Shareholders who dispute the value of Canadian companies during takeovers face more legal hurdles following a new decision from the Supreme Court of British Columbia.

Lawyers and valuators say the decision will make wins harder for dissenting shareholders who are relying on the “discounted cash flow” valuation method, assuming the negotiations were fairly conducted. That method can result in much higher valuations; many dissenting shareholders view a trip to court to get more using this method as a no-lose proposition.

“The level of discussion around valuation techniques indicates this is a very well thought-out decision,” says Scott Lawritsen, a business valuator with Meyers Norris Penny LLP in Calgary. “It’ll be looked at in great detail in cases like this in future.”

That case centred on B.C. investor Clifford Grandison’s claim that shares in Coast Mountain Power Corp., an early-stage B.C. hydroelectric developer, were dramatically undervalued in a transaction that saw junior mining company NovaGold purchase the company at $2.20 a share in July 2006. The price represented a premium of about 10% over the market price for the thinly-traded shares.

Relying on expert testimony from Vancouver chartered business valuator Ronald Tidball, a partner in the firm of Campbell Saunders & Co., Grandison argued that Coast Mountain was worth at least $6.13 a share.

With ownership of slightly less than 10% of the company, Grandison stood to earn at least $8-million more from his shares had Judge Ian Pitfield agreed with that valuation.

Instead, however, Pitfield concluded that the transaction price reflected fair value based on a range of indications of fairness during the negotiations. (Coast Mountain’s operations are located near NovaGold’s Galore-Creek copper/gold mine in B.C. The miner’s share price fell steeply in November after it announced it would not be proceeding to develop the mine due to the rising costs of accessing the rugged terrain around the remote site.)

The factors Pitfield found reassuring in the negotiations included NovaGold’s position as an arms-length buyer and the absence of any external pressure to complete the transaction. It was also significant that no other buyer was interested in Coast Mountain. Pitfield’s decision notes that Coast Mountain was advised on the share valuation by independent financial advisors with Capital West Partners of Vancouver. The fact that Grandison was the only dissenting shareholder is also noted in the decision.

Pitfield also noted that he preferred the expert testimony provided to NovaGold by share valuator Jeffrey Harder, a chartered business valuator and partner with Deloitte & Touche LLP over the testimony provided by Tidball.

Both experts used the discounted cash-flow method of valuation to estimate the cumulative cash flow likely to be generated in each year over Coast Mountain’s foreseeable economic life in current dollars. But while Tidball and Harder agreed on the DCF methodology, they strongly disagreed in their estimates for the financial basis of Coast Mountain’s plans for future hydroelectric developments in the rugged interior of British Columbia.

“It is not possible to reconcile the disparity in the estimates with any degree of confidence,” Pitfied said. “With respect, the best that can be said is that if each opinion is considered in the context of its material assumptions, it is possible to determine which of the two ranges of value appears more reasonable.”

The distance between the two valuators’ estimates is not unusual, says business valuator and veteran expert witness Richard Wise, of Wise Blackman LLP in Montreal. “The DCF is a very good method, but there are so many variables involved and so much subjectivity. It has its limitations,” Wise says. “I love it when an opponent has applied the DCF method.”

The fact that neither valuator testified to the effect of a change in capital cost in their cash-flow estimates or in their estimates of value also worried Pitfield: “Absent helpful evidence on construction costs and risks from those qualified to provide it,” he noted, “the confidence I can have in either estimate of value is greatly reduced.”

Pitfield reviewed the financial terrain on which the DCF review was conducted; that included projections for Coast Mountain’s construction costs, revenue and material risks as well as the discount rate employed within the DCF valuations. Also included were “special purchaser considerations” proposed by Grandison relating to NovaGold’s strategic plans for Coast Mountain’s assets.

@page_break@Following the review, Pitfield concluded: “The appropriate starting point for the determination of value in present circumstances is the transaction itself.”

Convinced that the transaction was fairly conducted, Pitfield saw no reason to adjust the transaction price.

“This judge put an incredible amount of work into assessing the valuation before essentially deciding not to rely on it,” says James Hodgson, a lawyer with Hodgson Shields DesBrisay O’Donnell MacKillop Squire LLP in Toronto, with long experience in cases involving shareholder dissent over valuations. “At the end of the day, it’s a matter of what the market is willing to pay.”

Joe McArthur, the lawyer with Blake, Cassels & Graydon LLP in Vancouver who won the case for NovaGold, says Pitfield’s central question throughout the case was: “Why should I second-guess a freely negotiated transaction price?”

Noting that questions over the suitability of the DCF method are a perennial concern for courts considering complaints like Grandison’s, McArthur says Pitfield’s decision sends a message that the method may be falling out of favour.

“In previous cases, overreliance on the DCF approach has occasionally resulted in valuations of dissent shares far in excess of any other measure of value,” McArthur says. “Together with other factors, this has led to an impression by some that dissent proceedings are a no-lose proposition for the dissenting shareholder. The common-sense approach by the court in Grandison may go some way toward dissuading shareholders from dissenting in the absence of manifest indications of unfairness.”

Wise finds a similar, although blunter, message in Pitfield’s decision. “The moral of the story here is that you can no longer bully a corporation into a settlement [using the DCF methodology],” Wise says. “The courts increasingly recognize that it’s more of an art than a science. If you’re going to take a matter like this to court you’d better have a very good valuation case.” IE