Tad's Board - Valuation
 
per share
  
Asset Sale (net tax reserves)
$ 10.87 
$ 6,224,750
(net iIndemnification)
($ 0.59)
($ 337,518)
Cell Tech
$ 0.98
$ 563,000
EPG
$ 1.99
$ 1,136,000
TOTAL
$ 13.25 
$ 7,586,232 
n14 In this ease, the market price for Tad's shares prior to the announcement of the Asset Sale and Merger reflected the existence of the Townsends 72.6% control block, and also illiquidity due to the relatively small number of outstanding minority shares being traded. In such circumstances the market price of Tad's shares will not be regarded as a reliable or an appropriate measure of Tad's "fair" value. See, Kahn v. Tremont Corp., Del. Ch., C.A. No. 12339, Allen, C., Mem. Op. at 21-24 (Mar. 27, 1996).
[**32]

Because the plaintiffs attack the defendants' valuations of all four of these price components, each contested component is separately addressed.

1. The Asset Sale Price

The plaintiffs argue that the payment of $ 2 million to the Townsends for the consulting and non-competition agreements evidences that the Asset Sale price was not fair because those agreements had little or no value. Therefore, the plaintiffs conclude, the $ 2 million was -- and should be deemed -- a part of the overall transaction price paid for the corporation's assets, that the Townsends wrongfully diverted to themselves

The defendants insist that the Asset Sale price was fair and deny that the $ 2 million consulting and non-competition agreements were a "sham." They contend that the plaintiffs have adduced no evidence that the Asset Sale agreement had any higher value than what was negotiated, or that if the payments to the Townsends had been reduced, the $ 9.75 million Asset Sale price would have been correspondingly increased. n15

n15 The defendants also emphasize that this transaction structure (as opposed to one where all of the consideration was payable to Tad's at the time of the Asset Sale) had certain cash flow and tax advantages to Riese. That may well be true, and those factors may be probative on the question of whether the transaction structure was reasonably fair to Tad's minority shareholders. However, they are not significantly probative on the issue of whether disproportionate consideration was diverted from the shareholders as a group to the majority stockholders individually.
[**33]

I regard this latter argument as a thinly disguised (and improper) effort to shift the burden of proof to the minority shareholders. It is the defendants who stood on both sides of the transaction and dictated its terms, and it is they who were obligated to persuade the Court that the price they selected was fair. The defendants have failed to carry that burden.

The defendants have not persuaded me that the consulting and non-competition agreements were objectively worth $ 2 million -- a 21% premium over the $ 9.75 million Asset Sale price -- to Riese. The defendants presented no testimony of Riese or of any independent expert on this question. n16 The circumstances make it apparent that at the time agreement was reached, the parties were aware that those provisions would likely never be invoked. n17 All contracting parties knew that after the completion of the Asset Sale, Donald Townsend (who was 79 years old) planned to retire to Nevada and Neal Townsend (who was 72 years old) would continue living in California and operating a restaurant business there. The restaurants Riese was acquiring were all located in New York City, almost 3,000 miles away. Those facts, while not conclusive [**34] on the value (or lack thereof) of the side agreements to Riese, do support the plaintiffs' position that Riese had no intention of calling upon the Townsends [*695] for consulting services and that the Townsends had no intention of competing with Riese. They also support the inference that the agreements, viewed objectively, were not worth $ 2 million, and that Riese was willing to pay that amount in order to obtain an item of value unrelated to those agreements: the Townsends' assent, as Tad's majority stockholders, to the Asset Sale.

n16 One document created by the Riese organization indicates that during the negotiations, Riese was considering (before the stock market crash) an $ 11 million purchase price that explicitly included the cost of a restrictive covenant and a management consulting agreement. (PX 6).

n17 In fact, they never were. For two months after the Asset Sale and before he left New York for Nevada, Donald Townsend assisted in the transition of the restaurant business to the new owners. (Tr. 749-751). However, as defendants' own expert testified, such temporary accommodations are customarily provided by sellers of businesses, independently of any obligation contracted for under a consulting agreement. (Tr. at 905-906).

[**35]

The defendants have adduced no persuasive evidence to the contrary, despite having had ample opportunity to do so. Because they have not established the fairness of the allocation of consideration as between the corporation and the Townsends, the defendants have not satisfied the Court that the Asset Sale price was fair to the minority stockholders of Tad's.

2. The Merger Price

The plaintiffs also contend that the Merger price was not fair, because: (i) its largest component was the Asset Sale price, which (as this Court has now found) was not shown to be fair, (ii) the Merger price rested upon undervaluations of Cell Tech and EPG, and (iii) the Merger consideration was reduced by over-deductions for tax and indemnity reserves. For the reasons next discussed, those contentions are valid.

(a) Asset Sale Price

Because the largest component of the $ 13.25 Merger price was the $ 10.87 per share Asset Sale price which has not been shown to be fair, it follows, for that reason, that the Merger price was not shown to be fair. However, the board's valuations of the other components of the Merger price also compel that conclusion.

(b) Reserve for Estimated Tax [**36] Liabilities

The Merger price is also claimed to be unfair because the Tad's board over-reserved for anticipated tax liabilities. It is undisputed that the board deducted from the monies to be paid to Tad's shareholders in the Merger, $ 3,964,000 for anticipated taxes relating to the Asset Sale. It also is undisputed that Tad's actual tax liability was $ 2,597,205. The result was an over-reserve of $ 1,366,795 that benefitted Newco and thus Newco's owners, the Townsends. The plaintiffs argue that the over-reserve was intended to generate a windfall for Newco. Alternatively, they contend, even if the over-reserve was inadvertent, its magnitude and the board's failure to provide for its repayment to the minority shareholders, clearly evidences that the Merger price was not fair.

The defendants' response is as follows: the plaintiffs have not proved that the over-deduction for future taxes was deliberate or in any way wrongful. The amount of the tax liability reserve was estimated by Tad's auditors, based on their assumption that the transaction would close shortly before the end of the fiscal year ending April 30, 1988. Only because of a six day delay in the Asset Sale closing, [**37] which moved that closing into the more tax advantageous 1989 fiscal year, did the tax liability turn out to be less than the originally reserved amount. Thus, defendants conclude, the over-reserve was fortuitous and unplanned, and ought not to be a basis for imposing liability upon them. n18

n18 The defendants also argue that Tad's tax burden was lower in fiscal year 1989 than it would have been in fiscal year 1988, because Newco generated losses in that year that offset Asset Sale gains, partly because of substantial increases in the salaries of the Townsends. The defendants contend that the plaintiffs should not be permitted to benefit from the reduced tax liability unless they are also willing to share in Newco's losses that contributed to the reduction. This argument sidesteps the issue, which is whether it was reasonable for the Tad's conflicted board, at the time of the Merger, to deduct the amount of the reserve for Tad's future tax liabilities from the Merger consideration without providing for a (pro-rated) repayment to the minority shareholders of any overreserved excess.
[**38]

The defendants' burden required them to show that the amount deducted from the Merger price as a reserve for future taxes was fair. Cinerama, Inc., Del. Ch., 663 A.2d at 1143. I conclude that the defendants have failed to make that showing. To the extent that the Tad's board relied upon the company's auditors to estimate the amounts to reserve for future taxes relating to the Asset Sale, that factor favors the defendants. However, that does not end the analysis, [*696] because even if the directors estimated a reasonable amount to reserve, they made no effort to protect the minority stockholders' interests if the reserve later proved to be excessive. Had the Merger been negotiated by an independent representative of the minority shareholders, the possibility of an over-reserve would in all likelihood have been anticipated, and a pro rata distribution of any excess reserves to Tad's of Tad's shareholders would have been provided for. Here, however, the interested board of Tad's approved a Merger agreement with no provision for repayment of any excess reserves to Tad's shareholders. Instead, the Townsends were permitted to retain the "windfall" solely for their own benefit, which [**39] was unfair.

Because the defendants have not adequately addressed these concerns the defendants have failed to establish that the "excess" tax reserve component of the Merger price was fair.

(c) Reserve for Asset Sale Indemnity

The plaintiffs next contend that the further reduction of the Merger price by $ 337,000 to secure certain indemnity rights of Riese in the Asset Sale, also establishes that the Merger price was not fair.

The Asset Sale agreement required Tad's to deposit $ 500,000 in escrow to secure an indemnity obligation, running in favor of Riese, against damages arising from any breaches of the Asset Sale agreement (the "indemnity reserve"). The plaintiffs contend that the Townsends funded approximately $ 337,000 of this escrow deposit by deducting that amount from the Merger price. That indemnity reserve was to remain in place for two years, at which point any unutilized funds would be returned to Tad's. In fact the $ 500,000 was never utilized, and at the end of the two year period the funds were restored to Tad's. However, the Tad's to which those funds (including the $ 337,000) were restored was the post-merger Tad's, which was a subsidiary of Newco. Thus, [**40] the minority shareholders derived no benefit from that restoration.

The plaintiffs claim that the Tad's board should either have not deducted the $ 337,000 from the Merger price at all, or, alternatively, should have provided that any unutilized portion of the $ 337,000 be repaid to Tad's shareholders as of the Merger date. Had the latter course been chosen, the minority shareholders' proportionate share of the unutilized indemnity reserve would have been about $ 100,000.

The defendants concede that $ 337,518 was deducted from the Merger price. n19 They argue, however, that those monies were not used to fund the indemnity reserve but, rather, represented compensation to the Townsends for assuming unique risks in the Asset Sale transaction. As the defendants explain it, Riese required Tad's (as a subsidiary of Newco), and the Townsends personally to furnish an indemnity against liabilities arising out of potential breaches of the Asset Sale agreement and also to guarantee Newco's obligations to Riese. According to the defendants, the Tad's board decided that the Townsends should be compensated for the risks they assumed in agreeing to these arrangements, and that such compensation [**41] took the form of a $ 337,518 deduction from the Merger price. It is undisputed that the minority shareholders' pro rata share of the $ 337,518 would have been approximately $ 100,000.

n19 Somewhat inconsistently the defendants also claim that the plaintiffs "erroneously contend that the deduction was $ 337,000 ... [when only] ... approximately $ 100,000, or $ 0.59 per minority share, was deducted from the Merger price." (DB at 42, n.27, emphasis added). However, $ 0.59 per share x Tad's 572,064 outstanding shares equals $ 337,518, and $ 100,000 represents the minority shareholders' proportionate share of that amount. The plaintiff's contention that the total deduction was $ 337,000 is, therefore, not "erroneous" as defendants suggest.
Regardless of which of these competing characterization of the facts is accepted, the issue is the same: have the defendants shown that the $ 337,518 deduction from the Merger price was entirely fair to the minority shareholders? In my view they have not, because the claim [**42] that the $ 337,518 deduction was fair compensation to the Townsends for assuming unique risks created by the Asset Sale agreement, is without evidentiary support. The record does establish that in the Merger the Townsends (through Newco) assumed [*697] Tad's liabilities, including its contingent liabilities. However, the defendants point to no record evidence that Newco and the Townsends "negotiated" a specific deduction from the Merger price to "compensate" the Townsends for assuming those particular risks. The minutes recording the board's decision to pay $ 337,518 as compensation to the Townsends provide only a conclusory statement to that effect, and the record contains no evidence that independently corroborates that conclusory statement or shows how the $ 337,518 amount of such "compensation" was arrived at. I, therefore, am unable to conclude that the retention of this amount for the benefit of the Town sends was fair.

(d) The Valuations of Cell Tech and EPG

The plaintiffs next claim that the Tad's board undervalued Cell Tech and EPG in the Merger. Specifically, the plaintiffs argue that in arriving at the Merger price, (a) the board valued Cell Tech based solely on Tad's [**43] historical dollar investment in that business ($ 563,000), without taking into account Cell Tech's significant future earnings potential; and that (b) EPG was valued at net book value ($ 1,136,000) which not only was an improper measure of EPG's fair value, but also was understated because it was the product of accelerated depreciation accounting treatment.

The plaintiffs also point to post-Merger events as confirming the unfairness of the board's valuation of Cell Tech. Four months after Cell Tech was valued at $ 563,000 for purposes of the Merger, the manager of Cell Tech, Daryl Kollman, and his wife offered to buy Cell Tech from Newco for $ 1,330,000, payable in three year notes. The Townsends rejected that offer. Later, in September 1989, one and one-half years after the Merger, the Townsends granted the Kollmans an option, exercisable for six months, to purchase Cell Tech for $ 4,400,000. The option was not exercised. Finally, in August 1990, two and one-half years after the Merger, the Kollmans purchased outright the assets of Cell Tech from Tad's (then a subsidiary of Newco) for $ 3,789,470. Approximately $ 3.5 million of that purchase price took the form of a ten year note [**44] at 19% annual interest; another $ 200,000 took the form of a five year note at 13% annual interest. In that transaction, Tad's also obtained the right to receive certain additional "override" payments based on Cell Tech's future revenue. Between August 1990 and the October 1994 trial, those "override" payments totaled $ 741,568. The plaintiffs argue that the foregoing facts establish that the board's $ 563,000 valuation of Cell Tech in the Merger was not fair.

The plaintiffs contend that the board's valuation of EPG was also not fair. As earlier noted, EPG was valued at its book value less an outstanding $ 400,000 loan, for a net book value of $ 1,136,000. That net book value figure reflected the accelerated depreciation of EPG's capital assets over five years, rather than over those assets' thirty year useful life.

The plaintiffs contend that the defendants knew that the use of a book value based on accelerated depreciation would understate EPG's fair value. Indeed, during the trial Mr. Bressler admitted that the Board "knew the depreciation was very heavy and, therefore, the profit and loss was not an accurate measure of its value to us." (Tr. at 566). If the board knew that the [**45] artificially high annual depreciation charges distorted the profit and loss statement, then, the plaintiffs argue, they must also have known that those charges would also distort EPG's balance sheet. * * *

The defendants have failed to respond both to the foregoing challenges of the EPO and Cell Tech valuations and to the plaintiffs' prima facie showing that the Merger price was unfair. That is, the defendants have made no effort to show that those valuations were fair. Instead, they attempt to sidestep the entire fairness issue by arguing that the appropriate measure of damages is Tad's statutory appraisal value, which (defendants claim) is less than the value the plaintiffs seek as the measure of damages. Because the defendants made no serious effort to defend the fairness of the board's valuation of EPO or Cell Tech, and because the Court has found that the plaintiffs' fair price arguments are meritorious and that the value of Tad's far exceeds the Merger price (see Part [*698] IV, infra), it follows that the defendants have failed to establish that their valuation of Tad's in the Merger was fair. * * *

To summarize, the defendants have failed to prove to [**46] the Court's satisfaction that the Asset Sale and the Merger were the product of fair dealing or that they yielded a fair price. The absence of any adequate independent representation or procedural safeguards to protect the minority shareholders' interests; the absence of persuasive evidence that the consulting and non-competition agreements had significant value; the $ 563,000 valuation of Cell Tech in the Merger, followed by a $ 1.3 million offer for that same business (which the Townsends rejected) only four months later; and the defendants' failure to justify the board's valuation of Cell Tech and EPG -- all impel me to conclude that the Asset Sale and Merger cannot pass the test of entire fairness. The defendants, accordingly, are liable to the plaintiffs for breaching their fiduciary duty of loyalty. The question then becomes: what is the extent of that liability?

IV. DETERMINATION OF DAMAGES

A. Introduction

Having found that the defendant directors are liable, the Court must next determine an appropriate damages award. Were this action solely one for an appraisal pursuant to 8 Del. C. @ 262, the plaintiffs would be limited to a recovery of the "fair [**47] value" of their shares, "exclusive of any element of value arising from the accomplishment or expectation of the merger." 8 Del. C. @ 262(h); In the Matter of the Appraisal of Shell Oil Company, Del. Supr., 607 A.2d 1213, 1218 (1992). However, the measure of damages for breach of fiduciary duty is not limited to the corporation's fair value as determined in an appraisal. Weinberger, 457 A.2d at 714. Rather, in that procedural setting, the Court "may fashion any form of equitable and monetary relief as may be appropriate, including rescissory damages." Id.

The plaintiffs here seek rescissory damages on the basis that the directors breached their duty of loyalty and as a result, obtained substantial personal financial benefits for themselves at the minority stockholders' expense. The defendants respond that the plaintiffs should be precluded from recovering rescissory damages, because they unduly delayed in asserting their fiduciary duty claims and have otherwise failed to demonstrate that the appraisal remedy would be inadequate.

An award of rescissory damages may be appropriate in cases where directors are found to have breached their duty of loyalty. Id. However, [**48] because that remedy is grounded upon restitutionary principles, it is appropriate in cases involving "at a minimum persuasive evidence that the board was actually motivated by interests other than those of the shareholders..." Cinerama, Inc., Del. Ch., 663 A.2d at 1149. That is, an award of rescissory damages would be most appropriate where it is shown that the defendant fiduciaries unjustly enriched themselves by exercising their fiduciary authority deliberately to extract a personal financial benefit at the expense of the corporation's shareholders.

In this case, the directors' "actual" motivations in negotiating and carrying out these transactions are hotly disputed. The evidence goes both ways. However, in the end, it is unnecessary for this Court to undertake a pursuit of the directors' elusive subjective motives for their conduct, because the record clearly establishes that the plaintiffs unreasonably delayed in asserting their fiduciary duty claims. That delay makes it inequitable for this Court to award rescissory damages in this case.

As the defendants correctly point out, this case was initially filed in September 1988, and thereafter was repeatedly permitted to languish. [**49] In many instances the defendants had to prod the plaintiffs into further action. In March 1990, motivated by the need to preserve the testimony of the Townsends because of their advanced ages, the defendants noticed their own depositions. In February 1991, it was the defendants who asked that the case be scheduled for trial. Only thereafter, in February 1991, did the plaintiffs assert their fiduciary duty claim, but [*699] thereafter did not diligently pursue those claims. In February 1993, the defendants requested that the action be removed from the active calendar because of the plaintiffs' failure to prosecute. And, after further discovery, it was the defendants who requested a conference in January 1994 to schedule a trial date.

The plaintiffs claim that they did not delay excessively. They argue that they did not know the facts underlying the fiduciary duty claim until after they conducted discovery in the appraisal proceeding. The record repeatedly undermines that assertion. (PX 60, Tr. 451-454, 436-437, 438-439, 440, 443-444, 455). To cite but one example, plaintiff Donald Ryan's own notes disclose that, as early as November 1987, four years before the fiduciary claim [**50] was asserted, he believed that the consulting and non-competition agreements were a "fraud upon the minority stockholders of Tad's perpetrated by the management of Tad's as well as the Rieses". (PX 60). n20

n20 The plaintiffs also contend that the delay should not be attributed solely to themselves. They argue that during discovery the defendants withheld relevant evidence regarding the Kollman offer to buy Cell Tech four months after the Merger, and the option to buy Cell Tech given to the Kollmans in September 1989. While these alleged discovery abuses cannot be condoned, they do not justify the plaintiffs' pervasive pattern of delay during the six year period between the May 5, 1988 Merger and the October 1994 trial.
"It is a well-established principle of equity that a plaintiff waives the right to rescission by excessive delay in seeking it." Gaffin v. Teledyne, Inc., 1990 Del. Ch. LEXIS 198, Del. Ch., C.A. No. 5786, Hartnett, V.C., Mem. Op. at 49 (Dec. 4, 1990), aff'd, Del. Supr. 611 A.2d 467 (1992). The underlying policy [**51] reason is that excessive delay enables a plaintiff otherwise to "sit back and 'test the waters'," opportunistically waiting to see whether the defendants achieve an increase in the value of the company above its likely appraisal value, before deciding to assert a claim for rescission, or its monetary equivalent, rescissory damages. Id. The law "does not ... promote speculative damages at the [defendant's] expense." Myzel v. Fields, 386 F.2d 718, 740-741, n. 15 (8th Cir. 1967), cert. denied, 390 U.S. 951, 19 L. Ed. 2d 1143, 88 S. Ct. 1043 (1968). This case, in my view, fully merits the application of that principle.

That is not to say that this Court will ignore post-merger events that bear on the value of Tad's as of the Merger date. Indeed, because the directors of Tad's have been adjudicated in breach of their duty of loyalty, the damages award will not be limited to what would be recoverable in a statutory appraisal, as the defendants urge. Rather, the Court will exercise its discretion to craft from the "panoply of equitable remedies" a damage award that approximates a price the board would have approved absent a breach of duty. Cinerama, Inc., Del. Ch., 663 [**52] A.2d at 1137, Weinberger, 457 A.2d at 714.

B. The Damages Valuation

Having determined the nature of the damages to be awarded, the Court must next determine the appropriate valuation for each of the disputed components of Tad's at the time of the Merger. The following table provides an overview of the parties' valuation positions n21 and the result this Court ultimately reaches: [*700]

Valuation:

Tad's 
Board
The 
Plaintiffs
The
Defendants
The 
Court
Asset Sale 
6,224,750 
8,224,750 
6,224,750 
8,224,740
per share
$ 10.87 
$ 14.37 
$ 10.87 
$ 14.37 
Excess Tax Reserve 
-- 
1,366,695
--
1,366,795
per share 
$ 2.39 
$ 2.39
Indemnification 
(337,518)
--
(337,518) 
--
per share 
($ 0.59) 
($ 0.59)
Cell Tech
563,000 
3,872,390 
833,000 
2,923,760
per share 
$ 0.98
$ 6.77
$ 1.46 
$ 5.11
EPG
1,136,000 
2,390,000 
772,005 
1,136,000 
per share
$ 1.99 
$ 4.18 
$ 1.35 
$ 1.99 
Other Claims
-- 
1,617,000 
-- 
-- 
per share 
$ 2.83 
TOTAL n22 
7,586,232 
17,470,935 
7,492,732 
13,651,265 
per share 
$ 13.26 
$ 30.54 
$ 13.10 
$ 23.86 
n21 Actually, the plaintiffs contend that the fair value of Tad's is $ 31.07 per share and the defendants contend that the fair value is $ 13.69 per share. However, both of these figures are based on an error m calculation. Both the plaintiffs and the defendants assume that the $ 6,224,750 net proceeds from the Asset Sale (determined by the Tad's board) are net of the $ 337,518 payment to the Townsends relating to the Asset Sale indemnity. However, as the Tad's board meeting minutes (DX 77 at 6-7) and the Tad's proxy statement (PX 86 at 11) make clear, that is not so. The error is corrected here. [**53]

n22 The difference between the board's valuation of Tad's ($ 7,586,232) and the value realized by Tad's shareholders ($ 7,579,848) is accounted for by the Board having rounded the $ 13.26 per share value down to $ 13.25 per share.

1. Asset Sale Damages

The plaintiffs claim that the amount of damage they suffered in the Asset Sale is their proportionate share (5.5%) of the $ 2 million the Townsends diverted in the form of consulting and non-competition agreements.

The defendants respond that the plaintiffs have failed to prove both the actual value to the Townsends of the consulting and non-competition agreements, and the additional amounts (if any) Riese would have paid to Tad's for the restaurant assets, assuming that the consulting and non-competition payments were eliminated or significantly reduced. The defendants say that the cash cost to Riese of the consulting and non-competition payments would have been less than the cost to Riese of the payments for the restaurant assets, because the former were tax deductible and payable over five years, while the latter were nondeductible [**54] and payable all at once.

The defendants further argue that even if Riese had allocated all of the additional $ 2 million to Tad's as part of the Asset Sale price, the net value realized by shareholders would have been significantly less than $ 2 million, because Tad's would have paid real estate transfer taxes and New York City, State, and federal capital gains taxes on the incremental consideration. The defendants contend that because the plaintiffs failed to quantify any of those expense factors, the Court cannot possibly determine the amount of any actual, specific damage to shareholders from the $ 2 million consulting and noncompetition payments.

However, the defendants are unable to point to anything of record supportive of these contentions. It well may be that Tad's would have owed taxes on any increased Asset Sale consideration. It may also be the case that Riese would not have agreed to pay the entire $ 2 million to Tad's if that payment were not tax deductible. But there is no persuasive evidence that supports, let alone compels, a fact finding to that effect. What is established by a preponderance of the uncontroverted evidence is that the consulting and non-competition [**55] agreements were of de minimis value. The advanced ages and personal plans of the Townsends strongly indicate that Riese did not intend to consult the Townsends regarding the operation of the restaurant business, and that the Townsends posed no competitive threat to Riese. Because $ 2 million was paid to the Townsends for consulting and non-competition agreements having minimal or no value, it must be concluded that those payments were, in reality, part of the consideration for the Asset Sale, disguised as payments for consulting and non-competition agreements.

It was incumbent upon the defendants to present evidence to support their position [*701] that the Asset Sale price would not have been increased by $ 2 million, if all of the consideration was to be paid to Tad's. The defendants have not proved that case. Given the absence of any persuasive evidence to the contrary, I must conclude that but for the diversion of $ 2 million to the Townsends, the net Asset Sale consideration would have been $ 2 million more than the $ 6,224,750 Asset Sale price approved by the interested Tad's board, i.e., $ 8,224,750.

2. The Tax and Indemnity Reserve Damages

The plaintiffs contend, [**56] and I agree, that the "overdeductions" by the Tad's board for taxes and the indemnity obligation resulted in damage to the plaintiffs equal in amount to their proportionate share of those overdeductions. The Court has already concluded that if there had been independent negotiation on behalf of the minority shareholders on these issues, a fair outcome would have been a provision that the unutilized portion of those reserves would be distributed pro rata to all shareholders

Accordingly, I find that (i) the $ 1,366,795 of unused tax reserves should have been distributed pro rata to all of the Tad's former shareholders and that (ii) the $ 337,518 relating to the Riese indemnity should either have not been deducted from the Merger price at all, or have been made distributed pro rata to all former Tad's shareholders instead of to Newco. That finding results in a $ 1,703,795 increase in the Merger price.

3. Cell Tech Damages

The plaintiffs advance three separate valuations of Cell Tech. The first assumes a rescission of the Cell Tech sale. Under that approach, the plaintiffs claim entitlement to: (i) their proportionate share of all Cell Tech profits between the [**57] Merger date and the August 1990 sale of Cell Tech to Daryl Kollman, (ii) all payments received from Kollman between the August 1990 sale and the date of trial, and (iii) the present value of all future (i.e., override) payments. Because this valuation would amount essentially to an award of rescissory damages, it will not be considered for that reason. n23 See Part IV A, supra of this Opinion.
n23 In conjunction with their calculation of rescissory damages, the plaintiffs also rely on a so-called "cash collection" methodology which, at the eleventh hour, they attempted to introduce into the case by slipping a reference to it into the pretrial order. Because the plaintiffs failed to provide the defendants with fair pre-trial notice of their intention to use this methodology, the Court will not consider it either.
Second, the plaintiffs advocate a "liability action" valuation methodology, based upon the value of the notes the Kollmans paid to purchase Cell Tech in August 1990. To that value plaintiffs [**58] add the discounted value of all override payments Tad's received from the Kollmans through the October 1994 trial date, plus the discounted value of projected override payments receivable between October 1994 through July 2000. The sum of these amounts is claimed to represent Cell Tech's value at the time of its sale to the Kollmans in August 1990. From that value the plaintiffs subtracted Cell Tech's after-tax earnings for the period May 1988 through August 1990, to arrive at a net valuation of $ 4,070,490 for Cell Tech as of the Merger date.

The defendants contend that this approach would also be tantamount to awarding rescissory damages in a slightly different form, because it rests upon 20/20 hindsight and fails to take into account the significant business risks Cell Tech faced at the time of the Merger. Specifically, the defendants argue that this methodology does not reflect the risks that Cell Tech's future profitability depended critically upon the continued success of a single "fad" product line, and that Cell Tech's business could be shut down at any time by a U.S. Food and Drug Administration ("FDA") enforcement action. n24 Finally, the defendants argue that this valuation [**59] approach fails to account for the Townsends' nearly $ 1 million post-Merger investment in [*702] Cell Tech, and assumes an unrealistically low discount rate. I conclude that these objections are well founded and reject this second approach as well.

n24 Prior to 1988, Cell Tech had been found by the FDA to have violated various provisions of the Federal Food, Drug & Cosmetics Act by, inter alia, making unsubstantiated therapeutic claims. (DX 28).
The plaintiffs' third methodology is a discounted cash flow valuation -- an approach the defendants also advocate. In that context, the only subject on which the parties disagree concerns the projections of future Cell Tech cash flows that should be used in the model. For the following reasons, the Court adopts this methodology to value Cell Tech for purposes of determining an appropriate damages award.

The record discloses significant evidence of Cell Tech's value as reflected in the dealings between the Town sends and Daryl Kollman in connection with the sale of Cell [**60] Tech. Four months after the Merger, Kollman offered to buy Cell Tech for approximately $ 1.33 million, payable in three year notes. The Townsends' rejection of that offer evidences their belief that Cell Tech was worth more than $ 1.33 million. The question is how much more. As earlier stated, one year later the Townsends granted the Kollmans an option to purchase Cell Tech for $ 4.4 million, but the Kollmans did not exercise that option. Finally, two years after the Merger, the Kollmans purchased Cell Tech outright for $ 3.8 million, consisting mostly of notes payable at 19% interest, plus an override on future sales. By 1990, however, Cell Tech's circumstances had changed dramatically and other value-creating events unrelated to the Merger had intervened.

These indications of value, while helpful to some extent, are not a satisfactorily reliable measure of Cell Tech's value at the time of the Merger. Thus, while these post-Merger values should and will be considered as a "reality check" of any independently determined valuation of Cell Tech as of the Merger date, the discounted cash flow valuation methodology that both sides have used and endorsed is the approach that merits the [**61] greatest confidence.

The discounted cash flow valuation model is well-established and accepted in the financial community. Applied as of the Merger date, that methodology also best implements the Court's determination that any award of damages should reflect the Merger value Tad's would have been given had no fiduciary violations occurred. Moreover, that approach does not incorporate any values caused by unrelated, independent post-Merger events, and thereby avoids the risk that elements of rescissory damages might reappear through the back door.

The plaintiffs' cash flow projections, discounted at a rate of 17.7%, yield a valuation for Tad's of $ 3.9 million. The defendants' projections, discounted at a rate of 30%, result in a valuation of $ 833,000. The $ 3.1 million difference is largely attributable to the parties' differing assumptions about Cell Tech's revenue growth and what discount rate is appropriate. Those two disputed items are now addressed.

(a) Revenue Projections

The parties' revenue projections as of the Merger date are depicted in the chart below:

 
1987
1988
1989
1990
1991
1992
1993
Plaintiff's 
797
3,073 
3,679 
7,852
16,757 
16,757
16,757
Defendant's
797
3,073
4,608
6,912 
9,677
13,548
16,257
FY to Apr. 30 (1987 and 1988 Hist) (1989-1993 Proj) (all in 000) [**62]

In my view, the more credible cash flow projections are those advocated by the plaintiffs. I base that conclusion upon several facts that were known or readily apparent at the time of the Merger. First, Cell Tech, in the hands of Daryl Kollman, was worth at least of $ 1.33 million. That Kollman offered -- and the Townsends rejected -- $ 1.33 million only four months after the Merger, strongly evidences that neither Cell Tech's managers nor the Townsends believed that Cell Tech was worth as little as $ 833,000 as of the Merger date.

Second, at the time of the Merger, Kollman was Cell Tech's most likely buyer. [*703] During the Townsends' periodic employment contract negotiations with Kollman, Kollman repeatedly expressed his dissatisfaction with the compensation structure of Cell Tech. (See, e.g., Tr. at 564). Moreover, it is apparent that Kollman's continued management of Cell Tech was crucial to Cell Tech's continued success. Those circumstances created a foreseeable possibility (if not likelihood) that Kollman would offer to acquire Cell Tech. Indeed, the fact that only four months after the Merger Kollman offered to purchase Cell Tech, and only one year later the Townsends granted [**63] the Kollmans the $ 4.4 million option to buy Cell Tech, further supports the inference that the Townsends probably anticipated an eventual purchase of Cell Tech by the Kollmans before the Merger in May, 1988.

Third, and finally, in adopting the plaintiffs' projections I cannot ignore Cell Tech's actual performance. By the 1990 fiscal year, Cell Tech's annual sales were close to $ 10 million; by the time of the trial, they were running close to $ 40 million. (DX 57; PX 139). That performance is consistent with Daryl Kollman's prediction, expressed in a letter he wrote to the Townsends before the Merger, that Cell Tech had "been in the 'hard work, low profit' stage for the last three years ... [but had] just started the rapid growth phase which precedes the 'hang onto your hats' phase." (PX 15). For this reason as well, the defendants' highly conservative revenue projections for Cell Tech at the time of the Merger lack credibility. n25

n25 The defendants also challenge of the plaintiffs' projections on the grounds that the plaintiffs failed to account for Kollman's profit participation and to subtract a debt owed by Cell Tech to its former owners, and that they also erroneously included a franchise fee in Cell Tech's profits. On that score I am satisfied that the plaintiffs have either proved the defendants' objections to be misguided, or have otherwise adequately explained the basis for their experts' choice of numbers. (Revised Post-Trial Reply Brief of Petitioners and Plaintiffs in the Consolidated Actions at 30-34).
[**64]

Accordingly, I adopt the plaintiffs' "total free cash flow" projections, which are as follows:
 

Fiscal Year to Apr. 30
Court
1989
290.0 
1990
169.3
1991
361.3
Terminal value
5,350.4

(b) Discount Rate

The other subject of the Cell Tech valuation dispute is the appropriate discount rate. On that issue, the defendants have the better side of the argument. Although both sides argue that their respective discount rates are supported by the Capital Asset Pricing Model ("CAPM"), their chosen rates differ vastly. The plaintiffs' discount rate is 17.7%; the defendants', 30%.

However, only the defendants have mathematically applied the CAPM to derive quantitatively the discount rate they propose. n26 Moreover, the plaintiffs' 17.7% discount rate relies heavily upon a highly questionable assessment of company-specific risk. In selecting their 30% rate, the plaintiffs' expert derived Cell Tech's beta, (which is a measurement of the risk of a particular company relative to the market) from the beta of a "comparable" company that represented an investment less risky than Cell Tech. The plaintiffs' expert relied primarily upon a New York Stock [**65] Exchange-traded company that had a beta of 2.2 and that owns and operates a national health food retail store chain and sells multiple health food products. The plaintiff's expert derived Cell Tech's beta of 2.0 from this "comparable" company's beta of 2.2, thereby suggesting that Cell Tech involved lower risk than did the "comparable" company. The comparison is factually unsupported. The plaintiffs have not persuaded this Court that their 17.7% discount rate is realistic.

n26 The defendants calculated a discount rate of 26.5% using the CAPM. The defendants' expert explained that on the basis of his experience, he considers 30% to be more appropriate, given the risks associated with Cell Tech. Unlike the defendants, the plaintiffs never demonstrated how precisely they derived their discount rate from the CAPM.
[*704] I recognize that the defendants' 30% discount rate is unusually high, but the record demonstrates that Cell Tech, at the time of the Merger, was an unusually risky investment. Cell Tech faced regulatory, [**66] management, and "fad" product-related risks, any one of which could result in that company's failure. I find it entirely plausible that a prudent investor in a venture of that kind would demand an annual return in the 30% order of magnitude. Accordingly, I adopt 30% as the appropriate discount rate for valuing Cell Tech's projected future cash flows.

The plaintiffs' cash flow projections, discounted at the rate of 30%, yield a $ 2,923,720 net present value for Cell Tech as of the Merger date, which amount is the adjudicated value of Cell Tech for purposes of calculating damages.

4. EPG Damages

The plaintiffs also seek damages for the undervaluation of EPO, measured as their pro rata share of their expert's $ 2,390,000 valuation. Using a similar discounted cash flow methodology, the defendants' expert concluded that EPG should be valued at far less -- $ 445,000.

Although I ultimately do not accept it, I find the defendants' expert's discounted cash flow valuation of EPG to be the more credible. First, the plaintiffs' expert assumed that EPG would realize annual 4% price increases for the power it produces. But EPG's prices are linked to coal prices, and at the time [**67] of the Merger, future coal prices were forecasted to be flat or falling. Accordingly, the defendants' assumed 1% growth rate is more realistic. Second, the plaintiffs' expert assumed fixed annual operating and maintenance fees of $ 45,000, even though that figure was based on EPG's experience when one of its two power generators was brand new. The defendants' estimate that these operating costs would rise to $ 60,000 per year is the more plausible. Finally, the higher rate of parasitic power consumption that the defendants' expert assumed is supported by the testimony of the plaintiffs' own expert. Without resolving each disputed detail of the two sets of projections, I am persuaded that the defendants' cash flow projections for EPG are the more accurate, and I accept them.

However, that docs not end the analysis. Although I reject the plaintiffs' valuation of EPG, I cannot accept the defendants' lower valuation either, because it is significantly less than the value that the Tad's board approved in the Merger. To adopt a lower value would be inequitable. Given the adjudicated disloyalty of the directors, I find the $ 1,136,000 value they fixed for purposes of the Merger to be the [**68] lowest acceptable valuation of EPG for damages calculation purposes.

5. The Remaining Damage Claims

Finally, the plaintiffs urge the Court to include the value of several never-asserted derivative claims on behalf of Tad's for breach of fiduciary duty. These include claims against (i) Mr. Bressler, for representing the Townsends individually in connection with the consulting and non-competition agreements; (ii) the Townsends, for permitting Tad's to sell steaks, without any markup, to certain restaurants owned by the Townsends individually; and (iii) the Townsends, for authorizing Tad's to provide management services free of charge on behalf of Tad's Inc. of San Francisco, a company wholly-owned by Neal Townsend. All told, the plaintiffs value these claims at $ 1,617,000.

I find it unnecessary to address these unasserted fiduciary claims, because their asserted value is too speculative. That value assumes that the defendants are liable, with no discount being applied to take into account the potential defenses to these unasserted claims or to reflect the less-than-perfect probability of their success. Most important, the plaintiffs advanced no evidence to support their [**69] damage claims. They offer only unsupported assertions that are too speculative to form the basis for a damage award. * * *

Having independently valued Tad's, the Court is now able to determine the amount of the defendants' liability as of the date of the Merger. Because the plaintiffs [*705] have sued individually rather than derivatively or on behalf of a shareholder class, any damages awarded to the plaintiffs must be proportionate to their approximately 5.5 % stock ownership in Tad's. Accordingly, as of the Merger date, the plaintiffs' damages will be their proportionate share of the adjudicated value of Tad's. That adjudicated value is $ 23.86 per share, n27 which, when multiplied by the 31,600 Tad's shares owned by the Ryans, results in a total damages award of $ 753,976.

n27 This total includes the $ 13.25 per share Merger price that the plaintiffs never received, because they did not tender their shares in the Merger.

6. Interest, Costs and Attorneys' Fees

In addition to damages, the [**70] plaintiffs seek an award of 19% compound prejudgment interest, plus costs and attorneys' fees.

Interest is typically awarded on the basis of a combination of the plaintiffs' lost opportunity cost, measured by a prudent investor rate; and the benefit realized by the defendant, measured in terms of the reduction in defendants' borrowing costs. Chang's Holdings, S.A. v. Universal Chemicals and Coatings, Inc., 1994 Del. Ch. LEXIS 222, C.A. No. 10856, Chandler, V.C., Mem. Op. at 2-3 (Nov. 22, 1994). Where the evidence is insufficient to enable the Court to balance these factors, however, the "legal interest rate serves as a useful default rate..." for prejudgment interest. 1994 Del. Ch. LEXIS 222 at *8.

The plaintiffs claim that they are entitled to compound interest at a rate of 19%, because that rate of interest is what the defendants received on the notes executed by Kollman for the financed portion of the Cell Tech purchase price. But using the return to defendants from their investment in high yield notes as a basis, is inconsistent with the legal standard governing the determination of prejudgment interest.

The defendants point out that the actual interest earned on the plaintiffs' portion of the Merger consideration [**71] invested by Tad's represents an average return of 5.5% per year (not compounded). According to the defendants, that is some evidence of the plaintiff's prudent investor rate. The defendants also contend that because they had substantial liquid assets and no debt following the Asset Sale and Merger, they had no need to "borrow" the plaintiff's portion of the Merger consideration, and hence, derived no benefit from continuing to hold it. I find that argument somewhat disingenuous. Even if Tad's was cash-rich after the Asset Sale and Merger, the defendants derived a benefit from having the use of the plaintiffs' funds at no cost. It therefore is appropriate that that benefit be considered in determining a fair interest rate during the period that the defendants had the cost-free use of plaintiffs' funds.

Given the parties' superficial treatment of the prejudgment interest date question, I conclude that they have failed adequately to develop the record on that subject. Accordingly, the Court adopts the legal interest rate as the appropriate rate of prejudgment interest. Because the plaintiffs have not established that the circumstances of this particular case warrants a departure from [**72] the normal practice of awarding simple interest (Chang's Holdings at 10), the prejudgment interest rate will be based on the simple interest rate of 11% that prevailed as of May, 1988. (Revised Opening Post-Trial Brief of Petitioners and Plaintiffs in the Consolidated Actions at 90).

However, because of the plaintiffs' excessive delay in prosecuting this case, an award for the entire six years at the 11% statutory rate would, in my view, constitute an undeserved windfall for the plaintiffs and an unjustified penalty for the defendants. See, Wacht v. Continental Hosts, Ltd., 1994 Del. Ch. LEXIS 216, Del. Ch., C.A. No. 7954, Chandler, V. C., Mem. Op. at 8 (Dec. 23, 1994). These actions could and should have been brought to trial in approximately one half to two-thirds the time that it actually took. To reflect that determination, I award prejudgment interest at two-thirds the 11% statutory rate of simple interest as of May 1988, i.e., 7.33%. n28

n28 Because the fiduciary duty breached by the defendants was the duty of loyalty, I err in the plaintiffs' favor by reducing the interest rate to two-thirds, rather than to one half, of the statutory rate. That result is significantly higher than the 5.5% rate advocated by defendants.
[**73]

[*706] The plaintiffs also seek, pursuant to 8 Del. C. @ 262(j), an award of the litigation costs they incurred in bringing these proceedings, including fees for expert advice and trial testimony. Because the record does not disclose the amount of those costs, any award of costs must be separately determined in a later proceeding.

Finally, the plaintiffs seek attorneys fees on the basis that the defendants acted in bad faith and committed fraud against the minority stockholders, citing Weinberger v. UOP, Inc., Del. Ch., 517 A.2d 653 at 656 (1986).

In these particular circumstances the only arguable basis for fee shifting would be that the defendants acted in bad faith, which is the argument plaintiffs advance here. Because the plaintiffs have sued individually and not representatively on behalf of the corporation or a shareholder class, the plaintiffs cannot recover fees on the basis of having created a "common fund" or conferred a "common benefit" to a larger class of shareholders. n29

n29 Nor do the plaintiffs come within the doctrine of Initio Partners v. Tandycrafts, Inc., Del. Supr., 562 A.2d 1162 (1989) because no stockholder other than the plaintiffs has dissented from the Merger or sued. Accordingly, the only beneficiary of the judgment entered in this case would be the plaintiffs.
 [**74]

The difficulty, however, is that the facts do not support the plaintiffs' "bad faith" theory. Although the defendants have failed to carry their burden of showing entire fairness, that does not necessarily establish that the defendants acted in bad faith as that term is defined for fee-shifting purposes. The plaintiffs must carry the burden of persuading the Court that the defendants acted with scienter sufficient to warrant a finding of bad faith. For the Court to award attorneys fees on that basis, the conduct at issue must rise to a "high level of egregiousness." Abex, Inc. v. Kohl Real Estate Group, Inc., Del. Ch., C.A. No. 13452, Jacobs, V.C. (Dec. 22, 1994). The plaintiffs have failed to demonstrate that the defendants' conduct rises to the highly egregious level described in Abex and the decisions cited therein. That a fiduciary is found to have breached his duty cannot, without more, justify a fee-shifting award of attorney's fees against the fiduciary or the corporation. Weinberger v. UOP, Inc., Del. Ch., 517 A.2d 653, 656 (1986). Otherwise, every adjudicated breach of fiduciary duty would automatically result in a fee award. In short, I find that the plaintiffs [**75] have failed to demonstrate wrongdoing of the kind that would justify fee-shifting.

V. CONCLUSION

For the reasons previously set forth, judgment will be entered in favor of the plaintiffs and against the defendants in the amount of $ 753,976, plus prejudgment interest calculated at the rate of 7.33% from May 5, 1988 to the date of judgment, plus costs to be determined (in the absence of an agreement among the parties) in a later proceeding. Counsel shall confer and submit a form of order implementing the foregoing rulings.