December 2014

The Delaware Supreme Court has scheduled the case of Huff Fund Investment Partnership v. CKx Inc. for en banc review in February 2015.

The Chancery Court rejected the valuation methods proposed by the parties and deferred to the merger price as the only reliable indicator of value. The Chancery Court likewise rejected the shareholders’ argument for an upward adjustment to the merger price as well as the company’s argument for a downward adjustment.

On appeal, the parties are asking the Supreme Court to consider whether the Chancery Court erred by:

  • deferring exclusively to the merger price, in lieu of performing any valuation analysis, to determine the stock’s fair value.
  • rejecting both of the DCF valuations presented by the shareholders as well as the company.
  • rejecting the shareholders’ other valuation methodologies; namely, their expert’s (a) guideline publicly-traded companies analysis and (b) precedent transactions valuation.
  • refusing to attribute any value to a corporate acquisition that materialized after the merger price was agreed upon but prior to the time the merger was consummated.
  • refusing to decrease the merger price by certain claimed synergies and other cost-savings that the acquirer expected to achieve.
  • refusing to allow the company to make a partial payment to the shareholders to stop the running of statutory interest prior to the entry of final judgment.

The Supreme Court seldom reviews appraisal cases en banc. In fact, the seminal cases of Weinberger v. UOP, Inc. (1983) and M.G. Bancorporation, Inc. v. Le Beau (1999) are the only other en banc appraisal cases of which we are aware.

**Note: this law firm is of counsel to the appellant-petitioner shareholders in CKx.

 

The question of whether voting agreements, or so-called drag-along provisions, in stockholder agreements can be used to prevent a dissenter from exercising appraisal rights has not been tested in the courts.  Such clauses are often included in stockholders agreements to secure advance shareholder consent to such corporate actions as a sale of the company.  Prospective buyers tend to look favorably upon drag-along provisions because they offer the prospect of supportive votes favoring the acquisition, with the added hope that the drag-along rights may be sufficient to quash any appraisal rights that the shareholder might otherwise be inclined to exercise.

Interestingly, we are not aware of any case in Delaware or New York that has decided whether a drag-along clause can be enforced to effectively waive appraisal rights on the part of the shareholder being dragged along to consent to the deal.  Absent a specific waiver of appraisal rights, it is difficult to imagine that a chancery judge will be inclined to sweep them aside, and yet there is no guiding precedent to inform that decision.  Some academic commentary has speculated that common shareholders who have agreed to vote their shares as directed by drag-along provisions may lose their right to appraisal, which is generally available only to shareholders who vote against the transaction.  See Brian Broughman & Jesse M. Fried, Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups, 98 Cornell Law Review 1319, 1331, n. 50 (2013).  But again, no court has yet accepted or rejected this notion.  While courts are indeed inclined to appraise preferred stock as a matter of pure contract law  based on a clear and unambiguous provision in the company’s certificate of designation, it remains to be seen whether the courts will likewise deem a common stockholder to have waived her appraisal rights by virtue of a voting agreement or drag-along clause in a stockholder agreement, especially where that waiver has not been made explicitly in the contract itself.

Like common stockholders, holders of preferred stock may exercise appraisal rights.  The extent of what those rights actually entail, however, may be far more limited than what common shareholders may experience.  As a general rule, preferred stock has the same appraisal rights as common stock, but “[u]nlike common stock, the value of preferred stock is determined solely from the contract rights conferred upon it in the certificate of designation.”  Shaftan v. Morgan Joseph Holdings, Inc., 57 A.3d 928, 942 (Del. Ch. 2012) (citing In re Appraisal of Metromedia International Group, Inc., 971 A.2d 893, 900 (Del. Ch. 2009)).

Delaware courts have consistently ruled that if the company’s certificate of designation is clear in providing just what the preferred stock is to receive upon a merger, then the certificate controls and effectively preempts the rights of the preferred stockholders to seek appraisal.  Thus, as Delaware Chancery has held, when the terms of preferred stock “clearly describe[d] an agreement between the [preferred stockholders] and the company regarding the consideration to be received” by the stockholders in the event of a specific type of merger, and that specific type of merger occurred, the stockholders were deemed to have waived their appraisal rights and were only entitled to the compensation provided for in the governing certificate.  Shaftan 57 A.3d at 928 (citing In re Appraisal of Ford Holdings, Inc. Preferred Stock, 698 A.2d 973, 978 (Del. Ch. 1997)).  Put another way, where the certificate of designation is clear in “contractually establish[ing] the metric for valuing the preferred shares in the event of a merger,” the court need not entertain competing valuation models and undertake the customary appraisal analysis; instead, the court simply views the valuation of the preferred stock “through the defining lens of its certificate of designation, unless the certificate is ambiguous or conflicts with positive law.”  Metromedia, 971 A.2d at 900.

In the case of unclear or indirect drafting in the certificate, the courts will not deprive stockholders of their statutory right to judicial appraisal of their preferred shares.