The Only Legal Requirement for Fairness Opinions
California Corporations Code Section 1203
A tender offer is a public, open offer to buy all or a portion of existing shareholders’ stake in a corporation. In 1968, Congress enacted the Williams Act to regulate and define rules of acquisitions and tender offers. Nearly twenty years later, California passed Corporations Code Section 1203 setting forth additional requirements for tender offers made by insiders. As corporate reorganizations became more common in the 1980s, target shareholders, third-party bidders, and legislators started paying more attention to specific abuses on the part of controlling shareholders. Section 1203 was enacted as an effort to provide target shareholders with greater protection in takeovers and to guide directors in performing their fiduciary duties in these situations.
Section 1203 applies to tender offers made by an interested party, including share exchange tender offers (i.e., any acquisition by one corporation in exchange in whole or in part for its equity securities), as well as written proposals for approval of a reorganization subject to Section 1200 or for sale of assets subject to Section 1001(a).
California Corporations Code, in many different sections, defines an “interested party” as a person who is a party to the transaction and who:
- Directly or indirectly controls the subject corporation;
- Is, or is directly or indirectly controlled by, an officer or director of the subject corporation; or
- Is an entity in which a material financial interest is held by any director or executive officer of the subject corporation.
A director’s duty of loyalty requires that they place the corporation and the interests of its shareholders first. In instances where a director wishes to buy out shares from existing shareholders, he or she faces a potential conflict of interest, as both the bidder for those shares but also as a member of the body recommending the acceptance of that bid to the target shareholders. Section 1203 provides an avenue to mitigate that conflict of interest – insiders are less likely to underbid for the target shares if their offer is subject to an outside opinion of fairness.
Fairness Opinion Requirement
Section 1203 requires an affirmative opinion as to the fairness of the consideration offered to the shareholders of the subject corporation in any transaction involving an interested party. A fairness opinion is a letter summarizing an analysis performed by a valuation firm or investment bank that indicates whether the terms of an offer are fair to a specific constituent. In practice, fairness opinions are often accompanied by a supporting report detailing the information utilized and the financial analysis performed in developing the opinion.
Section 1203 states that the opinion must be rendered, in writing, by a party who is not affiliated with the offering party and who regularly performs business and securities valuations for compensation. Section 1203 is an exception in that it requires a fairness opinion; fairness opinions are otherwise not required by law. However, they are commonly used in M&A transactions to assist the board in assessing the fairness of the financial terms of a proposed transaction. Fairness opinions do not constitute a recommendation as to how shareholders should vote and do not address the legal, regulatory, accounting, insurance, tax or other merits of a transaction.
Smaller companies are not subject to the fairness opinion requirement — Section 1203 only applies to corporations with more than 100 shareholders, obviating the need for most closely-held companies. Also, Section 1203 does not apply to transactions in which the issuance of securities is qualified after a fairness hearing.
In addition to the fairness opinion requirement, subsection b of Section 1203 also protects minority shareholders by ensuring that any third-party bids (made at least ten days before a vote on the proposed interested party offer) be shared with the target shareholders. The subsection also provides those shareholders with a reasonable opportunity to withdraw any prior vote, consent, or proxy given to the interested party proposal if the third-party bid is more favorable.
Unlike the standard scope of M&A fairness opinions, the wording of the statute does not explicitly limit the opinion to the fairness of the consideration “from a financial point of view.” However, it is unclear whether, or in what circumstances, a more extensive opinion may be required and what other aspects of fairness such an opinion would address. In addition, while the statute mandates that the opining party must be non-affiliated, it fails to indicate who gets to select the provider of the opinion. If the interested party itself chooses the opinion party, then there could still be the appearance of a potential conflict of interest. That risk may be mitigated if the responsibility of selecting the opining party is assigned to another, disinterested director. Lastly, Section 1203 does not specify what access to the company’s financial and operating information the opining party is entitled, and how the opining party can ensure that the information provided for its analysis is complete and credible and accurately reflects the views of both “sides.”
VRC was one of the first providers of corporate transaction opinions. We have issued over 1,000 fairness, solvency and capital surplus opinions for transactions valued from $10 million to over $10 billion in market capitalization. For a more in-depth conversation and information regarding our opinion practice, we invite you to contact your VRC professional.