Below is a roundup on 2024 proxy voting guidelines that have come out in favor of appraisal rights. We’ve previously covered that numerous investors support appraisal rights when the issue is at the corporate ballot box. Here are some more proxy voting guidelines in favor of this pro-investor remedy:

Major proxy adviser ISS: “Vote for proposals to restore or provide shareholders with rights of appraisal.”

Boston Partners: “Vote FOR proposals to restore or provide shareholders with rights of appraisal.”

Franklin: “We vote for proposals to restore, or provide shareholders with, rights of appraisal.”

Clearbridge: “We vote for proposals to restore, or provide shareholders with, rights of appraisal.”

J.P. Morgan Asset Management: “Vote for proposals to restore, or provide shareholders with, rights of appraisal. Rights of appraisal provide shareholders who are not satisfied with the terms of certain corporate transactions the right to demand a judicial review in order to determine a fair value for their shares.”

MassPRIM: “Appraisal rights give shareholders the right to receive an independent valuation of a company’s fair value stock price from a court during a merger or asset transaction, and to have the company purchase shares of the stock at this
price. These rights allow shareholders recourse if they believe the price they received from the deal was under fair value. Shareholders may earn statutory interest on the award between the merger and the date the appraisal price is paid.
MassPRIM will generally vote FOR management or shareholder proposals to restore or provide shareholders with rights of appraisal.”

Horizon Mutual Funds (follow ISS): “Vote for proposals to restore or provide shareholders with rights of appraisal.”

New Hampshire Retirement System: “Vote for shareholder proposals to provide rights of appraisal to dissenting shareholders.”

This post kicks off a running series of thoughts we’ll be sharing on earn-outs.  But first, some basics.

Earn-out provisions appear to solve several problems in the M&A space: they might provide the grease needed to close a sticky transaction, easing a buyer’s concerns over the target’s strategic fit or expected performance.  They could also alleviate financing pressure by reducing the buyer’s cash at closing requirements. 

But their initial superficial appeal is often overshadowed by the difficult realities of enforcing these agreements over time.  Despite the lofty goal of attempting to align the buyer’s and seller’s interests post-closing, they are just as likely to foster sharp disagreement over missed expectations or to engender more threshold problems such as definitional debates over whether those expectations were even met in the first place.

On occasion, they work.  Very often, they don’t.  While intended to bridge valuation gaps, earn-out agreements very often trigger the costly disputes they were intended to avoid, spawning fights over valuation metrics or unresolved questions as to just what the required thresholds really are:

  1. Post-Acquisition Realities: No amount of pre-closing drafting and planning can account for unforeseen integration challenges or real-world external events that could hamper the target’s performance.
  2. Allegations of Interference: Targets often accuse the buyer of carrying on a course of conduct that itself hinders the expected performance and thus appears to justify the buyer’s withholding of arguably earned payments.
  3. Ambiguous Metrics: despite careful drafting, the performance criteria outlined in the agreements often turn out to be vague or disputable when played out in reality.
  4. Accounting Disputes: Varied accounting practices themselves may lead to conflicting performance calculations, even where a specific accounting firm is designated or a particular accounting convention is specified.
  5. Material Adverse Changes: Unforeseen shifts in the firm, the industry or the larger economy are likely to impact business performance and spawn disagreements over whether the earn-out requirements could have been made in that climate.

It’s tempting and rather facile to argue that earn-out disputes can be solved if only the parties committed themselves to better drafting early on, at the documentation stage.  But the most experienced transactional counsel, who have been drafting sophisticated earn-outs for years if not decades, are still capable of failing to predict just what operational or mechanical difficulties will impede unambiguous acceptance by both sides of whether the requisite thresholds were met. 

It goes without saying that earn-out agreements should be carefully crafted to minimize ambiguity.  And that exhaustive pre-deal investigations is essential to mitigate potential conflicts.  Indeed, several other basic protections are necessary – but not sufficient – conditions to guard against outright failure for missing any predictable problems that would inevitably eviscerate the value of an earn-out:

  • Documented Tracking is needed to put in place robust performance systems and generate transparent progress reports along the way;
  • Open Communication is key to prevent simple misunderstandings; and
  • Mediation or Arbitration dispute resolution mechanisms are helpful to manage the parties’ control over the timing and confidentiality of any resolution procedures and can even help deter protracted litigation or arbitration by reining in the parties’ choice of forum and manner of litigating any dispute.

But thorough attention to all of these considerations is still not enough to ward off conflict.  We are hard put to find any credible M&A lawyer willing to an earn-out provision is unassailable and guaranteed to work without controversy.  The better questions to ask during the negotiation stage isn’t whether litigation will ensure over an earn-out, but when, and how costly and protracted it might be.

Indeed, the sooner the parties accept the likelihood that litigation will follow from an earn-out clause, the better their expectation management will be.  Whatever early promises of alignment and cooperation an earn-out may tantalize the parties with, those hopes are often dashed by performance and market factors – as well as basic linguistic disputes over the contractual terms – knocking the well-planned merger off course.  Yes, there are strategies to mitigate some risks, and very often there’s no better alternative to an earn-out provision, but it’s always best to go eyes wide open into the post-acquisition venture, understanding that the can of initial conflicts may have simply been kicked down the road while the closing is able to proceed. 

There’s no shame — and often no alternative — to walking through a rainstorm, but forgetting your umbrella is an unforced, unnecessary mistake that doesn’t take too much forethought and planning to avoid.

On April 23, 2024, the FTC announced a rulemaking banning noncompete agreements. Noncompetes, which generally restrict employees from working for competitors after leaving a company, have faced increasing scrutiny in recent years. With the new rulemaking in place, how will banning noncompetes (if ultimately implemented) affect valuation litigation?

Noncompetes act as a negative right of the corporate entity – they aim to block competition after an employee or similar leaves an employer. The more so the value of a company is based on its human capital and workforce assets, as opposed to property, plant and equipment assets (or similar), the more so a noncompete ban can affect value.

The healthcare industry is one are where noncompetes are generally common (setting aside jurisdictions that already ban them) and for logical reasons. The healthcare workforce, its experience, knowledge, and stability, often forms the core value of healthcare businesses. Noncompetes remain a controversial topic in the industry.

More generally, a noncompete ban is likely to result in some valuation impacts, including:

  1. Litigation Over the Impact of the Ban on Pending/Contemplated Transactions. Pending transactions, or contemplated ones, will necessarily have to take into account whether the ban affects their value. Deals agreed to pre-ban but with a likely closing date post-ban may be affected, but so would any deal where the fundamental value premise is based on retention of human capital. This will likely result in valuation litigation over these deals.
  2. Focus by Parties on the Value of Talent Retention and Recruitment: Noncompete agreements can act as a deterrent for talented individuals considering employment opportunities. Banning such agreements would likely increase the mobility of skilled workers, encouraging them to explore new job prospects without the fear of legal repercussions. In valuing a business focused on human capital, experts will necessarily focus on the value the enterprise is able to gain from that human capital before the ban and after. Similarly, more granular assessment of corporate value may be required when focusing on the specific human capital and goodwill of these businesses.
  3. Possible Increase in Valuation for Junior Players: Noncompetes have faced criticism for inhibiting innovation, stopping seasoned employees from launching entrepreneurial ventures or moving to junior rivals in an industry. Increased innovation potential could translate into higher growth prospects for companies, positively impacting their valuation metrics.

Any significant rule change can affect valuation and lead to valuation litigation. With that said, the impact should not be over-hyped. Several jurisdictions already ban noncompetes, the rule is currently being challenged in court, and even as written has several significant exceptions (including upon sale of a business). Nonetheless, it always bears note that valuation is a creature of the regulatory, legal, and in some cases cultural landscape of the time. Any change to that landscape can lead to change in value.

The Fifth Circuit Court of Appeals – the federal appeals court covering Texas, Louisiana, and Mississippi – is not known for being a particularly friendly forum for investor-plaintiffs.  But perhaps that reputation is unwarranted, in particular when it comes to the issue of proving “loss causation” under the federal securities law. 

Loss causation is one of the elements that a defrauded investor must prove under Rule 10b-5.  Under the Private Securities Litigation Reform Act, an investor must show that the defendants’ misrepresentations caused the investment losses – and were not the result of some other factor unrelated to the fraud, such as a decline in the market or industry as a whole. The most common way to establish loss causation is for the investor to show (usually through an event study conducted by an expert) that the issuer’s stock price declined in connection with the release of information relating to the fraud.  Most courts have rejected the notion that news causing the stock price drop must actually use the word “fraud” or admit conscious wrong-doing.  Indeed, fraud can be revealed (and harm investors) via a series of partial-but-incomplete disclosures of the underlying truth or by the gradual materialization of a previously concealed risk. 

However, recently, a few stray courts have adopted a much higher standard for loss causation, requiring that the corrective information directly reveal the fraud itself, as opposed to the truth the fraud concealed.  This more-exacting standard would suggest it is nearly impossible to establish loss causation except in the extremely rare case where an issuer who commits securities fraud confesses to conscious wrongdoing.  In fact, issuers often take steps to prevent the truth from coming out in a clear and conspicuous manner, such as by burying the revelation of fraud-related information with the disclosure of other news – a process known as information bundling that has been discussed by the SEC and commentators.

Given its reputation as a judicially conservative forum, one might expect the Fifth Circuit Court of Appeals to be among the courts adopting this heightened standard for loss causation.  But that is not the case.  In fact, the Fifth Circuit has adopted a practical approach for assessing loss causation that is grounded in economic reality and acknowledges that the revelation of the truth can take various forms. 

For example, In Spitzberg v. Houston American Energy Corp., 758 F.3d 676 (5th Cir. 2014), the Fifth Circuit held that the disclosure causing the stock price drop need not “squarely and directly contradict the earlier misrepresentations.”  In another case, Public Employees Retirement System of Mississippi v. Amedisys, Inc., 769 F.3d 313 (5th Cir. 2014), the Fifth Circuit explained that “[a] corrective disclosure can come from any source, and can take any form from which the market can absorb the information and react.”  The Amedisys court further found that sometimes there will be multiple partial disclosures, which, taken collectively, reveal the defendant’s fraud to the market – even though none of them standing alone directly discloses the truth (not that there was conscious misconduct).  The Fifth Circuit has expressly declined to adopt a standard that a corrective event must precisely mirror the alleged misrepresentation because doing so would allow “a defendant [to] defeat liability by refusing to admit the falsity of its prior misstatements.”  Alaska Elec. Pension Fund v. Flowserve Corp., 572 F.3d 221 (5th Cir. 2009).

The Fifth Circuit’s approach to loss causation is consistent with the salutary purpose of the federal securities laws.   It does not allow investors to recover losses that were not caused by the defendant’s fraud.  At the same time, however, it protects investors by prohibiting a crafty defendant from evading liability for wrongdoing through concealment or obfuscation of the truth.  In that sense, the Fifth Circuit provides a forum that is perhaps more investor-friendly than some might anticipate.

The debate over “MFW creep” tends to distract from understanding just what protections the Delaware courts have been intending to provide in controller transactions.  Much of the commentary on the Delaware Supreme Court’s recent ruling over’s restructuring focuses on the “MFW creep” sideshow rather than the main event: the question of who the Delaware courts are trying to protect.

So-called MFW creep consists of the Delaware courts’ expansion of MFW review beyond the controller squeeze-out transaction in which the MFW doctrine was born.  The much-awaited ruling in was widely framed as a test for whether Delaware’s Supreme Court would push back on such “MFW creep” and limit the expansion of that doctrine.  Even framing the issue this way is confusing and diversionary: MFW reflects a significant protection extended to a controlling stockholder and the board that supports it, an exit ramp off the road to entire fairness review down to the more easily navigated path of business judgment.  By extension, then, a phenomenon known as MFW creep would logically be though to consist of an expansion of those controller protections, and yet it was the company and the controller of seeking to curb MFW review and encourage a push-back against MFW creep.  The defendants wanted an easier path to business judgment review than what MFW would have required. 

Just like centrifugal force is only an apparent force that appears to contrast with the very real dynamic of centripetal force, the concept of MFW creep is more apparent than real.

This point was nicely captured at the Tulane Corporate Law Institute in New Orleans last month, an annual gathering of Delaware law jurists and lawyers.  At a March 8 panel on Conflicts, Controllers, Entire Fairness & Delaware, several notable panelists, including Justice Karen Valihura of the Delaware Supreme Court and Gregory Varallo of Bernstein Litowitz, discussed evolving Delaware case law regarding controller transactions.  The panel addressed the most notable controller-transaction case of the year and years to come, Tornetta v. Musk, which invalidated Elon Musk’s $55 billion performance-based equity compensation award.  In that case, Chancellor McCormick found Musk to be a controller while owning only a 21.9% ownership stake in Tesla, and also found the shareholder vote approving the compensation package was uninformed.  These factors impelled the holding that the transaction was not “cleansed” under MFW, and the Court utilized entire fairness review rather than business judgment review.

As the panel addressed whether the Musk decision reflected MFW creep, Varallo noted the absurdity of framing the issue in that manner, given that MFW is what allows boards to “cleanse” controller transactions that would otherwise face stricter scrutiny if not for that MFW cleansing.  As Varallo put it, MFW was a gift to defendants, and talking about its “creep” in a manner that was somehow damaging to controllers and boards of directors was non-sensical.

The continuing discussion about MFW creep seems to go hand-in-hand with some muted alarmism about whether Delaware is losing its edge as the cradle of modern corporate law and the most reasonable safe-haven for companies to incorporate.  Musk himself publicized this debate rather widely after griping about having his pay package struck down by the Delaware court.  Like the question of MFW creep, the question of Delaware losing its relevance is overblown.  Nevada and Texas, the natural runners-up to Delaware, are not exactly overloaded with applicants for incorporation fleeing the First State just yet.

Which constituency is the Delaware court trying to protect?  All of them, in a continuing balancing act safeguarding the best interests of the company and its constituent members – the board, management, a controller, minority stockholders. itself demonstrates how the narrow focus on MFW creep unfairly limits the analysis to a binary equation of whether the controller will benefit from a cleansed transaction or not, when the reality is more multi-layered: the Supreme Court indeed extended MFW beyond its squeeze-out paradigm, but was willing to give the defendants the benefit of that cleansing if only they met the MFW prerequisites.  But they didn’t.  So, back to Chancery for an entire fairness review.  Nothing creepy about that.

RKS thanks Daniel Kalansky, Partner at Loria e Kalansky Advogados and Professor in the LLM program at Insper University for this guest post.  Professor Kalansky holds a PHD in Corporate Law from the University of São Paulo – USP and is the Former president of the Brazilian Institute of Business Law – IBRADEMP.   To contact the author:

*** RKS does not practice in the Federative Republic of Brazil and takes no position on Brazilian law or changes to it. ***


Appraisal Rights and Fair Value as Investor Protection: A Needed Brazilian Reform

It was in Professor Joshua Mitts’ class, based on his article “Asking the right question: The Statutory Right of Appraisal and Efficient Markets”, co-authored with Professor Jonathan Macey, that made me reflect on the share value for appraisal rights in Brazilian law and subsequently formed the basis of my thesis to achieve my PHD in Brazil, which later was published as a book prefaced by Judge Karen Valihura of the Supreme Court of Delaware.

My thesis focuses on the following questions: what would be the best valuation method to determine the value of the shares of a company in an appraisal process? Should a mandatory legal criterion be predetermined, or should the law allow for the corporation itself determine such criteria in the bylaws? Is calculating the reimbursement model adopted in Brazilian legislation the most adequate to produce the desired effects of the appraisal rights in publicly held corporations?

The current Brazilian Corporation Law (Law nº 6.404 of 1976) sets book value as the standard method to define the share value, even in the case of a listed company. Companies may adopt a different approach in their corporate by-laws; however, few have done so. This method does not reflect the company’s inherent value, which results in shareholder’s not being offered a fair value.

Appraisal rights are unlikely to be effective in Brazil, since the valuation criterion used, the book value (in the omission of the bylaws), does not consider the goodwill, or the profitability of the company, and, consequently, produce smaller measures of fair value. Thus, the disparity in the application of such is evident because: (i) the impact on the company’s management is minimal, since the chances of a shareholder requesting appraisal rights are small; (ii) the minority shareholder is provided with the misconception of choice between staying in the company and enduring an ownership environment that could potentially be non-beneficial to them or leave and receive only a fraction of the value of what the investment represents; (iii) the company provides for reimbursement at a value well below that of the market and, from this perspective, retains unjust enrichment.

In Brazil, appraisal rights do not effectively manage to boost investor protection, because the valuation method leaves most of the company value out of the equation, since the valuation method provided for in the Law, whenever the bylaws do not provide for one, is the book value of the company, regardless of any particularities of the company.

In the State of Delaware, United States of America, Section §262 of the Delaware General Corporations Law, dissenting shareholders shall receive the fair value of their shares. This means that, for each case, the Court must seek the best method for meeting the company’s fair value. In Italy, the reimbursement must be calculated using the six-month running average of closing prices on the stock exchange, for listed companies.

Considering such a theoretical framework used in Unites States of America or in Italy, it is evident to observe flaws in the Brazilian Corporation Law, which regulates appraisal right in Brazil. It is fair to conclude that, when the law determines that the appraisal right must be calculated according to the book value, the value for the shares would be below fair value, as the law would stipulate that the shareholder buy the shares based on profitability however receive the company’s book value when requesting appraisal rights.

The setting of an appraisal right amount in the bylaws is at the company’s discretion; the Brazilian Corporation Law does not require companies to provide for this, but they are allowed to, if they wish to do so.

However, based on the assumption that almost all listed companies do not adopt an assessment criterion in their bylaws, the appraisal rights operating scenario is not practical to provide adequate protection to the minority shareholder, in view of the prevailing notion that, in the absence of not being listed in the bylaws, book value is applied.

This results in the minority shareholder being left with an illusion of choice between leaving the company and receiving reimbursement or remaining and accepting the new shareholder environment. This is a choice between suffering the decision they disagree with or paying to leave the company.

Thus, the Brazilian Corporation Law should take it upon itself to determine the calculation of the value of the shares for the purpose of reimbursement, expressly establishing the valuation criteria, and not leaving this to the freedom of varied interested parties.

In my opinion there are rights that should not be bargained against contractual freedom, that is, they should be non-negotiable and exposed to pricing, as they represent “public order laws” that cannot be waived by the will of the parties.

Appraisal rights are a legal remedy to protect the minority shareholder against the decision-making power of the controlling shareholders. The current wording of the appraisal right calculation allows for parties to choose the calculation criterion for a right that is essential, whose function should be to “cure” a problem.

It is safe to conclude that the reimbursement value should be provided for as public law and be non-negotiable. It is also understood that the criterion adopted by Section 45 of the Brazilian Corporation Law obscures the intention of the law. While creating a necessary right, it allows for compensation to be minimal. In this scenario, the dissenting shareholder is unlikely to be effectively reimbursed for his investment.

If the amount the shareholder will receive does not result in a material difference to the company, the right will be considered virtually useless, who “wins, however does not gain the spoils”. Thus, it is unacceptable, for the legislator to grant an ineffective right.

However, despite this legislative drama, one case judged by the Brazilian Superior Court of Justice, contrary to the prevailing doctrine, understood that, in the case of omission of the bylaws, the criterion of book value should not be applied, as the value calculated for the appraisal right harmed the minority shareholder. (BRASIL. STJ. RE No. 1.572.648).

It can be said that the Superior Court introduced the use of the “fair value” thesis in Brazil. The existence of this decision confirms the premise that the Brazilian Corporation Law is controversial in relation to the valuation method in the absence of the bylaws and that there is room for interpretation of what price effectively corresponds to the share value mentioned in the caput of art. 45 of the Brazilian Corporation Law.

My conclusion was that an amendment in our Brazilian Corporation Law is required to establish the fair value as a mandatory rule to obtain the payment for the dissenting shareholder to protect the minority shareholders and foster the capital market.

Stewart Investors, an asset manager focused on emerging markets equity, reaffirmed its policy of voting in favor of appraisal rights in its most recent proxy guidelines.  Keeping it simple, Stewart wrote it would “Vote for proposals to restore, or provide shareholders with, rights of appraisal.”

This is consistent with its prior proxy guidance, which we covered here.

For US readers, the idea of voting in favor of appraisal rights may not entirely track – appraisal rights are (generally) set by state law.  But this ignores two salient details. First, even in the US, appraisal rights are sometimes a matter of shareholder vote – especially in LLC or alternative corporate firm scenarios.  Second, appraisal rights, especially in non-US jurisdictions, can be a creature of contract and shareholder proposal.

The near unanimity of investors in voting in favor of appraisal rights speaks to the reality that appraisal rights are pro-investor.

Boston Partners Logo

Boston Partners, a specialized equity investor with nearly $75 billion under management, says to vote for appraisal rights as part of its proxy guidelines.  This is no surprise as appraisal rights are critical shareholder rights, especially in instances of unfair mergers or management’s actions that undervalue the company.

Boston Partners’ proxy guidelines join those of major proxy advisory firm ISS and many others in guiding votes in favor of appraisal.

The State of Michigan Retirement System Proxy Voting Guidelines are straightforwardly “for” on appraisal, writing:

“Appraisal rights are intended to help protect shareholders from unfair pricing in corporate transactions. The SMRS will vote for proposals that (i) provide shareholders with appraisal rights, (ii) restore rights of appraisal, or (iii) which otherwise support rights of appraisal.”

Voting in favor of appraisal, a right that, as SMRS recognizes, helps protect shareholders from unfairness, is a common theme among proxy guidelines.

Major proxy advisory firm Institutional Shareholder Services (ISS) issues guidance every year for investors laying out ISS’ recommendations for voting on various shareholder issues.  The 2022 US voting guidelines recommend voting in favor of appraisal rights when such rights are on the ballot.  This is in line with the 2021 guidelines (which we covered).  Continued support of appraisal rights is unsurprising as appraisal rights remain critical shareholder rights and can provide immense value to shareholders in varied situations, including as a check on minority shareholder oppression.