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Appraisal Rights Litigation Blog

Appraisal Rights a Hot Topic at 27th Annual Tulane Corporate Law Institute

Posted in Arbitrage, Interest on Appraised Value, Merger Price

Delaware judges, SEC leaders and lawyers from across the country convened in New Orleans last week for the 27th annual Tulane Corporate Law Institute, a two-day series of panels on March 19-20 analyzing Delaware corporate law and M&A deal making.  Appraisal arbitrage garnered considerable attention as several panels discussed the practice as well as the proposed legislation by the Corporation Council of the Delaware bar, which avoided any proposals to eliminate or limit the practice.  Several panelists were highly critical of the Delaware bar council for its refusal to curb appraisal arbitrage in any way, and expressed skepticism over the council’s findings that arbitrage did not stoke strike suits but instead advanced the statutory aim of investor protection.  In response to such criticism, Chief Justice Strine of Delaware’s Supreme Court observed that the reaction by arbitrage critics is overblown, and that the arbitrage phenomenon may well die down over time because funds that recover the merger price alone will not recoup their litigation expenses.  Accordingly, he predicted that the so-called event-driven funds pursuing appraisal arbitrage will be more selective in picking their spots and there may well be fewer of them down the road, and fewer such arbitrage plays, as a result.

On the related subject of interest — and the proposed legislation to allow acquiring companies to stop the statutory interest on at least a portion of the disputed amount by permitting them to prepay a cash amount, in whatever amount they may choose, on a non-recourse basis — Chief Justice Strine again chided the appraisal critics (who would prefer to see even further reductions to the interest component) by suggesting that the statutory interest award, even at 5% above the Federal Reserve discount rate, still does not compensate shareholders enough for being out of their money pending the appraisal litigation, especially in the past three years, during which time the statutory interest rate alone fell well below any credible market index.  The Chief Justice also observed that the legislative proposal allowing a non-recourse prepayment could itself eliminate or reduce much of the interest arbitrage pursued by petitioners.  Another panelist responded later in the day that the proposed prepayment legislation would not at all chill appraisal petitions, because the prepayment mechanism will only incentivize shareholders to redeploy their capital to pursue the next appraisal petition.

In sum, the Chief Justice closed his discussion by stating that appraisal rights enhance shareholder value and play a systemic role in promoting fair treatment.  Indeed, as he explained, unlike fiduciary duty actions, appraisal rights cases do not yield “disclosure only” settlements (which the courts tend to frown upon), and they are not pursued on a class basis and settled for “garbage.”  Thus, he concluded that the state of appraisal rights is not in crisis, and when the new proposals and the current case law play out, the incentives will require that only serious cases be brought.

Delaware Bar Finds That Appraisal Remedy Protects Investors

Posted in Arbitrage, Number of Appraisal Rights Filings, Record Date

We posted earlier this week regarding a white paper written by the Council of the Corporation Law Section of the Delaware state bar, which was issued alongside the Council’s proposed amendments to Delaware’s appraisal statute.  The Council had considered amendments to address the practice of appraisal arbitrage, but ultimately did not make any recommendations to eliminate or limit that practice.  One reason the Council decided not to act to curtail appraisal arbitrage is that it perceived certain concerns expressed over the negative effects of arbitrage to be overblown, as the Council reviewed data from studies of appraisal arbitrage that did not indicate a material uptick in speculative or frivolous appraisal litigation.  The following additional findings from the white paper further explain why the Council has suggested that the Delaware legislature not hinder appraisal arbitrage:

  • Default fiduciary duties may not suffice to ensure that merger prices reflect the fair value of a target company’s shares, especially in deals such as buyouts by a controlling stockholder and other transactions that are not subject to a market check.  In light of the fact that appraisal is a necessary remedy to protect shareholders, it would be much less effective if the appraisal statute were amended to curtail the ability to transfer that right.  The law generally looks favorably on the assignment of financial claims, and there is no principled basis to depart from that position in the appraisal context.
  • Appraisal actions tend to target two species of deals: conflict transactions and those involving questionable pricing.  In both of these instances, which in the Council’s words have “a greater potential for unfairness,” the appraisal award is often a premium (significant, in many cases) to the merger price.
  • “Appraisal cases attacking the merger consideration in non-conflict transactions are fewer in number and often result in appraisal results below or near the merger consideration.”
  • “To the extent that the buyer in a merger has concern about an increased number of merger claimants and the overall cost of the transaction, the buyer can negotiate an appraisal-out condition (e.g., a right not to close the merger if more than a specified percentage of shareholders dissent and demand appraisal).  The fact that such appraisal-out conditions remain fairly rare suggests that the availability of appraisal arbitrage is not a significant factor in the market.”

At least one commentator who represented the respondent in the Ancestry.com case and who had (unsuccessfully) requested the Chancery Court to disallow arbitrage in that case has been extremely critical of the Council’s determination not to limit appraisal arbitrage.  We will continue to monitor developments in the state legislature and report on the assembly’s reaction to the Council’s proposal.

Delaware Bar Committee Decides Not to Eliminate or Limit Appraisal Arbitrage

Posted in Arbitrage, Number of Appraisal Rights Filings, Record Date

We posted last week about new legislative amendments to the appraisal remedy proposed by the Council of the Corporation Law Section of the Delaware state bar association, an influential group of Delaware lawyers.  The amendments were accompanied by an explanatory white paper explaining the rationale behind those recommendations that the Council made, and of note, those it did not make.  In particular, the Council did not advance a proposal to limit or eliminate outright appraisal arbitrage.  We have posted previously about so-called appraisal arbitrage, in which professional investors purchase shares ‒ with attendant appraisal rights ‒ after the terms of a merger are announced but before the deal closes.  See here, here, and here.

By way of background, the Council had created a subcommittee in February 2014 to consider the desirability of amendments to the appraisal statute.  As the Council’s report explained, the very creation of the subcommittee arose in part because of the increasing use of appraisal arbitrage and resultant commentary as to whether arbitrage was consistent with the intended purpose of the appraisal statute.  As the Council further reported, several considerations led the subcommittee to recommend, and the Council to conclude, that the appraisal statute should not limit appraisal rights to shares held before the public announcement of a proposed transaction.  In specific, the Council found that appraisal arbitrage is not contrary to the “balance” envisioned by the Delaware appraisal remedy, which the Council identified to be “the ability of corporations to engage in desirable value enhancing transactions and the ability of dissenting stockholders to receive fair value for their holdings.”  One of the primary factors behind this finding was the Council’s determination that appraisal arbitrage ‒ and appraisal litigation more generally ‒ does not encourage frivolous litigation.  As the Council found: “Unlike the case of representative litigation, which occurs in more than 90% of the public mergers and consolidations, only 17% of the appraisal eligible transactions during 2013 resulted in appraisal litigation in Delaware.”

We will post some additional highlights from the Council’s report later this week.

Can Drag-Along Provisions Eliminate Appraisal Rights [Part 2]?

Posted in Drag-Along Rights, Preferred Stock, Waiver of Appraisal Rights

As we have posted previously, whether a voting agreement, or so-called drag-along provision, can be successfully enforced to prevent common stockholders from seeking appraisal is an open question in the Delaware courts.  And so it remains, even in the wake of Halpin v. Riverstone National, Inc., (Del. Ch. Feb. 26, 2015), in which the Court of Chancery faced the question of whether common shareholders can be charged with having waived their statutory appraisal rights in advance of the transaction under a drag-along provision.  The drag-along provision at issue did not actually include a waiver of appraisal rights, and instead required the minority stockholders to vote in favor of a change-in-control transaction upon advance notice of the transaction.  While in theory an agreement that forces a shareholder to vote in favor of a deal arguably leads to a waiver of appraisal rights insofar as such an agreement eliminates a stockholder’s opportunity to provide the requisite dissent from the proposed merger, it is also true that in order to be effective such an agreement would have to be in place prior to any vote on the transaction.  In Halpin, the company did not invoke the drag-along provision until after the merger vote, so the Court avoided deciding the question of whether a waiver took place and instead held that as a matter of contract the minority stockholders were free to seek statutory appraisal of their shares.  The minority shareholders obviously could not be forced to consent to a deal that had already occurred.

The Court did assume, without deciding the issue, that as a theoretical matter holders of common stock could indeed waive their appraisal rights by contract in advance of a transaction.  But that assumption is simply that, an assumption, which as a legal matter was not decided and remains an open question of law.  The Court also noted that, unlike common stockholders, it is well-established Delaware law that  preferred stockholders may waive their appraisal rights.  Indeed, we have previously posted here about the important differences between the appraisal rights of preferred and common stockholders, and Chancery once again acknowledged the unique nature of the preferreds’ appraisal rights.

Delaware Bar Committee Introduces Proposed Legislative Amendments to Appraisal Remedy

Posted in Arbitrage, Dollar Amount of Appraisal Rights Filings, Interest on Appraised Value, Number of Appraisal Rights Filings, Record Date

The Corporation Council of the Delaware bar released proposed amendments to Delaware’s General Corporation Law last week.  Among the various proposals, ranging from fee-shift provisions to forum-selection clauses in corporate bylaws, the committee proposed two changes to Delaware’s statutory appraisal remedy: first, to bar appraisals by shareholders holding 1% or less of the outstanding stock of a public company if the value of their shares is $1 million or less as based on the merger price; and second, to allow acquiring companies to stop the statutory interest on at least a portion of the disputed amount by permitting them to prepay a cash amount, in whatever amount they may choose.  The proposed amendments to the appraisal statute are here, and the Corporate Council’s white paper explaining the amendments is here.

The legislature has not yet approved or even considered these proposals; we’ll post about any developments in that regard.  In the meantime, the first such proposal will not likely have much of a practical impact, as there are not too many petitions, if any, brought by stockholders with such a small position.  After all, a holder of a $1 million stake would not have sufficient economic incentive to bring an appraisal petition in the first place, given the expert and other litigation costs incurred in pursuing such a claim.  It presents a limitation on such a rare class of cases so that the proposal will have precious little consequence.  But that does not mean the legislature will readily take up the measure.  There may be a concern among some legislators that once an effort is underway to eliminate “small” claims, future proposed amendments could take aim at cutting off larger claims.  As to the second proposed amendment, the option of allowing respondent companies to make cash prepayments might have interesting results; it could encourage companies to prepay significant amounts, even up to the full merger price, just to stop the interest clock, which in turn could actually encourage more appraisal claims by inviting challenges from otherwise-reluctant stockholders concerned about having their capital locked up during the pendency of the appraisal proceeding.

Significantly, the proposals do not include an amendment to eliminate or limit appraisal arbitrage; we’ll post more about that issue in the coming days.

Supreme Court Affirms Without Opinion Chancery’s Resort To Merger Price

Posted in Arbitrage, Fair Value, Independent Valuation, Interest on Appraised Value, Merger Price, Synergies

Last week the Delaware Supreme Court’s en banc hearing in the CKx case resulted in a simple affirmance, without opinion, of the Chancery Court’s 2013 decision that the merger price in this particular case was the best proxy for the fair value of petitioners’ stock.  In CKx, the Chancery Court had rejected the valuation methodologies presented by both sides and yet also failed to consider any other valuation approach, pointing instead to the price paid by the acquirer as the most reliable indicator of fair value given its finding that the merger price was the product of a fulsome and robust auction process.  The Supreme Court also rejected the company’s request to set fair value below the merger price after taking out supposed synergistic gains that the acquirer had planned to capture from the merger entity (to which post-merger synergies dissenting stockholders are not entitled by statute).  Likewise, the Supreme Court rejected the company’s cross-appeal challenging the full award of statutory interest at 5.75%, affirming Chancery’s ruling that it had no authority under the appraisal statute to permit the respondent to compel the petitioners to accept a partial pre-payment of the award that would cut off the accrual of interest.

As reported by Reuters, if you read the Supreme Court order in CKx as setting the market price as a floor in appraisal litigation, rather than a ceiling, and after taking the statutory interest award into account, the decision may ultimately incentivize appraisal arbitrage for big investors.

**Note: this law firm is of counsel to the appellant-petitioner shareholders in CKx.

Delaware Chancery Court Looks to Merger Price for Fair Value

Posted in Discounted Cash Flow Analysis, Fair Value, Independent Valuation, Merger Price, Valuation Expert

We posted last month about the Delaware Chancery Court’s ruling in Ancestry.com, in which it upheld the growing practice of appraisal arbitrage. The Chancery Court has now rendered its valuation decision in that case, finding the merger price itself to be the most fair measure of stockholder value on a going concern basis. As Reuters has reported, the court also declined to find fair value below the deal price. To the extent that the court relied on merger price for its valuation, it is reminiscent of the same judge’s decision in the CKx case, which is currently scheduled for en banc review next week in the Delaware Supreme Court (as we have previously posted). But unlike the court’s approach in CKx, in Ancestry.com the court undertook a DCF analysis based on the parties’ competing valuations. The court’s own DCF analysis yielded a value 21 cents short of the $32 merger price, but given its uncertainty over the projections, the court said it was uncomfortable insisting that a buyer who actually put its own money at risk nevertheless overpaid. The court refused to second-guess the market price, especially given what it found to be a robust sales process.

The court expressed skepticism over the reliability of any after-the-fact valuation analyses, suggesting that valuation experts are more in the business of reverse engineering to arrive at their pre-selected values than in presenting the court with truly objective values. To underscore the point, the court cited one side’s expert who saw it as his job to “torture the numbers until they confess[ed].” The other side’s expert likewise suggested that if he had reached a valuation that widely departed from the merger price, he would have had to find a way to reconcile those numbers, or, as the court put it, he would have “tailored his analysis to fit the merger price.” One option the court did not address is having the court itself engage a non-party independent valuation expert to report its own analysis directly to the court, which the Chancery Court has done in the past.

With respect to the particular DCF issues the court addressed, the court focused on certain components in the calculation of terminal value that have not traditionally been addressed in court opinions, including how to determine the “plowback” ratio — the percentage of future profits that the company would have to “plowback” into capital expenditures to remain competitive over the long term — and whether to “normalize” EBIT margin. Both of these adjustments can temper the valuation-enhancing effect of a high terminal growth rate. Another interesting issue raised by this case is whether and, how to account for stock-based compensation (SBC) in a DCF, which is especially significant for Internet-based companies in particular, as they tend to have large SBC components to their employee compensation programs. Here, the court concluded that SBC had to be taken into account, and it did so in a way that reduced its valuation.

Finally, the court lamented that appraisal actions are unique in that each party bears the burden of proof, such that if neither party meets its burden, the burden instead falls on the court. But this observation effectively repeats the long-standing principle that courts in appraisal cases are required to perform an independent analysis. In that regard, it will be interesting to see how the Supreme Court reacts next week to this judge’s prior opinion in CKx and whether the court sufficiently discharged its duty to perform an independent valuation when it deferred to the merger price as the only reliable indicator of value after having rejected the valuation methods proposed by the parties, unlike its approach in Ancestry.com.

Lawyers Who Lost Ancestry.com Ruling Call for Legislative Reform of the Appraisal Rights Statute

Posted in Arbitrage, Merger Vote, Record Date

We recently posted about the two related January 5, 2015 arbitrage decisions, in which the Delaware Chancery Court refused to impose share-tracing requirements or other obligations on beneficial stockholders and reaffirmed that only record owners bear the burden to no-vote their shares and otherwise perfect their appraisal rights. This week the lawyers defending Ancestry.com, whose arguments were rejected by the Court, have posted this blog calling for legislative reform of the appraisal rights statute to remedy what they perceive to be a “troubling expansion” of stockholder appraisal rights.

How Appraisal Rights Litigation Adds Value to Deals

Posted in Arbitrage, Fair Value, Interest on Appraised Value, Merger Price, Number of Appraisal Rights Filings

A new piece by Reuters Breakingviews, M&A at Last Finds a Way for Lawsuits to Pay, covers last week’s rulings on appraisal arbitrage by the Chancery Court in Ancestry.com and BMC (which we posted about last week), and also observes generally that appraisal actions are “surprisingly successful” and are thus witnessing a surge in filings over the past few years. The author finds appraisal cases to be “the rare litigation strategy that can benefit investors more than their lawyers.” The article also briefly discusses the upcoming en banc hearing by the Delaware Supreme Court scheduled for February 2015, in the appeal of the appraisal of CKx shares, which we’ve addressed in a prior post.

In conjunction with this article, the author discussed his research and findings about the success of appraisal actions in a short Reuters Breakingviews video, “A New Way to Make M&A Hay.

 

Delaware Chancery Reaffirms Appraisal Arbitrage Strategy

Posted in Arbitrage, Fair Value, Merger Vote, Notice of Demand for Appraisal, Record Date

In two separate rulings on January 5, 2015 — In re Appraisal of Ancestry.com., Inc., and Merion Capital LP v. BMC Software, Inc., both by Vice Chancellor Glasscock — the Delaware Chancery Court reaffirmed the legitimacy of the appraisal arbitrage strategy and refused to impose share-tracing requirements or other obligations on the beneficial stockholder, continuing to require only of the record owner that it perfect appraisal rights by not voting in favor of the deal and making a timely demand for appraisal. News of these rulings has already been widely reported, including by Reuters and The Wall Street Journal.

We’ve posted before about arbitrage opportunities in appraisal rights and the increased utilization of this strategy by professional investors. Indeed, we had been awaiting the Chancery Court’s ruling in Ancestry.com, as it presented the first opportunity since the Delaware appraisal statute was amended in 2007 to decide whether the Court’s prior ruling in Transkaryotic would remain good law in light of that amendment.

Both new cases address the practice of so-called appraisal arbitrage, in which an investor buys the target company’s stock after a merger announcement. In the Ancestry.com case, the Court rejected the company’s argument that given the 2007 amendment to the appraisal statute — by which Delaware’s legislature expressly permitted beneficial owners to file appraisal petitions directly on their own behalf — the beneficial owner should be required to show that its predecessors did not vote in favor of the merger, and if it cannot do so, it lacks standing. The Court held that under a plain reading of the statute, it remains the record holder alone who must have no-voted the shares for which it seeks appraisal; the statute does not impose any requirement on a stockholder to demonstrate that previous owners also refrained from voting in favor. In other words, the Court affirmed Chancellor Chandler’s previous ruling in Transkaryotic that the actions of the beneficial holders are irrelevant in appraisal actions, and the Court thus refused to adopt the company’s proposed share-tracing requirement. As a matter of procedure, the Court denied the company’s motion for summary judgment on this issue; the appraisal decision itself has not yet been made and will issue separately.

The ruling in Ancestry.com is thus the first decision to uphold appraisal arbitrage after the 2007 statutory amendment was made; Transkaryotic, which first permitted arbitrage, was decided in 2007 prior to the amendment. The ruling in Transkaryotic was based in large part on Chancellor Chandler’s accounting for the fact that in a typical situation the owner of stock certificates, such as Cede & Co. — which is usually the nominal owner of shares that are on deposit with the Depository Trust Company — holds their shares in an undifferentiated manner in “fungible bulk,” and so no shareholder has ownership rights to any particular share of stock. Vice Chancellor Glasscock’s new ruling continued to recognize that reality and found nothing in the 2007 amendment to Section 262 to suggest that the Delaware legislature intended to require beneficial owners who made post-record-date purchases to show that their specific shares were not voted in favor of the merger. In fact, the Court found Ancestry.com’s proposed requirement to contradict and be invalidated by the Court’s prior approach in Transkaryotic.

The action in Merion Capital v. BMC Software was brought by Merion Capital, a self-described “event-driven investment” fund that specializes in appraisal arbitrage. The stockholder in that case faced a unique problem because Cede refused to make its appraisal demand on its behalf, so Merion was forced to have its holdings in BMC stock withdrawn from the “fungible mass” at DTC/Cede and registered directly with BMC’s transfer agent, Computershare. Merion thus sought to become its own record holder as well, and the Court found that it succeeded in doing so and properly made demand. BMC challenged Merion’s standing by saying Merion needed to prove that each share it seeks to have appraised was not voted by any previous owner in favor of the merger. The Court rejected BMC’s challenge and found that Merion succeeded in showing that it had not voted the shares in favor of the merger; as it did with Ancestry.com and Transkaryotic, the Court held that nothing in the statute requires a stockholder to prove that the specific shares it seeks to appraise were not voted in favor of the merger.

These rulings clearly reaffirm the validity of appraisal arbitrage, at least as a legal matter. Of course, as a practical matter, that strategy remains subject to the very real risk that the number of shares presented for appraisal actually outnumbers the number of no-voted shares eligible for appraisal, causing the appraisal action to be oversubscribed. The Court refused to make any pronouncement on how it might rule in such an overappraised situation, since it was not presented with those facts in either of these two cases.