## Facts

- Energy Services Group, Inc. (ESG) was a closely held Delaware corporation providing technology and related services to the energy industry.
- Nathan Owen (Nate), ESG’s founder and former president, owned about 35% of ESG and continued receiving substantial profit distributions after leaving day-to-day management in 2009.
- Lynn Cannon became president in 2009; together with Bryn Owen (Nate’s brother), Cannon was one of ESG’s largest stockholders.
- In May 2013, Cannon and Bryn caused ESG to consummate a conflicted cash-out merger that eliminated Nate’s ownership.
- Nate was cashed out for $19.95 per share (about $26.334 million total), while Cannon, Bryn, and another manager rolled over equity into the surviving entity.
- The merger was financed with a $25 million credit facility; management prepared five-year “2013 Projections” to support that financing and the valuation used to set the merger price.
- Nate objected to the transaction, received limited notice of a special board meeting approving the merger, and pursued both appraisal and fiduciary-duty claims after the merger closed.

## Issues

1. In appraisal under DGCL § 262, what was the fair value of Nate’s shares as of the merger date, and should the court rely on contemporaneous management projections or litigation-created projections in a DCF analysis?
2. In valuing a Subchapter S corporation, whether and how earnings should be tax-affected in the DCF model.
3. Whether the controller-led cash-out merger satisfied entire fairness (fair dealing and fair price), and whether Cannon and Bryn breached fiduciary duties by causing the merger at an unfair price and through a conflicted process.

## Decision

- The Court of Chancery determined the fair value of Nate’s shares as of the merger date to be $42,165,920, materially above the merger consideration.
- The court used a DCF valuation and relied primarily on the contemporaneous 2013 Projections prepared for business and financing purposes, rejecting defendants’ litigation-driven ten-year projections.
- The court tax-affected earnings in the DCF analysis while accounting for ESG’s Subchapter S status.
- Applying entire-fairness review, the court held the merger was not entirely fair, principally due to unfair price, and held Cannon and Bryn liable for breach of fiduciary duty.

## Legal Principles

- In an appraisal action, DCF analysis may be used when supported by reliable inputs; contemporaneous management projections prepared in the ordinary course and used for financing can be more credible than projections prepared for litigation.
- For a Subchapter S corporation, a court may tax-effect earnings in a DCF while recognizing that pass-through tax characteristics can have economic value relevant to fair value.
- A conflicted controller-led cash-out merger is subject to entire-fairness review; defendants must prove both fair process and fair price, and a substantial gap between merger price and judicially determined value can support a finding of unfair price and fiduciary-duty liability.
- Deal price may receive limited weight as an indicator of fair value when the process is conflicted or lacks robust market testing.

## Conclusion

The Court of Chancery awarded appraisal value substantially higher than the cash-out price and, under entire-fairness review, held the controller group liable where a conflicted process produced an unfair price in a closely held company buyout.


Owen v. Cannon, 2015 WL 3819204 (Del. Ch. June 17, 2015)