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We’ve covered South African appraisal rights before – it remains a jurisdiction with active valuation and appraisal disputes making the news.   One recent news article recaps a situation involving South African appraisal in the case of Sabvest Capital/Sabcap.

Per the article, and this filing, “Sabcap” acquired all the shares of “Sabvest” in exchange for Sabcap shares via a scheme of arrangement. (For US readers, a scheme of arrnagement can be understood to be a form of merger of acquisition but involving additional steps).

South Africa provides appraisal rights under Section 164.

Certain Sabvest shareholders demanded appraisal, requiring a Court to determine the fair value of Sabbest shares.  Petitioners/Applicants initially set out that R69,21 (~$4.75 USD at current exchange rate) represented the fair value per Sabvest share.    They referenced the published NAV of Sabvest shares of R66,89 (~$4.50) as a point in favor of their valuation.

Sabvest/Sabcap responded that Sabvest was worth either R30,00 (~$2.05) or the 30-day Volume Weighted Average Price of R33,67 (~$2.30).   Sabvest/Sabcap apparently offered R33,67 in settlement.

We can view this as the ‘bid-ask’ spread in an appraisal negotiation.  Both parties having set out positions with a significant spread: about R39,21 (~$2.70).

The parties ultimately resolved the matter, again, per the article and filing, with the vast majority of shares settling for R47,54 (~$3.25).  This is close to, and only slightly under, the midpoint of petitioners demand and Sabvest’s offer.

South African appraisal remains an active area of appraisal and we look forward to covering issues in the future.

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The Delaware Court of Chancery was asked last week to approve a $6.85 million settlement in case brought by a class of public stockholders challenging a corporate restructuring alleged to have favored insiders at the expense of the class.

According to this Law360 article, PennyMac Financial Services, Inc. had been set up as an “Umbrella-C” or “Up-C” structure, whereby an LLC held all of the public company’s operating assets.  This structure was supposed to provide certain benefits to large stockholders and insiders BlackRock and HC Partners LLC, but the company restructured in 2018 after the Up-C structure proved unfavorable.  The plaintiff class alleged the restructuring provided massive tax benefits to insiders, which were not shared with common stockholders.  The case had previously survived a motion to dismiss after Vice Chancellor Kathleen S. McCormick found that, due to various conflicts, the case may be decided under an “entire fairness” standard of review.

Entire fairness is the highest review standard available when reviewing transactions – favoring plaintiff-shareholders challenging a transaction and requiring the company to show, in effect, that the deal was entirely fair.

But the high standard of review was only part of the case.  Because there was no deal price associated with the restructuring, Plaintiffs would have had to employ different and potentially novel damages theories in pursuing the case through trial.  With both parties facing risk, the shareholders and company reached the settlement.

This case demonstrates that when a corporate action – even if not a merger – seems to benefit insiders at the expense of minority shareholders, shareholders have a wide variety of claims to potentially vindicate their rights.

In a comprehensive ruling handed down last week, the Grand Court of the Cayman Islands confirmed that minority shareholders of companies that undertake a ‘short-form’ merger are entitled to dissent from the merger and to be paid fair value for their shares, as determined by the Grand Court. The ruling, delivered in Changyou.com Limited, has wide-ranging implications, given that a number of Cayman Islands mergers have already been completed without dissent rights being offered to minority shareholders.

Read further analysis here.

New Law Enforcement Challenges: Is it Marijuana or Hemp? - Cannabis Business Times

As reported in this Law360 piece, “Illegality Nixes Most of Marijuana Investment Scheme Suit,” a Colorado judge dismissed an investor’s fraud claim against the principal behind an investment vehicle whose strategy revolved around the Colorado cannabis industry.  The court found that the relief sought would violate the Controlled Substances Act, underscoring the perils of investing in a space that remains federally illegal.  While courts generally understand themselves to be capable of granting relief so long as such relief does not require the production or distribution of marijuana, as the article reports, the lines defining that distinction are not nearly as clearly drawn as such a test may suggest.

This decision yet again demonstrates how federal illegality is a key aspect of cannabis valuation and litigation, and must be considered at each stage.

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In an apparent question of first impression, the Delaware Court of Chancery is considering whether stockholders in a Delaware corporation can relinquish their rights to object to the sale of the company and waive fiduciary duty claims through a stockholder agreement.  Law360 reports here that Vice Chancellor Sam Glassock III has asked for supplemental motion-to-dismiss briefing on the role the implied covenant of good faith and fair dealing, as well as public policy arguments, should play in applying such provisions in stockholder agreements.

Several minority stockholders, including Manti Holdings LLC, sued the controlling stockholder Carlyle Group and the directors of the company, Authentix, claiming Authentix and its board accepted a “fire sale” price because Carlyle was seeking a quick exit from its majority interest in the company.  Vice Chancellor Glasscock previously held that the stockholder agreement barred the minority investors’ statutory appraisal rights in a decision that has been appealed to the Delaware Supreme Court.  It would appear that if the stockholder agreement’s bar against merger objections and waiver of fiduciary claims is upheld, the Authentix minority stockholders will be left with no remedies for the alleged “fire sale.”

Nevada Lawmakers Head to Oregon – Cannabis Fact-Finding (with audio) - Oregon Cannabis Connection

In this interesting piece on cannabis valuation, Oregon Cannabis: What is My Partial Marijuana Dispensary Ownership Interest Worth?, Harris Bricken takes a look at the value of a less-than-100% interest in an Oregon marijuana dispensary, and what may happen if an LLC needs to value the interest of a former member after a forced expulsion from the LLC.

As we’ve written about before, LLC valuation and appraisal rules can be unique and depend on each states’ rules.

Marijuana Business Opportunity Cannabis Business Start Marijuana Business Cannabis Events

As reported by Law360 here, state regulators in California have proposed regulations designed to decriminalize under state law activities by banks and accountants working with the cannabis industry, purporting to ease access to financial services for marijuana businesses.  Such state legislation appears more symbolic than realistic, however, as most banks will continue to refuse working with cannabis businesses as the industry remains illegal under federal law.

The unique nature of marijuana businesses, and their complex interplay with state and federal regulatory regimes, as well as the unique risks they face all make for a complex valuation picture.

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Do stockholders as a group lose something when the appraisal remedy is weakened, perhaps overly so?  And should something be done about it?  Is there social utility in appraisal arbitrageurs testing merger prices, such as by keeping buyers and sellers honest in what may otherwise be a rather unfair market?

These questions are addressed, along with a policy (legislative) prescription in the 2020 article: Protecting the Social Utility of Appraisal Arbitrage: A Case for Amending Delaware Law to Strengthen the Appraisal Remedy after Dell by Thomas Meriam.*

Starting from the no-doubt accurate premise that “the appraisal remedy [has perhaps become] the most divisive and contentiously debated issue in Delaware corporate law” – the article first sets out to describe the Dell case (which we have written about extensively) and the fallout that has resulted since.

The empirics are straightforward: appraisal activity, at least public appraisal activity involving public companies in Delaware, has fallen since a surge in the mid-2010s.  And tracing that back to Dell and progeny is a fair move.

The article criticizes Dell, and more concretely, courts who have considered Dell in inconsistent manners or looked at Dell as an overly simplistic rubric – creating what the article describes as a “merger price deference rule” contrary to the statute and statutory intent.  And another critique follows as well – if the legislature intended appraisal to simply revert to merger price, why have appraisal?

The Article goes on to set out its most fundamental premise: appraisal arbitrage may be “the last line of defense for stockholders.”  Setting out its premises, the article argues: First: fiduciary litigation has been weakened as a result of the rejection (in certain courts) of ‘disclosure-only’ settlements, and – critically – the connected issue that fiduciary duty litigation now generally does not involve discovery, and thus has little chance of finding corporate wrongdoing.  Second: appraisal arbitrage offers a way to police corporate malfeasance.  The article argues that the threat of viable appraisal arbitrage sets a “reservation price” for the firm.  Citing Korsmo and Myers, the article notes that appraisal arbitrage cases generally targeted mergers with “highly negative residual premiums” – put another way: meritorious cases where the selling stockholders were getting ripped off.

With fiduciary litigation less able to ferret out malfeasance, the fall of appraisal arbitrage (per the article), leaves shareholders vulnerable.  The article traces the fall to Dell and DFC Global, but then focuses on the post-Dell cases, applying Dell, such as Aruba Networks, and notes that the short attention the Delaware Supreme Court has given to the reasoning in certain chancery court decisions has left the appraisal arbitrage area with poor precedent – less predictable, and where predictable, predictable only in deference to merger price.

What to do?  If appraisal arbitrage is beneficial to shareholders (and there is certainly evidence appraisal itself is beneficial to shareholders, though that evidence is contested) the article proposed legislative solutions.  In particular, the article suggests adding language to DGCL 262(h) restricting how a court can rely on deal process and deal price, or adding an equitable consideration component.

The article makes an interesting case for legislative changes to strengthen the appraisal remedy.   We would add one further: appraisal started as a compromise, and another compromise seems warranted again now. Stockholders, in exchange for the loss of the unanimity requirement in approving M&A transactions – something surely impossible given the size and complexity of today’s corporations, were given appraisal as a remedy for their lost hold-up power; they would now (re)gain a right that afforded minority shareholders fundamental protections against oppression by the majority (and management).  Appraisal started as a check on the abuses of management and the majority, and, in part, on the idea of resistance to short-termism – and can return to this valuable check in the future.

Weakening appraisal weakens minority shareholder rights because it weakens the threat of appraisal as well.  It weakens the need to consider appraisal in M&A deals, and weakens the disclosure regime that upholds a significant portion of Delaware corporate law and the US securities laws.  Strengthening appraisal may very well, paradoxically, result in fewer successful appraisal claims, as better deals mean better value for shareholders.

Read the entire article here [.pdf].

*Suggested citation: Thomas J. Meriam, Protecting the Social Utility of Appraisal Arbitrage: A Case for Amending Delaware Law to Strengthen the Appraisal Remedy after Dell, 85 Brook. L. Rev. (2020).

Major proxy firm Institutional Shareholder Services (ISS) issues guidance every year for investors laying out ISS’s recommendations for voting on various shareholder issues.  The 2021 US voting guidelines, in line with the 2020 guidelines, recommend voting in favor of appraisal rights.  This is of little surprise as appraisal rights remain critical shareholder rights and can provide immense value to shareholders in certain situations.

ISS also issues guidelines for investors focused on specific issues.  For example, ISS’s 2021 Climate Proxy Voting Guidelines also endorse appraisal rights, while mostly focused on issues of interest to investors seeking to bring about other forms of corporate change, generally in the “ESG” (Environmental, Social, and Corporate Governance) arena.

Prior ISS ‘specialty’ guidelines include their Catholic Advisory Services Recommendation – which, again, was in favor of appraisal rights.

The Delaware Supreme Court heard argument on January 13th in the SourceHOV case, with interesting issues on the proper standard of review, the concept and application of operative reality, and expert credibility coming up.  Some key questions asked and argued were:

  • Of relevance to private company investors: what is the standard of review appropriate when there is no market evidence for an appraisal fight, and the Court is forced to decide between a ‘battle of the experts’?  While questions of ‘standard of review’ may seem foreign to investors, the standard of review can heavily influence how likely a higher court is to leave the decision of the lower court in place.  Here, where SourceHOV has so far refused to pay the investors despite the judgment, a sense of how likely the decision being overturned is would weigh into any calculation of resolution.
  • Of relevance to all investors interested in appraisal rights:  How must a court deal with the “operative reality” of the company? Operative reality speaks to what is ‘actually’ occurring at the time of the challenged corporate action.  For example, in 2017 case SWS, changes to SWS’s capital structure as the result of cancelling debt in exchange for equity were part of the “operative reality” because the exercise of the warrants and debt cancellation was a known element of value as of the Merger Date and was not conditioned or contingent on the merger.   Operative reality depends on the facts of each specific case.
  • And of relevance to all: how much does expert credibility matter, and how is credibility overall determined by the trial court in an appraisal case?  Of relevance here, in SourceHOV, the Company’s expert, and the Company, were considered less credible in part because of extremely low valuations, as well as alleged malfeasance regarding the backdating of a document. As one prior analysis observed, the Chancery Court, in a case where the parties agreed that market based evidence of value was lacking or irrelevant, went back to ‘traditional’ valuation methodologies, ultimately adopting the vast majority of the petitioner’s expert’s discounted cash flow analysis based on the credibility of that analysis.

We’ll continue to cover this case as the Delaware Supreme Court renders its decision.

You can view arguments of the Delaware Supreme Court here.

You can read Law360’s review of the argument here.

We previously covered the Chancery Court decision here.