Appraisal-Eligible Deals

The Corporate Council of the Corporation Law Section of the Delaware State Bar Association has put out proposed amendments to Delaware law, including a technical change to Section 262, the statutory basis for Delaware appraisal. Richards Layton, a Delaware law firm, summarizes the proposed amendment:

The proposed amendments would amend Section 262(b) of the General Corporation Law to provide that the “market-out” exception to the availability of statutory appraisal rights will apply in connection with an exchange offer followed by a back-end merger consummated without a vote of stockholders pursuant to Section 251(h). As currently drafted, Section 262(b)(3) provides that appraisal rights will be available for any “intermediate-form” merger effected pursuant to Section 251(h) unless the offeror owns all of the stock of the target immediately prior to the merger. Practically speaking, under existing Section 262(b)(3), holders of shares of stock of a target corporation that is listed on a national securities exchange are entitled to appraisal rights in an intermediate-form stock-for-stock merger in which they receive only stock listed on a national securities exchange even if they would not be entitled to appraisal rights in a comparable “long-form” merger as a result of the market-out exception set forth in subsections (b)(1) and (b)(2) of Section 262. To address the incongruity between long-form and intermediate-form mergers with respect to the availability of appraisal rights in stock-for-stock mergers, the proposed amendments to Section 262(b)(3) provide that in the case of a merger pursuant to Section 251(h), appraisal rights will not be available for the shares of any class or series of stock of the target corporation that were listed on a national securities exchange or held of record by more than 2,000 holders immediately prior to the execution of the merger agreement as long as such holders are not required to accept for their shares anything except (i) stock of the surviving corporation (or depository receipts in respect thereof), (ii) stock of any other corporation (or depository receipts in respect thereof) that at the effective time of the merger will be listed on a national securities exchange or held of record by more than 2,000 holders, (iii) cash in lieu of fractional shares or fractional depository receipts in respect of the foregoing, or (iv) any combination of the foregoing shares of stock, depository receipts, and cash in lieu of fractional shares or fractional depository receipts. Accordingly, if the proposed amendments are enacted, exchange offers followed by a merger under Section 251(h) will receive the same basic treatment as long-form mergers requiring a vote of stockholders with respect to the availability of appraisal rights.

We’ve covered before whether appraisal is available in an all-stock deal: generally, it is not. We’ve also discussed the market-out exception and the way in which it is applied in Delaware.

A second technical change in the proposed amendments would clarify the information a corporation must disclose in an intermediate-form merger.

Section 262 was amended in 2016, though whether that amendment achieved what its proponents sought is a subject of debate.

**Update: For another view on the proposed amendments, see Shearman & Sterling’s take.

If a company structures a merger to avoid appraisal rights, does a shareholder have no recourse?  That question will no doubt be part of the debate as City of North Miami Beach v. Dr. Pepper Snapple Group, Inc. is litigated.  In a complaint filed in Delaware Chancery court on March 28, 2018, plaintiffs, a putative class of investors in Dr. Pepper, allege that the Dr. Pepper board has created a merger structure meant to frustrate their appraisal rights and that the merger will ultimately undervalue their shares. Describing the merger structure as one “only a contortionist can appreciate,” the plaintiffs seek to enjoin the merger, announced January 29, 2018, between Dr. Pepper and Keurig, among other remedies [$$].

According to the complaint, the ‘merger’ at issue has been structured as an amendment to Dr. Pepper’s charter, which would multiply the number of Dr. Pepper shares by seven. The shares would be issued to Keurig shareholders, the result being that post-merger/not-merger, Keurig shareholders would own about 87% of Dr. Pepper – a de facto merger, according to the complaint.  In economic effect, Keurig will purchase ‘new’ Dr. Pepper shares (as a result of the total share count being multiplied by seven) and thereby receive a supermajority of total company shares, rather than purchasing 87% of Dr. Pepper on the market or via a tender offer.

How are appraisal rights involved?  The consideration for the share issuance takes the form of a onetime cash dividend for $103.75 per share to pre-amendment shareholders.  Normally, if this were a classic merger, such a deal would be subject to appraisal rights under DGCL §262 – a cash merger has appraisal rights attached.  But the unique Dr. Pepper structure would not provide for appraisal rights – because the stockholders are just approving an amendment, so the theory goes, they are not actually engaged in a merger.

The plaintiff in Dr. Pepper pleads that appraisal rights are meaningful and important to investors, writing “The availability of appraisal provides an important protection for all investors, including small investors who could not otherwise bear the expense and burden of pursuing appraisal actions on their own. This is because the assertion of appraisal rights by the investors who can justify the investment provides a deterrent to corporate misconduct and incentivizes fair pricing.”

This is the fourth lawsuit challenging the Dr. Pepper merger, but one of the relatively rare lawsuits that focus on appraisal rights and their availability in a merger (or not-merger, as the case may be).  We will follow developments in this action.

In this post by Professor Afra Afsharipour of the UC Davis School of Law, she discussed what she identifies as the bidder overpayment problem, where bidders often pay more for publicly traded targets due to managerial agency costs and behavioral biases. The article notes that there are less monitoring mechanisms for bidder shareholders than there are for target shareholders to ensure a fair price. For instance, while target shareholders can bring appraisal proceedings in some transactions, bidder shareholders do not receive any appraisal rights even in transactions where they have the right to vote. The author ultimately argues for a “shareholder voice in situations of high importance to firm value and share price.”

 

The New York Law Journal recently ran an article, Looking Beyond Delaware: Exercising Shareholder Appraisal Rights in N.Y. [via ALM], which analyzes the New York appraisal statute and observes that while appraisal litigation has remained underutilized outside of Delaware, it is possible that with the uptick in Delaware appraisal New York will see more appraisal litigation in its courts as well. As the article shows, the New York appraisal statute deviates from Delaware’s and provides appraisal rights even beyond merger transactions, extending to share exchanges and all-asset dispositions as well.

 

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.

The so-called market-out exception precludes appraisal where the target’s stock trades in a highly liquid market.  In other words, appraisal is normally available to shareholders except, as the rationale goes, where the M&A target’s stock trades in such a liquid, highly efficient market that its stock price naturally reflects its fair value, and any M&A transaction offering a premium to that market price thus provides shareholders even greater, above-market value that would render an appraisal challenge superfluous.  Or, at least, so the theory goes.

Delaware’s appraisal statute incorporates the market-out exception, precluding appraisal rights where the target’s stock is either “(i) listed on a national securities exchange or (ii) held of record by more than 2,000 holders.”  DGCL § 262(b)(1).  But the Delaware statute doesn’t stop there, and this is where it parts ways with many other states:  it then carves out from the market-out exception circumstances where the target’s stock is being acquired for cash, in whole or in part.  As a result of this exception to the exception, Delaware’s market-out exception has far fewer teeth than do those of jurisdictions that adopted the market-out exception outright, without exception.  Thus, based on the theory underlying the statute, and notwithstanding the purported liquidity and efficiency of the stock markets in which most public M&A targets are traded, Delaware allows stockholders of its corporations to assert appraisal rights rather than assume that the market price inevitably captures the maximum value of their shares.

Many other states, such as Arizona, have adopted the market-out exception as is, without any carve-outs.  Indeed, back in February, when it was announced that the Apollo Education Group (“APOL”), which is incorporated in Arizona, had agreed to be acquired by a consortium of investors including The Vistria Group, affiliates of Apollo Global Management, and the Najafi Companies for $9.50 per share in cash, many investors immediately took to social media and other informal outlets to consider mounting an appraisal case against APOL.  However, such plans were just as immediately halted as they ran into Arizona’s market-out exception. AZ ST. § 10-1302(D).  Unlike Delaware, Arizona does not allow any exceptions to the exception, and a target such as APOL that trades on a sufficiently large stock exchange is shielded from appraisal.

Massachusetts, in contrast, has not adopted the market-out exception, but appraisal rights in that state are limited to transactions presenting potential conflicts of interest.  Thus, when EMC agreed to be acquired by Dell in late 2015, stockholders who believed they faced an uphill battle of demonstrating conflict of interest were likewise stymied from pursuing appraisal.  MA GL § 13.02(a)(1)(B).

The bottom line: Investors cannot presume that all jurisdictions providing for appraisal rights afford stockholders similar rights in their statutes.  Before investing the time and diligence in evaluating a target’s acquisition price, shareholders must fully inform themselves of the applicable state statute as well as its exceptions (and any carve-outs to those exceptions).

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.

A frequently asked question involves the availability of appraisal rights when investors are being offered only stock in the acquiring corporation in exchange for their shares.

The answer is typically no.  The Delaware appraisal statute provides that appraisal rights are available in a wide range of statutorily permitted mergers.  8 Del. C. § 262(b).  However, in what is commonly referred to as the “market-out exception,” the statute further provides that appraisal rights are not available for stock that is “either (i) listed on a national securities exchange or (ii) held of record by more than 2,000 holders.”  8 Del. C. § 262(b)(1).  Of course, if this is where the story ended, the market-out exception would render appraisal rights unavailable in most cases.  But the Delaware legislature created another exception in the appraisal statute, which Delaware courts have labeled the “exception to the exception.”  The exception to the exception states that the market-out exception does not apply when the shareholders of the target corporation are required to accept consideration for their shares that is not (a) shares of stock in the surviving corporation, (b) shares of stock in any other corporation that are either listed on a national securities exchange or held of record by more than 2,000 holders, or (c) cash in lieu of fractional shares described in (a) or (b).  8 Del. C. § 262(b)(2).  Thus, the statute provides that when the holders of a nationally listed or widely held stock are offered cash consideration for their shares (other than cash in lieu of fractional shares), appraisal rights exist, but when they are offered only the stock of the acquirer or other nationally listed or widely held stock, there are no appraisal rights.

In Louisiana Municipal Police Employees’ Retirement System v. Crawford, 918 A.2d 1172 (Del. Ch. 2007), the Delaware Chancery Court addressed the interesting question of whether appraisal rights exist when the shareholders of the target company are offered only stock of the acquiring company, but the acquiring company also causes the target’s board to declare a special dividend immediately prior to the merger.  The acquiring company argued that appraisal rights were not available because the merger was technically an all-stock deal and the special dividend was not part of the merger consideration being offered by the acquirer.  The Chancery Court rejected that argument, however, finding that it elevated form over substance.  The payment of the special dividend was dependent on the shareholders of the target approving the merger.  Thus, the Court found, “[w]hen merger consideration includes partial cash and stock payments, shareholders are entitled to appraisal rights.  So long as payment of the special dividend remains conditioned upon shareholder approval of the merger, [shareholders of the target corporation] should not be denied their appraisal rights simply because their directors are willing to collude with a favored bidder to ‘launder’ a cash payment.”

In another interesting application of the appraisal statute, Krieger v. Wesco Financial Corp., 30 A.3d 54 (Del. Ch. 2011), the Chancery Court addressed whether appraisal rights exist when shareholders are given the option of receiving either cash or stock.  Shareholders who failed to make an election would receive cash.  The Chancery Court held that appraisal rights were not available in that instance because the shareholders had the option to elect to receive stock.  Even though they might ultimately receive cash, they were not required to accept cash.

Accordingly, whether or not an ostensibly all-stock deal is appraisal eligible requires an examination of all the forms of consideration being offered in the merger and any election features available to stockholders.