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

February 2021

Alexa Flórez y Andrés Recalde 

In a sentence released on November 23, 2020 the Supreme Court reached a decision concerning an appeal case against the annulment by the National Court of Spain of an agreement made by the National Securities Market Commission authorising a buyout takeover. In particular, the Supreme Court has taken a stand on (i) 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; (ii) the existence, or not, of precedence between the different methods offered to determine the price in a takeover; and (iii) the power that the National Securities Market Commission has to impose a specific evaluation method for this report.  

The National Securities Market Commission had authorised a buyout takeover, through an agreement dated December 22, 2016, after having considered that the terms of the offer met the current rules and that the prospectus was sufficient.
According to the National Court of Spain, the bank that carried out the valuation report on the proposal and the offered buyout takeover sum - required in order to determine the price (see article 10.6 of Royal Decree-law 1066/2007) for which the buyout takeover should be presented, once the valuation report of the company has been carried out in accordance with legal criteria (see article 82 of Royal Decree-law 82 TRLMV, upon which the aforementioned article 10.6 of Royal Decree-law 1066/2007 is based) - should have abstained and refused the task from the bidder. 

The National Court of Spain believed that the financial institution should have abstained because it was a global player  that provides finance to the bidder, as well as acting as guarantor for a takeover bid concerning the bidding company and, furthermore, this bank took on the role of intermediary and liquidator for the buyout 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 financial entity may have been interested in the success of the buyout takeover and may have caused a conflict of interest.  By taking part in the valuation the financial entity may have prejudiced the minor shareholders, despite the effective presence of  "Chinese walls" (information barriers between departments) at that entity.  

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

However, in the appeal decision, the Supreme Court overturned the National Court of Spain's ruling and concluded:

(i) If the valuation report issued by directors of a company (as in line with the second paragraph of article 82.3, LMV) includes or is based upon 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 CNMV should focus its attention". 

(ii) 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 Royal-decree law on Takeovers. In particular, 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 legislator 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." 

(iii) With regards to the supervisory role of the National Securities Market Commission  as attributed in the rules governing takeovers, this body has the authority to decide upon 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. Notwithstanding the above, the Supreme Court points out 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 buyout takeover.

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