Wednesday, March 26, 2008

Fairness Opinions: Art or Science?

It has been said that valuation of a company is more of an art than a science. This has manifested again in the Bear Stearns transaction that is currently hogging limelight among legal circles. In this case, Lazard issued a fairness opinion when JP Morgan’s transaction with Bear Stearns was first announced that a stock consideration of $2 per share was fair to Bear’s shareholders. Now, under the revised deal announced earlier this week, Lazard again provided a fairness opinion that the new consideration of $10 per share is also fair. The question that is being asked is how $2 per share could have been fair when $10 per share is also fair. For details of the views opposing and defending Lazard’s position, see DealLawyers.com Blog and The Harvard Law School Corporate Governance Blog.

Fairness opinions are not altogether alien to Indian corporate law. Though not statutorily required, it has become a matter of practice for courts to examine valuation reports (customarily issued by chartered accountants) that determine the valuation of companies involved in a merger transaction or other schemes of arrangement, before they grant their seal of approval to such transactions. Even shareholders (or other interested parties) that oppose mergers and similar transactions usually use the valuation as their main prong of attack while challenging such transactions, which requires courts to determine the fairness of the valuation to shareholders of the companies involved.

Fortunately, courts are reluctant to disturb valuation on the merits so long as they have been arrived at by qualified, competent and independent professionals who are well-versed in valuation matters. Courts would however, look into the credibility of the process by which valuation was undertaken – for instance whether the valuer did a proper job, which is justifiable on the face of the report, and whether it is a detailed report with necessary reasons and explanations for arriving at the conclusion. The jurisprudence on this count has been fairly well developed, especially in the Hindustan Lever and Miheer Mafatlal cases decided by the Supreme Court.

Since the court’s oversight on valuation is limited, problems as to differences in valuation are bound to arise even in Indian circumstances, and they have in fact done so in several instances in the past. While one valuer can arrive at a particular figure, another valuer may arrive at a completely different figure, although both are based on the same set of financial figures relating to the companies. It seems almost impossible to obliterate the element of subjectivity in valuation.

However, efforts have been taken to minimise the uncertainty involved by introducing better practices on valuation. For instance, in January 2003, an Expert Group under the chairmanship of Mr. Shardul Shroff had submitted a report suggesting a framework for valuation of companies, and to make the process more transparent. As far as I am aware, the recommendations are yet to be implemented. Fairness opinions and valuations therefore continue to be matters of practice to be regarded by courts while sanctioning schemes of arrangement.

1 comment:

Anonymous said...

TRUE FAIRNESS OPINIONS VARY ACROSS THE SPECTRUM THE LAW HAS DONE THE BEST BY TRYIN NOT TO SECONDGUESS THE EXPERTS...

METHINKS CORPORATE LAW CAN BORROW FROM MEDICAL LAW WHERE THERE IS THIS CONCEPT OF "FRIE HEARINGS" IN A NUTSHELL IF A REASONABLE NUMBER OF PEOPLE IN THE FRATERNITY BELIEVED THAT A PARTICULAR TREATMENT WAS A WAY TO GO, THEN THE LAW DEFERS TO IT.
ADPATED TO CORPORATE LAW, IT 'D MEAN THAT A VALUATION IS CHECKED AGAINST A CROSS SECTION OF EXPERT OPINION IN THE FRATERNITY. IN THE INDIAN CONTEXT, IT WOULD MODIFY THE LAW IN MAFATLAL IN THAT COURT UNDER SECTION 391-394 WOULD HAVE AN ENHANCED ROLE TO PLAY THAN IT CURRENTLY DOES.
IN THE BEAR STEARNS CONTEXT, JP MORGAN FINISHED ITS EARLIER DUE DILIGENCE IN RECORSD TIME OF 32 HOURS; PERHAPS THE PRASCTISE ADOPTED IN CDS TRANSACTIONS MIGHT BE HELPFUL IN MORE SANER TIMES( COZ THE PANIC IN THIS CONTEXT WAS SUCH THAT A COOLING PERIOD WAS NOT WARRANTED) CDS TRANSACTIONS TYPICALLY ALLOW A 30 DAY COOLING PERIOD AFTER THE "CREDIT EVENT" OCCURS TO ASSESS THE EXACT AMOUNT ( ASSUMING IT IS CASH SETTLMENT) THAT MOVES FROM THE pROTECTION SEL;LLER TO THE BUYER.