Professors Korsmo and Myers, whom we have blogged about before, have a new post on CLS Blue Sky Blog, titled “A Reality Check on the Appeals of the DFC Global Appraisal Case.” The Professors argue that the DFC Global appeal, which we’ve been covering, presents an attempt by deal advisors “to alter Delaware’s appraisal jurisprudence[,]” seeking to “undermine appraisal rights and shield opportunistic transactions from judicial scrutiny.” Urging the Supreme Court not to “tie the Court of Chancery’s hands in future cases” – the Professors cite recent research showing that appraisal petitions are “more likely to be filed against mergers with perceived conflicts of interest, including going-private deals, minority squeeze outs, and acquisitions with low premiums, which makes them a potentially important governance mechanism.”
Korsmo & Myers Article Analyzing Surge in Appraisal Activity Now Published
We have blogged before (see here) about a then-forthcoming law review article by Professors Charles Korsmo (Associate Professor at Brooklyn Law School) and Minor Myers (Associate Professor at Brooklyn Law School) analyzing the value-creation resulting from the increased use of appraisal arbitrage. The authors’ paper has now been published in the final 2015 issue of the Washington University law review: http://openscholarship.wustl.edu/law_lawreview/vol92/iss6/7/
While there have been some revisions to the final version, their underlying data points, arising from their study of all Delaware appraisal cases for the ten-year period from 2004 to 2013, remain intact.
Article Calls for Del. Legislative Reform to Strengthen Appraisal Remedy
Do stockholders as a group lose something when the appraisal remedy is weakened, perhaps overly so? And should something be done about it? Is there social utility in appraisal arbitrageurs testing merger prices, such as by keeping buyers and sellers honest in what may otherwise be a rather unfair market?
These questions are addressed, along with a policy (legislative) prescription in the 2020 article: Protecting the Social Utility of Appraisal Arbitrage: A Case for Amending Delaware Law to Strengthen the Appraisal Remedy after Dell by Thomas Meriam.*
Starting from the no-doubt accurate premise that “the appraisal remedy [has perhaps become] the most divisive and contentiously debated issue in Delaware corporate law” – the article first sets out to describe the Dell case (which we have written about extensively) and the fallout that has resulted since.
The empirics are straightforward: appraisal activity, at least public appraisal activity involving public companies in Delaware, has fallen since a surge in the mid-2010s. And tracing that back to Dell and progeny is a fair move.
The article criticizes Dell, and more concretely, courts who have considered Dell in inconsistent manners or looked at Dell as an overly simplistic rubric – creating what the article describes as a “merger price deference rule” contrary to the statute and statutory intent. And another critique follows as well – if the legislature intended appraisal to simply revert to merger price, why have appraisal?
The Article goes on to set out its most fundamental premise: appraisal arbitrage may be “the last line of defense for stockholders.” Setting out its premises, the article argues: First: fiduciary litigation has been weakened as a result of the rejection (in certain courts) of ‘disclosure-only’ settlements, and – critically – the connected issue that fiduciary duty litigation now generally does not involve discovery, and thus has little chance of finding corporate wrongdoing. Second: appraisal arbitrage offers a way to police corporate malfeasance. The article argues that the threat of viable appraisal arbitrage sets a “reservation price” for the firm. Citing Korsmo and Myers, the article notes that appraisal arbitrage cases generally targeted mergers with “highly negative residual premiums” – put another way: meritorious cases where the selling stockholders were getting ripped off.
With fiduciary litigation less able to ferret out malfeasance, the fall of appraisal arbitrage (per the article), leaves shareholders vulnerable. The article traces the fall to Dell and DFC Global, but then focuses on the post-Dell cases, applying Dell, such as Aruba Networks, and notes that the short attention the Delaware Supreme Court has given to the reasoning in certain chancery court decisions has left the appraisal arbitrage area with poor precedent – less predictable, and where predictable, predictable only in deference to merger price.
What to do? If appraisal arbitrage is beneficial to shareholders (and there is certainly evidence appraisal itself is beneficial to shareholders, though that evidence is contested) the article proposed legislative solutions. In particular, the article suggests adding language to DGCL 262(h) restricting how a court can rely on deal process and deal price, or adding an equitable consideration component.
The article makes an interesting case for legislative changes to strengthen the appraisal remedy. We would add one further: appraisal started as a compromise, and another compromise seems warranted again now. Stockholders, in exchange for the loss of the unanimity requirement in approving M&A transactions – something surely impossible given the size and complexity of today’s corporations, were given appraisal as a remedy for their lost hold-up power; they would now (re)gain a right that afforded minority shareholders fundamental protections against oppression by the majority (and management). Appraisal started as a check on the abuses of management and the majority, and, in part, on the idea of resistance to short-termism – and can return to this valuable check in the future.
Weakening appraisal weakens minority shareholder rights because it weakens the threat of appraisal as well. It weakens the need to consider appraisal in M&A deals, and weakens the disclosure regime that upholds a significant portion of Delaware corporate law and the US securities laws. Strengthening appraisal may very well, paradoxically, result in fewer successful appraisal claims, as better deals mean better value for shareholders.
Read the entire article here [.pdf].
*Suggested citation: Thomas J. Meriam, Protecting the Social Utility of Appraisal Arbitrage: A Case for Amending Delaware Law to Strengthen the Appraisal Remedy after Dell, 85 Brook. L. Rev. (2020).
Did the Aruba Decision Make “Serious” Corporate Finance Mistakes?
Yes – at least according to Professors Korsmo and Myers. In this piece from the HLS Forum on Corporate Governance, the Professors argue that the Aruba decision continued a trend of the Delaware Supreme Court misapplying certain modern finance concepts, starting most glaringly in Dell and DFC, and with Aruba only slowly turning the ship back towards a truer course. The Professors argue that the decision makes four errors: (1) failing to differentiate between how diversified and undiversified investors price risk; (2) misapplying market efficiency concepts in particular the difference between a market for an entire company versus the market for a share of the company; (3) conflating meeting fiduciary obligations with the factors suggesting an environment of pricing efficiency; and (4) viewing valuation as a mechanical exercise, while it must contain some human judgment.
Professors Korsmo and Myers are two of the most respected names in the arena analyzing appraisal rights – we’ve written about their work on a number of occasions.
New Coverage of DFC Global Case Focuses on Court’s Refusal to Set Presumption in Favor of Deal Price
Professor Robert Reder and Vanderbilt JD candidate Blake Woodward have published a piece in the Vanderbilt Law Review En Banc reviewing the Delaware Supreme Court’s DFC decision and the intricacies of Chancellor Strine’s 85 page opinion. We’ve posted extensively about DFC throughout its history. The authors of the current piece point out that DFC can be partially read as a requirement for clearer explanations by the trial court of their reasoning with respect to valuation. The authors summarize DFC’s import when it comes to encouraging explanation by lower courts as: “when the Chancery Court is faced with a choice between the deal price and a discounted cash flow analysis as the basis for a fair value determination, a sliding metric balancing the quality of the sales process with the reliability of the projections utilized in the discounted cash flow analysis ought to be employed.”
This sliding mechanism – involving a review of the sales process that then feeds into how much weight the court gives the deal price – fits well with recent research that shows appraisal is “more likely to be filed against mergers with perceived conflicts of interest, including going-private deals, minority squeeze outs, and acquisitions with low premiums, which makes them a potentially important governance mechanism” – i.e., the kind of cases where the ‘slide’ is against a reasonably fair process.
“Appraisal Risks Factor High”
Cooley LLP highlights that increased appraisals are being factored into mergers. Following up on a previous piece, Cooley LLP notes that appraisal costs can be large, referencing the over $50 million added to the merger price in Dell, and further comments on the rise of appraisal claims, which Cooley calculates as a 267% increase from 2012 to 2016. We’ve posted previously on the uptick in appraisal filings, and how the August 2016 amendments may further increase filings, as well as what this means for investors interested in the strategy.
Does the Appraisal Remedy Discipline Corporate Management?
In a March 2016 working paper, Corporate Darwinism: Disciplining Managers in a World With Weak Shareholder Litigation, Professors James D. Cox and Randall S. Thomas detail several recent legislative and judicial actions that potentially restrict the efficacy of shareholder acquisition-oriented class actions to control corporate managerial agency costs. The authors then discuss new corporate governance mechanisms that have naturally developed as alternative means to address managerial agency costs. One of these emerging mechanisms possibly as a response to judicial and legislative restrictions on shareholder litigation, is the appraisal proceeding. As readers of this blog are well aware, the resurgence of appraisal proceedings has also been fueled by the practice of appraisal arbitrage.
Does the resurgence of appraisal litigation provide an indirect check on corporate managerial or insider abuse? Professors Cox and Thomas are skeptical, citing several factors that may limit an expansion of appraisal litigation beyond its traditional role. However, they acknowledge that there are circumstances where appraisal litigation can potentially fill the managerial agency cost control void that other receding forms of shareholder litigation have created.
As the paper argues, at first glance, appraisal litigation appears to be a powerful tool for investors to monitor corporate management and control managerial agency costs. However, shareholders face certain disadvantages in an appraisal proceeding, including the completion of required, difficult procedural steps that must be followed precisely to maintain appraisal rights (highlighted by the recent Dell decision); the lack of a class action procedure that would allow joinder of all dissenting shareholders in order to more easily share litigation costs; and the narrow limits of appraisal as purely a valuation exercise that does not take aim at corporate misconduct.
After identifying these general obstacles to appraisal, the authors discuss more specific factors that arguably limit the efficacy of appraisal for remedying management abuse in all M&A transactions. Thus, appraisal is available as a remedy only in certain transactions (e.g., the market-out exception), and even among those transactions that qualify for appraisal, initiating appraisal litigation may often not be cost effective, especially for small shareholders. Also, deals can be structured to minimize or even avoid appraisal altogether.
Cox and Thomas also highlight circumstances where appraisal may well serve as a check on management power. First, appraisal can protect shareholders from being shortchanged in control shareholder squeezeouts. Because these transactions are not subject to a market check, appraisal gives shareholders a tool to ensure that the merger price reflects the fair value of the acquired shares. Leveraged buyouts that do not undergo market checks may also raise conflict of interest concerns, especially when the target’s executives may seek to keep their jobs and be hired by a private equity buyer to run the firm. In this scenario, appraisal arbitrage may ensure shareholders are not shortchanged in a sale of control. Shareholders facing these circumstances may benefit from appraisal.
Second, appraisal arbitrage, as repeatedly covered by this blog, is a viable appraisal tactic. As we’ve previously discussed, appraisal arbitrage has been facilitated by the Delaware Chancery Court decision of In re Appraisal Transkaryotic Therapies Inc., which held that shareholders who purchased their stock in the target company after the stockholders’ meeting, but before the stockholder vote, could seek appraisal despite not having the right to vote those shares at the meeting.
In their 2015 article Appraisal Arbitrage and the Future of Public Company M&A, Professors Korsmo and Myers argued that a robust appraisal remedy could work as a socially beneficial back-end check on insider abuse in merger transactions, but the authors appear skeptical that appraisal can fill this role due to limitations discussed here. These authors don’t take a normative position on appraisal arbitrage but simply query its efficacy as a control on managerial agency costs.
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The Appraisal Rights Litigation Blog thanks Charles York, a student at the University of Pennsylvania Law School and summer law clerk for Lowenstein Sandler, for his contribution to this post.
Academics Propose New Reforms for Appraisal
We’ve posted before about the article by Professors Charles Korsmo and Minor Myers analyzing the recent surge in appraisal activity. These co-authors have prepared a new draft article to be published in the Delaware Journal of Corporate Law, proposing reforms for appraisal litigation. Based on their latest research the authors stand by their prior conclusion that appraisal plays a “salutary if small role” in M&A practice.
The new article expands their data set to include 2014 (the prior study ranged from 2004 to 2013), and the authors provide updated charts showing the number of appraisal petition filings by year (Figure 2 on pages 14-15) and the percentage of equity value in appraisal by year (Figure 3 on page 16). Some new metrics include a useful summary of appraisal trial outcomes for public company common stock (Figure 6 on page 22) and descriptive statistics of transactions challenged in appraisal to show which deals attract the most appraisal litigation (Table 1 on page 11). It is this study that the authors use to demonstrate that the only independent variables in M&A transactions that have a statistically significant effect are the merger premium residual and the presence of insider participation: in other words, the lower the premium residual, the higher the likelihood of appraisal. And appraisal is more likely to occur when an insider participates in the purchase. See pages 10-12.
Given these observations, the authors conclude that “appraisal petitioners focus their resources on meritorious claims.” This conclusion impels the authors to reject the reforms suggested by both respondent companies and deal advisors to limit or eliminate appraisal arbitrage, though they do suggest a less drastic compromise in setting the record date at least 20 days after mailing of the appraisal notice, giving stockholders material disclosures prior to the record date.
In addition, the authors propose other reforms to improve the effectiveness of appraisal, including (i) requiring disclosure of more financial information in M&A transactions subject to appraisal; (ii) eliminating the “irrational” exemption for all-stock transactions; and (iii) adopting a de minimis requirement. Finally, the authors hint at improvements to the system of awarding interest in appraisal cases, but plan to develop that suggestion more fully in a separate article.
**Update: Korso and Meyers preview their article at the Columbia Law BlueSky Blog.
“Shareholder Litigation That Works”
Professors Korsmo and Myers have once again lauded the benefits of appraisal litigation and chastised its critics for pressuring the Delaware bar council to reconsider its recent decision not to limit or eliminate appraisal arbitrage. In their latest piece, the authors reaffirm their findings that appraisal cases comprise that rare form of shareholder suit “where the merits actually matter.” They suggest that the emergence of appraisal arbitrage specialists should be “reassuring, not shocking” to the deal community, as it evidences “beneficial specialization” that allows shareholders unfamiliar with the appraisal process to cash out, sometimes at a premium to the merger price, without being forced to accept an undervalued deal or to prosecute appraisal rights for themselves.
Appraisal Actions Are Increasingly Viewed as a Considered Investment Strategy
The forthcoming article on appraisal arbitration by Professors Korsmo and Myers is rich with data confirming the sophistication of the new breed of appraisal rights petitioners. (A previous post linked to graphs demonstrating the recent sharp increase in appraisal petitions and the spike in the dollars at play in appraisal cases.) We wanted to highlight some more of that data here.
Two metrics merit attention. The first is a graph representing the value of shares in Delaware appraisal actions held by “repeat players.” (view here) This shift from “one-off” filings by aggrieved shareholders to multiple petitions filed by single entities has been driven almost entirely by investment funds. Professors Korsmo and Myers hypothesize, and the data bears out, that these investors are increasingly looking to Delaware appraisal litigation as a considered investment strategy. Indeed, as the article states, “[t]he institutions that are beginning to specialize in appraisal . . . are among the most sophisticated financial entities in the United States.”
Another data point demonstrates that these sophisticated entities are filing their petitions much more quickly. (view here) Under Delaware law, shareholders dissenting from a merger have 120 days after the effective date to bring their appraisal petition. The professors suggest that prior to 2010, petitioners generally took that entire period to negotiate a settlement before filing. From 2011 onward, however, the professors believe that dissenting shareholders appear to be foregoing this initial round of settlement discussions and filing their appraisal petitions immediately. Another interpretation of this data is that this increase in the pace of filings may result from the fact that historically stockholders often gave pre-closing notice to the target of their intent to exercise appraisal rights simply as a means to preserve their optionality and buy time to consider a challenge. Now, however, as funds and other dissenters have become more deliberate in their strategy to follow through with an appraisal proceeding, they don’t need extended time to consider their options and thus tend to file a petition more promptly post-closing to follow through with their predetermined litigation plan.