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.