[Guest Post by Professor Alexandros Seretakis]*

In 2019 the European Union adopted the Mobility Directive, which introduces significant amendments to the legal framework for cross-border mergers aimed at enhancing legal certainty and diminishing the transaction costs of such operations. Most notably, the Directive introduces an appraisal remedy as a protection mechanism for minority shareholders in cross-border mergers in the EU. The adoption of a harmonized shareholder remedy was considered to be necessary because of the dangers posed by the change of the applicable company law for shareholders of the merging company after the cross-border merger. In the absence of appraisal rights, shareholders of the acquired company could involuntarily become members of a company incorporated in a jurisdiction with weak minority shareholder protection leaving them exposed to expropriation by controlling shareholders.

Overall, the adoption of a harmonized appraisal regime in the EU is a welcome development. It signals that the EU legislator recognizes the importance of appraisal rights for the protection of minority shareholders. Indeed, academic research has univocally documented that investor protection is crucial for capital market development and economic growth Nevertheless, significant scope of improvement remains. The appraisal regime, currently applicable only to cross-border mergers in the EU, should also be extended to domestic mergers, which also pose dangers to minority shareholders, such as an inadequate merger consideration or expropriation by controlling shareholders. Moreover, the new appraisal regime does not achieve full harmonization in crucial areas, such as the calculation of fair value where Member States accord differing importance to different valuation methods.

Read the working paper here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4931617

**RKS does not practice outside the United States and presents this information for educational purposes only. For legal issues, consult a licensed professional in your relevant jurisdiction.

It’s been eight years since the Delaware legislature amended the appraisal statute to allow appraisal respondents the discretion to prepay some or all of the merger consideration, and at a time of their choosing.

We have previously blogged to mark the anniversary of this statutory amendment, one year after the amendment and two years afterward; seems like a good idea to refresh on this lively issue today.

The amount and the timing of any prepayment is entirely within the discretion of the appraisal respondent; the stockholder has no say-so or other input into this piece. The appraisal target is faced with a game-theory proposition of wanting to pay enough to stop the interest clock on outstanding merger consideration, on the one hand, while leaving ample room to argue that the appraised fair value should fall somewhere comfortably below merger price, on the other hand.  After all, it is well settled Delaware law that prepayment amounts are not subject to clawback or disgorgement, so any amounts prepaid cannot be recovered by the appraisal target.  Hence the decision-making around how best to size the prepayment amount to meet the competing interests of (i) halting the interest accrual without (ii) setting too high a floor on the appraisal fair-value determination.  

By our anecdotal experience, prepayment amounts tend to be in the range of approximately 75 to 80% of merger consideration, with those levels increasing in a high-interest rate environment.  (This is contra to some early academic commentary, which suggested prepayment would be rare.) Of course, the exact prepayment amount will obviously vary in any particular case, based on such factors as the respondent’s financing costs, integration success and litigation-risk management concerns, among others.

We’ve covered South African appraisal rights before, including the mechanics of appraisal, results from that jurisdiction, and the reach of the statute. In a new journal article in the South Africa Law Journal, Professor Maleka Femida Cassim discusses the divergent approaches of two South African High Court cases to the interpretation of “fair value.” The journal article mentioned [$$] heavily discusses two significant South African cases, linked here and here for ease of reference.

Why is South Africa the most interesting appraisal jurisdiction at the moment? South African appraisal is ‘young’ compared to Delaware appraisal. The South African appraisal remedy springs from Section 164 of the Companies act of 2008. But in a relatively short period of time the caselaw on Section 164 has developed quickly and has done so while often considering both the logic and result of decisions from other jurisdictions, including Delaware and the Cayman Islands (with references to Canadian, Australian and New Zealand appraisal rights as well).

South African courts are wrestling with the bedrock questions that Delaware courts were confronted when appraisal was a younger remedy in the “First State” (and Delaware courts sometimes still wrestle with these foundational questions on occasion). Issues such as how to define fair value, is the merger price relevant (or dispositive), how are market distortions to be accounted for, should the Court seek the assistance of a neutral expert, what discounts or premia need to be applied, is appraisal arbitrage allowed, and many more, come through in the caselaw.

There is the added complication that though the South African appraisal remedy (like the Cayman remedy) was modeled on Delaware law, that does not make Delaware jurisprudence on the issue anything more than persuasive. (This is true, as we saw, when the Privy Council, reviewing Cayman law, has held that Delaware authorities on minority discount are not the law of the Cayman Islands.)

South African courts are thus writing fair value law with the benefit of, but not controlled by, bodies of jurisprudence both to learn from but also critically examine.

*RKS does not practice outside the United States and presents this information for educational purposes only. For legal issues, consult a licensed professional in your relevant jurisdiction.

Today marks the five-year anniversary of the Delaware Chancery Court’s ruling in the appraisal of Stillwater Mining Company.

Of continuing vitality today is the Court’s special focus on the right of the appraisal claimant to receive the benefit of any change in value of the appraised asset between signing and closing.  As recognized in Stillwater:

Under Section 262 [the appraisal statute], the time for determining the value of a dissenter’s shares is the point just before the merger closes.  The deal price provides a data point for the value of the company as of the date of signing, but the valuation date for an appraisal is the date of closing.  Consequently, if the value of the corporation changes between the signing of the merger and the closing, the fair value determination must be measured by the “operative reality” of the corporation at the effective time of the merger [citations omitted].

That principle was subsequently applied with even greater force in the Regal Entertainment Group appraisal case, where the court found that there was no dispute the appraising stockholder was entitled to the benefit of Regal’s improved valuation due to the passage of the Tax Cuts and Jobs Act having been enacted by Congress in between the signing and the closing of the subject merger, with the only dispute between the parties in that case being precisely the methodology and amount by which that change in value should be calculated.  

In Stillwater, the court identified the policy rationale underlying the need to potentially adjust merger price based on post-signing factors, such as inflation.  Indeed, the court recognized that the purchasing power of the dollars for a deal priced in December 2016 had declined in value by the time of the May 2017 closing.  The court offered a “pop-culture illustration” of this principle, pointing to J. Wellington Wimpy’s offer to “gladly pay you Tuesday for a hamburger today,” as dollars paid next Tuesday are worth less than dollars paid today (a good deal for Wimpy). 

Given that the statutory interest award in appraisal is measured from closing, even that aspect of the appraisal remedy does not capture the decline in the purchasing power of dollars used to measure the deal-price metric.

These principles continued to be applied today to a variety of appraisal targets but are especially appropriate to consider where there is a meaningful time span between signing and closing.

We have previously covered (thanks to a guest post) that Saudi Arabia does not have appraisal rights, though its Companies Law provides for a number of other shareholder rights. Is it time for a change?

Professors Alhasani and Hassan of Prince Sultan University say “yes.” In a comprehensive paper in the International Journal for Scientific Research, the two professors call for the Saudi Companies Law to add explicit appraisal rights, along with a number of other suggested changes. Get the Article Here [.pdf]

The Professors write about appraisal: “appraisal serves to protect shareholders who oppose a fundamental corporate action by establishing a way out for them if the new fundamental change does not align with their investment approach” and urge that “it is important that The Companies Law explicitly states [an appraisal right] because it will provide shareholders who oppose the merger or acquisition decision a way out while
receiving a fair value for their shares.”

This echoes what some US academics and market participants have said – appraisal is pro-investor and holds social utility, and joins others who have explicitly called for an appraisal remedy in their relevant jurisdictions law.

Whether future reforms will include an appraisal remedy is uncertain, but strengthening shareholder protections certainly seems to be on the table.

An interesting question has surfaced lately: how does publicly traded stock get valued when held by an M&A target that is itself the subject of an appraisal action?  Not a ton of guidance on this question, but we did locate a turn-of-the-century case worth dusting off: in Paskill Corp. v. Alcoma Corp., Delaware’s Supreme Court weighed in on this question. 

Paskill involved determining the fair value of Okeechobee, Inc., a closed-end investment company acquired by its majority owner, Alcoma.  In setting its purchase price, Alcoma applied a net asset value (“NAV”) approach; for Okeechobee’s marketable stocks and bonds, those assets would be valued by using their trading values on the New York Stock Exchange or other public listing just prior to the effective date of the merger.

In reviewing the valuation analysis, the Supreme Court held that it would not be appropriate to reduce the value of those assets by deducting future tax liabilities or speculative expenses relating to potential future sales that were not contemplated by Okeechobee on the date of the merger.  Since the appraised company’s “operative reality” did not envision selling those assets, the appraisal exercise should value those assets as they were, on the assumption that they would continue to be retained by the company; any deductions for expenses associated with a make-believe sale, or tax lability resulting from such a hypothetical sale, were speculative and therefore inappropriate to subtract from the valuation analysis.

The Supreme Court further held that a NAV should not have been relied upon as the only criterion for measuring Okeechobee’s value, since NAV reflects a liquidating value and thus cant be the sole measure of an appraised stock, as Delaware appraisal requires a going-concern valuation.  In sending the case back down for further proceedings, the Supreme Court invited the Chancery Court to use any admissible valuation technique based on reliable and relevant record evidence.  By thus avoiding exclusive reliance on a NAV and being nimble enough to utilize the most appropriate valuation metric(s), the lower court would then be in the best position to determine the appraisal target’s “fair value” as a going concern on the date of the merger closing, consistent with the statutory mandate for appraisal.

*RKS thanks Summer Law Clerk Sean Ji, currently attending Columbia Law School, for his assistance with this post.

Appraisal petitioners who receive a fair value award are entitled to interest as set by statute. In particular, DGCL § 262 provides that “. . . interest from the effective date of the merger, consolidation, conversion, transfer, domestication or continuance through the date of payment of the judgment shall be compounded quarterly and shall accrue at 5% over the Federal Reserve discount rate (including any surcharge) as established from time to time during the period between the effective date of the merger, consolidation or conversion and the date of payment of the judgment.”

Breaking this down, this provision sets three variables for the calculation of interest:

  • the rate (5% over the federal reserve discount rate; today, 5% over the federal reserve discount rate is 10.5%);
  • how often the judgment compounds (quarterly);
  • how often the rate resets (as established from time to time).

Let’s focus on the second variable: compounding.

Because of the clear statutory mandate setting forth these inputs, many an appraisal lawyer would readily recite that appraisal interest is “compounded quarterly at the legal rate, taking into account any adjustments in the underlying Federal Discount rate.”  In re AT & T Mobility Wireless Operations Holdings Appraisal Litig., No. CV 5736-VCL, 2013 WL 3865099, at *5 (Del. Ch. June 24, 2013).

But apparently there’s room for departing from that statutory directive.  In a recent case involving the appraisal of a privately held M&A target, Hyde Park Venture Partners Fund III, L.P. v. FairXchange, LLC, No. 2022-0344-JTL, 2024 WL 3579932, at *24 (Del. Ch. July 30, 2024), the Chancery Court awarded interest to be compounded on a monthly basis, as opposed to quarterly, with the greater compounding frequency having the effect of increasing the interest awarded to the stockholders.

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The SEC’s Costly Crackdown on Firms

In April 2024, SEC Deputy Director Sanjay Wadhwa updated the investor community on the SEC’s record-keeping enforcement initiative against broker-dealers and investment advisors. The efforts focus particularly on firms’ failing to properly record off-channel communications which discuss business activity, such as personal emails, messaging apps, and text messages. The SEC reported that since December 2021, the commission had charged nearly 60 firms with record-keeping violations totalling $1.7 billion in penalties. SEC., Remarks at SEC Speaks (2024). Notable charges include nine firms each sanctioned $125 million for “widespread and longstanding failures by the firm and their employees to maintain and preserve electronic communications.” SEC, SEC Charges 16 Wall Street Firms with Widespread Recordkeeping Failures (2022).

The Impact on Shareholders

Firm mismanagement resulting in significant monetary penalties are not only an issue for the firm but carry externalities for shareholders as well. First, the penalty itself, especially one exceeding $100 million, can decrease the equity value of the firm. Therefore, Shareholders often absorb the cost of sanctions through decreased share value. Sonia A. Steinway, SEC “Monetary Penalties Speak Very Loudly,” But What Do They Say? A Critical Analysis of the SEC’s New Enforcement Approach, 124 Yale.L.J. 209, 222-23 (2014). Second, a firm’s publicized mismanagement may result in reputational harms that directly and indirectly decrease share value. Id. Reputational harm can indirectly decrease share value by hindering a firm’s ability to generate revenue and secure financing as well as creating investor apprehension that directly diminishes share value. Id. Third, a firm can experience lost revenue as executives divert attention away from the business and towards addressing the violations. Id. The externalities flowing from SEC violations create a downstream effect against shareholders by sinking share value.

Shareholders’ Failed Attempt to Seek Redress

Lase Guaranty Trust on Behalf of JPMorgan Chase & Co. v. Bammann (2024)

JP Morgan was one of the nine firms sanctioned $125 million by the SEC for failure to preserve and record widespread use of off-channel communications. As a result of the sanctions, shareholders filed a derivative suit against JP Morgan (JMP) in the Eastern District of New York asserting both federal and Delaware state law actions. Lase Guar. Tr. on behalf of JPMorgan Chase & Co. v. Bammann, No. 22-CV-01331(EK)(JAM), 2024 WL 1117043, at *1–2 (E.D.N.Y. Mar. 14, 2024). Both claims focus on board members’ proxy statements made in 2021 that expressed the robustness of JPM’s compliance environment, governance practices, risk controls, and employee conduct while simultaneously failing to disclose the known, widespread use of non-compliant off-channel communications. Id.

In the federal law claim, shareholders alleged board members’ statements and omissions of record-keeping violations violated Section 14(a) of the Exchange Act. Id. Section 14(a) “prohibits registrants from soliciting proxy statements in a manner that violates SEC regulations–including rule 14a-9, which forbids material misstatements and omissions in proxies.” Id. The court held that the proxy statements were immaterial because JMP’s  upfront disclosures were too general. The court held it is “well-established that general statements about reputation, integrity, and compliance with ethical norms are inactionable” for securities fraud cases. Id at 5 (quoting City of Pontiac Policemen’s & Firemen’s Ret. Sys. v. UBS AG, 752 F.3d 173, 183 (2d Cir. 2014)). The court found the statements were too general for a reasonable investor to detrimentally rely on. Id.  The court also found no liability based on the board members’ omissions of the non-channel communications because there was no duty to further disclose the omitted information. Id. at 6. The court held that a duty to disclose “more” is triggered only when the original disclosures are “sufficiently specific.” Id. Here, because the court found the statements too general, the statements did not trigger a duty for JPM board members to disclose the off-communication misconduct. Therefore, the court dismissed the federal law action because there was no actionable claim under Section 14(a).

The court never addressed the shareholders’ Delaware state claims as the dismissal of the Section 14(a) claim eliminated federal subject matter jurisdiction. The dismissal leaves an unresolved question on whether Delaware state law claims would remedy shareholder damages resulting from a firm’s failure to regulate off-channel communications.

Does Delaware State Law Provide a Pathway for Shareholder Action?

Under Delaware state law, shareholders could potentially assert a Caremark claim against JMP board members in a derivative action. A Caremark claim arises when a company’s directors or officers, acting in bad faith, fail to oversee the company’s key operations. Litigating Caremark Claims in a Shareholder Derivative Action, Practical Law Practice Note w-025-1308. There are two general categories of Caremark claims: (1) the board or officers failed to implement any reporting system or controls, or (2) the board or officers learned of wrongdoing, usually through intentional reporting, and consciously failed to respond. Id. Here, JPM board members admitted to the SEC they knew of the widespread use of non-channel communications, and consciously failed to respond. The SEC found:

“JPMS further admitted that these failures were firm-wide and that practices were not hidden within the firm. Indeed, supervisors, including managing directors and other senior supervisors – the very people responsible for implementing and ensuring compliance with JPMS’s policies and procedures – used their personal devices to communicate about the firm’s securities business.”

JPMorgan Admits to Widespread Recordkeeping Failures and Agrees to Pay $125 Million Penalty to Resolve SEC Charges (2021).

Shareholders must additionally demonstrate board members acted in bad faith in failing to prevent or correct the violations. Id. This could prove a significant barrier against a cause of action. To evidence bad faith, shareholders must demonstrate that JPM board members were not only aware of red flags but that the red flags could amount to an SEC enforcement violation. Id. Here, JPM’s admissions to the SEC likely demonstrate awareness of off-channel communication misconduct, but it is less clear whether board members knew the misconduct amounted to SEC violations. Finally, the shareholders must demonstrate they incurred damages as a result of board members’ bad-faith mismanagement, such as diminished share value caused by lost-revenues or decreased equity value. Id.

Ultimately, the fate of shareholders and firms affected by recent SEC record-keeping violations may rest in future state court actions requiring less stringent pleadings than Federal claims.

In April 2024, after extensive public debate and Congressional interrogation of Shou Zi Chew, TikTok’s CEO, President Biden signed into law the Protecting Americans From Foreign Adversary Controlled Applications Act (“the Act”), which will ban TikTok from the United States unless ByteDance, its parent company located in Beijing, divests TikTok’s U.S. business to approved entities within 270 days. The Act, subject to ongoing constitutional challenge, opens the door to future government regulations and expropriations of U.S. entities with foreign shareholders and may pose serious threats to shareholders’ rights.*

Investors and the government will likely hold opposite views on whether the Act, or similar future regulation, constitutes expropriation. While the Act ostensibly offers the option to divest and doesn’t “seize” any private property rights, political obstacles and logistical infeasibility may render divestment impossible (as TikTok claims to be the case), which would devalue shareholders’ interests essentially to zero. Such effective deprivation of value may amount to indirect expropriation without taking title legally. Domestic investors are protected by the Fifth Amendment against takings without just compensation, but how can foreign investors protect themselves against expropriation?

Below are a few questions that foreign investors should ask themselves when considering investing in the U.S.:

  1. Does your country have a Bilateral Investment Treaty (BIT) with the U.S.?

BITs are international treaties between two signatory countries designed to protect investors from either country against performance requirements, restrictions on transfers and arbitrary expropriation when investing in the other signatory country.

Generally, a BIT prohibits all expropriations or nationalizations, except those that are for a public purpose; carried out in a non-discriminatory manner; in accordance with due process of law; with prompt, adequate, and effective compensation. Indirect expropriations (when the value of the asset is essentially deprived without taking title) and creeping expropriation (when a series of measures is taken to incrementally destroy the value of the investment) are generally prohibited as well.

The U.S. currently has BITs with 39 countries in force, with 6 additional BITs signed but not yet in force. If an investor thinks the BIT had been violated, they may seek relief through investor-state dispute settlement (ISDS) mechanisms, which usually means arbitration.

  1. Are you a qualifying investor?

To be a qualifying investor, you must be a national of the contracting state, meaning that as a natural person, you must be a national under the definitions of the country’s domestic law; or as a company, you must be legally constituted under or organized in accordance with laws of the country.

  1. Is the investment you are making a covered investment?

Covered Investments are defined relatively broadly in BITs. Most BITs include “every kind of investments” in the territory of the U.S. owned or controlled directly or indirectly by a qualifying investor. Covered investments can include shares or valuable interests, tangible properties, or intellectual properties.

But not all BITs are identical, so foreign investors should refer to the specific BIT for their respective country and consult legal counsel on the types of investment covered and the extent of protection offered.

  1. If your country does not have an active BIT with the U.S., does it have investment protection under other international treaties such as Free Trade Agreements (FTAs)? Does the investment provision allow investor-state arbitration if there were to be expropriation?

Investors from some countries are offered protection against expropriation of investment through investment provisions within an FTA. However, dispute resolution mechanisms may be more limited under FTA investment provisions. For example, investor-state dispute resolution has been eliminated as an option for Canadian investors under the 2020 U.S.-Mexico-Canada Agreement (USMCA) and Mexican investors only retain the investor-state option in limited sectors. State-to-state dispute mechanisms are still available, but the change significantly limits individual investors’ ability to seek relief.

  1. If your country has no international agreements that offer investment protection with the U.S., can you layer your investment through another jurisdiction that does?

“Treaty shopping” may be an effective way to seek more investment protection if your original country does not have an enforceable investment agreement with the U.S. If the terms “qualifying investor” and “covered investments” are defined broadly in a specific treaty between the U.S. and a contracting state, an investor, whose home country does not offer protection, may become a national of that contracting state by constituting a shell entity in accordance with their domestic law and invest in the U.S. through that shell entity for protection and recovery through ISDS in case of expropriation. While treaty shopping may generate high rewards, it is not without risks as some tribunals have expressed concerns over the legitimacy of forum shopping.

  1. Is the industry you are considering investing in particularly vulnerable to political interference? Will the existing shareholder structure of the investment target trigger suspicions?

In light of recent escalations of international conflicts, financial investments are inevitably affected. Pre-investment risk management would be better than looking for legal remedies after the fact. Investors can look to policy tendencies and international relations trends to figure out whether the investment target is at greater risk of regulatory expropriation. Factors to consider include the investment target’s industry, concerns that the host countries may be particularly sensitive about, and existing shareholder structure. The TikTok ban is a perfect example. Today’s concerns over data privacy and national security may be a cautionary tale against investments in social media and e-commerce platforms, or a deterrence from targets with ties to China or other authoritarian governments.

Obviously, political climates and trendlines are difficult to predict, but investors should consider minimizing their losses based on all currently known risks – high risk alone never guarantees high (or any) reward.

*RKS thanks author Cody Huyan, a summer law clerk at RKS for the summer of 2024, joining us from Columbia Law School.

Delaware’s latest decision on the combined pursuit of appraisal and fiduciary duty claims continues the Delaware tradition of welcoming the litigation of those claims jointly up until the time an election between the two must be made. Vice Chancellor Laster’s recent Opinion in In re Columbia Pipeline Group, Inc. Merger Litigation, C.A. No. 2018-0484-JTL (May 15, 2024) bears that out following years of litigation asserting both types of claims. 

The Opinion reiterated long-standing Delaware law that a stockholder seeking appraisal can simultaneously pursue breach of fiduciary duty claims:

TransCanada contends that by “electing” to seek appraisal, the appraisal petitioners foreclosed their ability to participate in any equitable remedy [citing Cede & Co. v. Technicolor, Inc., 542 A.2d 1182, 1190–91 (Del. 1988)]. The Delaware Supreme Court rejected that argument thirty-six years ago. The justices held that a stockholder who has also sought appraisal can “proceed simultaneously with its statutory and equitable claims for relief.” “What the [appraisal petitioner] may not do, however, is recover duplicative judgments or obtain double recovery.” To make the litigation process more straightforward, the Delaware Supreme Court instructed trial courts to prioritize the breach of fiduciary duty claim because that remedy was likely to be broader and render the appraisal action moot.

Columbia Pipeline, at 77.

In addition, the Court further clarified that appraisal petitioners remain eligible to elect (or decline) the equitable remedies made available to them in a fiduciary duty class action:

The Appraisal Decision determined that the fair value of Columbia for purposes of the appraisal statute was the deal price of $25.50 per share. The damages for the Sales Process Claim and the Disclosure Claim are greater than $25.50 per share. In a consolidated action, the rulings on the fiduciary duty claims would have rendered the Appraisal Action moot, and the appraisal petitioners could have elected to receive the equitable remedy. The same result applies in this case.

Columbia Pipeline, at 78.

Delaware’s preferred sequence – having the fiduciary duty claim litigated first – was flipped in Columbia Pipeline, as the appraisal trial proceeded first, and yet the Court still held that the (later-determined) fiduciary duty remedy was available to appraising stockholders long after the appraisal trial and fair-value determination had been made.  The sequencing in Columbia Pipeline of the appraisal trial being decided prior to the adjudication of the fiduciary duty claim was not the Court’s intended plan but resulted from the fiduciary duty claims only first being filed when trial in the appraisal case was already imminent.  Id. at 84.

The holding affirms that shareholders are required to decide which claim they’re electing only once the remedy from the breach of fiduciary duty claim is finally adjudicated.  In Columbia Pipeline the fiduciary duty claim was adjudicated following trial; we’re not aware of any authority directly addressing the question of how a settlement of the fiduciary duty claim, short of judicial determination, might impact this result.  In any event, what remains clear is that the appraising stockholder is entitled to the benefit of electing the potentially broader equitable remedies resulting from the fiduciary duty claim, with the limitation on this principle being that once a stockholder has elected its remedy, it cannot continue to pursue the other claim.