrew that
proposal in favor of its $10.3 million proposal in December 2019. JX 213 at 3; accord
JX 211.
The results the go-shop achieved were inconsistent with the valuation
advanced by the Jacobs Group’s expert. They are more consistent with the valuation
prepared by the KV Fund’s expert. Nevertheless, because of the arguable flaws in the
go-shop, this decision will not rely on it for market evidence regarding the Company’s
fair value.
b. The 409A Valuation
In September 2019, the Company procured a Rule 409A valuation report that
valued the Company at $32.03 million and the common stock at $8.72 per share. JX
179 at 19. The Board unanimously approved the Rule 409A valuation for use in
granting equity awards to employees. JX 188 at 3–4. The Jacobs Group points to the
Rule 409A report as a reliable valuation indicator.
Federal law mandates that if an issuer wants to avoid generating immediate
income for an option recipient, then the exercise price for the option must be equal to
or greater than the “fair market value of the stock at the time such option is granted.”
26 U.S.C. § 422(b)(4). IRS regulations require that a non-public company determine
fair market value of its stock by considering “the company’s net worth, prospective
54
earning power and dividend-paying capacity, and other relevant factors.” 26 C.F.R.
§ 20.2031–2(f)(2). Serious penalties attach when taxpayers make false statements to
the IRS.45
Those considerations might suggest that Rule 409A valuations would be
reliable, but the opposite is true. The firms who prepare Rule 409A valuations
generally do not charge much, and the directors who rely on them are often less
concerned with their accuracy and more concerned with how employees will react to
the valuation. An employee who receives common stock supported by a high Rule
409A valuation may feel like they have received something meaningful.46
Given these motivations, Rule 409A valuations warrant a heavy dose of
skepticism.47 It is tempting to hold the defendants to their determination of fair
market value, and a case may come where a court will use the Rule 409A valuation
for that purpose. In this case, however, the defendants’ expert testified credibly the
Rule 409A analysis was both stale and unreliable. Clarke Tr. 895–97. It was also an
45 See 26 U.S.C. § 6662 (civil penalty for accuracy-related tax underpayment);
id. § 6663 (civil penalty for fraudulent tax underpayment); id. § 6701 (civil penalty for
aiding and abetting understatement of tax liability); id. § 7201 (criminal penalty for
willfully attempting to evade or defeat tax).
46 See In re Trados Inc. S’holder Litig., 73 A.3d 17, 70 (Del. Ch. 2013) (citing
directors’ testimony that “they needed to ascribe positive value to the common stock
so current and prospective employees would think [their stock] options were worth
something”).
47 See, e.g., id. at *70 (declining to rely on minutes in which directors
determined value of stock for purposes of Rule 409A); Hyde Park, 2024 WL 3579932,
at *20 (declining to rely on Rule 409A valuation).
55
outlier, and the Company’s efforts during the 2020 Process failed to yield anything
resembling the Rule 409A valuation. The valuation also assumed that the Company
was not in financial distress and would continue as a going concern, neither of which
was true in 2020. Given these factors, the court gives no weight to the 409A valuation.
c. The VitalSource Transaction and Follett Offer
The Jacobs Group also points to the results of a sale process that the KV Fund
ran in 2023, two years after the merger. That process generated an expression of
interest from Follett in a deal at $30 million and resulted in a sale of the Company to
VitalSource for $20 million. That information constitutes post-valuation date
evidence that a court generally will not consider.48
C. Determining The Proportionate Share Of Standalone Value
Attributable To The Common Stock
The second step in determining the fair value of the Jacobs Group’s shares is
to determine the value attributable to those shares as a proportionate interest in the
company as a going concern. For a company with a multi-class capital structure, that
requires determining how much of the company’s going concern value should be
allocated to the class of stock being appraised. Once that determination has been
made, the court can determine the pro rata share of that value attributable to the
shares held by the appraisal class.
48 In re Sears Hometown & Outlet Stores, Inc. S’holder Litig. (Sears), 309 A.3d
474, 534 (Del. Ch. 2024).
56
The principal factors affecting the common stock’s proportionate interest in the
value of the Company are the KV Notes and the Preferred Stock. The Company owed
approximately $6 million on the KV Notes, plus another $6 million for the 2x
repayment premium. The Company also owed approximately $32 million in accrued
dividends and principal associated with the Preferred Stock. The KV Fund argues
that the common stock sat behind the KV Notes and underneath the Preferred Stock,
the common stock could not have had any value unless and until the Company’s value
approached $40 million. The KV Fund also argues that because it could veto any
transaction that did not allocate consideration first to paying off the KV Notes and
the Preferred Stock’s liquidation preference, any realistic valuation of the common
stock had to consider the priority claims held by those securities.
The Orchard decision considered a similar issue.49 There, as here, a private
equity fund held preferred stock that carried a $25 million liquidation preference.
The private equity fund cashed out the minority in a going private merger. Although
conceding that the merger did not trigger the liquidation preference, the fund made
the same argument that the KV Fund now advances: Because its consent was
required for any third-party deal, the fund could insist that any acquirer agree to pay
its liquidation preference first. Therefore, “no third-party investor or market
participate would value Orchard without taking into account [the liquidation
preference], and [the fund] would never approve a transaction with a third party in
49 Orchard, 2012 WL 2923305.
57
which it did not receive its liquidation preference.” 50 The fund concluded that as a
matter of market reality, the liquidation preference had to be deducted from the
company’s standalone valuation.51
While acknowledging that those arguments might well be “grounded in market
realities,”52 then-Chancellor Strine held that they could not survive the Delaware
Supreme Court’s holding in Cavalier Oil,53 which required that minority shares be
valued for appraisal on a pro rata basis, without crediting the controlling stockholder
with a control premium or imposing a discount on the minority shares.54 Thus,
although Delaware law gives majority stockholders the right to a control premium,
50 Id. at *8.
51 Id. at *1; accord id. at *7 (“Faced with the inescapable fact that the Going
Private Merger did not trigger the liquidation preference, Orchard also argued that
Dimensional’s legal rights as a preferred holder and its firm voting control as an
overall holder of equity increased the probability of payment of the liquidation
preference such that it was near certainty on the Merger date.” (internal quotation
marks omitted)).
52 Id. at *8.
53 Cavalier Oil, 564 A.2d at 1144; see id. at 1145 (“[T]o fail to accord a minority
shareholder the full proportionate value of his shares imposes a penalty for lack of
control, and unfairly enriches the majority shareholders who may reap a windfall
from the appraisal process by cashing out a dissenting shareholder, a clearly
undesirable result.”).
54 Orchard, 2012 WL 2923305, at *8. The court also noted that the Cavalier Oil
approach could reflect the recognition “that appraisal is a risky, time-consuming, and
burdensome remedy that involves a stockholder tying up its investment in a legal
proceeding for several years and having to bear its own cost of prosecution, without
any guarantee to receive any floor percentage of the merger consideration.” Id. at *8
n.45.
58
Cavalier Oil tempers the realistic chance to get one by requiring that the court value
the minority shares on a pro rata basis in an appraisal.55
Explaining further, Chief Justice Strine observed that “[u]nlike a situation
where a preference becomes a put right by contract at a certain date, the liquidation
preference here was only triggered by unpredictable events such as a third-party
merger, dissolution, or liquidation.”56 He also held that incorporating the liquidation
preference would equate to basing standalone value on liquidation value rather than
going concern value. He reasoned that a standalone valuation had to consider the
rights carried by the preferred stock that affected the company’s value as a going
concern. In Orchard, the preferred stock did not have any set dividend rights; its “only
right to share in cash flow distributions made by Orchard while the company was a
going concern (i.e., dividends) was on an as-converted basis.”57 The preferred stock
therefore received no incremental value for its rights, and Chief Justice Strine
55 See id. at *8.
56 Id. at *1 (footnote omitted); see also id. at *6 (“The Going Private Merger was
not an event triggering the payment of the liquidation preference . . . . [A]s of the date
of the Merger, the liquidation preference had not been triggered, and the possibility
that any of the triggering events would have occurred at all, much less in what
specific time frame, was entirely a matter of speculation.” (footnote omitted)).
57 Id. at *1; see id. at *3 (“The preferred stock has no set dividend rights, but is
entitled to participate in any dividends declared by Orchard on its common stock on
an as-converted basis.”).
59
allocated the going-concern value of the company as a standalone entity as if the
preferred stock had been converted into common stock.58
Chief Justice Strine addressed similar issues in the Shiftan decision, also while
serving as Chancellor. There, however, the preferred stockholders held different
rights.59 The corporation completed the merger giving rise to appraisal rights six
months before the certificate of designations conferred on the preferred stockholders
a right to put their shares to the corporation in return for their liquidation preference.
The court treated that right as a non-speculative obligation to pay out the liquidation
preference and took that obligation into account when valuing the corporation as a
going concern.60
1. Taking Into Account The Rights Of The Preferred Stock
The Preferred Stock carries rights that affect the value of the Jacobs Group’s
shares as a proportioned interest in a going concern. There are three pertinent
provisions in the Company’s Certificate of Incorporation (the “Charter”): (i) a
provision calling for the payment of the Preferred Stock’s liquidation preference upon
a Deemed Liquidation Events (the “Deemed Liquidation Provision”), (ii) a provision
58 See id. at *7 (“[I]n the domain of appraisal governed by the rule of Cavalier
Oil, the preferred stockholders’ share of Orchard’s going concern value is equal to the
preferred stock’s as-converted value, not the liquidation preference payable to it if a
speculative event (such as a merger or liquidation) that Cavalier Oil categorically
excludes from consideration occurs.”).
59 Shiftan v. Morgan Joseph Hldgs., Inc., 57 A.3d 928 (Del. Ch. 2012).
60 Id. at 941–42, 941 n. 37.
60
granting the Preferred Stock a right of mandatory redemption (the “Mandatory
Redemption Provision”), and (iii) a provision calling for accrued dividends (the
“Accrued Dividend Provision”). JX 19. Under Orchard, the Deemed Liquidation
Provision does not affect the allocation of value. Under Shiftan, the Mandatory
Redemption Provision and the Accrued Dividend Provision do. Because of those
provisions, the common stock has no value, even for purposes of allocating the
Company’s standalone value as a going concern.
a. The Deemed Liquidation Provision
The first potentially pertinent provision is the Deemed Liquidation Provision.
The parties have debated whether the Merger triggered the Deemed Liquidation
Provision, but for determining the value of the Jacobs Group’s shares as a
proportionate interest in a going concern, the answer is immaterial. Under Orchard,
the Deemed Liquidation Provision does not affect the allocation of value when the
court values the Company as a going concern.
Under the Charter, the Preferred Stock becomes entitled to receive its
liquidation preference “[i]n the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Corporation (including a Deemed Liquidation Event
(as defined below)).”61 The Deemed Liquidation Provision defines a Deemed
Liquidation Event as follows:
(a) a merger in which . . . the Corporation is a constituent party . . . ;
except any such merger involving the Corporation . . . in which the
61 JX 19 art. FOURTH, § B.2.1.
61
shares of capital stock of the Corporation outstanding immediately prior
to such merger continue to represent, or are converted into or exchanged
for shares of capital stock that represent, immediately following such
merger, at least a majority, by voting power, of the capital stock of (1)
the surviving corporation or (2) if the surviving corporation is a wholly
owned subsidiary of another corporation immediately following such
merger, the parent corporation of such surviving corporation . . . ; or
(b) the sale, lease, transfer, exclusive license or other disposition, in a
single transaction or series of related transactions, by the Corporation
. . . of all or substantially all of the assets of the Corporation and its
subsidiaries taken as a whole . . . , except where such sale, lease,
transfer, exclusive license or other disposition is to a wholly owned
subsidiary of the Corporation.62
The Charter elsewhere provides that the Company cannot engage in a Deemed
Liquidation Event without the written consent of the holders of a majority of the
Preferred Stock, voting as a single class and on an as-converted basis.63
Relying on these rights, the KV Fund argues that the company’s standalone
valuation must deduct the liquidation preferences because the Company cannot have
62 JX 19 art. FOURTH, § B.2.3.1 The quotation above the line simplifies the
text in three ways. First, wherever the word “merger” appears, the actual provision
uses the phrase “merger or consolidation.” Second, wherever the word “surviving
corporation” appears, the actual provision uses the phrase “surviving or resulting
corporation.” Those omissions are not marked with ellipses. Third, the actual text
includes language that extends the definition to transactions at the level of a
Company subsidiary. Those omissions are marked with ellipses.
63 JX 19 art. FOURTH, § B.3.3(a). In its original form, the Charter stated that
the Company lacked the power to engage in a merger that would constitute a Deemed
Liquidation Event unless the merger agreement allocated the consideration
consistent with the Preferred Stock’s right to its liquidation preference. The Charter
also stated that if the Company engaged in a sale of assets, then the Company had to
use the proceeds to redeem all of the shares of Preferred Stock in return for their
liquidation preference before distributing any remaining amounts to the common
stockholders.
62
engaged in the Merger, or any similar transaction, without KV Fund consenting as
the majority Preferred Stockholder.
This is the same argument made in Orchard, and it fails for the same reasons.
The Deemed Liquidation Provision does not apply when the Company is operating as
a going concern. In this case, the Deemed Liquidation Provision only could come into
effect because of the Merger. It is therefore a negative component of value “arising
from the accomplishment or expectation of the merger,”64 which the appraisal statute
commands this court to exclude.
b. The Mandatory Redemption Provision
The second potentially pertinent provision is the Mandatory Redemption
Provision. Under Shiftan, this provision establishes a sufficiently definite obligation
to require consideration as a relevant valuation factor. As a consequence of the
Mandatory Redemption Provision, the common stock has no value.
The Mandatory Redemption Right authorizes the holders of a majority of the
Preferred Stock to demand redemption starting on the third anniversary of the
Original Issue Date, defined as the date of issuance of the Series B Preferred.65 If the
requisite majority of the Preferred Stock demands redemption, then the Company
must redeem the Preferred Stock in exchange for its redemption price in three annual
64 8 Del. C. § 262(h).
65 JX 19 art. FOURTH, § B.6.1; accord id. art. FOURTH, § B.4.4.1(b).
63
installments, with the first installment paid not more than sixty days after the notice
of redemption. The Mandatory Redemption Right states that if
the Corporation does not have sufficient funds legally available to
redeem on any Redemption Date all shares of Preferred Stock [entitled]
to be redeemed . . . , the Corporation shall redeem a pro rata portion of
each holder’s redeemable shares . . . out of funds legally available . . . ,
and shall redeem the remaining shares to have been redeemed as soon
as practicable after the Corporation has funds legally available
therefor.66
The Mandatory Redemption Provision thus creates a binding obligation to redeem
shares as funds that can be used legally for that purpose when they become available,
until the Company has redeemed all shares for which redemption has been granted.
The Original Issue Date was in December 2016. The KV Fund therefore could
exercise the Mandatory Redemption Provision as early as December 2019. Jacobs Tr.
24–25, 115–17. Through the Mandatory Redemption Provision, the KV Fund could
sweep up all of the funds that became legally available for making redemptions. The
common stock would not be able to receive any cash flows until the Company had
fully redeemed the Preferred Stock.
c. The Accrued Dividend Provision
A third provision that affects the determination standalone value provides for
accrued dividends on the Series A Preferred, regardless of whether any dividends are
declared. The operative language states:
From and after the date of the issuance of any shares of [Series A Stock],
dividends at the Applicable Dividend Rate per share shall accrue on
66 Id. art. FOURTH, § B.6.1.
64
such shares of Series A Stock . . . (the “Accruing Dividends”). Accruing
Dividends shall accrue from day to day, whether or not declared, and
shall be cumulative . . . .67
For the Series A Preferred, the Applicable Dividend Rate was $1.28 per year. For the
Series A-1 Preferred, the Applicable Dividend Rate was $1.60 per year. Under the
Charter, the Board could not declare any dividends unless (i) all Accrued Dividends
were paid first and (ii) all of the outstanding Preferred Stock participated in the
dividend on an as-converted basis.68
As with the Mandatory Redemption Provision, the Accrued Dividend Provision
affects the ability of the common stock to benefit from cash flows while the Company
operates as a going concern. Before the Company can pay any dividends to the
common stock, the Company must first satisfy any Accrued Dividends. As long as the
dividends remained opposed, the common stock could not receive any value from the
Company as a going concern.
2. The Contingent Claims Analysis
The KV Fund’s expert presented a contingent claims analysis to allocate the
Company’s equity value across its different securities. This methodology models each
class of securities as a call option with a claim on the value of the company. The
option’s exercise price reflects the value at which that class of securities can claim a
share of the value. Since the total value of the firm is equal to the sum of the value of
67 JX 19 art. FOURTH, § B.1.
68 Id.
65
the securities in its capital structure, option pricing models can be used to allocate a
known firm value across the securities in its capital structure. Although Orchard and
Shiftan suggested that any effort to model claims to liquidation preferences or other
rights would be speculative, the contingent claims methodology can be used for that
purpose and is generally accepted in the financial community, making it suitable for
use in an appraisal proceeding.69
The KV Fund’s expert conducted his contingent claims analysis using a value
of $6.56 million that he derived from the deal price. This decision will not use the
squeeze-out deal price as a valuation indicator, because his DCF valuation is the more
persuasive. The resulting valuation of $2.4 million is below the $6.56 million figure
used in the contingent claims analysis. As the $6.56 million figure already yields $0
for common stock, it follows that the common stock has no value under a contingent
claims analysis using a valuation of $2.4 million.
3. The Fair Value Determination
The KV Fund proved that the fair value of the Jacobs Group’s shares at the
time of the Merger was zero. The appraisal claim does not generate any recovery for
the Jacobs Group.
69 See Scott P. Mason & Robert C. Merton, The Role of Contingent Claims
Analysis in Corporate Finance, in Recent Advances in Corporate Finance (Edward I.
Altman & Marti G. Subrahmanyam eds. 1985); See generally Weinberger, 457 A.2d
at 713 (holding that a valuation can be based on any method generally accepted in
the financial community).
66
III. THE BREACH OF FIDUCIARY DUTY CLAIM
The Jacobs Group separately contends that the Company’s directors (other
than Jacobs) breached their fiduciary duties by (i) agreeing to the Merger, (ii) treating
the Merger as a Deemed Liquidation Event for purposes of the Preferred Stock’s
liquidation preference, and (iii) approving the KV Notes. The defendants proved that
their conduct was entirely fair, so judgment will be entered in their favor on the
breach of fiduciary duty claims.
“A claim for breach of fiduciary duty requires proof of two elements: (1) that a
fiduciary duty existed and (2) that the defendant breached that duty.” 70 The first
element is easily satisfied. “For over two centuries, American courts have treated
corporate directors as fiduciaries. Today, the proposition is axiomatic. . . . For just as
long, American courts have treated corporate officers as fiduciaries.”71 The members
of the Board were fiduciaries as directors, and Kaji was also a fiduciary as an officer.
The second element is more complex. To determine whether corporate
fiduciaries have breached their duties when approving a transaction, Delaware law
distinguishes between the standard of conduct and the standard of review.72 The
70 Beard Rsch., Inc. v. Kates, 8 A.3d 573, 601 (Del. Ch. 2010).
71 In re Columbia Pipeline Gp., Inc. Merger Litig. , 299 A.3d 393, 452 (Del. Ch.
2023) (footnotes omitted).
72 Id. at 453.
67
standard of conduct describes what corporate fiduciaries are expected to do and is
defined by the content of the duties of loyalty and care.73
When litigation arises, a court does not judge corporate fiduciaries by the
standard of conduct but rather by using a standard of review. “Delaware has three
tiers of review for evaluating director decision-making: the business judgment rule,
enhanced scrutiny, and entire fairness.”74 The parties agree that the entire fairness
standard of review applies to this case.
The entire fairness standard has two dimensions: substantive fairness (fair
price) and procedural fairness (fair dealing).75 Though a court may analyze each
aspect separately, they are not distinct elements of a two-part test. “All aspects of the
issue must be examined as a whole since the question is one of entire fairness.”76
The substantive dimension of the fairness inquiry tests the transactional
result. “[T]he court examines the economic and financial merits of the transaction,
taking into account all relevant factors.”77 Thus, in the canonical framing, fair price
“relates to the economic and financial considerations of the [transaction], including
73 Trados, 73 A.3d at 35–36 (Del. Ch. 2013).
74 Reis v. Hazelett Strip-Casting Corp., 28 A.3d 442, 457 (Del. Ch. 2011).
75 See Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983).
76 Id.77 Sears 309 A.3d at 520 (citing Cinemera, Inc. v. Technicolor, Inc. (Technicolor
Plenary IV), 663 A.2d 1156, 1162–63 (Del. 1995)).
68
all relevant factors: assets, market value, earnings, future prospects, and any other
elements that affect the intrinsic or inherent value of a company’s stock.”78
The techniques used to evaluate the fair price dimension of the entire fairness
test can parallel the techniques used in an appraisal proceeding, but the two inquiries
are not identical. The appraisal statute requires that the court determine a point
estimate for fair value measured in dollars and cents using the special valuation
standards derived from the statutory language.79 By contrast, the fair price aspect of
the entire fairness test is not itself a remedial calculation; it is a standard of review
that the court applies to identify a fiduciary breach.80 For purposes of determining
fairness, the court’s task is not to pick a single number, but to determine whether the
transaction price falls within a range of fairness.81 That means determining 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.”82 This standard recognizes the reality that “[t]he value of a corporation is not
78 Weinberger, 457 A.2d at 711.
79 ACP Master, Ltd. v. Sprint Corp., 2017 WL 3421142, at *18 (Del. Ch. July
21, 2017) (footnotes omitted), aff’d, 184 A.3d 1291 (Del. 2018) (TABLE).
80 Id.81 In re Dole Food Co., Inc. S’holder Litig., 2015 WL 5052214, at *33 (Del. Ch.
Aug. 27, 2015).
82Technicolor Plenary IV, 663 A.2d at 1143.
69
a point on a line, but a range of reasonable values.”83 “Applying this standard, a court
could conclude that a price fell within a range of fairness that would not support
fiduciary liability, and yet the point calculation demanded by the appraisal statute
could yield an award in excess of the merger price.”84
The procedural dimension of the fairness inquiry works in service of the fair
price element by examining the process that led to the challenged decision or
transaction. Known as “fair dealing,” it “focuses upon the conduct of the corporate
fiduciaries in effectuating the transaction.”85 The procedural dimension “embraces
questions of when the transaction was timed, how it was initiated, structured,
negotiated, disclosed to the directors, and how the approvals of the directors and the
stockholders were obtained.”86
The two dimensions of the entire fairness test interact. “Fair price can be the
predominant consideration in the unitary entire fairness inquiry.”87 But because
pricing and valuation are often contestable, the procedural dimension can take on
significant importance. “A strong record of fair dealing can influence the fair price
inquiry, reinforcing the unitary nature of the entire fairness test. The converse is
83 Technicolor Appraisal III, 2003 WL 23700218, at *2.
84 ACP, 2017 WL 3421142, at *19.
85 Kahn v. Tremont Corp. (Tremont II), 694 A.2d 422, 430 (Del. 1997).
86 Weinberger, 457 A.2d at 711.
87 Dole, 2015 WL 5052214, at *34.
70
equally true: process can infect price.”88 A dubious process can call into question a
low but nominally fair price. “Factors such as coercion, the misuse of confidential
information, secret conflicts, or fraud could lead a court to hold that a transaction
that fell within the range of fairness was nevertheless unfair compared to what
faithful fiduciaries could have achieved.”89 Where those factors are present, a court
may conclude that the transaction is not entirely fair. As a remedy, the court could
award a “fairer price” or rescissory damages.90
“The range of fairness concept has most salience when the controller has
established a process that simulates arm’s-length bargaining, supported by
appropriate procedural protections.”91 “The range of fairness permits a court to give
some degree of deference to fiduciaries who have acted properly; it is not a rigid rule
that permits controllers to impose barely fair transactions.”92 The true test of
financial fairness is whether “the minority stockholder shall receive the substantial
equivalent in value of what he had before.”93
88 Reis, 28 A.3d at 467 (collecting authorities).
89 ACP, 2017 WL 3421142, at *19.
90 Id.91 Reis, 28 A.3d at 467.
92 Id. at 466.
93 Sterling v. Mayflower Hotel Corp., 93 A.2d 107, 114 (Del. 1952); accord
Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 956–57 (Del. 1985) (quoting
Sterling and describing the substantial equivalence test); Rosenblatt v. Getty Oil Co.,
71
Ultimately, fairness is not a technical concept. “No litmus paper can be found
or [G]eiger-counter invented that will make determinations of fairness objective.”94 A
judgment concerning fairness “will inevitably constitute a judicial judgment that in
some respects is reflective of subjective reactions to the facts of a case.”95
A. Whether The Merger Was Entirely Fair
The Jacobs Group primarily challenges the Merger as a breach of fiduciary
duty. The defendants proved that the Merger was entirely fair.
1. Fair Price
In this case, the common stockholders received no consideration in the Merger.
Notwithstanding that stark result, the Merger provided the common stockholders
with a fair price. Before the Merger, the common stockholders were so far underwater
in the capital stack that they had no prospect of receiving value from the Company.
The Merger provided the stockholders with the substantial equivalent of what they
had before.
Evaluating whether the minority stockholders received the substantial
equivalent of what they had before requires accounting for the fact that the KV Fund
already controlled the Company. Unlike in an appraisal proceeding, where the going-
493 A.2d 929, 940 (Del. 1985) (quoting Sterling and applying the substantial
equivalence test); Trados, 73 A.3d at 76 (same); Reis, 28 A.3d at 462 (same).
94 Kahn v. Tremont Corp. (Tremont I), 1996 WL 145452, at *8 (Del. Ch. Mar.
21, 1996) (Allen, C.), rev’d on other grounds, 694 A.2d 422 (Del. 1997).
95 Technicolor Appraisal III, 663 A.2d at 1140.
72
concern standard looks to the value of the corporation without considering issues of
control,96 a claim for breach of fiduciary duty that challenges the fairness of a squeeze-
out transaction must account for the implications of control.
The Mendel v. Carroll97 case is instructive. There, the Carroll family controlled
Katy Industries, Inc. (“Katy”). The family proposed to acquire all of Katy’s
unaffiliated shares for $22 each and informed the board that the family was only
interested in buying, not selling. The board appointed a special committee, which
negotiated with the family and reached agreement on a squeeze-out merger in which
the minority stockholders would receive $25.75 per share.
At that point, a third party named Pensler proposed to purchase all of Katy’s
outstanding shares for at least $27.80 per share. In the face of the higher Pensler
offer, the special committee withdrew its support for the Carroll family’s merger and
negotiated with Pensler. To circumvent the Carroll family’s refusal to sell, Pensler
asked for an option to purchase a sufficient number of Katy shares at the transaction
price to dilute the Carroll family’s ownership to approximately forty percent. Not
surprisingly, the Carroll family objected and asserted that issuing the dilutive option
would constitute a breach of fiduciary duty. The special committee was willing to
issue the option, but only if the committee’s Delaware counsel could opine that the
issuance was legal. When Delaware counsel declined to render the opinion, the
96 E.g., Cavalier Oil, 564 A.2d at 1144.
97 651 A.3d 297 (Del. Ch. 1994).
73
Pensler deal fell apart.
A stockholder plaintiff filed suit and sought a mandatory injunction requiring
the Katy board to issue the option. Citing Revlon, the plaintiff argued that the board
breached its fiduciary duties by not issuing the option because the third-party deal
constituted the best transaction reasonably available.
Chancellor Allen declined to issue the injunction. He first held that Revlon did
not apply, but he agreed that the “obligation the board faces is rather similar to the
obligation that the board assumes when it bears what have been called ‘Revlon
duties.’” Id. at 306. That was because
if the board were to approve a proposed cash-out merger, it would have
to bear in mind that the transaction is a final-stage transaction for the
public shareholders. Thus, the time frame for analysis, insofar as those
shareholders are concerned, is immediate value maximization. The
directors are obliged in such a situation to try, within their fiduciary
obligation, to maximize the current value of the minority shares.98
For Chancellor Allen, the critical legal issue was whether the directors’ authority
included the ability to facilitate a third-party transaction by diluting a control block.
On that issue, Chancellor Allen agreed that a board could dilute a majority
holder. As he had in three prior decisions, Chancellor Allen explained that incumbent
directors could not dilute an existing block holder for the purpose of preserving their
own positions, but they could permissibly dilute a dominant block if they acted “in
good faith and on the reasonable belief that a controlling shareholder is abusing its
98 Id. (emphasis in original).
74
power and is exploiting or threatening to exploit the vulnerability of minority
shareholders.”99 Under this framework, if the Carroll family’s refusal to sell their
shares could be deemed an abuse of power or exploitive of the minority, then the board
could have authorized the dilutive option. By the same token, a court would have the
ability to issue mandatory injunctive relief on an appropriate factual record.
On the facts, however, Chancellor Allen concluded that the Carroll family’s
proposal and their refusal to support the Pensler offer did not present the type of
“threat of exploitation or even unfairness towards a vulnerable minority that might
arguably justify discrimination against a controlling block.”100 He began by
explaining why the two offers were not directly comparable, such that the Carroll
family’s refusal to support Pensler’s numerically higher offer could not by itself give
rise to an inference of exploitation or unfairness:
Plaintiffs see in the Carroll Group’s unwillingness to sell at $27.80 or to
buy at that price, a denial of plaintiffs’ ability to realize such a price, and
see this as exploitation or breach of duty. This view implicitly regards
the $27.80 per share price and the Carroll Family Merger price of $25.75
as comparable sorts of things. But they are legally and financially quite
different. It is, for example, quite possible that the Carroll $25.75 price
may have been fair, even generous, while the $27.80 Pensler price may be
99 Id. at 304. The earlier cases in which Chancellor Allen had expressed similar
views were Blasius Indus. Inc. v. Atlas Corp., 564 A.2d 651, 662 n.5 (Del. Ch. 1988),
Freedman v. Rest. Assocs. Indus., Inc., 1987 WL 14323, at *8 (Del. Ch. Oct. 16, 1987),
and Philips v. Insituform of N. Am., Inc., 1987 WL 16285, at *8 (Del. Ch. Aug. 27,
1987). Chancellor Allen drew support for the underlying premise that a board could
deploy corporate power to address a threat posed by an existing stockholder from
Unocal, 493 A.2d 946.
100 Mendel, 651 A.2d at 304.
75
inadequate. If one understands why this is so, one will understand one
reason why the injunction now sought cannot be granted.
The fundamental difference between these two possible transactions
arises from the fact that the Carroll Family already in fact had a
committed block of controlling stock. Financial markets in widely traded
corporate stock accord a premium to a block of stock that can assure
corporate control. Analysts differ as to the source of any such premium
but not on its existence. Optimists see the control premium as a
reflection of the efficiency enhancing changes that the buyer of control
is planning on making to the organization. Others tend to see it, at least
sometimes, as the price that a prospective wrongdoer is willing to pay in
order to put himself in the position to exploit vulnerable others, or
simply as a function of a downward sloping demand curve
demonstrating investors’ heterogeneous beliefs about the subject stock’s
value. In all events, it is widely understood that buyers of corporate
control will be required to pay a premium above the market price for the
company’s traded securities.
The law has acknowledged, albeit in a guarded and complex way, the
legitimacy of the acceptance by controlling shareholders of a control
premium.
The significant fact is that in the Carroll Family Merger, the buyers
were not buying corporate control. With either 48% or 52% of the
outstanding stock they already had it. Therefore, in evaluating the
fairness of the Carroll proposal, the Special Committee and its financial
advisors were in a distinctly different position than would be a seller in
a transaction in which corporate control was to pass.
The Pensler offer, of course, was fundamentally different. It was an
offer, in effect, to the controlling shareholder to purchase corporate
control, and to all public shareholders, to purchase the remaining part
of the company’s shares, all at a single price. It distributed the control
premium evenly over all shares. Because the Pensler proposed $27.80
price was a price that contemplated not simply the purchase of non-
controlling stock, as did the Carroll Family Merger, but complete control
over the corporation, it was not fairly comparable to the per-share price
proposed by the Carroll Group.101
101 Id. at 304–05 (citations and footnotes omitted).
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The fact that the Pensler offer was nominally higher than the Carroll Family offer
thus did not, by itself, support a claim for relief.
But the difference between the offers also did not end the analysis. As
Chancellor Allen explained, “[t]o note that these proposals are fundamentally
different does not, of course, mean that the board owes fiduciary duties in one
instance but not in the other.”102 Instead, the directors were “obligated to take note
of the circumstance that the proposal was being advanced by a group of shareholders
that constituted approximately 50% of all share ownership.” 103 In that circumstance,
“the board’s duty was to respect the rights of the Carroll Family, while assuring that
if any transaction of the type proposed was to be accomplished, it would be
accomplished only on terms that were fair to the public shareholders and represented
the best available terms from their point of view.”104 The rights of the Carroll family
included the right not to sell their shares.105
102 Id. at 305.
103 Id. at 305–06.
104 Id.
105 Mendel, 651 A.2d at 306 (“No part of their fiduciary duty as controlling
shareholders requires them to sell their interest.”); accord Bershad v. Curtis-Wright
Corp., 535 A.2d 840, 844–45 (Del. 1987); In re MFW S’holders Litig., 67 A.3d 496,
508; see Jedwab v. MGM Grand Hotels, Inc., 509 A.2d 584, 598 (Del. Ch. 1986) (Allen,
C.) (“While the law requires that corporate fiduciaries observe high standards of
fidelity and, when self-dealing is involved, places upon them the burden of
demonstrating the intrinsic fairness of transactions they authorize, the law does not
require more than fairness. Specifically, it does not, absent a showing of culpability,
require that directors or controlling shareholders sacrifice their own financial
interest in the enterprise for the sake of the corporation or its minority
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The board’s fiduciary obligation to the corporation and its shareholders,
in this setting, requires it to be a protective guardian of the rightful
interest of the public shareholders. But while that obligation may
authorize the board to take extraordinary steps to protect the minority
from plain overreaching, it does not authorize the board to deploy
corporate power against the majority stockholders, in the absence of a
threatened serious breach of fiduciary duty by the controlling stock.106
Chancellor Allen found no indication that the Carroll family’s proposal of $25.75 per
share was an inadequate or unfair price for the non-controlling stock, nor could he
infer that the Carroll family had abused its control by proposing the transaction or
refusing to sell.
I applied Mendel’s teachings in the Books-A-Million case.107 There, the
Anderson family controlled Books-A-Million, Inc. and effectuated a squeeze-out
merger in which the minority stockholders received $3.25 per share. The Anderson
family had announced it was only a buyer, not a seller, and conditioned the
transaction on the twin MFW protections.108 The plaintiffs argued that MFW did not
apply because the special committee had acted in bad faith by not seeking to sell
shareholders.”); see also In re Trans World Airlines, Inc. S’holders Litig., 1988 WL
111271 (Del. Ch. Oct. 21, 1988) (“[A] controlling shareholder who bears fiduciary
obligations . . . also has rights that may not be ignored . . . . includ[ing] a right to
effectuate a [squeeze-out] so long as the terms are intrinsically fair . . . . to the
minority considering all relevant circumstances.”), abrogated on other grounds by
Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110 (Del. 1994).
106 Mendel, 651 A.2d at 306.
107 In re Books-A-Million, Inc. S’holders Litig., 2016 WL 5874974 (Del. Ch. Oct.
10, 2016), aff’d, 164 A.3d 56 (Del. 2017) (ORDER).
108 Id. at *3.
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Books-A-Million to a third party, noting that one year earlier, a third party had
offered to buy all of the company’s outstanding shares for $4.15 per share.109
Guided by Mendel, I rejected that argument as a matter of law and dismissed
the complaint, holding that the Anderson Family did not breach its duties by refusing
to sell its shares to third party, then subsequently proposing a going-private
transaction at a substantial premium to the market price that nevertheless was less
than what a third party might pay for the firm as a whole.110 The plaintiffs argued
that the court could not assume that the third-party offer incorporated a control
premium, but that argument was contrary to (i) Delaware decisions recognizing that
third-party offers typically include a control premium,111 (ii) Delaware decisions
recognizing that minority shares customarily trade at a discount when a dominant or
controlling stockholder is present,112 and (iii) scholars who have documented those
109 Id.
110 Id. at *16.
111 See, e.g., Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34, 43
(Del. 1994) (“The acquisition of majority status and the consequent privilege of
exerting the powers of majority ownership come at a price. That price is usually a
control premium which recognizes not only the value of a control block of shares, but
also compensates the minority stockholders for their resulting loss of voting power.”);
Cheff v. Mathes, 199 A.2d 548, 555 (Del. 1964) (“[I]t is elementary that a holder of a
substantial number of shares would expect to receive the control premium as part of
his selling price . . . .”); In re Marriott Hotel Props. II Ltd. P’ship Unitholders Litig.,
1996 WL 342040, at *5 (Del. Ch. June 12, 1996) (“[T]he right to direct the
management of the firm’s assets . . . gives rise to the phenomena of control premia.”).
112 See, e.g., ONTI, Inc. v. Integra Bank, 751 A.2d 904, 912 (Del. Ch. 1999)
(“[B]ecause the market ascribed a control premium to the privately-held majority
ownership, it similarly ascribed a minority share discount to the publicly-traded
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propositions113 and noted that the premiums and discounts vary across legal systems
shares . . . .”); Robotti & Co., LLC v. Gulfport Energy Corp., 2007 WL 2019796, at *2
(Del. Ch. July 3, 2007) (“References to trading price may not be especially useful . . .
in this instance, because the trading . . . was limited and [the company] had a control
shareholder.”); Andaloro v. PFPC Worldwide, Inc., 2005 WL 2045640, at *8 (Del. Ch.
Aug. 19, 2005) (pointing out that in the appraisal context, “the fair value standard
itself is, in many respects, a pro-petitioner standard that takes into account that
many transactions giving rise to appraisal involve mergers effected by controlling
stockholders. The elimination of minority discounts, for example, represents a
deviation from the fair market value of minority shares as a real world matter in
order to give the minority a pro rata share of the entire firm’s value—their
proportionate share of the company valued as a going concern.”); Klang v. Smith’s
Food & Drug Ctrs., Inc., 1997 WL 257463, at *11 (Del. Ch. May 13, 1997) (recognizing
that “factors that tend to minimize or discount [a] premium [include] the fact that the
. . . stock price contain[s] a minority trading discount as a result of [a party’s] control”
of a company); MacLane Gas Co. Ltd., P’ship v. Enserch Corp., 1992 WL 368614, at
*9 (Del. Ch. Dec. 11, 1992) (finding that the “the stock market price . . . was not a
reliable indication of the value of the [shares of the company at issue because] . . . the
trading price contained an implicit minority discount as a result of [the defendant’s]
control over [the company].”); see also Goemaat v. Goemaat, 1993 WL 339306, at *6
(Del. Fam. May 19, 1993) (applying a minority discount to wife’s 11% ownership in a
private family business in a divorce proceeding because wife’s sister controlled and
owned 60% of the business).
113 Compare John C. Coates IV, “Fair Value” As an Avoidable Rule of Corporate
Law: Minority Discounts in Conflict Transactions, 147 U. Pa. L. Rev. 1251, 1273–74
(1999) (“Whether measured against very small blocks that trade on the public stock
markets daily or against larger but noncontrol share blocks, control shares command
premium prices.”), with James H. Eggart, Replacing the Sword with A Scalpel: The
Case for A Bright-Line Rule Disallowing the Application of Lack of Marketability
Discounts in Shareholder Oppression Cases, 44 Ariz. L. Rev. 213, 220 (2002) (“A
minority discount accounts for the fact that a minority interest, because it lacks the
power to dictate corporate management and policies, is worth less to third-party
purchasers than a controlling interest.”). See also Matthew D. Cain, Jill E. Fisch,
Sean J. Griffith & Steven Davidoff Solomon, How Corporate Governance is Made:
The Case of the Golden Leash, 164 U. Pa. L. Rev. 649, 657 (2016) (“[P]ublicly traded
shares of firms with a controlling shareholder trade at a so-called ‘minority discount.’
Because minority shares in a controlled corporation lack the ability to influence the
management of the firm, they trade at a discount relative to other shares.”) (footnotes
omitted); Ronald J. Gilson & Jeffrey N. Gordon, Controlling Controlling
Shareholders, 152 U. Pa. L. Rev. 785, 787 (2003) (“[T]he controlling shareholder
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depending on the extent of the protections that a particular legal system provides to
minority stockholders.114 I explained that while it was not possible to infer the exact
amount of the premium or discount because the third party’s higher offer potentially
included synergies, a comparison between that offer and the Anderson family offer
implied a control premium (or concomitant discount) of approximately 30%—within
a rational range of discounts and premiums.115 The price difference was therefore not
secures value from its control position that is not received by the non-controlling
shareholders. In turn, the controlling shareholder can extract the same value from
control by selling it at a premium to the value of the non-controlling shares.”).
114 See, e.g., Alexander Dyck & Luigi Zingales, Control Premiums and the
Effectiveness of Corporate Governance Systems, 16 J. Applied Corp. Fin. 51 (2004);
Alexander Dyck & Luigi Zingales, Private Benefits of Control: An International
Comparison, 59 J. Fin. 537 (2004); Rafael La Porta, Florencio Lopez-de-Silanes,
Andrei Shleifer, Robert Vishny, Investor Protection and Corporate Governance, 58 J.
Fin. Econ. 3 (2000); Luigi Zingales, The Value of the Voting Right: A Study of the
Milan Stock Exchange Experience, 7 Rev. Fin. Stud. 125 (1994); Michael J. Barclay
& Clifford G. Holderness, Private Benefits from Control of Public Corporations, 25 J.
Fin. Econ. 371 (1989). Other factors can affect control premiums, including “an
independent and widely circulating press, high rates of tax compliance, and a high
degree of product market competition.” Dyck & Zingales, Control Premiums, supra,
at 53.
115 See, e.g., Wilmington Sav. Fund Soc’y, FSB v. Foresight Energy LLC, 2015
WL 7889552, at *9 n.3 (Del. Ch. Dec. 4, 2015) (“[A] number of studies have found that
control premia in mergers and acquisitions typically range between 30 and 50%.”)
(first citing FactSet Mergerstat, Control Premium Study 1st Quarter 2012, at 2 (2012);
then citing Jens Kengelbach & Alexander Roos, The Boston Consulting Group, Riding
the Next Wave in M & A: Where Are the Opportunities to Create Value? 10 (2011));
In re S. Peru Copper Corp. S’holder Deriv. Litig., 52 A.3d 761, 819 (Del. Ch. 2011)
(applying a “conservative” control premium of 23.4%, which was the “median
premium for merger transactions in 2004 calculated by Mergerstat . . . .”), aff’d sub
nom. Americas Mining Corp. v. Theriault, 51 A.3d 1213 (Del. 2012); Prescott Gp.
Small Cap, L.P. v. Coleman Co., Inc., 2004 WL 2059515, at *4, *13 n.77 (Del. Ch.
Sept. 8, 2004) (accepting as “consistent with Delaware law” a control premium
valuation range of “30 to 40 percent”); Agranoff v. Miller, 791 A.2d 880, 900 (Del. Ch.
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so facially large as to suggest that the special committee was acting in bad faith by
attempting to facilitate a sweetheart deal for the Anderson family.116
For purposes of this case, the fair price dimension of the entire fairness test
must account for the reality of the KV Fund’s control. That control meant that the
KV Fund could veto any transaction that did not first satisfy the $6 million due on
the KV Notes, then pay the $6 million repayment premium due on the KV Notes, and
then attribute value to the Preferred Stock’s liquidation preference of $32 million.
Even setting aside the $6 million repayment premium, the common stockholders
could not receive any value in a transaction priced below $40 million.
2001) (applying a 30% discount to a comparable companies analysis to adjust for an
implicit minority discount, noting that the discount in the relevant market sector
“tended to be lower on average than that for the entire marketplace”) (Strine, V.C.);
Kleinwort Benson Ltd. v. Silgan Corp., 1995 WL 376911, at *4 (Del. Ch. June 15,
1995) (citing available premium data ranging from 34%–48%); see also Coates, supra,
at 1274 n.72 (citing data for the period from 1981 through 1994, indicating that
“prices paid in acquisitions by negotiated purchase or tender offer of control shares
in public companies exceeded the market prices for the targets’ outstanding stock by
an average of approximately 38%” and that during the same period, “average prices
paid in the same types of acquisitions of large (>10%) but noncontrolling blocks of
shares in public companies also exceeded market prices for the targets’ outstanding
stock, but premiums for these noncontrol share blocks averaged only 34.5%”); Gary
Fodor & Edward Mazza, Business Valuation Fundamentals for Planners, 5 J. Fin.
Plan. 170, 177 (1992) (stating that control premiums paid for public companies
averaged 30% to 40% from the late 1960s to the late 1980s); see also Rebecca
Hollander-Bumoff & Matthew T. Bodie, The Market as Negotiation, 96 Notre Dame
L. Rev. 1257, 1312 (2021) (arguing that “the market for corporate control has
significantly high negotiation variance when it comes to the actual assessment of the
corporation’s control premium.”).
116 Books-A-Million, 2016 WL 5874974, at *16.
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This decision has determined that the going concern value of the Company was
$2.4 million. At that valuation, the KV Fund could demand that the entire amount
that any third party paid be allocated to the amounts due on the KV Notes. That
outcome would not change even if a third party might pay a control premium of 100%.
The common stock would not receive any value until the merger consideration
exceeded $40 million, and that type of valuation for the Company is impossible to
credit.
The reality of the KV Fund’s control also demonstrates why the few third-party
bids that the Company received did not offer superior value. eCampus submitted an
indication of interest in acquiring the Company for $6 million, with 50% cash and
50% stock. Invictus proposed $5 million in senior-secured, super-priority debtor-in-
possession financing for an anticipated bankruptcy. Ames Watson proposed $500,000
for a 75% interest in the Company, plus a commitment to fund the Company’s losses
going forward.
The Merger also contemplated a go-shop period during which the KV Fund was
committed contractually to support any offer that would pay off the KV notes.
Parchman Vaughn re-engaged with the four parties who had previously shown the
strongest interest in a transaction: eCampus, Ambassador, Ames Watson, and Red
Shelf. No one made a superior offer. Redshelf’s CEO sent a text message to Kaji
indicating that they would consider a deal in the range of $10 million. Lawrence
Berger, co-founder and Partner at Ames Watson, responded that “[i]f they can get
anything close to [the $12.5 million] they should run to closing.” JX 410.
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The most attractive third-party indication came from Ambassador, which
suggested it might proceed with a transaction with a notional value of between
$5,400,000 and $17,2000,000, depending on the assumptions. The deal structure with
Ambassador that provided the most cash valued the Company at $10.4 million, with
75% paid in cash over a two-year basis and the remaining 25% in Ambassador equity.
That deal thus offered $2 million less than the Merger.
Each of these third-party transactions would have triggered the Preferred
Stock’s liquidation preference. The common stock would have been out of the money
in every one of them. And each of these transactions would have resulted in a change
of control. Therefore, like the Pensler transaction in Mendel and the third-party
inquiry in Books-A-Million, the proposals were not comparable to the Merger. If
anything, a third party would have needed to pay significantly more than the $12.5
million contemplated by the Merger to compensate the KV Fund for giving up control.
No one did.
The common stock thus had no value before the Merger. The common
stockholders received nothing in the Merger, but that was the substantial equivalent
of what they had before. The Merger therefore offered a fair price.
2. Fair Dealing
The entire fairness test also contemplates an inquiry into the procedural
aspects of the transaction or decision under challenge. As discussed previously, a
strong record of fair dealing can bolster the reliability of the price. Conversely, a weak
record on fair dealing can undercut the reliability of the price. Here, the fair price
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evidence is sufficiently strong to carry the day without any inquiry into fair dealing.
Even if the KV Fund had implemented the Merger unilaterally, without any process
whatsoever, the defendants proved that the common stock was so far out of the money
that the Merger was entirely fair.
3. The Unitary Determination of Fairness
Taking the evidence as a whole, the defendants proved the Merger was entirely
fair. The Company did not have a reasonable prospect of generating value for the
common stockholders by operating as a going concern. To the contrary, the Company
could neither fund its own operations and nor raise capital from outside investors.
Over the course of twenty years, the Company had never turned a profit. In light of
this reality, “the directors breached no duty to the common stock by agreeing to a
Merger in which the common stock received nothing. The common stock had no
economic value before the Merger, and the common stockholders received in the
Merger the substantial equivalent in value of what they had before.”117
B. The Challenge To Treating The Merger As A Deemed Liquidation
Event
In a related attack on the Merger, the Jacobs Group contends that the director
defendants breached their fiduciary duties by treating the Merger as a Deemed
Liquidation Event. According to the Jacobs Group, because the Merger was not a
Deemed Liquidation Event, the Company should have distributed the $12.5 million
117 Trados, 73 A.3d at 78.
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in consideration without regard to the Preferred Stock’s liquidation preference. The
Jacobs Group contends that in that scenario, the common stockholders would have
received value.
1. Whether The Merger Constituted A Deemed Liquidation Event
The first question is whether the Merger qualified as Deemed Liquidation
Event. If it did, then the Jacobs Group’s argument fails on its own terms.
The definition of Deemed Liquidation Event appears in the Charter. “A
certificate of incorporation is a contract among the stockholders of the corporation to
which the standard rules of contract interpretation apply.”118 “Contracts are to be
interpreted as written, and effect must be given to their clear and unambiguous
terms.”119
Article 2.1 of the Charter provided as follows:
In the event of any voluntary or involuntary liquidation, dissolution or
winding up of the Corporation (including a Deemed Liquidation Event .
. . the holders of shares of Preferred Stock then outstanding shall be
entitled to be paid, on a pari passu basis, out of the assets of the
Corporation for available for distribution to its stockholders before aby
payment shall be made to the holders of Common Stock by reason of
their ownership thereof . . . .120
The Charter later defines a Deemed Liquidation Event to include a merger or
consolidation in which
118 Shiftan, 57 A.3d at 934.
119 Id. at 934–35 (cleaned up).
120 Charter § 2.1.
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(i) the Corporation is a constituent party or
(ii) a subsidiary of the Corporation is a constituent party and the
Corporation issues shares of its capital stock pursuant to such merger
or consolidation;
except any such merger or consolidation involving the Corporation or a
subsidiary in which the shares of capital stock of the Corporation
outstanding immediately prior to such merger or consolidation continue
to represent, or are converted into or exchanged for shares of capital
stock that represent, immediately following such merger or
consolidation, at least a majority, by voting power, of the capital stock
of (1) the surviving or resulting corporation or (2) if the surviving
corporation is a wholly owned subsidiary of another corporation
immediately following such merger or consolidation, the parent
corporation of such surviving or resulting corporation . . . .121
The definition of a Deemed Liquidation Event thus consists of a two-part
definition with an exception. The definition states in pertinent part that “a merger or
consolidation in which . . . [the Company] is a constituent party” qualifies as Deemed
Liquidation Event. The Company was a party to the Merger, satisfying that
requirement. But the definition continues with an exception for a transaction where
the pre-closing shares of the Company stock “continue to represent, or are converted
into or exchanged for shares of capital stock that represent, immediately following
such merger . . ., at least a majority, by voting power, of the capital stock of the (1)
surviving corporation . . . or (2) . . . the parent corporation of such surviving or
resulting corporation” (the “Exception”).
121 Id. § 2.3.1(a).
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The KV Fund structured the Merger as a reverse triangular merger that falls
within the Exception. “In a reverse triangular merger . . . the acquirer creates a
subsidiary that merges into the target. The merger subsidiary (and its stock)
disappear while the target (and its stock) survive as a subsidiary of the acquirer.”122
Through the Merger, the KV Fund’s pre-Merger majority ownership stake in the
Company became a 100% post-Merger ownership stake. Consequently, the pre-
closing shares of the Company continue to represent at least a majority, by voting
power, of the capital stock of the surviving corporation.
The defendants argue that the Exception turns on what happens to the stock,
not who owns the stock. They point to the phrase “the shares of capital stock of the
Corporation outstanding immediately prior to such merger” and argue that those
shares must “continue to represent” or be “converted into or exchanged for” shares
constituting a majority stake in the surviving entity. The defendants then argue that
all of the pre-closing stock in the Company converted into the right to receive the
Merger consideration. The Merger thus cancelled the KV Fund’s shares rather than
converting or exchanging those shares for stock in the post-Merger entity. Because of
that distinction, the defendants say the Exception does not apply.
The defendants’ interpretation is overly technical to the point of non-sensical.
Read as a whole, the Deemed Liquidation Provision has an obvious purpose: generally
122 W. Standard, LLC v. Sourcehov Hldgs., Inc. (Western Standard), 2019 WL
3322406, at *6 (Del. Ch. July 24, 2019).
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trigger the liquidation preference for purposes of a merger, but not when the merger
does not constitute a change of control. In place of that understandable and common
sense trigger, the defendants’ reading would substitute a manipulable and technical
test. Under the defendants’ reading, even a third-party acquisition would not trigger
the Deemed Liquidation Preference if the merger agreement called for the Company’s
pre-transaction shares of stock to be cancelled or converted into cash.
The Merger therefore falls within the Exception. The Merger did not
automatically trigger the liquidation preference as a Deemed Liquidation Event.
2. Did Treating The Merger As A Deemed Liquidation Event
Constitute A Breach of Fiduciary Duty?
The Jacobs Group argues that because the Merger was not a Deemed
Liquidation Event, the KV Fund and the Company’s directors could not agree to
allocate merger consideration to the Preferred Stock’s liquidation preference. The
Jacobs Group contends that the directors breached their duty of loyalty by channeling
consideration to the Preferred Stock that it was not contractually entitled to receive.
This is another way of arguing that the Merger was an interested transaction
such that the defendants had to prove that its terms were entirely fair. This decision
has already held that the terms of the Merger were fair. Because of the voting rights
associated with the Preferred Stock, the KV Fund could ensure that no value flowed
to the common stock as a going concern or in any transaction unless the consideration
first went to returning the KV Fund’s capital by paying off the KV Notes and
satisfying the liquidation preference. The common stock therefore was not entitled to
any value from the Company unless and until those prior claims were satisfied.
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That was never going to happen. The Company had not generated a profit in
twenty years and was headed towards another operating shortfall. Without an
additional capital infusion, the Company’s next stop was insolvency. The common
stock would not receive anything in an insolvency proceeding. The defendants proved
it was entirely fair for the common stock to receive nothing in the Merger.
3. The Challenge To The KV Notes
In addition to challenging the fairness of the Merger, the Jacobs Group
contends that the defendant directors breached their fiduciary duties when agreeing
to the KV Notes. The Jacobs Group only devoted two pages of their extensive post-
trial briefing to this argument. While it is tempting to treat those challenges as
waived, this decision will address the issue.
Purporting to quote Eastburn, the Jacobs Group argues that the KV Fund used
the KV Notes to “crush the common.” Jacobs Tr. 142. At the pleading stage, the court
drew the plaintiff-friendly inference that the KV Fund used the KV Notes—and
particularly the repayment premium—to shift value away from the common
stockholders. At trial, the defendants proved that the KV Notes were necessary and
that on the facts of this case, the repayment premiums were warranted. The
defendants thus proved that the KV Notes were entirely fair.
For starters, there is no dispute that when the Board agreed to the KV Notes,
the Company needed the capital and had no alternative sources of financing. Either
the Company would obtain capital from the KV Fund, or it would become insolvent.
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The Company’s desperate straits, however, did not give the KV Fund the right
to impose unfair terms. To the contrary, as the Company’s stockholder controller, the
KV Fund had to prove that the terms of the KV Notes were entirely fair.
The term in the KV Notes that stands out as supporting an inference of
unfairness is the 2x repayment premium. At trial, however, Eastburn testified
credibly that, in his experience, the 2x repayment premium was a market term given
the Company’s distressed status. Eastburn Tr. 310–11. The Jacobs Group offered no
contrary evidence, leaving Eastburn’s testimony unrebutted.
The terms of the 2018 Note provide additional evidence of fairness. Jacobs
voted in favor of the 2018 Note. Jacobs Tr. 128–29. The subsequent notes largely
reflected the same terms. The fact that the most skeptical member of the Board and
the leader of the plaintiff group voted in favor of a tranche of financing that included
the challenged terms undercuts the plaintiffs’ position.
The contemporaneous record of the Board’s deliberations provides still more
evidence of fairness. During a Board meeting on March 26, 2019, Jacobs questioned
the process that led to the 2019 Note. In response, management explained that they
had contacted thirteen potential sources of funding during a six-week period and only
received proposals from Concise Capital and Avidbank, the Company’s existing
lender. Neither proposal was actionable. The Concise Capital proposal required
Avidbank to subordinate its loans, which Avidbank would not do. The Avidbank
proposal required that the KV Fund place cash collateral in escrow, which the KV
Fund would not do. The Company’s inability to secure funding from other sources on
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the strength of its own balance sheet and financial performance suggests that the
terms of the 2019 Note were fair.
A similar series of events led to the 2020 Note. The Company was projecting a
cash shortage of $2 million in April 2020 and hoped to fund that gap with new outside
capital. Parchman Vaughn sought out capital, but no one was willing to provide it.
When that effort failed, the Company turned to the KV Fund and agreed to the 2020
Note.
The evidence at trial also disproved the plaintiffs’ claim that the KV Fund
affirmatively sought to “crush the common.” The KV Fund wanted the Company to
succeed and would have happily supported an outside investment. The KV Fund
provided bridge financing through the KV Notes because the Company had no other
alternatives. Although the court credits that Eastburn said the additional financing
would crush the common, that was simply the reality of the preferences that new
money would demand.
On the facts of this case, therefore, the defendants proved that the 2x
repayment premium was entirely fair. On a different record, or with the benefit of
expert testimony, a court could reach a different conclusion. But not in this case.
C. Aiding And Abetting
The plaintiffs sought to prove that the KV Fund aided and abetted breaches of
fiduciary duty by the director defendants. Because the director defendants did not
breach their fiduciary duties, the aiding and abetting claim fails.
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IV. CONCLUSION
The KV Fund proved that the fair value of the common stock for purposes of
appraisal was zero. The defendants proved that the Merger and the KV Notes were
entirely fair and that the KV Fund did not aid and abet any breaches of fiduciary
duty.
The parties will submit a form of order designed to bring this case to a close at
the trial court level. If there are additional issues the court must address, the parties
will submit a joint letter identifying those issues and proposing a path for resolving
them.
93