Date Submitted: March 28, 2014
Richard M. Beck and Sean Brennecke, of Klehr Harrison Harvey Branzburg LLP, Wilmington, Delaware; OF COUNSEL: Joseph J. Shannon, of Bodman PLC, Detroit, Michigan, Attorneys for the Petitioner.
Richard P. Rollo, of Richards, Layton & Finger, P.A., Wilmington, Delaware; OF COUNSEL: John N. Bolus, of Maynard Cooper & Gale, P.C., Birmingham, Alabama, Attorneys for the Respondent.
GLASSCOCK, Vice Chancellor
This case presents a demand for a statutory appraisal,  response to which should be a daunting task for a law-trained judge: the statute in question requires the Court—not either party through assignment of a burden of proof—to determine the fair value of a corporation. Here, the Plaintiff is entitled to the fair value of her interest in Hesco Bastion USA, Inc. ("Hesco, " or the "Company"), which interest was lost when Hesco merged with an affiliate. The task is made more difficult, perhaps, by the facts that the merger was not the result of an auction process, and thus the market provides no guidance; that management produced no projections for the Company in the ordinary course of business; that the Company was about to lose the benefit of a license and patent covering its sole product; and that the sales of that product, in part, are driven by natural disasters, the frequency of which are of dubious predictability. The results of my analysis are below.
A. The Hesco Merger
Hesco Bastion Ltd. ("HBL"), not a party to this action, is a United Kingdom corporation that designs and manufactures "Concertainer units." These rapidly deployable barriers consist of multi-cellular wall systems built from steel wire mesh coated with zinc-aluminum and lined with polypropylene geotextile, which are designed to be filled with sand and rock to create mobile barriers for military, asset, and flood protection. The Concertainer units are stored accordion-style (hence, presumably, the name); once deployed, they operate as giant sandbags. HBL designs and manufactures Concertainer units outside of North America. Prior to her termination in 2011, Petitioner Patricia Laidler acted as Company Secretary, General Manager, and Managing Director of HBL.
In 2003, Hesco Bastion USA, LLC was created for the purpose of licensing intellectual property from HBL in order to manufacture and market Concertainer products to non-military clients in North America. In 2006, Stephanie Victory became head of management at the LLC. On February 24, 2009, Hesco, the corporation that is the subject of this appraisal proceeding, was incorporated in Delaware, and the Hesco Bastion USA, LLC business was merged into Hesco with little change to its ongoing management structure or business. That business included the assembly of Concertainer units at the Company's Hammond, Louisiana facility, but not manufacture of the components—the wire mesh, pins, coils, or geotextile—required to assemble the Concertainer units. At its incorporation, an affiliate of HBL, Respondent Hesco Bastion Environmental, Inc. ("Environmental"), held a majority interest in Hesco.
To reiterate, as of the first day of 2012, the relationships among the various corporate entities were as follows: HBL and Environmental were each wholly-owned by the same party, as described in more detail below; Environmental held a majority interest in Hesco; and HBL licensed to Hesco its intellectual property rights relating to the Concertainer units. The Petitioner was the Managing Director of HBL, and held a minority interest in Hesco.
On January 26, 2012 (the "Merger Date"), Hesco was merged into Respondent Environmental. Before and after the Merger Date, HBL, Hesco, Environmental, and several other entities bearing the Hesco name operated under common control. Prior to September 2010, British entrepreneur and inventor of the Concertainer units, James William Heselden, retained a controlling interest in these entities; in September 2010, Heselden passed away and his interests in the group of entities were held by his estate. In order to value the businesses in which Heselden held an ownership interest, his estate hired Michael Hughes, who in turn commissioned BDO Seidman to evaluate the financial position of the individual entities as well as the Hesco group as a whole. The resulting reports included Project Green, which detailed HBL's business plan to acquire Hesco Military Products, an entity affiliated with the Hesco entities but owned by its director, Leo Clifford; Project Red, which set out HBL's business plan to acquire the minority interests in Hesco; and Project Blue, which collected necessary information for use in the sale of the entire corporate group, once the minority interests in the individual entities were acquired.
In 2011, HBL terminated Laidler's employment due to her alleged involvement in shipping fraud. At that time, pursuant to a shareholder agreement, Laidler retained a contractual right to compel Hesco to repurchase her shares. In preparation for her exercise of that right, Hesco sought an opinion from Willamette Management Association ("Willamette") valuing Laidler's stake in Hesco. On November 18, 2011, Willamette issued its first valuation opinion (the "Fair Market Value Opinion"), opining that the fair market value of Hesco's stock was $180 per share. Laidler chose not to exercise her put right at that time.
In January 2012, Victory, Clifford, and the Petitioner each held 10, 000 shares of Hesco, a respective 10% interest. Shortly thereafter, Victory and Clifford tendered their shares in the Company to Environmental for $207.50 per share; Laidler did not. On January 26, 2012, pursuant to 8 Del. C. § 253, Hesco merged into Environmental. As of the Merger Date, Heselden's estate owned 100% of Environmental, which in turn owned 90% of Hesco, with the Petitioner retaining her 10% interest. Because Environmental held a 90% interest in Hesco, no stockholder vote was required to consummate the short-form merger. The Petitioner—the only remaining minority stockholder of Hesco—was offered $207.50 per share for her interest in the Company. Declining that consideration, on May 23, 2013, the Petitioner filed her Verified Petition for Appraisal, pursuant to 8 Del. C. § 262.
B. Floods and Other Disasters
Operating in the flood barrier industry, Hesco's customers primarily consist of architecture and civil engineering firms as well as governmental organizations providing storm and flood protection. Accordingly, Hesco's revenue is in large part determined by natural disasters and other weather-related events: the bigger the disaster, the more revenue Hesco generates, but revenue in any given year is difficult to predict. As a result of fluctuations in demand for Concertainer units, prior to the Merger, the Company typically retained fifteen permanent employees, who sometimes did not have enough work to keep them occupied; at other times the Company had so much work that it had to hire a significant number of short-term employees. Hesco never generated forward-looking projections,  and the parties dispute whether and to what extent weather-related events would have continued to create demand for the Hesco product had the Company continued as a going concern. At trial, the parties pointed to three events that significantly impacted revenues in 2009, 2010, and 2011.
1. Howard Hanson Dam
In 2009, Hesco's revenues totaled approximately $8.5 million, $1.7 million of which was derived from a single project, the Howard Hanson Dam project. In January of that year, the Green River in Washington state flooded, exposing structural flaws in the Howard Hanson Dam. Though it worked to make repairs, "[t]he United States Army Corps of Engineers warned residents that there could be a one in four chance of a potential flood-level release of water in 2010 and suggested that barriers should be used as an interim precaution . . . ." As a result, several companies with assets to protect, including Boeing,  contracted with Hesco to provide Concertainer units for use as barriers in the event the dam failed. At trial, Hesco's former CEO, Stephanie Victory, explained that providing Concertainer units to Boeing escalated sales from other companies in the area, "just because people figure[d] that Boeing ha[d] done their due diligence."As it turned out, those barriers proved to be unnecessary, since the Army Corps finished repairs to the dam before any leaks caused flooding. Once repairs were made, sales "essentially stopped"—"[t]he opportunity basically ceased as soon as the dam was shored up."
2. BP Oil Spill
In 2010, the Deepwater Horizon oil rig exploded in the Gulf of Mexico in what resulted in one of the largest accidental marine oil spills in history. In that year, Hesco generated $7 million in revenues from experimental attempts to use Concertainer units in the clean-up effort. These included staking the Concertainer units' steel mesh baskets to shorelines and filling those baskets with hydrocarbon capture powder—chemicals designed to solidify oil in order to "capture" the spill—as well as deploying the Concertainer units along shorelines to create barriers in order to prevent the spilled oil from seeping onto the shore. While the latter effort represented a more traditional use for the units,  the former was largely unsuccessful, as the Concertainer units proved poor oil receptacles because it was difficult to secure the Concertainer baskets to the shoreline without weighting them with rocks. Victory explained:
It was a very challenging project because our product is held in place because of the fill material that is inside of it and there wasn't any fill material in it. And it wouldn't rest on the beach appropriately, and the waves would come and it would get knocked over.
So they—the National Guard was assigned by the governor to come in and assist us in getting the units set up, and then they were taking pieces of rebar and sticking the rebar into the coils and hammering it down, trying to get something to hold those baskets in place.
So they would do that, and then the waves would come and the scour would happen around the rebar, and the rebar—so you would go sleep and wake up and the rebar's up out of the baskets. And so you'd have to go back and you'd have to hammer it back down, and sometimes the wall would fall over. And it's all connected. So when one section would fall, it would fall for—you know, for quite some period—it was a—it was a very high maintenance project to try and keep in place.
Victory opined that the Company would not likely realize future sales based on that particular use of the units, explaining that "it was highly experimental, and I would argue that it's not—our product is not fit for purpose to be a fence cage to sit on the shoreline."
3. 500-Year Flood
In 2011, Hesco generated approximately $22.5 million in revenues, largely due to a "500-year flood"—declared a federal disaster in three states—that occurred along the Red River and Mississippi River in the western United States and Canada. To minimize the extensive damage caused by flooding, the Concertainer units were used as flood barriers throughout the flooded region, which included Manitoba and North Dakota. For example, in some circumstances, Concertainer units were stacked in columns three units high, creating a twelve-foot wall that protected buildings located along the river, including a convention center, medical center, and hotel. Many sales were made as "premitigation" efforts, "stocking  or installing [the units] in advance of the flood, anticipating that a flood may occur." At that time, the Company had trouble meeting the sudden demand for the product: the Company did not itself manufacture the component parts of the units, and Hesco was able to purchase enough raw material only because "the [HBL] requirements afforded [a manufacturer] to dedicate lines only for [Concertainer] geotextile because of their Department of Defense contract, " and HBL permitted Hesco to draw textiles from those dedicated lines. The Company did not, however, seek to obtain its own dedicated lines at that time, as it understood the demand generated by the impending 500-year flood to be only temporary.
C. South Carolina Manufacturing Plant
The parties dispute whether plans to open a manufacturing facility in South Carolina as of the Merger Date reflected the "operative reality" of Hesco, or HBL. The Respondent contends that "the plan to open a production facility in South Carolina was for the purpose of serving the HBL [that is, non-Hesco] business and its military sales, which as of the Merger Date Hesco had no right to pursue." In support of that position, the Respondent emphasizes that HBL—but not Hesco— maintained dedicated lines at unaffiliated production facilities from which Hesco was permitted to draw in very busy seasons—as with the 500-year flood in 2011— but that in usual circumstances Hesco did not manufacture enough Concertainer units to justify ...