We recently posted about the two related January 5, 2015 arbitrage decisions, in which the Delaware Chancery Court refused to impose share-tracing requirements or other obligations on beneficial stockholders and reaffirmed that only record owners bear the burden to no-vote their shares and otherwise perfect their appraisal rights. This week the lawyers defending Ancestry.com, whose arguments were rejected by the Court, have posted this blog calling for legislative reform of the appraisal rights statute to remedy what they perceive to be a “troubling expansion” of stockholder appraisal rights.
A new piece by Reuters Breakingviews, M&A at Last Finds a Way for Lawsuits to Pay, covers last week’s rulings on appraisal arbitrage by the Chancery Court in Ancestry.com and BMC (which we posted about last week), and also observes generally that appraisal actions are “surprisingly successful” and are thus witnessing a surge in filings over the past few years. The author finds appraisal cases to be “the rare litigation strategy that can benefit investors more than their lawyers.” The article also briefly discusses the upcoming en banc hearing by the Delaware Supreme Court scheduled for February 2015, in the appeal of the appraisal of CKx shares, which we’ve addressed in a prior post.
In conjunction with this article, the author discussed his research and findings about the success of appraisal actions in a short Reuters Breakingviews video, “A New Way to Make M&A Hay.”
In two separate rulings on January 5, 2015 — In re Appraisal of Ancestry.com., Inc., and Merion Capital LP v. BMC Software, Inc., both by Vice Chancellor Glasscock — the Delaware Chancery Court reaffirmed the legitimacy of the appraisal arbitrage strategy and refused to impose share-tracing requirements or other obligations on the beneficial stockholder, continuing to require only of the record owner that it perfect appraisal rights by not voting in favor of the deal and making a timely demand for appraisal. News of these rulings has already been widely reported, including by Reuters and The Wall Street Journal.
We’ve posted before about arbitrage opportunities in appraisal rights and the increased utilization of this strategy by professional investors. Indeed, we had been awaiting the Chancery Court’s ruling in Ancestry.com, as it presented the first opportunity since the Delaware appraisal statute was amended in 2007 to decide whether the Court’s prior ruling in Transkaryotic would remain good law in light of that amendment.
Both new cases address the practice of so-called appraisal arbitrage, in which an investor buys the target company’s stock after a merger announcement. In the Ancestry.com case, the Court rejected the company’s argument that given the 2007 amendment to the appraisal statute — by which Delaware’s legislature expressly permitted beneficial owners to file appraisal petitions directly on their own behalf — the beneficial owner should be required to show that its predecessors did not vote in favor of the merger, and if it cannot do so, it lacks standing. The Court held that under a plain reading of the statute, it remains the record holder alone who must have no-voted the shares for which it seeks appraisal; the statute does not impose any requirement on a stockholder to demonstrate that previous owners also refrained from voting in favor. In other words, the Court affirmed Chancellor Chandler’s previous ruling in Transkaryotic that the actions of the beneficial holders are irrelevant in appraisal actions, and the Court thus refused to adopt the company’s proposed share-tracing requirement. As a matter of procedure, the Court denied the company’s motion for summary judgment on this issue; the appraisal decision itself has not yet been made and will issue separately.
The ruling in Ancestry.com is thus the first decision to uphold appraisal arbitrage after the 2007 statutory amendment was made; Transkaryotic, which first permitted arbitrage, was decided in 2007 prior to the amendment. The ruling in Transkaryotic was based in large part on Chancellor Chandler’s accounting for the fact that in a typical situation the owner of stock certificates, such as Cede & Co. — which is usually the nominal owner of shares that are on deposit with the Depository Trust Company — holds their shares in an undifferentiated manner in “fungible bulk,” and so no shareholder has ownership rights to any particular share of stock. Vice Chancellor Glasscock’s new ruling continued to recognize that reality and found nothing in the 2007 amendment to Section 262 to suggest that the Delaware legislature intended to require beneficial owners who made post-record-date purchases to show that their specific shares were not voted in favor of the merger. In fact, the Court found Ancestry.com’s proposed requirement to contradict and be invalidated by the Court’s prior approach in Transkaryotic.
The action in Merion Capital v. BMC Software was brought by Merion Capital, a self-described “event-driven investment” fund that specializes in appraisal arbitrage. The stockholder in that case faced a unique problem because Cede refused to make its appraisal demand on its behalf, so Merion was forced to have its holdings in BMC stock withdrawn from the “fungible mass” at DTC/Cede and registered directly with BMC’s transfer agent, Computershare. Merion thus sought to become its own record holder as well, and the Court found that it succeeded in doing so and properly made demand. BMC challenged Merion’s standing by saying Merion needed to prove that each share it seeks to have appraised was not voted by any previous owner in favor of the merger. The Court rejected BMC’s challenge and found that Merion succeeded in showing that it had not voted the shares in favor of the merger; as it did with Ancestry.com and Transkaryotic, the Court held that nothing in the statute requires a stockholder to prove that the specific shares it seeks to appraise were not voted in favor of the merger.
These rulings clearly reaffirm the validity of appraisal arbitrage, at least as a legal matter. Of course, as a practical matter, that strategy remains subject to the very real risk that the number of shares presented for appraisal actually outnumbers the number of no-voted shares eligible for appraisal, causing the appraisal action to be oversubscribed. The Court refused to make any pronouncement on how it might rule in such an overappraised situation, since it was not presented with those facts in either of these two cases.