Contractual Valuation Mechanisms and Corporate Law

Abstract

"Legal valuation" - the resolution of disputes over the value of legal entitlements - is an inevitable aspect of any legal system. Across time and place and doctrinal boundaries, the problem is the same: each side seeks to have a self-servingly high or low figure assigned to the entitlement in question, and a mechanism is needed to choose a conclusive value from a range of plausible outcomes. Usually the mechanism involves litigation of some sort, such as a trial before a judge, jury, or hearing officer. But not always.

This Article analyzes a transactional alternative to valuation litigation that has become increasingly popular: the contractual valuation mechanisms ("CVs") that sophisticated firms use to resolve anticipated valuation disputes. Various CVMs recently adopted by public firms are introduced, and two contrasting approaches to CVM enforcement found in recent case law are evaluated. One of these enforcement approaches, developed by a federal court applying New Jersey law, involves intrusive judicial review of CVM-generated outcomes. The other approach, that of Delaware, defers to whatever value the CVM produces.

Widespread adoption of the intrusive approach would undermine the viability of CVMs as transactional alternatives to valuation litigation. The deferential approach is therefore a better way for courts to handle CVM-enforcement litigation. So long as intrusive enforcement remains a transactional risk, parties drafting a CVM are well advised to choose a deferential jurisdiction such as Delaware as the exclusive forum and source of law for the CVM's enforcement. A further protection would be for parties drafting CVMs to specify in the CVM itself the extent of judicial review desired. Parties wishing to limit judicial review may do so in this way, even in an intrusive jurisdiction. But also selecting a deferential jurisdiction's law and forum is an even safer course. The dynamics affecting choice of law and forum for CVMs in many ways resemble the conditions that led to Delaware's triumph in the jurisdictional competition for corporate charters.

Keywords: valuation, legal valuation, contracts, corporations, law and economics

JEL Classification: K00, K12, K22, K41