Legal news site Law360 ran this analysis [$$$] of Aruba, focusing on whether the decision should be seen as a fight between valuation methodologies, or between two courts trying to fulfill their respective roles. The Chancery Court, left to apply the Delaware Supreme Court’s precedent to complex fact situations and manage cases from their infancy through decision, may be struggling with the Dell and DFC decisions. The Supreme Court, perhaps reconsidering some of the positions it held as law in Dell and DFC, is left to ‘police’ the lower court as that court struggles to apply sometimes conflicting rules and views.

As the diverse reactions to Aruba consider, no doubt scholars will analyze the decision (and decisions still to come) as part of both the evolution of appraisal law, but also in how lower courts and higher courts interact.

It looks that way, according to this analysis on the CLS BlueSky Blog. From the authors:

  • “… investors pay close attention to how stock-based deals affect the acquirer’s short-term earnings per share (EPS). Merger announcements are regularly accompanied by discussions of whether the deal will be accretive or dilutive for the acquirer’s EPS, and if immediately dilutive, how quickly the deal would turn accretive. Finance theory, however, does not imply any particular benefit of an EPS-accretive deal (in which the post-merger EPS is higher than the acquirer’s pre-merger EPS), focusing instead on whether the deal creates value.”
  • “… post-merger EPS is mainly determined by the stand-alone EPS of the acquirer and target, the incremental earnings from deal synergies, and the number of shares issued by the acquirer to finance the deal.”

The evidence the authors analyze suggests deals are structured to avoid EPS dilution and that deals which would be dilutive under an all-stock purchase are then done in cash. In short: “cash and mixed deals replace stock deals when the latter become dilutive.

Even assuming a deal is good for both acquirer and target objectively, it remains a question what portion of the deal synergies (or, more simply, value) will accrue to the acquirer versus the target. The evidence adduced by these authors is not good for the target: the target is giving up premium to have the acquirer avoid EPS dilution. The authors explain: “For deals with a range of feasible exchange ratios that allow for a premium and accretive EPS, a smooth distribution of bargaining power between acquirer and target would suggest that, for pure stock deals, the exchange ratio would also be smoothly distributed. In contract, what we find is that there is a clustering of deals just below the dilutive exchange ratio. This result suggests that the target is giving up part of the premium to enable the acquirer to avoid EPS dilution.

How is this relevant to appraisal? As readers of this blog may know, all-stock deals are not appraisal eligible (at least in Delaware), whereas stock+cash deals are appraisal eligible. This may be one factor that contributes to the “costs” which, per the author’s evidence “prevent small amounts of cash from being used to mitigate the minor EPS dilution.” In addition, the evidence suggests that target management may be willing to part with premium to assist the acquirer get the deal done – ultimately shortchanging their shareholders.

Does the valuation method parties pursue, and that a Court uses, matter to the ultimate valuation of a firm? This recent paper studying data from Finnish appraisal of private terms over a 16 year period suggests that the choice of methodology does matter.

For readers of this blog, or those who know of appraisal predominantly through the Delaware-dominated and – more relevant here – public company dominated area, this conclusion may seem obvious. Of course valuation methodology matters to valuation!  Important to recognize is that appraisal is not solely (or even mostly) a concern for shareholders in large, publicly traded companies with likely liquid public markets for their securities. Instead, appraisal is often the remedy of the minority shareholder in a private firm; the oppressed shareholder or the person being squeezed out of an enterprise. Unlike with some large public company transactions, the “merger price” in such instances is almost definitively not set by an arm’s length transaction, and the ‘merger’ itself often involves the irreducible conflict of management being on both sides of the transaction.

These cases are further complicated by the fact that because no public market exists for the individual shares of the business (and setting aside whether a market may exist for the business as a whole), and thus the valuation question is far more tabula rasa (blank slate) for an appraiser of a private company. The Finland evidence suggests that in such instances, the choice of valuation method is a significant determinant on how the valuation comes out.

More generally, this is evidence against the “rationality” perspective and for the “measurement” perspective – per the authors “The ‘rationality’ perspective believes that the choice of a valuation method does not affect the outcome. That is, the valuation estimate incorporates all the available information pertaining to the valuation, and the chosen valuation method is rationally adjusted if needed. Conversely, the ‘measurement’ perspective argues that the chosen method determines which information and adjustments are incorporated into the valuation estimate. In other words, the limitations and biases inherent in valuation methods manifest themselves in valuation estimates.”

We’ve covered before that major proxy voting analyst Taft-Hartley suggests investors vote in favor of appraisal rights and that a major pension fund’s guidelines likewise favor appraisal. Add Boston Partners, a major investment manager, to the list of those favoring appraisal rights in their proxy voting, according to their 2019 proxy voting guidelines [.pdf]. This follows, as research suggests appraisal can be favorable for shareholder value.

Legal news site Law360 published this analysis [$$$] about whether, in light of Aruba, it’s time for a new “checklist” on appraisal. The core takeaway is something academics have been observing over time: appraisal is growing closer to breach of fiduciary duty litigation – and the space between the two types of cases is shrinking. With that said, appraisal remains a distinct type of action, even if the substantive room for the remedy is (as the authors content) is reduced.

While there are many areas of appraisal up for debate, and actively being debated in the Delaware courts, sometimes there’s an easy one.  When a company engages in a merger, under the DGCL, the Company must timely notify shareholders of their appraisal rights if those rights exist. What a company cannot do – as its alleged the Defendant in Anurag Mehta v. Mobile Posse Inc. et al. did – is conduct a merger in secret, complete with an alleged a failure to inform shareholders of their appraisal rights. (Case number 2018-0355, in the Court of Chancery of the State of Delaware).

Appraisal notices are critical to shareholders, especially in smaller or more closely held entities, as the shareholders may not have full information about whether the corporate action at issue triggers their appraisal rights. (And sometimes even the lawyers allegedly get it wrong.)

By timely including an appraisal notice, or a statement that appraisal rights are unavailable, the Company both fulfills its statutory duty and also serves its shareholders. Here, Mobile Posse is alleged to have failed in that – in part, by including incorrect appraisal information in its supplemental notice of the merger, rendering the whole supplement incorrect. Sometimes we have to go back to basics: getting the appraisal notice right.

Read more about the Mobile Posse case at Law360 [$$$].

Yes – at least according to Professors Korsmo and Myers. In this piece from the HLS Forum on Corporate Governance, the Professors argue that the Aruba decision continued a trend of the Delaware Supreme Court misapplying certain modern finance concepts, starting most glaringly in Dell and DFC, and with Aruba only slowly turning the ship back towards a truer course. The Professors argue that the decision makes four errors: (1) failing to differentiate between how diversified and undiversified investors price risk; (2) misapplying market efficiency concepts in particular the difference between a market for an entire company versus the market for a share of the company; (3) conflating meeting fiduciary obligations with the factors suggesting an environment of pricing efficiency; and (4) viewing valuation as a mechanical exercise, while it must contain some human judgment.

Professors Korsmo and Myers are two of the most respected names in the arena analyzing appraisal rights – we’ve written about their work on a number of occasions.

Sometimes!  Appraisal is almost always an issue for the shareholders of the target, or seller, corporation.  But, in very rare instances, the shareholders of the acquiring corporation may have appraisal rights.  Enter the 2005 case of Proctor & Gamble and Gillette.  In 2005, Procter & Gamble (P&G) announced a multibillion dollar merger with Gillette, to be consummated a stock-for-stock reverse triangular merger.  A P&G merger sub would merge into Gillette, giving P&G control of Gillette.   (Regular readers of this blog may recall that a similar structure was used recently by Dr. Pepper, in a case where the Court found no appraisal rights.)

For the P&G merger – Gillette was  Delaware corporation.  And under Delaware law, stock-for-stock mergers (nevermind reverse triangular stock-for-stock mergers) lack appraisal rights.  But under Ohio law, which governed P&G, a Ohio corporation, P&G shareholders would have appraisal rights.  See P&G’s SEC filing.  Under Ohio law, a P&G shareholder dissenting from the merger would be entitled to receive fair cash value of their shares – even though P&G would be the surviving company.  The final result was the extremely odd event that the seller shareholders lacked appraisal rights, while the buyer shareholders had appraisal rights.  The parties took this account in their deal, providing that the deal was conditioned on a 5% ‘blow’ provision – but as to the buyers shareholders exercising appraisal.

The lesson of the P&G case is that when dealing with non-Delaware appraisal, it is especially important for practitioners and investors to not assume the Delaware regime applies.  Regimes outside Delaware, especially foreign regimes, may have rules allowing stock-for-stock appraisal; or, stranger still, appraisal for an acquirer’s shareholders.  Every merger and every situation needs to be evaluated.

A recurring topic in appraisal litigation (and merger litigation more generally) is that potential buyers, and in particular those who are most engaged with the company get a “look under the hood” that general investors do not.  But this simplistic analogy may actually understate the informational advantage of a buyer compared to the market at large.  Shareholders often are left in the dark – until a merger is announced, often as a fait accompli – as to possible conflicts, as to side deals made between a buyer and the board, or as to other potential buyers the board has either not considered or cast aside.

One answer to the informational asymmetry, proposed in “A Governance Solution to Prevent the Destruction of Shareholder Value in M&A Transactions” by Stephen Weiss, is to appoint an independent monitor, who acts on behalf of the shareholders themselves, able to observe and report on corporate governance and Board actions.  While one could consider the appointment of a monitor in a number of scenarios, we focus on its application to a merger.  The article suggests that an independent monitor (defined by a lack of relationship with the Board, the buyer, and the company) could both protect shareholders against Board actions against their interest, but also protect Boards against merger-related litigation challenging parts of the merger.  In the context of appraisal, an independent monitor could act to review the deal process and make (effectively live) comment on whether the deal process is Dell-compliant.

A monitor is one of many potential ideas being floated to alter the merger process (such as blockchain solutions, which we have covered before), seeking to make the process fairer and more efficient.

From Deallawyers.com, observing that the decision can be read as a pretty direct rebuke to the lower Court, and focusing on the Delaware Supreme Court’s finding that the lower court decision appeared “results-oriented.”

From Bloomberg Law, arguing that Aruba harms appraisal arbitrage (despite rejecting unaffected stock price), but concluding that “ . . . the court’s decision, which narrowly applied to the facts in the Aruba case, raises questions because it doesn’t settle the dispute on how much weight to give the market price” and “. . . raises questions about when and where to use them, or what kind of evidence is needed[.]”

From Business LawProf Blog, discussing how Aruba fits with Dell and DFC in how one figures out what the real purpose of the remedy is.

From Reuters, on how Aruba may hurt appraisal arbitrage.