November 2015

The July 2015 article “Appraisal Arbitrage – Is there a Delaware Advantage?” by Gaurav Jetley and Xinyu Ji of the Analysis Group analyzes the extent to which economic incentives have improved for appraisal arbitrageurs in recent years, which the authors believe helps explain the “observed increase” in appraisal activity.  The article concludes that appraisal arbitrageurs enjoy an economic benefit by delaying their investment until after the record date, as they are privy to better information about the target’s value while minimizing their exposure to the risk of deal failure.  The study also finds that the Delaware Chancery Court utilizes a lower equity risk premium than do the financial advisors handling the deal itself, resulting in another benefit to arbitrageurs (and, one would think, historical holders as well).  Finally, the authors conclude that the statutory interest rate more than compensates appraisal petitioners for the time value of money.

Based on these findings, the authors propose several policy recommendations, including (i) a limitation on the arbitrage strategy by reducing stockholders’ ability to seek appraisal for shares acquired after the record date, and (ii) enactment of the proposal by the Council of the Delaware Bar Association’s Corporation Law Section (which the Delaware legislature has not enacted) to allow appraisal respondents to prepay claimants some portion of the merger consideration in order to limit the interest accruing during the pendency of the case.  On this latter point, the authors likewise acknowledge that allowing such prepayment is tantamount to funding claimants’ appraisal actions, thus potentially spurring on funds to increase their arbitrage strategy as they can redeploy such prepaid capital to the next case.

In this 2015 article from the Arizona Law Review, “Shareholder Litigation Without Class Actions,” Boston University Law School Professor David Webber imagines a “post-class-action landscape for shareholder litigation,” positing that the class action vehicle is becoming gutted by the courts and that mandatory arbitration provisions are undermining the class action device.  In this so-called post-class-action environment, the author considers what devices shareholders would have at their disposal to protect themselves.  He argues that “the decline of the transactional class action may be offset by, and may enhance, the rise of appraisal litigation, particularly of hedge fund participation in such litigation,” requiring a more active litigation strategy by fund managers than currently undertaken in furtherance of their fiduciary duties to their beneficiaries.

The article provides an interesting thought experiment and suggests that appraisal is a unique and narrow remedy that is highly individualized, as the right only accrues to the “no” voter and the resultant settlement or trial award does not benefit nonparticipating investors, unlike a class action.  For instance, unlike the typical fiduciary duty class action accompanying M&A deals, there are no additional disclosures to other shareholders.  In addition, as Professor Webber states on page 242, “[i]n the deal context, mandatory arbitration would make it impossible for plaintiffs to enjoin a shareholder meeting, which is the source of much of plaintiffs’ settlement leverage.  This could then shift the focus of institutional investors to appraisal proceedings.  Lately, such proceedings have attracted increased attention from investors, and the loss of a meaningful remedy under Revlon might force more institutions to seek out appraisal remedies, particularly in cases where institutional lead plaintiffs have had success in litigating transactional class actions in the past.”

In sum, if mandatory arbitration prohibits the injunction possibility, the institutional investor may be left solely with its appraisal rights.  And in an interesting twist, the author suggests that if appraisal rights are circumscribed by the legislature, the dissenter is in effect left with no choice but to pursue the strike-suit strategy, which in turn may be further limited by an arbitration provision.  In other words, if appraisal is the stockholder’s last hope, it should be left undisturbed and remain a robust tool.