John Q. Hammons: An Unfair Method of Proving Fairness

In re John Q. Hammons Hotels Inc. Sec. Litig., 2011 Del. Ch. 1 (Del. Ch. Jan. 14, 2011) was the first Chancery Court opinion of the new year.   We are a bit overdue in offering a comment.

The case involved a mostly straight forward application of entire fairness to a transaction between the company and a controlling shareholder.  In effect, the issue in the case was whether the $24 per share price was fair.  The case essentially became a battle of experts, with the company’s expert attesting to the fairness of the price and shareholder’s expert asserting otherwise.

The court sided with management.  The court gave a number of reasons for disregarding the opinion of the expert submitted by shareholders.  One in particular caught our eye.  Apparently the expert made the mistake of relying on estimates provided by management. 

• [Plaintiff’s expert] also relied on management’s projections in performing his DCF analysis.  Generally, management projections made in the ordinary course of business aare considered to e reliable.  In this case, however, testimony at trial established that management’s projections were not created in the ordinary course of business.  [Plaintiff’s expert], nonetheless, performed no independent analysis of the assumptions underlying management’s projections and did nothing to determine whether those projections were prepared by management in the ordinary course of business.  Management projections were, in fact, based on numerous overly optimistic assumptions. 

Rather than impose on management an obligation to provide accurate estimates (after all, management has access to the information), the court shifted the burden to shareholders.

If shareholders do not use management's estimates, their valuation is open to challenge.  Now if they do use estimates provided by management, their valuation is open to challenge.  This approach would have been ripe for a Joseph Heller novel.  Judge Judge anyone?