Fairness Opinions: Sometimes the Best Defense is a Good Offense

What is Considered Good Business Sense Today May Be Considered a Breach of Fiduciary Duty Tomorrow. Pay Special Attention to Fairness Opinions.

Are your clients risking liability as they complete their daily tasks? What is considered good business sense today may be considered a breach of fiduciary duty tomorrow. That possibility is increasing. Business appraisers should pay special attention to fairness opinions. Bill Bavis explains why.

Are your clients risking liability as they complete their daily tasks? What is considered good business sense today may be considered a breach of fiduciary duty tomorrow.  And, with today’s economic climate, that possibility is increasing.  Fairness opinions may be just the offense to prove fiscal prudence and to ward off the need for a defense.

Fairness opinions can serve as evidence that officers and directors have conducted a process that helped them fulfill their fiduciary obligations.  Generally, a fairness opinion is a determination by an expert that a business transaction is fair from a financial point of view.  In some cases, fairness may be based on non-financial criteria such as normal industry or business practices.  The fairness opinion is the overall consideration of the facts and circumstances at the time of the business decision or action, combined with the opining expert’s judgment—as an independent third-party and based on their experience in the industry—that yields the finding of fairness.  Experts offering fairness opinions do so based on procedures designed to give a balanced view of the subject transaction.

The Sarbanes-Oxley Era 
The passage of Sarbanes-Oxley (SOX) in response to corporate scandals more than a decade ago created a climate of increased attention on the overall concept of corporate responsibility.  In particular, there has been an increase in the expectations for those who accept positions as officers and directors of not only public companies, but also of private companies and even nonprofit organizations. 

Because of the increasingly complex capital structures of private companies, ownership of private companies is no longer concentrated among one or two shareholders; multiple classes of stock, equity funds, mezzanine financing, and various forms of trust structures result in divergent interests in corporate transactions and, therefore, more stakeholders.

Nonprofits are also getting their fair share of attention from some state legislatures and attorneys general who have extended some SOX-like provisions to nonprofits and have increased scrutiny on these organizations.

Tough Economy
The spotlight on corporate responsibility has been further focused by the tough economic times we have faced over the past several years. There have been numerous professional liability claims against corporate fiduciaries associated with bankruptcies and business failures. Corporate fiduciaries face the risk that shareholders or other stakeholders will claim that a transaction unfairly dilutes their interests or fails to resolve a burden that threatens the long-term viability of the company or their investment.

One such case that got a lot of attention was Just for Feet, which filed for bankruptcy in 1999 and in which outside directors of the company agreed to personally pay more than $41 million to settle a lawsuit brought by the bankruptcy trustee. The directors were accused, among other things, of breaching their fiduciary duties and acting in bad faith by delaying the bankruptcy filing against the advice of outside experts. This settlement was one of the largest ever of its kind.

Business Judgment Rule 
Officers and directors have long relied on the business judgment rule as a defense against fiduciary claims. As stated in Aronson v. Lewis, Del. Supr., 47 A.2d 805, 811 (1984), the business judgment rule “…is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.”

In circumstances where the company’s fiduciaries are likely to be second-guessed about their ability to act on the behalf of all stakeholders, fiduciaries should pay careful attention to good processes, adequate information, and proper analysis as a basis for their actions.  Board members have a fiduciary duty of care that requires them to be reasonably informed when making specific decisions that may affect stakeholders who are not actively participating in the decision making.  Independent analysis resulting in a fairness opinion is a powerful tool corporate fiduciaries can use to fulfill their responsibilities to all stakeholders and minimize their own risk.

Bill Bavis, CPA/ABV/CFF, ASA, CVA, is a Managing Director at Invotex where he leads investigations of financial fraud for publicly held and privately held companies.  Mr. Bavis is skilled in forensic accounting, financial and economic analysis, and fact-finding.  He can be reached at (410) 824-6009 or wbavis@invotex.com.