Does appraisal arbitrage create costly uncertainty for a putative corporate buyer? In The Cost of Appraisal Rights: How to Restore Certainty in Delaware Mergers, 52 Ga. L. Rev. 651 (Winter 2018), the author argues that the well-established ability to alienate voting interest from equity interest with common stock opened the door to appraisal arbitrage – and that either a legislative, or a market plumbing solution, could ameliorate corporate buyers risks when entering into a merger. We’ve covered before how deal lawyers and others must factor in the possibility of appraisal when looking at a transaction (perhaps even more so when a transaction involves insiders, has a poor process, or otherwise does not comply with shareholder-protective standards) – here, the author proposes solutions.
First, a legislative change to the appraisal holding requirement is proposed: require appraisal seeking shares to be continuously held from the record date. Second, structurally, move the securities recording system from one of fungible bulk to actual share tracing through a system of centralized recording. (Note: We’ve written before about how blockchain solutions, which can be centralized or decentralized, could affect appraisal).
To briefly recap and oversimplify what these changes seek to ‘solve’: The vast majority of stock in the United States is held in “fungible bulk” by the Deposit Trust Clearing Corporation (DTCC). Fungible bulk means that one share cannot be differentiated from another share. If a company issued 1,000 shares of stock – any given one of those thousands shares is ‘fungible’ with any other given share – and they are held by DTCC in ‘bulk’ – meaning not assigned to a specific (even individual) beneficial owner, but rather in bulk lots assigned to certain nominees, brokers, etc.
Setting aside the wisdom (or lack thereof) of this system, the result is that it is a metaphysical impossibility, generally, to show that any particular share of stock voted for or against a merger (or abstained). The result is that a share purchased after the record date may well be one of the (again, this is metaphysical – the shares cannot be differentiated) shares that voted against the merger (or abstained), and thus, it carries appraisal rights. This becomes an issue only if more shares seek appraisal than could have possibly voted against the merger or abstained.
The author’s changes here would certainly restrict appraisal arbitrage; as we’ve discussed before, structural solutions that allow for actual share tracing could make for all kinds of changes to corporate governance and shareholder rights (including appraisal). Delaware courts — as well as the legislature — have rejected efforts to import a share-tracing requirement in Delaware appraisal.