A South African trial court has found that an investor who owned shares of a parent company which sold off its operating subsidiary is entitled to appraisal rights. The case concerns the appraisal rights of an activist investor in the company KWV, which had an operating subsidiary that owned liquor assets. According to a press account, the original merger was structured as a purchase of the KWV operating subsidiary, leaving the holding company with some property, art and cash. The investor demanded appraisal, arguing that the transaction for ~13 South African Rand per share undervalued his shares in the holding company – which he pegged as worth significantly more, and which a press account says the acquirer valued at ~25 South African Rand. As the proceedings progressed, the investor’s entitlement to appraisal was challenged on the basis that the acquirer did not purchase the holding company – just the operating subsidiary. The South African court rejected this argument, finding that the investor has appraisal rights and thus may continue his appraisal claim.

*** Lowenstein Sandler LLP does not practice in South Africa and does not provide advice on South African law. The content of this post is derived from press accounts about the case.

In Delaware, appraisal is a creature of statute. It is a statutory claim, born from 8 Del. Code Section 262; it is a claim in its own right, but it also carries with it statutory requirements. Appraisal requires that the right kind of demand be sent at the right time by the right entity. Quasi-appraisal is a creature of the common law and, as lawyers from Blank Rome observe in a growing concern for deal lawyers. Whereas appraisal rights claims are basically individual in nature, quasi-appraisal has been brought as a potential remedy for a class of all shareholders who have otherwise foregone their appraisal rights.

The differences between appraisal and quasi-appraisal go deeper than just their source in statute or common law. While appraisal is a well-defined “claim” in its own right, quasi-appraisal is far more akin to a remedy than to a claim. While both demand a determination of “fair value,” the vast majority of Delaware case law determines fair value within the confines of the statutory appraisal scheme, including, for example, a bar on considering synergies. Quasi-appraisal is more “amorphous”–as the authors observe–and can frustrate predictability in a merger. Whereas appraisal claims must, by statute, be known (and pressed) at a certain time, quasi-appraisal remedies/claims can pop up later, after the appraisal window has closed.

The authors of this piece also point out that unlike appraisal, the quasi-appraisal remedy is often connected to a breach of fiduciary claim (note that appraisal claims require no breach of any duty and require no proof of any wrongdoing by anyone). Breach of fiduciary duty claims, in turn, are directed at the corporate officers and directors, not the company itself, and those officers and directors, in turn, may have indemnification rights from the company or the insurance that covers claims against them. The takeaway then is that a when a party is seeking quasi-appraisal, it may well involve many more parties and may come up at a time well past the otherwise statutorily set appraisal window. As the authors observe:

[A]s quasi-appraisal claims continue to increase, the predictability that comes with the timely perfection of appraisal rights may be lost. Buyers may need to consider more than just the number of dissenting stockholders and, more specifically, also consider if a class of all (or most) of the stockholders would or could pursue a quasi-appraisal claim against the seller’s former directors for which the buyer might have indemnity responsibility. … [The] intersection of quasi-appraisal remedies and directors’ indemnification rights could put a buyer potentially at odds with a seller’s former directors, and highlight further unanticipated deal risks. Navigating these changing tides in Delaware corporate law is of critical importance, particularly for buyers, and these considerations should receive appropriate attention in the early stages of the deal negotiations.

In the wake of the Dr Pepper decision that a reverse triangular merger does not carry appraisal rights and considering corporate counsel’s growing concern over appraisal petitions, one might wonder whether we will see a rush of reverse triangular mergers in order to try and thwart investor’s appraisal rights. Lawyers from Fried Frank say no in this Law360 piece [$$$]. At its core, the authors focus on the Chancery Court’s own, footnoted view that a rush to reverse triangular mergers is an “overstated” risk, because the structure has been known and employed before. The authors agree that there will not be a move toward this contorted merger structure (with a major caveat, covered below), writing this:

In our view, it is unlikely that the structure would be broadly used solely for the purpose of avoiding appraisal rights. We note that the structure involves the disadvantages of complexity (making it potentially impractical in any competitive bidding situation) and leaving an equity stub in the hands of the target public stockholders (a result that acquirers typically disfavor). Moreover, generally, with an exception possibly in the case of conflicted controller transactions, it would be inadvisable to structure a transaction based primarily on avoiding appraisal rights–given that appraisal claims are made only in a relatively low (and recently declining) percentage of transactions, that appraisal awards significantly above the deal price are made only rarely (recently, even more rarely), and that appraisal awards at (or even below) the deal price have been increasingly prevalent recently.

This is a notable analysis. The authors contend that the structure may be impractical when there are competitive bids (i.e., when appraisal is not particularly favored to begin with) and then draw an exception for conflicted-controller transactions (when appraisal would be favored because of issues with the deal process. Put another way, the reverse triangular merger structure may not be used when appraisal isn’t viewed as much of a threat to begin with. But does Dr Pepper open the door to using this anti-appraisal structure in the exact kind of deal where a significant appraisal uplift is possible, such as conflicted-controller transactions? The authors seem to acknowledge as much.

As appraisal risk continues to be meaningful in conflicted-controller transactions, the Dr Pepper structure might be attractive in these situations if the controller is prepared to leave some of the equity of the target company with the sellers. We note that the public equity stub could be eliminated through a reverse stock split following completion of the merger; however, there would be an issue whether that additional step might (1) convince the court to view the structure as an impermissible contrivance to avoid appraisal (thus leading to a different result than in Dr Pepper) and/or (2) raise fiduciary issues and affect the court’s review of the transaction under the “entire fairness” standard. … There are other, less complex structures that could be considered and that could render appraisal rights inapplicable, although, of course, any novel structure could raise business and practical issues and prompt legal challenges.

Like with the appraisal amendments and differing predictions of how those would affect appraisal filings, the impact of Dr Pepper on choice of deal structure remains to be seen.

A new piece by Skadden focuses on some old, and some new factors regarding prepayment. Since the 2016 appraisal amendments, respondents in an appraisal proceeding have had the right to ‘prepay’ some or all of the merger consideration.  The mechanics of this are basic, but deserve a moment of explanation.  In appraisal proceedings, unlike in many other lawsuits, the petitioner/plaintiff already owns something of value (stock) at the start of the proceeding – the Court’s job is to determine how much money that stock is worth.  At the end of the proceeding, which is potentially years away from the start, the petitioner is due interest on the funds they were denied during the pendency of the lawsuit – i.e., the value of their stock as determined by the Court.  As an example: if a merger occurred for $10 a share (merger price), and a shareholder demanded appraisal for 10 shares, it may be 2 years before the Court determines that the “fair value” of those shares was actually $15 a share.  The shareholder has lost 2 years of use of $150 of value, and thus is due interest on that.  Even if the Court found that the merger price was fair value, the shareholder still has lost 2 years of use of $100 – and interest would attach to the $100.

Now, enter prepayment.  It is doubtful, if not impossible, that any appraisal proceeding would ever reveal a value of 0 for the appraising shares – so a company will always owe some interest on some portion of the consideration. In order to allow a company to reduce its interest risk, while also providing the shareholder use of their value, in 2016 the Delaware legislature allowed companies to prepay some (or all) of the consideration, and thereby cutoff the interest clock on the portion they prepaid.  Multiple companies have taken this route in their appraisal proceedings.

Last year, we covered how prepayment had been progressing after a year, and how the reality compared to suggested prepayment factors and strategies considered in the runup to the 2016 change in law. As we near the two year mark, others have continued to cover the factors for and against prepayment.  Skadden’s new piece points out that the federal reserve (which sets the ‘base’ interest rate on which the appraisal-related interest rate is determined) has been increasing rates over time.  This augurs for prepayment as the interest exposure goes up as the base rate goes up. Skadden also points out that prepayment can ‘break up’ the need for capital to pay off the appraisal consideration  – as opposed to a company having to come up with the entirety of the appraisal consideration at the end of the case, when business conditions, interest rates, or other financial considerations may be different.

Each case will no doubt be different, and no one size fits all strategy of prepayment will apply.

In April 2018, shareholders of Dr. Pepper filed a lawsuit challenging a merger with Keurig – a deal they called convoluted and which was allegedly designed to deny them appraisal rights.  One particular branch of that challenge, that the deal itself actually should have carried appraisal rights, was decided in June 2018 against the shareholders.  Dr. Pepper shareholders will not have appraisal rights in this reverse triangular merger because, as the Delaware Chancery Court found, Dr. Pepper is merely the parent of the subsidiary merging with Keurig and not the “constituent corporation” the statute requires.   A constituent corporation, the Court wrote, is one that is actually “being” merged or combined. Here, while Dr. Pepper’s original shareholders will end up as 13 percent minority shareholders in the combined entity, with Keurig shareholders owning the rest, the formalities of the merger are such that only a Dr. Pepper subsidiary is “being merged” – hence, no appraisal rights.

Further, the Court found that since an original Dr. Pepper shareholder would still be a Dr. Pepper shareholder (albeit, significantly diluted) after the ‘merger’ – the shareholder is not giving up their Dr. Pepper holdings, and thus, no appraisal rights.

Might this be a template for those seeking to avoid appraisal rights in the future?  Perhaps.  Though the Delaware court seemed concerned with the opposite effect: that applying appraisal rights in this instance may change the meaning of the appraisal statute for a relatively rare merger structure and specific set of facts.  But with appraisal prominent in corporate counsel’s minds, perhaps a rare deal structure will become more common.

As shown in a presentation to the Association of Corporate Counsel, despite predictions (and calls) for the death of appraisal, it remains prominent in discussions of M&A trends. In the May 10, 2018 presentation, attorneys from Cadwalader discuss their view of “Dell-Compliance” – noting a series of factors that would make a deal more likely or less likely to reflect fair value. For example (in this instance, using AOL as an example), a company that was approached by “other logical buyers” with a good merger process and without a prohibitive breakup fee is, according to the authors, more likely to be Dell-compliant than a deal where a buyer had an informational advantage, there was a no shop provision, and the existence of public statements by management all augured against Dell-compliance.

It’s a general truism that appraisal only directly benefits those who dissent and seek fair value for their shares.  But appraisal can also spur further litigation – especially when the result of the appraisal decision is a 100% premium over merger price. Such is the case with Shanda Games Limited. While our friends in Cayman have covered the Shanda Games Cayman appraisal, US litigation has followed.  In a class action complaint filed in the SDNY, ex-Shanda shareholders have alleged that the Shanda board made misrepresentations in the lead-up to the merger, relying in part on the findings of the Cayman courts in their determination of Shanda’s fair value.

While appraisal requires no showing of wrongdoing, a board could overstep in campaigning for (or perhaps, against) a merger – and thus lead to additional fiduciary duty or securities law liability. As we previously covered, appraisal can be linked to disclosure obligations, and the failure to make proper disclosure can lead to liability.

Can a block of appraisal demands derail a merger?  In South Korea, they certainly can. In the recent Hyundai-Mobis deal, involving a transfer of assets by Hyundai of assets from one Hyundai entity to another Hyundai entity, the deal contains a 9 percent “appraisal condition.” If 9 percent of shares demand appraisal, Hyundai may be forced to kill the deal – or else pay 2 trillion SKWon ($1.8BB USD).

We’ve posted before about appraisal ‘blow’ provisions. And mid last year, media reports speculated on whether appraisal filings (in that instance, looking at the US) would cause companies to take steps to address appraisal risk. With the Hyundai deal, we see an example of this in action.

We previously covered the proposed DGCL amendments, which would make changes to the appraisal statute with respect to intermediate-form mergers, and clarify requirements for disclosure with respect to the number of shares not voting for a merger.

If adopted, the appraisal amendments would become effective August 1, 2018.

Coverage of these proposed amendments has intensified; here are some highlights:

It is exceedingly uncommon for stock-for-stock transactions to be effected as a two-step tender offer/merger under§251(h). One of the possible reasons for this [ ] is the insulation from appraisal claims that a long form merger offers (and that a two-step transaction does not). By eliminating this discrepancy, the proposed amendments to the DGCL potentially increase the utility of the§251(h) two-step merger structure. That said, in a stock-for-stock transaction, the acquiror will be required to register its shares on Form S-4 (or Form F-4), and often will not commence the exchange offer until after its registration statement has cleared SEC comments.

Effectively, the current statute permits appraisal rights for intermediate-form mergers even if the market out exception would apply to the analogous “long-form” merger, which requires shareholder approval.  The proposed amendment would eliminate this illogical result and provide the same exception to appraisal rights for mergers under 251(h) as are provided for long-form mergers.

The amendments to Section 262(e) would modify the information to be included in the statement that must be furnished to dissenting stockholders upon their request in connection with Section 251(h) mergers. In recognition of the fact that no shares are “voted” for the adoption of the merger agreement in a Section 251(h) transaction, the amendments would clarify that the surviving corporation must provide stockholders, upon their request, with the number of shares not purchased in the tender or exchange offer, rather than the number of shares not voted for the merger.”

Further coverage here, and here.

In its recent blog post, VentureCaseLaw covers a 2015 Delaware decision and how Delaware law deals with appraisal in instances where a Company has drag-along rights. In summary:

Venture-backed companies should not assume an implied waiver of minority appraisal rights in a merger that utilizes a voting agreement’s drag-along rights if procedural requirements are not followed. When a waiver of appraisal rights has procedural requirements, they need to be followed or eliminated via an amendment. Alternatively, the drag-along can require minority stockholders to explicitly approve the sale, instead of having the sale be de facto valid without their signatures given the drag-along.