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Appraisal Rights Litigation Blog

The Market-Out Exception: Delaware’s Unique Twist on a Commonly Used Anti-Appraisal Device

Posted in Appraisal-Eligible Deals, Arizona Appraisal Rights, Fair Value, Market-out Exception, Massachusetts Appraisal Rights, Stock Market Price

The so-called market-out exception precludes appraisal where the target’s stock trades in a highly liquid market.  In other words, appraisal is normally available to shareholders except, as the rationale goes, where the M&A target’s stock trades in such a liquid, highly efficient market that its stock price naturally reflects its fair value, and any M&A transaction offering a premium to that market price thus provides shareholders even greater, above-market value that would render an appraisal challenge superfluous.  Or, at least, so the theory goes.

Delaware’s appraisal statute incorporates the market-out exception, precluding appraisal rights where the target’s stock is either “(i) listed on a national securities exchange or (ii) held of record by more than 2,000 holders.”  DGCL § 262(b)(1).  But the Delaware statute doesn’t stop there, and this is where it parts ways with many other states:  it then carves out from the market-out exception circumstances where the target’s stock is being acquired for cash, in whole or in part.  As a result of this exception to the exception, Delaware’s market-out exception has far fewer teeth than do those of jurisdictions that adopted the market-out exception outright, without exception.  Thus, based on the theory underlying the statute, and notwithstanding the purported liquidity and efficiency of the stock markets in which most public M&A targets are traded, Delaware allows stockholders of its corporations to assert appraisal rights rather than assume that the market price inevitably captures the maximum value of their shares.

Many other states, such as Arizona, have adopted the market-out exception as is, without any carve-outs.  Indeed, back in February, when it was announced that the Apollo Education Group (“APOL”), which is incorporated in Arizona, had agreed to be acquired by a consortium of investors including The Vistria Group, affiliates of Apollo Global Management, and the Najafi Companies for $9.50 per share in cash, many investors immediately took to social media and other informal outlets to consider mounting an appraisal case against APOL.  However, such plans were just as immediately halted as they ran into Arizona’s market-out exception. AZ ST. § 10-1302(D).  Unlike Delaware, Arizona does not allow any exceptions to the exception, and a target such as APOL that trades on a sufficiently large stock exchange is shielded from appraisal.

Massachusetts, in contrast, has not adopted the market-out exception, but appraisal rights in that state are limited to transactions presenting potential conflicts of interest.  Thus, when EMC agreed to be acquired by Dell in late 2015, stockholders who believed they faced an uphill battle of demonstrating conflict of interest were likewise stymied from pursuing appraisal.  MA GL § 13.02(a)(1)(B).

The bottom line: Investors cannot presume that all jurisdictions providing for appraisal rights afford stockholders similar rights in their statutes.  Before investing the time and diligence in evaluating a target’s acquisition price, shareholders must fully inform themselves of the applicable state statute as well as its exceptions (and any carve-outs to those exceptions).

Proposed 2016 Changes to Delaware Appraisal Statute

Posted in Dollar Amount of Appraisal Rights Filings, Interest on Appraised Value, Short-Form Merger

A number of amendments to Delaware’s appraisal statute have once again been proposed by the Corporate Council of the Corporation Law Section of the Delaware State Bar Association, the committee that customarily recommends legislative action to Delaware’s state lawmaking body. If certain proposed changes to the Delaware General Corporation Law (“DGCL”) are approved by the Corporation Law Section, they will be introduced to the Delaware General Assembly.

The proposed legislative changes – available here – are intended to (i) set a floor for the number and value of shares asserting appraisal and (ii) permit M&A targets to prepay some or all of the merger consideration to dissenters to avoid the accrual of interest on such prepaid amounts.

  1. Threshold for Appraisal

Under the proposed amendments, the Court of Chancery shall dismiss an appraisal proceeding for a public company, unless (1) the total number of shares entitled to appraisal exceeds 1% of the outstanding shares of the class or series eligible for appraisal, (2) the value of the merger consideration for such dissenting shares exceeds $1 million, or (3) the merger was a short-form merger pursuant to § 253 or § 267 of the DGCL.

To be clear, the legislature has not yet approved or even considered these proposals; we’ll post about any future developments in that regard. Since most appraisal cases already exceed such levels, we don’t anticipate that the thresholds set forth in items (1) and (2) will have a terribly profound impact; indeed, the cost of mounting an appraisal action naturally dissuades small stockholders from doing so.

  1. Prepayment Option

The proposed legislation also permits the surviving company to make a cash payment to dissenters in an amount of its choosing, with interest accruing only on the difference between the amount so paid and the fair value of the shares as determined by the Chancery Court (as well as any interest that had previously accrued on the paid amount as of the effective date of the merger).

Interestingly, while this second proposal would encourage appraisal respondents to prepay significant amounts to stop the interest clock, investors might utilize the opportunity to redeploy such returned capital to their next appraisal case, thus having the unintended effect of increasing the number of appraisal petitions.

It is worth noting that the draft legislation does not include any specific proposals to eliminate or limit appraisal arbitrage. The proposed legislation includes several provisions unrelated to appraisal that are not addressed here.

If ultimately adopted by the Delaware legislature, the legislation would become effective in respect of merger agreements entered into on August 1, 2016, and thereafter.

Moot Court Focuses on Delaware Appraisal Rights

Posted in Arbitrage

Attorneys here at Lowenstein congratulate students of The Ohio State University’s Moritz College of Law on their victory in the 2016 Ruby R. Vale Corporate Moot Court Competition, as well as all the other teams participating.  The competition problem, authored by Professor Lawrence Hamermesh, considered issues of appraisal rights raised by recent cases Merion Capital LP v. BMC Software, Inc., In re Appraisal of Ancestry.com, and In re Appraisal of Dell Inc.  According to the Widener Law School Blog, “The issues centered around the question of the appropriate interpretation of the statutory term ‘stockholder of record,’ and its effect on so-called ‘appraisal arbitrage,’ in which purchasers of shares after the record date for voting on a merger seek judicial appraisal of their shares.”

The focus on appraisal rights among practitioners, academics, and, in this case, students, highlights their importance to investors and investor rights.

Academics Propose New Reforms for Appraisal

Posted in Appraisal-Eligible Deals, Arbitrage, Award Premium, Dollar Amount of Appraisal Rights Filings, Interest on Appraised Value, Merger Price, Number of Appraisal Rights Filings, Record Date

We’ve posted before about the article by Professors Charles Korsmo and Minor Myers analyzing the recent surge in appraisal activity.  These co-authors have prepared a new draft article to be published in the Delaware Journal of Corporate Law, proposing reforms for appraisal litigation.  Based on their latest research the authors stand by their prior conclusion that appraisal plays a “salutary if small role” in M&A practice.

The new article expands their data set to include 2014 (the prior study ranged from 2004 to 2013), and the authors provide updated charts showing the number of appraisal petition filings by year (Figure 2 on pages 14-15) and the percentage of equity value in appraisal by year (Figure 3 on page 16).  Some new metrics include a useful summary of appraisal trial outcomes for public company common stock (Figure 6 on page 22) and descriptive statistics of transactions challenged in appraisal to show which deals attract the most appraisal litigation (Table 1 on page 11).  It is this study that the authors use to demonstrate that the only independent variables in M&A transactions that have a statistically significant effect are the merger premium residual and the presence of insider participation: in other words, the lower the premium residual, the higher the likelihood of appraisal.  And appraisal is more likely to occur when an insider participates in the purchase.  See pages 10-12.

Given these observations, the authors conclude that “appraisal petitioners focus their resources on meritorious claims.”  This conclusion impels the authors to reject the reforms suggested by both respondent companies and deal advisors to limit or eliminate appraisal arbitrage, though they do suggest a less drastic compromise in setting the record date at least 20 days after mailing of the appraisal notice, giving stockholders material disclosures prior to the record date.

In addition, the authors propose other reforms to improve the effectiveness of appraisal, including (i) requiring disclosure of more financial information in M&A transactions subject to appraisal; (ii) eliminating the “irrational” exemption for all-stock transactions; and (iii) adopting a de minimis requirement.  Finally, the authors hint at improvements to the system of awarding interest in appraisal cases, but plan to develop that suggestion more fully in a separate article.

**Update: Korso and Meyers preview their article at the Columbia Law BlueSky Blog.

Opportunities with Appraisal Litigation

Posted in Arbitrage, Award Premium, Number of Appraisal Rights Filings

Today’s Hedge Fund Law Report ran an article about the appraisal remedy, its positive results and its distinctiveness from traditional stockholder litigation.  That article, “Stockholder Appraisal Actions Present an Attractive Litigation-Based Strategy for Hedge Fund Managers,” also discusses the proposed legislative amendments, judicial limitations and potential opportunities that we’ve posted on before.

Korsmo & Myers Article Analyzing Surge in Appraisal Activity Now Published

Posted in Arbitrage, Dollar Amount of Appraisal Rights Filings, Merger Vote, Number of Appraisal Rights Filings, Record Date

We have blogged before (see here) about a then-forthcoming law review article by Professors Charles Korsmo (Associate Professor at Brooklyn Law School) and Minor Myers (Associate Professor at Brooklyn Law School) analyzing the value-creation resulting from the increased use of appraisal arbitrage.  The authors’ paper has now been published in the final 2015 issue of the Washington University law review: http://openscholarship.wustl.edu/law_lawreview/vol92/iss6/7/

While there have been some revisions to the final version, their underlying data points, arising from their study of all Delaware appraisal cases for the ten-year period from 2004 to 2013, remain intact.

Appraisal Rights and “Risk Arbitrage”

Posted in Award Premium

In this working paper (available via SSRN), “Influencing Control: Jawboning in Risk Arbitrage,” authors Jiang, Li, and Mei consider the use of appraisal strategies, among others, by the so-called “activist” investor. In studying instances of appraisal arbitrage, among other activist strategies, the authors conclude that activist investors can utilize a variety of tools – including appraisal – to realize abnormal returns on M&A transactions.

In particular, Table 7 of the attached article (pages 50-51) presents the results of their analysis of such abnormal returns. The sample used in this study included only 14 mergers with appraisal actions, but their findings on “appraisal returns” are interesting: “The average (median) appraisal return is 15.6% (19.6%). The average (median) length between deal completion and the appraisal decision is 1,043.1 (1,106) calendar days,” or just over three years (footnote 14). In addition, Appendix A analyzes the Golden Telecom decision as an illustrative case in their study, in which the appraisal strategy experienced an annualized return of 15%.

Fed’s Recent Rate Increase Bumps up Statutory Appraisal Interest

Posted in Interest on Appraised Value

As a result of the recent increase in the Federal Reserve discount rate, statutory interest in appraisal cases is now up to 6%, compounding quarterly.  The discount rate had been 0.75% from February 19, 2010 through December 17, 2015, at which time it was increased to 1%.  As the appraisal statute sets interest at 5% over the Federal Reserve discount rate, the recent .25% increase pushes the appraisal interest rate up from 5.75% to 6%.

Delaware Chancery Recognizes Quasi-Appraisal Remedy, But Stockholders Here Were Too Late

Posted in Quasi-Appraisal

In last month’s decision in Houseman v. Sagerman, Vice Chancellor Glasscock addressed the common law analogue to Delaware’s appraisal rights statute – the remedy of “quasi-appraisal” for a breach of fiduciary duty.  In the November 19 opinion, the court described a long litigation history stemming from the merger of Universata, Inc., into an LLC purchaser.  The Housemans, shareholders of Universata, did not in the first instance exercise statutory appraisal rights, choosing instead to sue a putative purchaser of their shares under a “put contract” in Minnesota.  The Minnesota state court dismissed that breach of contract action in 2012.  More than two years after the close of the Universata merger, the Housemans filed a complaint in Delaware Chancery alleging breach of fiduciary duty in the sale process.  Of interest to us was the Court’s discussion of the Housemans’ claim for quasi-appraisal.  Vice Chancellor Glasscock observed that quasi-appraisal was not a cause of action at all, but was rather a remedy available to shareholders upon a finding of a breach of fiduciary duty.  The Vice Chancellor acknowledged that there could be confusion as to what, exactly, quasi-appraisal was, but made clear that it is ultimately a remedy whereby the court awards shareholders damages “based on the going-concern value of their previously owned stock” upon an appropriate finding of liability.  For background on the quasi-appraisal remedy in stockholder litigation in general, see this article from the HLS Forum on Corporate Governance and Financial Regulation.

Notwithstanding the ostensive viability of their claim, the Housemans would not receive quasi-appraisal – not because it was not a cause of action, but because of the doctrine of laches, an equitable doctrine similar to a statute of limitations that bars a cause of action when there is prejudicial delay in bringing it.  In the Houseman case, the plaintiffs waited 27 months to bring a breach of fiduciary duty claim (and thus seek quasi-appraisal), choosing to litigate the Minnesota breach of contract issues in the first instance.  The Court thus granted summary judgment to defendants on the breach of fiduciary claim, and in doing so barred the quasi-appraisal remedy, as the claim was simply brought too late.

**Update on January 21, 2016: the Westlaw Journal has now covered the same case discussed in this post:  Houseman et al. v. Sagerman et al., 31 Westlaw Journal Delaware Corporation Law Update 3 (2016).