Possible conflicts of interest in evaluation reports compiled by directors and evaluation methods used in takeovers

Introduction
Facts
Supreme Court decision

Introduction

On 23 November 2020 the Supreme Court reached a decision concerning an appeal case against the National Court's annulment of a National Securities Market Commission agreement authorising a buy-out takeover. In particular, the Supreme Court took a stand on:

• the potential conflicts of interest between the proposed evaluation report and the price offered in the takeover framework when the evaluation report is carried out by an independent expert;
• the existence, or not, of precedence between the different methods offered to determine the price in a takeover; and
• the National Securities Market Commission's power to impose a specific evaluation method for this report.

Facts

Through a 22 December 2016 agreement, the National Securities Market Commission had authorised a buy-out takeover after having considered that the terms of the offer met the current rules and that the prospectus was sufficient.

According to the National Court, the bank that carried out the valuation report on the proposal and the offered buy-out takeover sum – which is required in order to determine the price (Article 10.6 of Royal Decree-Law 1066/2007) for which the buy-out takeover should be presented, once the company's valuation report has been carried out in accordance with legal criteria (Article 82 of Royal Decree-Law 82 of the Consolidated Text of the Securities Market Act, on which Article 10.6 of Royal Decree-Law 1066/2007 is based) – should have abstained and refused the task from the bidder.

The National Court believed that the bank should have abstained because it:

• was a global player providing finance to the bidder;
• was acting as guarantor for a takeover bid concerning the bidding company; and
• took on the role of intermediary and liquidator for the buy-out takeover which had been authorised by the National Securities Market Commission and which became a matter of discussion in the current appeal case.

For these reasons, the bank may have been interested in the success of the buy-out takeover and may have caused a conflict of interest. By taking part in the valuation, the bank may have prejudiced the minor shareholders, despite the effective presence of so-called 'Chinese walls' (ie, information barriers between departments) at that entity.

On the other hand, the National Court understood that the National Securities Market Commission should have imposed a valuation method on the takeover bid (eg, the underlying book value) as – in the court's opinion – the choice of discounted cash flows as a valuation method is seldom used.

Supreme Court decision

However, in the appeal decision, the Supreme Court overturned the National Court's ruling and concluded the following.

If the valuation report issued by a company's directors (as aligned with Paragraph 2 of Article 82.3 of the Securities Market Act) includes or is based on a report drawn up with the help of an independent expert, the existence of a conflict of interest that this expert may have due to professional links with entities involved in the bid does not impede their intervention as an expert. The reason is that it is the directors who are responsible for this report and therefore it is they who should abstain from causing a conflict of interest. According to the Supreme Court:

what is truly relevant is that the report presented by the directors (regardless of who actually drew up such report) contains a detailed explanation of the proposal and the offering price, because this is what will ensure adequate protection of the interests of the affected shareholders, and, in particular, the minor shareholders, which is the aim implied in the rules and upon which the [National Securities Market Commission] should focus its attention.

On the other hand, the Supreme Court understood that in the prevailing law there is no type of precedence between the valuation methods offered in a takeover among those listed in Article 10 of the Royal Decree-Law on Takeovers. In the court's opinion, the methods in Section (e) of the provision cannot be described as seldomly used. The way in which it was written shows that the legislature had not intended to exhaustively list every admissible valuation method, but rather, by means of example, it lists some "such as, discounted cashflows, trading multiples of comparable companies or others", leaving open the possibility of using other valuation methods "applicable to the case at hand and frequently accepted by the international financial community".

With regard to the supervisory role of the National Securities Market Commission as attributed in the rules governing takeovers, this body has the authority to decide on the proficiency and transparency of information provided by company directors to shareholders, as well as the eligibility of the information that partners affected by the takeover have available to them in order to decide whether to stay in the delisted company or to sell their shares. Nonetheless, the Supreme Court highlighted that:

what has not been contemplated in the prevailing law is that the National Securities Market Commission has authority to insist that one valuation method in particular is used for the valuation report.

Therefore, the Supreme Court did not consider there was reason enough to invalidate the decision by the National Securities Market Commission of authorising the public buy-out takeover.

For further information on this topic please contact Alexa Flórez or Andrés Recalde at CMS Albiñana & Suarez de Lezo by telephone (+34 91 451 9300) or email (alexa.florez@cms-asl.com or andres.recalde@cms-asl.com). The CMS Albiñana & Suarez de Lezo website can be accessed at www.cms.law.