William Prickett, of Wilmington, and Wm. Dwight Whitney (of Cravath, Swaine & Moore), of New York City, for appellants.
Charles F. Richards (of Richards, Layton & Finger), of Wilmington, and George Rosier and Zelig R. Nathanson (of Austrian & Lance), all of New York City, for appellees.
TERRY, CAREY, LAYTON and WOLCOTT, JJ., sitting.
WOLCOTT, Judge, delivering the opinion of the Court:
Section 61 of the General Corporation Law Code 1935, § 2093, provides that upon the merger of a corporation, stockholders who object to the merger and who fulfill the statutory requirements to register their objection shall be paid the value of their stock on the date of the merger, exclusive of any element of value arising from the expectation or accomplishment of the merger. The meaning of the word 'value' under this section of the Corporation Law has never been considered by this court. However, the Court of Chancery has, on several occasions, applied a definition of value under the section. This definition was first formulated in Chicago Corporation v. Munds, 20 Del.Ch. [31 Del.Ch. 526] 142, 172 A. 452, and was followed in Root v. York Corporation, Del.Ch., 50 A.2d 52 and In re General Realty & Utilities Corporation, Del.Ch., 52 A.2d 6. We think the basic doctrine of valuation applied in Chicago Corporation v. Munds, supra, was formulated in accordance with proper principles and the better reasoned authorities.
The basic concept of value under the appraisal statute is that the stockholder is entitled to be paid for that which has been taken from him, viz., his proportionate interest in a going concern. By value of the stockholder's proportionate interest in the corporate enterprise is meant the true or intrinsic value of his stock which has been taken by the merger. In determining what figure represents this true or intrinsic value, the appraiser and the courts must take into consideration all factors and elements which reasonably might enter into the fixing of value. Thus, market value, asset value, dividends, earning prospects, the nature of the enterprise and any other facts which were known or which could be ascertained as of the date of 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 by the agency fixing the value.
The rule as stated requires that certain obvious conclusions be drawn. Thus, since intrinsic or true value is to be ascertained, the problem will not be settled by the acceptance as the sole measure of only one element entering into value without considering other elements. For example, as was specifically held in Chicago Corporation v. Munds, supra, market value may not be taken as the sole measure of the value of the stock. So, also, since value is to be fixed on a going-concern basis, the liquidating value of the stock may not be accepted as the sole measure.
General was a regulated closed-end investment company with leverage, and was engaged in the business of investing in the stock market generally seeking to acquire [31 Del.Ch. 527] and hold a cross-section of the stock market. Investments were made by General primarily with the possibility of capital appreciation in view. General's portfolio held diversified investments, practically all of which fell within the class of marketable securities readily liquidated.
A regulated close-end investment company is of a peculiar nature. The common stockholder of a closed-end company has no right at any time to demand of the company
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On September 30, 1948, the day preceding the merger, General had outstanding debentures and preferred stock equaling in value 60.8% of the total assets of the company, leaving 39.2% of the company's assets applicable to the common stock. This condition of General made applicable the principle of leverage. Simply stated, this meant that since the debentures and preferred stock of General were a fixed liability, the same amount of assets at all times was required to be set off against them. The result of this unalterable fact was that if the stock market declined, thus decreasing the value of the assets of General, all of the decrease fell upon the common stock. On the other hand, when the stock market rose, thus increasing the value of General's assets, all of the increase accrued to the benefit of the common stock.
[31 Del.Ch. 528] Experience demonstrates that when the stock market declines, the market price of the common stock of closed-end investment companies with leverage declines at a more rapid rate because of the resulting shrinkage of asset value behind the common stock. Conversely, a rise in the stock market results in a rise in the market price of the common stock of such companies at a more rapid rate than the market is increasing generally.
The closed-end feature and leverage have a direct effect on the market value of the common stock of closed-end investment companies. When the market price of the common stock moves into a certain price range in relation to its net asset value, upward leverage disappears and the stock sells on the market at a lower price than its net asset figure. This fact, together with the inability of the common stockholder to withdraw his proportionate interest in the assets of the company, has consistently resulted in a lower market value of the common stock in comparison with its net asset value. This difference between the net asset value and the market value of the common stock of a closed-end investment company is known as discount.
The record discloses that the common stock of General, prior to the merger, was selling within the price range which brought discount into play. The appraiser found the discount rate applicable to General to be 25%. This rate of discount is accepted for the purposes of this case since the parties do not argue that this finding was error.
Discount, therefore, may be applied to net asset value to determine on any day a theoretical or constructed market value of the common stock of a closed-end investment company with leverage. On September 30, 1948, the net asset value of the common stock of General was $4.90 per share and, if the discount of 25% is applied to that figure, a market value of General's common stock on that day of $3.67 per share is constructed.
The appraiser considered various factors which all [31 Del.Ch. 529] agree should be considered in valuing the common stock of General. Those factors were: The nature of the enterprise, i. e., a regulated closed-end investment company; leverage; discount; net asset value; market value; management; earnings and dividends; expenses of operation; particular stockholdings in General's portfolio; and a favorable tax situation which General had.
The appraiser found that the factors of management, earnings and dividends, expenses of operation, and the particular stockholdings of General, under the circumstances, were not entitled to be debited or credited in arriving at a value for the common
stock. It is not necessary to review his reasons, for the parties are agreed that his findings in this respect were correct. Since, however, earnings and dividends of a corporation are ordinarily of prime importance in valuing common stock, we feel, in order to avoid future confusion, that we should state briefly why they are not of much importance in this case. The reason is that General was an investment company with large leverage which meant that normal income of the company necessarily went in large part to the servicing of the senior debentures and preferred stock, leaving a relatively small amount left to be paid out in dividends to the common. Actually, dividends on the common stock of General in the past were negligible, nor were the prospects for the future materially brighter.
The favorable tax situation of General was found by the appraiser to be worth 29cents to each share of common stock. This finding is not urged as error. The favorable tax situation resulted from realized losses in 1948 and loss carryovers which would have enabled General to take profits gained before the end of 1948 equal to the realized losses incurred in 1948 and the loss carryover expiring at the end of that year, to the extent of over $1,500,000, without paying a 25% capital gains tax or distributing the proceeds to its stockholders who would then be taxed on them.
[31 Del.Ch. 530] The appraiser found that, at the time of merger and prior thereto, there was no actual market of General's common stock uninfluenced by the merger and, accordingly, excluded actual market value of the stock as a factor to enter into the final determination of value. This was not error, nor would it have been error had the appraiser constructed a hypothetical uninfluenced market value by discounting the net asset value of the common stock on the day of merger and given some effect to it in his final valuation. Had there been an actual market value uninfluenced by the merger in existence, it would have been error to disregard it, but the absence of such an element does not require the construction of a hypothetical market value to be given effect in the final determination of value.
A great deal of argument in this cause has turned around the phrase 'net asset value' which is simply a mathematical figures representing the total value of the assets of General less the prior claims. The net asset value of the common stock of General could be determined as of any date by computing the total market value of the securities in the portfolio, adding to that sum the cash in the company's possession, deducting the total of the outstanding ...