Now that the amendments to the Delaware appraisal statute have been signed into law, the new provisions will apply to all M&A agreements entered into on or after August 1. Here is a link to the rule as revised, showing the new terms (only Sections 8-11 relate to appraisal). As we have posted previously, the statute, as amended, now (i) sets a floor for appraisal proceedings based on the quantum or dollar size of shareholdings and (ii) permits M&A targets to prepay dissenters in an amount of their choosing to halt the interest clock on the amount prepaid. As we’ve observed before, investors may welcome the opportunity to redeploy any such prepayments to the next appraisal case, thus indirectly solving the liquidity problem that has prevented some shareholders from exercising appraisal in the first place.
As we’ve previously covered in this blog, the Delaware Legislature has proposed two changes to its appraisal statute in response to an increasing number of appraisal filings. The first proposal, the De Minimis Exception, would require that anyone bringing an appraisal action have, at minimum, a $1 million stake in the company or 1 percent of its shares. The second proposal, the Interest Reduction Amendment, would allow companies subject to appraisal actions to prepay any desired amount on the merger consideration. This prepaid amount would count toward any final judgment rendered by the Court, and would not be subject to the prejudgment interest rate.
With these proposals in mind, academics Wei Jiang, Tai Li, Danqing Mei, and Randall Thomas have considered whether these proposed reforms will achieve their stated goals. They provide a statistical analysis of the rise of appraisal actions in their article “Reforming the Delaware Appraisal Statute to Address Appraisal Arbitrage: Will It Be Successful?” First, they find that, in recent years, hedge funds have dominated the appraisal arbitrage strategy, with the top seven hedge funds accounting for over 50 percent of the dollar volume of all appraisal petitions. Second, most appraisal petitions target deals with potential conflicts of interest, such as going-private deals, minority squeeze-outs, and short-form mergers. Each of these deals is associated with a 2-10 percent increase in the probability of an appraisal filing. Low takeover premiums also generate a higher probability of appraisal petitions.
The authors find that the De Minimis Exception will likely lead to a 23 percent drop in the number of appraisal filings. Although about 39 percent of appraisal petitions between 2000 and 2014 failed to meet the De Minimis Exception, about 16 percent of these petitions were short-form mergers, which would be excluded from this exception. The authors contend that this 23 percent drop provides an accurate estimate of how many claims would be barred in the future if the De Minimis Exception were to pass.
The authors argue that the Interest Reduction Amendment would have a much larger impact on appraisal filings, though this blog recently covered an opposing view. Interest accounted for about 60 percent of the returns in appraisal arbitrage trials between 2000 and 2014, and 11 percent of cases would have had negative raw returns were it not for the interest rate. The authors conclude that the current interest rate likely stimulated 45 percent of all the appraisal petitions filed. Based on this rationale, the prepayment amendment could significantly lower how much interest accrued, and in turn, theoretically lower the number of appraisal petitions filed as it would change the economic calculus of filing a petition. However, as we’ve previously posted, the prepayment amendment may just as well increase the number of filings, since stockholders would have more liquidity and could redeploy the prepayment capital to their next appraisal case.
Whether the amendments will ultimately become law remains to be seen, as well as their ultimate effect on appraisal proceedings.
* The Appraisal Rights Litigation Blog thanks Trevor Halsey, a student at Brooklyn Law School and summer law clerk for Lowenstein Sandler for his substantial contribution to this post.
Today’s New York Times ran this piece analyzing the proposed Delaware amendments on appraisal proceedings, which we blogged about last week. The New York Times shares our own observation that the proposed legislation’s provision allowing for prepayment by the M&A target could have the unintended effect of increasing appraisal filings: “Rather than discourage appraisal petitions, the elimination of interest accrual through prepayment may actually spur more appraisal actions because hedge funds would be paid sooner and be able to use that money to bring more appraisal actions.”
Proposed changes to the Delaware appraisal statute have cleared Delaware’s House of Representatives without dissent, and now move on to the state Senate. The new legislation, which we blogged about in March, sets a floor for the number of shares and value of suit necessary to bring an appraisal action. It also permits M&A targets to prepay merger consideration to dissenting shareholders to avoid interest accruing on the prepaid amounts. We note that the target’s ability to prepay some or all of the merger consideration could have the unintended effect of increasing the number of appraisal filings by ameliorating an investor’s illiquidity problem in prosecuting an appraisal action. Investors may now be enabled to redeploy their otherwise trapped capital in a new appraisal case; while investors would obviously lose their statutory interest on the prepaid amount, that might be a trade-off they can live with.
A number of amendments to Delaware’s appraisal statute have once again been proposed by the Corporate Council of the Corporation Law Section of the Delaware State Bar Association, the committee that customarily recommends legislative action to Delaware’s state lawmaking body. If certain proposed changes to the Delaware General Corporation Law (“DGCL”) are approved by the Corporation Law Section, they will be introduced to the Delaware General Assembly.
The proposed legislative changes – available here – are intended to (i) set a floor for the number and value of shares asserting appraisal and (ii) permit M&A targets to prepay some or all of the merger consideration to dissenters to avoid the accrual of interest on such prepaid amounts.
- Threshold for Appraisal
Under the proposed amendments, the Court of Chancery shall dismiss an appraisal proceeding for a public company, unless (1) the total number of shares entitled to appraisal exceeds 1% of the outstanding shares of the class or series eligible for appraisal, (2) the value of the merger consideration for such dissenting shares exceeds $1 million, or (3) the merger was a short-form merger pursuant to § 253 or § 267 of the DGCL.
To be clear, the legislature has not yet approved or even considered these proposals; we’ll post about any future developments in that regard. Since most appraisal cases already exceed such levels, we don’t anticipate that the thresholds set forth in items (1) and (2) will have a terribly profound impact; indeed, the cost of mounting an appraisal action naturally dissuades small stockholders from doing so.
- Prepayment Option
The proposed legislation also permits the surviving company to make a cash payment to dissenters in an amount of its choosing, with interest accruing only on the difference between the amount so paid and the fair value of the shares as determined by the Chancery Court (as well as any interest that had previously accrued on the paid amount as of the effective date of the merger).
Interestingly, while this second proposal would encourage appraisal respondents to prepay significant amounts to stop the interest clock, investors might utilize the opportunity to redeploy such returned capital to their next appraisal case, thus having the unintended effect of increasing the number of appraisal petitions.
It is worth noting that the draft legislation does not include any specific proposals to eliminate or limit appraisal arbitrage. The proposed legislation includes several provisions unrelated to appraisal that are not addressed here.
If ultimately adopted by the Delaware legislature, the legislation would become effective in respect of merger agreements entered into on August 1, 2016, and thereafter.
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.
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.
As reported in the Wall Street Journal, stockholders owning about 5 percent of AOL, Inc., are seeking greater returns than the $50/share buyout price paid by Verizon Communications by pursuing appraisal of their shares. The deal was valued at $4.4 billion. As reported in the article, this appraisal case is yet another example of how the appraisal mechanism has evolved from a “little-used remedy” to a “bona fide investing strategy.” Thus, as the Wall Street Journal reports, a record 40 appraisal cases were brought in 2014, and another 28 have been filed already in 2015 having a face value of about $1.8 billion.
The Corporation Council of the Delaware bar released proposed amendments to Delaware’s General Corporation Law last week. Among the various proposals, ranging from fee-shift provisions to forum-selection clauses in corporate bylaws, the committee proposed two changes to Delaware’s statutory appraisal remedy: first, to bar appraisals by shareholders holding 1% or less of the outstanding stock of a public company if the value of their shares is $1 million or less as based on the merger price; and second, to allow acquiring companies to stop the statutory interest on at least a portion of the disputed amount by permitting them to prepay a cash amount, in whatever amount they may choose. The proposed amendments to the appraisal statute are here, and the Corporate Council’s white paper explaining the amendments is here.
The legislature has not yet approved or even considered these proposals; we’ll post about any developments in that regard. In the meantime, the first such proposal will not likely have much of a practical impact, as there are not too many petitions, if any, brought by stockholders with such a small position. After all, a holder of a $1 million stake would not have sufficient economic incentive to bring an appraisal petition in the first place, given the expert and other litigation costs incurred in pursuing such a claim. It presents a limitation on such a rare class of cases so that the proposal will have precious little consequence. But that does not mean the legislature will readily take up the measure. There may be a concern among some legislators that once an effort is underway to eliminate “small” claims, future proposed amendments could take aim at cutting off larger claims. As to the second proposed amendment, the option of allowing respondent companies to make cash prepayments might have interesting results; it could encourage companies to prepay significant amounts, even up to the full merger price, just to stop the interest clock, which in turn could actually encourage more appraisal claims by inviting challenges from otherwise-reluctant stockholders concerned about having their capital locked up during the pendency of the appraisal proceeding.
Significantly, the proposals do not include an amendment to eliminate or limit appraisal arbitrage; we’ll post more about that issue in the coming days.
Among the compelling metrics compiled by Professors Korsmo and Myers in their article on appraisal rights that has been approvingly cited by the Delaware Court of Chancery, they have highlighted two key trends which, taken together, demonstrate the sophistication of the investors now driving what appears to be a pronounced spike in appraisal rights cases. Thus, the first graph (view here) shows the sharp increase in the number of petitions filed over the past decade, and the second graph (view here) shows the sheer size of the dollar amounts at stake.