The Case For A Second Opinion On Certain Fairness Opinions

The Case For A Second Opinion On Certain Fairness Opinions

Find out why getting a second opinion on certain fairness opinions during energy M&A transactions can go a long way in ensuring that the best interest of the company and its stakeholders are met.


Before trying to decide if it makes sense to get a second opinion on a fairness opinion, it’s necessary to understand why fairness opinions started and how they have evolved over the years. Fairness opinions are closely tied with the ideas of fiduciary duty and the business judgment rule. The hallmarks of the business judgment rule are to act independently, in good faith, on an informed basis (due care) with the honest belief that a transaction is in the best interest of a company.

Fairness opinions essentially became mandatory for all big public merger and acquisition (M&A) deals following the 1985 Smith v. Van Gorkom case. In that case, the Court held that the directors were grossly negligent for approving the sale without knowing the “intrinsic value” of the company (informed basis). The court stated that the directors could have satisfied this informed basis part of their duty by obtaining a fairness opinion.

READ MORE: Fairness & Solvency Opinions

Over the years (and still today), in most marquee M&A transactions, a Board receives a fairness opinion from the company’s advisor. While the fairness opinion compensation can vary, typically a company’s M&A advisor (bulge-bracket investment bank for big public company deals) will provide an opinion and credit the cost against its M&A fee. In transactions where negotiations are between independent third parties on an arms-length basis, there is less risk of a successful challenge and, therefore, these fairness opinions are done as a matter of course.

Types Of Transactions Where Fairness Opinions Are More Critical

As opposed to the standard types of transactions highlighted above, there are times when a transaction has characteristics that make the fairness opinion more important; cases where a plaintiff’s attorneys will look for reasons to discredit the opinion provider, the analysis, or the process:

  • Marquee Deals with a Potential Conflict of Interest: These types of transactions could include situations where one party has equity or even controlling interest in both sides of the transaction and, therefore, may not be exactly aligned with one or both sets of shareholders. One example of this was seen in the 2016 Tesla-SolarCity merger. Elon Musk’s ownership on both sides created a potential conflict. Another example would be a de-SPAC combination transaction. The SPAC sponsor is not exactly aligned with the shareholders, due to effective contingent ownership. In these and other transactions where a potential conflict exists, the purpose of a fairness opinion is not simply an “informed basis,” but it also serves as protection for the independent interest holders vs. the potentially conflicted party.
  • Smaller Private Company Transactions with Conflicts of Interest: These transactions tend to be the bread and butter of independent fairness opinion providers. Typically, the risk associated with these transactions is such that bulge-bracket investment banks often aren’t willing to take on relative to the smaller fees. However, in recent years, especially with the energy market slowdown during the pandemic, many investment banks without a dedicated transaction opinion practice have been dabbling in fairness opinions to supplement declining traditional M&A fees. The following are examples of these types of transactions:
  1. Going private transactions
  2. Sales among affiliates
  3. Drop-down transactions
  4. Portfolio company mergers, acquisitions, or investments between two or more different private equity funds (i.e., Fund I and Fund II)

Potential Fairness Opinion Provider Considerations

Selecting a fairness opinion provider is critically important. Choosing the right provider can mean a strong defense in the face of a legal challenge and potential legal challenges. However, in many legal cases, deciding on an opinion provider, or the circumstances around the engagement, have sometimes hurt the defense of the fairness of a transaction. Two of the most common pitfalls that can hurt a defense are success fees and conflicts of interest:

  • Success Fees: Many successful challenges of fairness opinions stem from the perception that the advisor is conflicted from making an independent valuation assessment due to the nature of their success fees. In a large public-to-public M&A deal, each side’s advisors’ fees are typically heavily success-weighted. If the deal closes, the investment bank often will make tens of millions of dollars. This is a big incentive to show that the negotiated deal is “fair” to their client.
  • Perception of Conflict of Interest for Advisor: Especially with the types of transactions outlined above, where an innate conflict is part of the transaction, the perception that the advisor is beholden or loyal to the conflicted party has led to successful challenges. Imagine if six months after delivering a fairness opinion the advisor is awarded a key role in an equity offering with a multi-million-dollar fee.

Process Considerations

To be truly effective, a fairness opinion process needs to avoid the multitude of potential pitfalls that can make or break a legal challenge. The nicely formatted Board presentation accompanying a fairness opinion is useless if it isn’t supported with methodical processes, documentation, internal scrutiny, and review. Investment banks that don’t have a dedicated transaction opinion practice typically view the opinion as an add-on to the M&A process. There have been examples of firms delegating the process and work to junior staff. As was shown in the 2015 El Paso decision, this can have disastrous implications for the client. A good lawyer can help educate all parties, but most work done by fairness opinion advisors is done behind the scenes and will never become known until a challenge is brought up.

READ MORE: Opportune Partners LLC Renders Fairness Opinion To FAST Acquisition Corp. II In Connection With Falcon’s Beyond SPAC Merger

Obvious process pitfalls like rogue emails or lack of well-documented Board meetings are easy to warn against. However, things like routine changes to the analysis (in some cases that the Board never even knows about) can call objectivity into question. Plaintiff’s attorneys will subpoena all drafts of analysis hoping to find earlier drafts where the analysis looks unfavorable to a transaction, but then adjustments are made that make the result look “fairer.” The reasons for this can be completely reasonable, but only experienced practitioners will be consciously thinking about this throughout the process and diligently document reasons for changes that can be brought out if needed. In the El Paso decision, Delaware Supreme Court Vice-Chancellor J. Travis Laster was extremely critical of the investment bank’s continued answer as to why assumptions were made: “It was our professional judgment.”

Similarly, post-transaction process optics can be problematic when a fairness opinion advisor is acting as both advisor to the Board and fairness opinion provider (which is quite common). The Board and their advisors’ role are clear: to get the best deal possible for shareholders (independent of the conflicted party) or even to be willing to walk away from a deal.

In arms-length third-party negotiations, part of an M&A advisor’s job is to look at the analysis and point out reasons why value should be lower (buyer) or higher (seller) depending on which side of the transaction they’re on. Advisors and Boards should negotiate as hard as possible to get the best deal. A potential issue that not a lot of investment banks think about is that putting forth a valuation, set of discount rate assumptions, or growth rate assumptions intended to support the negotiating position can create a pattern that looks bad in hindsight. Often, once a negotiated price is settled, the fairness opinion analysis will go back to less aggressive valuation assumptions (not a negotiating case), giving the impression that the analysis was changed to “make it work.”

Second Opinions

The cases outlined above highlight how a Board could benefit from a second fairness opinion in certain situations, including:

  • Big marquee deals with real or perceived conflicts or certain characteristics that could seem to invite a legal challenge. In these scenarios, the Board benefits from the work of an investment bank, which may already have a long working relationship with the company but may be receiving success fees or be subject to historical or future business with the company or conflicted party. This could call into question their independence. The second opinion provider would charge a non-contingent fee.
  • For transactions where significant negotiations are needed or expected. As discussed above, “negotiating cases” can cause difficulties for Boards. While it’s useful to make the fairness opinion provider the “bad guy,” it may be better to have a second independent fairness opinion where the provider isn’t part of the negotiations. In these cases, it might even be better to have separate advisors for each role (negotiations and fairness opinion) rather than a second opinion.

When Does A Second Opinion Not Make Sense?

For big marquee M&A deals that are arms-length third-party, and the opinion is only being sought to satisfy the “informed basis” (due care) standard as highlighted in Smith v. Van Gorkom, it’s not necessary to seek a second opinion. The inherent nature of third-party negotiations (especially as part of a well-run M&A process) mitigates many of the risks associated with legal challenges.

READ MORE: SPAC Market Is Poised For A Rebound With Increased Scrutiny

For other kinds of smaller deals with significant conflicts or perceived conflicts, it’s better to just go straight for one advisor that specializes in fairness opinions rather than the company’s traditional investment bank to avoid any pitfalls during a potential legal challenge.

How We Can Help

At Opportune LLP, we bring to bear a full array of capabilities within our firm to offer comprehensive solutions and actionable insights for our energy clients, including investment banking services offered by Opportune Partners LLC, an investment banking and financial advisory affiliate of Opportune. We have a dedicated Transaction Opinions team with extensive opinion process experience and unmatched energy industry expertise that provides strong defensible opinions to your M&A transaction—no matter how unique or complex the situation. Opportune Partners is a natural extension of the Opportune LLP platform, as many of the investment banking services are generally associated with our other reputable practice areas such as Reserve Engineering, Valuation, and Restructuring.

We believe that there are a vast number of public and private companies across the energy spectrum that need the experience and caliber of a bulge-bracket firm with the attention and focus of a boutique firm in these challenging times. Our Transaction Opinions team has extensive experience in mapping out a defensible process that provides comfort to Boards and independent directors. Contact us today and we will initiate the introduction to our team to assess your requirements.

Related Insights

Looking for expertise in the energy industry? We’ve got you covered.

Find out why the new landmark legislation should provide a much-needed boost for the development of carbon capture.