Today’s New York Times ran this piece analyzing the proposed Delaware amendments on appraisal proceedings, which we blogged about last week. The New York Times shares our own observation that the proposed legislation’s provision allowing for prepayment by the M&A target could have the unintended effect of increasing appraisal filings: “Rather than discourage appraisal petitions, the elimination of interest accrual through prepayment may actually spur more appraisal actions because hedge funds would be paid sooner and be able to use that money to bring more appraisal actions.”
Proposed changes to the Delaware appraisal statute have cleared Delaware’s House of Representatives without dissent, and now move on to the state Senate. The new legislation, which we blogged about in March, sets a floor for the number of shares and value of suit necessary to bring an appraisal action. It also permits M&A targets to prepay merger consideration to dissenting shareholders to avoid interest accruing on the prepaid amounts. We note that the target’s ability to prepay some or all of the merger consideration could have the unintended effect of increasing the number of appraisal filings by ameliorating an investor’s illiquidity problem in prosecuting an appraisal action. Investors may now be enabled to redeploy their otherwise trapped capital in a new appraisal case; while investors would obviously lose their statutory interest on the prepaid amount, that might be a trade-off they can live with.
On May 11, Vice Chancellor Laster issued an opinion in the Dell case denying the T. Rowe Price lead petitioner’s entitlement to proceed with its appraisal case on the grounds that it (inadvertently) voted in favor of the merger, when it should have abstained or voted against. The ruling did not address the underlying valuation issue, which is still outstanding.
The highlights of this ruling:
- The record evidence shows that T. Rowe instructed Cede via its custodian to vote in favor of the merger; the arguments that those instructions were mistaken and unintended are irrelevant.
- The Transkaryotic, BMC Software and com line of cases allowing appraisal arbitrage is irrelevant, as those cases involved an absence of proof regarding how the petitioners’ shares were voted; here there is record evidence of how those shares voted. It is not enough to rely on Cede having generally voted enough shares against the merger as was true in the Transkaryotic cases. To read more from previous posts on this topic, click here and here.
- Also irrelevant was the apparent confusion caused by the proxy statement that was issued after the shareholder meeting was rescheduled, telling shareholders that that there was no need to re-vote if they had previously voted (and here, T. Rowe had previously voted “Against”).
- The court was unapologetic and unequivocal in reaching this decision. This is unlike the court’s July 2015 opinion which dismissed approximately 1 million petitioning shares based on the violation of the continuous holder requirement, in which the chancery court so much as asked the Supreme Court to reverse that decision. That decision arose from certain petitioners’ custodians having directed Cede to re-certificate the shares in the names of their own nominees rather than that of Cede.
- Rowe was given the merger price, without interest (the merger closed in October 2013).
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).
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.
- 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.
- 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.
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.
Seeking Alpha posted this analysis of The Williams Companies merger, which has seen its merger consideration shrink over nearly five months from $43.50 to just $18.40 as of February 19. According to the report, this translates to a loss of approximately 58% and nearly $20 billion in shareholder value.
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.
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.
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.