InterOil decision: Yukon Court of Appeal offers guidance for determining the fair value of shares
By Jessica Brown, Lindsay Cox and Ben Otto
The most recent decision from the Yukon Court of Appeal (the Court of Appeal), Carlock v ExxonMobil Canada Holdings ULC, 2020 YKCA 4, determining the fair value of the shares held by dissenting shareholders of InterOil Corporation (InterOil) following ExxonMobil Canada Holdings ULC's (ExxonMobil) acquisition of InterOil, provides guidance that Canadian courts will take a negotiated deal price between two arm's length parties in public business combination transactions to be a strong indicator of fair value.
On February 22, 2017, InterOil announced the completion of ExxonMobil's acquisition of all of its common shares (InterOil Shares) by way of plan of arrangement (the Arrangement). Pursuant to the Arrangement, the holders (the Shareholders) of InterOil Shares received US$49.98 per InterOil Share comprised of $45 in shares of ExxonMobil and a contingent resource payment in the amount of $4.48 (together, the Consideration). Upon the completion of the Arrangement, the InterOil Shares were de-listed from the New York Stock Exchange.
Prior to entering into the Arrangement, the parties had previously agreed to a different plan of arrangement on similar terms (the Initial Arrangement). However, the Court of Appeal found that the Supreme Court of Yukon (the Supreme Court) erred in approving the Initial Arrangement and set it aside. The parties took a number of steps to address the governance deficiencies that were identified by the Court of Appeal and entered into the Arrangement.
Although the Arrangement was approved by over 90% of the Shareholders, 0.5% of the Shareholders did not agree that the Consideration reflected the "fair value" of the InterOil Shares and exercised their dissent and appraisal rights under the Yukon Business Corporations Act by applying to have the Supreme Court determine the fair value of the InterOil Shares.
In coming to its decision on fair value, the Supreme Court was of the belief that the Court of Appeal's decision in the Initial Arrangement precluded it from effectively giving any weight to the transaction price in assessing the fair value of the InterOil Shares. Relying primarily on expert testimony and a discounted cash flow (DCF) analysis, the Supreme Court determined that the Consideration did not reflect the fair value of the InterOil Shares and instead appraised them at $71.46 per InterOil Share. ExxonMobil appealed this decision to the Court of Appeal.
ExxonMobil's appeal of the Supreme Court's decision argued that the lower court "fell into a series of errors", particularly that the Supreme Court:
- failed to place proper weight on objective market evidence of fair value;
- misinterpreted the significance of earlier comments made by the Court of Appeal and its reasons for concluding that the Initial Arrangement was not demonstrated to be fair and reasonable; and
- in its decision, "placed undue emphasis on the DCF analysis without properly weighing the effect on value of flawed assumptions underlying the resulting valuation".
The Court of Appeal allowed the appeal by ExxonMobil and set the fair value of the InterOil Shares at $49.98, which reflected the Consideration paid under the Arrangement. The Court of Appeal provided that when there is an open market for shares or other evidence indicative of arm's length conduct, such evidence is generally a reliable indicator of fair value. The Court of Appeal further stated that while a theoretical search for value, such as a DCF analysis, may be beneficial when the parties are not dealing at arms-length or in a situation of market failure, objective market evidence is generally more reliable than theoretical analysis in determining fair value. The Court of Appeal went on to provide that the Supreme Court erred in their reasoning that the setting aside of the Initial Arrangement by the Court of Appeal precluded it from considering the transaction price in assessing the fair value of the Consideration. The Court of Appeal found that the Consideration reflected the fair value as, among other reasons:
- it was a negotiated price in a competitive market consisting of well-informed and sophisticated parties;
- there was no indication that any other process could have led to a higher price
- all potential purchasers of InterOil were fully informed and there was nothing preventing other purchasers from outbidding ExxonMobil;
- the Consideration was at a substantial premium to the pre-deal InterOil Share price;
- the InterOil Shares were widely traded and held by large and sophisticated investors, expert in assessing value, none of whom dissented;
- proxy advisory firms advised Shareholders to vote in favour of the Arrangement;
- the InterOil Shares' value were driven by an asset in the early stages of development, for which the future prospects were highly uncertain; and
- theoretical derivation of value were rife with uncertainty and speculation.
The Court of Appeal stressed the importance that no other potential transactions were available that contemplated an implied share value close to the Consideration. Prior to entering into the Arrangement, InterOil pursued deals with a number of interested parties in the attempts to raise the capital required to finance the development of its primary asset. InterOil had identified all possible counter-parties with the requisite financial ability and expertise to acquire the company. InterOil determined that a public auction would be unlikely to attract any new parties and may result in lower bids. The Court of Appeal's decision indicates that such processes are not necessarily required when using the negotiated transaction price to determine fair value.
The Court of Appeal stated that fair value was further demonstrated when no other potential purchasers, including those who previously expressed interest in acquiring all of the InterOil Shares, chose to outbid ExxonMobil. Considering that InterOil did not receive any bids greater than the Consideration, the Court of Appeal stated that the Supreme Court's appraisal of $71.46 per InterOil Share, resulting in an aggregate purchase price over $1 billion higher than the Consideration, was unreasonable. Further, the fact that ExxonMobil may have been willing to pay more for the InterOil Shares than it did was irrelevant in determining fair value as ExxonMobil was only required to pay the market price.
The Court of Appeal's decision confirms that a transaction price negotiated by sophisticated arm's length parties, particularly in the context of a widely-held publicly-traded company, may be the best indicator of fair value. Additionally, a public auction is not necessarily required to justify the use of the transaction price as fair value when other indicators exist, such as those discussed above.