While appraisal is typically a creature of statute, appraisal rights can also be a creature of contract–in particular, when an operating agreement, charter, or similar foundational document provides for them (including when a certificate of designation provides for the value of preferred stock). Many states, including New York, allow the members of an LLC–as an example–to include appraisal rights in the operating agreement. While we often cover appraisal on this blog as a statutory remedy focused on shareholder protection, negotiated appraisal rights can be a part of a corporate lawyer’s suggestion box in trying to get a deal done. A minority investor concerned about his or her minority status may be comforted by an appraisal rights mechanism in the foundational documents. Similarly, an investor who is contemplating a minority investment may wish to negotiate for an appraisal provision precisely because it can give an “out”–and, at minimum, bargaining power–if the minority investor sees issues with an otherwise-aboveboard merger. Because appraisal rights are different than breach of fiduciary duty claims and are a post-closing remedy, the minority investor can also point out that appraisal may be a viable remedy in lieu of filing a lawsuit seeking injunctive relief and attempting to block corporate action. This trade–giving up some rights before the closing in exchange for a post-closing remedy–allows the minority and majority investors to protect themselves while potentially creating value for both in the transaction.
In Delaware, appraisal is a creature of statute. It is a statutory claim, born from 8 Del. Code Section 262; it is a claim in its own right, but it also carries with it statutory requirements. Appraisal requires that the right kind of demand be sent at the right time by the right entity. Quasi-appraisal is a creature of the common law and, as lawyers from Blank Rome observe in a growing concern for deal lawyers. Whereas appraisal rights claims are basically individual in nature, quasi-appraisal has been brought as a potential remedy for a class of all shareholders who have otherwise foregone their appraisal rights.
The differences between appraisal and quasi-appraisal go deeper than just their source in statute or common law. While appraisal is a well-defined “claim” in its own right, quasi-appraisal is far more akin to a remedy than to a claim. While both demand a determination of “fair value,” the vast majority of Delaware case law determines fair value within the confines of the statutory appraisal scheme, including, for example, a bar on considering synergies. Quasi-appraisal is more “amorphous”–as the authors observe–and can frustrate predictability in a merger. Whereas appraisal claims must, by statute, be known (and pressed) at a certain time, quasi-appraisal remedies/claims can pop up later, after the appraisal window has closed.
The authors of this piece also point out that unlike appraisal, the quasi-appraisal remedy is often connected to a breach of fiduciary claim (note that appraisal claims require no breach of any duty and require no proof of any wrongdoing by anyone). Breach of fiduciary duty claims, in turn, are directed at the corporate officers and directors, not the company itself, and those officers and directors, in turn, may have indemnification rights from the company or the insurance that covers claims against them. The takeaway then is that a when a party is seeking quasi-appraisal, it may well involve many more parties and may come up at a time well past the otherwise statutorily set appraisal window. As the authors observe:
[A]s quasi-appraisal claims continue to increase, the predictability that comes with the timely perfection of appraisal rights may be lost. Buyers may need to consider more than just the number of dissenting stockholders and, more specifically, also consider if a class of all (or most) of the stockholders would or could pursue a quasi-appraisal claim against the seller’s former directors for which the buyer might have indemnity responsibility. … [The] intersection of quasi-appraisal remedies and directors’ indemnification rights could put a buyer potentially at odds with a seller’s former directors, and highlight further unanticipated deal risks. Navigating these changing tides in Delaware corporate law is of critical importance, particularly for buyers, and these considerations should receive appropriate attention in the early stages of the deal negotiations.
As shown in a presentation to the Association of Corporate Counsel, despite predictions (and calls) for the death of appraisal, it remains prominent in discussions of M&A trends. In the May 10, 2018 presentation, attorneys from Cadwalader discuss their view of “Dell-Compliance” – noting a series of factors that would make a deal more likely or less likely to reflect fair value. For example (in this instance, using AOL as an example), a company that was approached by “other logical buyers” with a good merger process and without a prohibitive breakup fee is, according to the authors, more likely to be Dell-compliant than a deal where a buyer had an informational advantage, there was a no shop provision, and the existence of public statements by management all augured against Dell-compliance.
Can a block of appraisal demands derail a merger? In South Korea, they certainly can. In the recent Hyundai-Mobis deal, involving a transfer of assets by Hyundai of assets from one Hyundai entity to another Hyundai entity, the deal contains a 9 percent “appraisal condition.” If 9 percent of shares demand appraisal, Hyundai may be forced to kill the deal – or else pay 2 trillion SKWon ($1.8BB USD).
We’ve posted before about appraisal ‘blow’ provisions. And mid last year, media reports speculated on whether appraisal filings (in that instance, looking at the US) would cause companies to take steps to address appraisal risk. With the Hyundai deal, we see an example of this in action.
Some authors have noted that appraisal has become the disciplining remedy for the fiduciary duties of corporate managers. This may be true, regardless of the fact that appraisal is an independent and distinct remedy from fiduciary duty litigation. But sometimes the two are inextricably bound.
In late February 2018, the Delaware Supreme Court handed down a decision in Appel v. Berkman, No. 316, 2017, 2018 WL 947893 (Del. Feb. 20, 2018), wherein stockholder-plaintiffs brought an action against the corporate directors of Diamond Resorts, alleging breaches of fiduciary duties with respect to merger disclosures. In Appel the plaintiff alleged that, pre-merger, Diamond failed to disclose to shareholders the concerns of the board chairman (and founder of the company), who was also abstaining on the merger itself–what the Supreme Court described as “no common thing.”
In discussing the importance of the disclosures, the Court observed that the “founder and Chairman’s views regarding the wisdom of selling the Company were ones that reasonable stockholders would have found material in deciding whether to vote for the merger or seek appraisal …” And further, it observed that the lack of the disclosure in this case was not inactionable just because the stockholder plaintiff tendered his shares–concerns outside the disclosures, such as the costs of litigation and the fact that capital can be tied up in appraisal (subsequently mitigated in some respects by legislative changes providing for prepayment), may well motivate a shareholder.
Here we have an example of disclosure litigation and appraisal being intertwined. While appraisal is a post-closing remedy, and thus a shareholder seeking appraisal does so after the merger and with whatever disclosures were made as they are, the Supreme Court recognizes that the disclosures themselves, if fulsome and sufficient, may motivate investors to seek appraisal. When those disclosures are deficient, one of the impacts may be denying investors who have rightful appraisal remedies a fair chance to decide.
See the decision in Appel here.
Cooley LLP provided a recap of 2017 M&A, along with an outlook for 2018 for Lexology, which includes a discussion of appraisal conditions in private M&A deals. We have blogged previously about the possibility of acquirers including appraisal conditions in public deals.
This 2018 M&A Outlook is a good reminder of the role that appraisal plays in mergers of non-public companies. As Cooley observes: “While the inclusion of any appraisal rights condition remains uncommon in public deals, we commonly negotiate these conditions in private sales of venture-backed companies. Commonly accepted conditions take one of two forms: the absence of available appraisal rights altogether or appraisal rights not having been exercised by a certain percentage of shares.” The piece further suggests the legality of any such advance waivers of appraisal rights “has not been resolved by the courts.”
In Kahn v. Stern, an opinion issued by the Delaware Court of Chancery mid last year, the Court dismissed a breach of fiduciary duty claim seeking, among other remedies, quasi-appraisal damages. The case arose out of the sale of Kreisler Manufacturing Corporation (“Kreisler”), a small, thinly-traded (listed only on the pink sheets), public aerospace manufacturing company, to Arlington Capital Partners (“Arlington”). The merger was approved by written consent of a majority of Kreisler’s outstanding shares, without a stockholder vote, and was announced on May 31, 2016. That same day, Kreisler distributed an information statement to its shareholders to inform them of the deal and allow them to decide whether to exercise their appraisal rights—the deadline for seeking appraisal was June 20, 2016. Notably, the merger agreement contained an “appraisal out” provision that permitted Arlington to back out of the merger if more than 10% of Kreisler’s outstanding shares sought appraisal (see our prior posts discussing such provisions here, here, and here). The plaintiff, however, did not seek to enjoin the merger pre-close or exercise his appraisal rights by the appraisal cutoff. Instead, the plaintiff filed a complaint for breach of fiduciary duty against the Kreisler board days after the appraisal deadline had passed.
The complaint, among other things, alleged that the Kreisler board breached its fiduciary duties by: (1) approving the transaction in light of certain “side deals” that were negotiated by two inside directors in connection with the merger, and (2) making misstatements and omissions in the information statement provided to Kreisler’s shareholders. With regard to the disclosure claims, the plaintiff alleged that the defendants knowingly withheld or misrepresented material information in the information statement to reduce the likelihood that Kreisler’s shareholders would prevent the merger by asserting appraisal rights, and in so doing, the defendants deprived Kreisler’s shareholders of their ability to make a fully informed decision regarding their appraisal rights. In light of the injury caused by these alleged disclosure deficiencies, the plaintiff sought quasi-appraisal damages.
In deciding the disclosure claims, the Court noted that if the plaintiff had sought injunctive relief before the merger closed, such relief may have been warranted. The Court explained that, in the pre-close, injunctive relief context, the Court would have applied enhanced scrutiny and looked to whether the information statement withheld or misstated information material to the stockholders’ decision to approve the deal or seek appraisal. In the post-closing, damages context, on the other hand, the Court explained that the plaintiff must have alleged facts making it reasonably conceivable that the director defendants, who were found to be independent and disinterested and were protected by an exculpatory charter provision, acted in bad faith in issuing the disclosures. The Court found that nothing in the record, even in light of the side deals and appraisal-out provision, created an inference that the alleged disclosure deficiencies were made in bad faith. Thus, the Court dismissed the disclosure claims, which included the plaintiff’s request for quasi-appraisal damages.
For additional insight on the Court’s views on the quasi-appraisal remedy, see our prior post here.
In a recent article on PolicyHolder Pulse attorneys from Pillsbury explore whether Directors and Officers (“D&O”) insurance covers, or could be considered to cover, Delaware appraisal claims. Critical to this analysis is whether an appraisal case raises issues of “Wrongful Acts” by the Board – including, for example, collusive behavior, or other process defects. The Pillsbury authors note that appraisal claims are often (though not always) coupled with breach of fiduciary duty claims (something that occurred in Dole), which involve claims of wrongdoing. Of course no proof of wrongdoing, or even of defective process, is necessary for a successful appraisal action. They also suggest Securities Claim coverage may be available, depending on the terms of the specific policy. D&O Diary, after discussing the arguments made, summarizes the article as finding that there “may be substantial grounds” for arguments in favor of coverage.
This Bloomberg BNA piece, “Dealmakers Eye Safeguards Amid Rising Valuation Challenges,” observes the spike in appraisal activity and queries whether M&A buyers are taking added steps to address appraisal risk.