In short, the market out exception (at least in Delaware) provides that a shareholder does not have appraisal rights if they are receiving stock and not cash for their shares in the target company. M&A Law Prof Blog compares the current state of appraisal (including the market out exception) with the premise that appraisal came about at a time when mergers were generally for stock, and thus appraisal gave one the ability to force (via appraisal) cash consideration instead of stock. The opposite of how the market out exception works today.
Although Delaware dominates when it comes to appraisal (as a result of its outsize attractiveness to U.S. companies as a place of incorporation), appraisal is not limited to the First State. As we’ve previously discussed, appraisal regimes also exist in other states including Massachusetts, Arizona, and Nevada. What about the Hawkeye State?
As a threshold matter, Iowa appraisal is limited by the market-out exception, and Iowa appraisal rights are not available if the target is traded in an organized market and has at least 2,000 shares and a market value of $20 million. Iowa, however, follows the Revised Model Business Act’s exception to the market-out exception (this “exception to the exception” is a common feature of appraisal regimes), allowing for appraisal rights with respect to publicly traded targets in interested transactions. See Iowa Code § 490.1302.
Like in Delaware, the Iowa appraisal statute requires a court to determine “fair value” of the stockholder’s shares. In Rolfe State Bank v. Gunderson, 794 N.W.2d 561 (Iowa 2011), the Iowa Supreme Court considered the exercise of appraisal rights in Iowa. As a result of a reverse stock split, a state bank offered to pay its minority shareholders $2,000 per share of stock based on an independent valuation that applied a minority discount and a lack of marketability discount. The minority shareholders exercised their appraisal rights and demanded $2,700 per share plus interest. Pursuant to the Iowa appraisal statute, the bank paid the minority shareholders $2,000 per share plus interest and then filed a petition with the district court to determine the fair value of the shares. The Iowa Supreme Court first reviewed the need to determine fair value as part of appraisal and then dove into whether minority and lack of marketability discounts would apply, ultimately concluding they did not.
Rolfe confirms that Iowa appraisal remains available in select instances and that a merger involving a company incorporated in Iowa can trigger appraisal rights, but the market-out exception must be considered.
We previously covered the proposed DGCL amendments, which would make changes to the appraisal statute with respect to intermediate-form mergers, and clarify requirements for disclosure with respect to the number of shares not voting for a merger.
If adopted, the appraisal amendments would become effective August 1, 2018.
Coverage of these proposed amendments has intensified; here are some highlights:
“It is exceedingly uncommon for stock-for-stock transactions to be effected as a two-step tender offer/merger under§251(h). One of the possible reasons for this [ ] is the insulation from appraisal claims that a long form merger offers (and that a two-step transaction does not). By eliminating this discrepancy, the proposed amendments to the DGCL potentially increase the utility of the§251(h) two-step merger structure. That said, in a stock-for-stock transaction, the acquiror will be required to register its shares on Form S-4 (or Form F-4), and often will not commence the exchange offer until after its registration statement has cleared SEC comments.”
“Effectively, the current statute permits appraisal rights for intermediate-form mergers even if the market out exception would apply to the analogous “long-form” merger, which requires shareholder approval. The proposed amendment would eliminate this illogical result and provide the same exception to appraisal rights for mergers under 251(h) as are provided for long-form mergers.”
“The amendments to Section 262(e) would modify the information to be included in the statement that must be furnished to dissenting stockholders upon their request in connection with Section 251(h) mergers. In recognition of the fact that no shares are “voted” for the adoption of the merger agreement in a Section 251(h) transaction, the amendments would clarify that the surviving corporation must provide stockholders, upon their request, with the number of shares not purchased in the tender or exchange offer, rather than the number of shares not voted for the merger.”
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.
**Update: For another view on the proposed amendments, see Shearman & Sterling’s take.
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).
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.