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.

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.

When the Delaware legislature recently struck down fee-shifting bylaws — those internal corporate laws that force losing plaintiffs to pay the company’s legal fees — it prompted a slew of commentary (e.g., here and here) suggesting Delaware may lose its place as the top venue to incorporate.  Nevada has been making a play to provide a Delaware-style business-friendly climate.  (See “Delaware’s loss of certainty could be Nevada’s gain.”)  Whether Nevada supplants Delaware as the leading corporate venue remains to be seen.  But it got us thinking — what does appraisal rights litigation (called “dissenters’ rights” in Nevada) look like for professional investors in Nevada corporations?  As it turns out, Nevada is not nearly as friendly a place as Delaware for professional investors whose shares are at risk of being cashed out for an amount below the going-concern value of their investment.

First and foremost, holders of securities in an exchange-listed Nevada corporation without a controlling shareholder (10% or greater) are not entitled to dissenters’ rights at all.  Nevada law allows for exceptions where the articles of incorporation provide otherwise or at least part of the merger consideration is not cash or shares of most kinds of corporate stock, but by default there are no appraisal rights.  In contrast, Delaware appraisal rights are generally available in a consolidation or merger for any series or class of stock.

Moreover, an investor still needs to clear several hurdles to get an appraisal claim before a Nevada judge.  Indeed, the investor and the corporation need to exchange three separate notices before a dissenter’s petition is even filed in court.  Initially, investors wishing to dissent from a merger or other business combination subject to appraisal rights must first, before the merger vote, deliver a written notice.  Investors must also be sure not to vote their shares in favor of the merger or consolidation.

The shareholder’s notice prompts a response from the subject corporation, to which the investor must respond by (i) demanding payment, (ii) certifying that he or she was actually a beneficial owner, and (iii) surrendering his or her stock certificates as formal evidence of stock ownership.  The company is then required to tender payment to the shareholder of an amount that it considers to be the fair value of the shares.  The company is highly incentivized to follow this procedure — if it does not, only then may an investor file its action directly and, if the investor prevails, he or she is entitled to recover the expenses of the lawsuit.

Presumably, the corporation’s payment will be insufficient.  But even then, an investor cannot go directly to a judge.  Instead, the investor has to object in writing and make a demand for what he or she thinks is the fair value of the shares.  Only then, with the payment demand unsettled, will a petition be filed in court.  Also, it is the company — not the investor, as in Delaware — that files the petition, and the company can wait two months to do so.

Two other considerations bear mention.  First, unlike Delaware, Nevada does not provide for an interest rate floor on appraisal awards (Delaware appraisal awards accrue at 5% above the Fed’s discount rate and are compounded quarterly).  Nevada law instead says that a dissenter’s award will be for fair value “plus interest.”  Second, there are very few decisions interpreting Nevada’s dissenters’ statute, making litigation in Nevada much more unpredictable for investors and companies alike.

Accordingly, professional investors who utilize appraisal rights to maximize their investment returns will not cheer on Nevada to supplant Delaware as the seat of American corporate law.

On Monday the Delaware Chancery Court heard challenges by Dell to the entitlement of various dissenting shareholders to pursue their appraisal claims.  Dell’s challenges included failures by shareholders to timely and accurately assert their appraisal rights, and a lack of continuous ownership of Dell stock based on purported changes in the nominal ownership of such stock.  The court has yet to rule on these arguments.  But perhaps the most closely watched challenge was the one not heard yesterday: namely, Dell’s challenge to T. Rowe Price’s appraisal claim based on the apparently recent revelation that T. Rowe voted “for” the merger, as we previously posted.  The court indicated that it would take up that issue after Dell proceeds with the targeted discovery that it advised the court it intends to pursue in respect of T. Rowe’s vote.

Also in the course of that hearing, Vice Chancellor Laster heard argument from an individual dissenting shareholder defending his entitlement to proceed and invoking historical case law to support his position.  As an amusing aside, the chancery judge commented that he appreciated hearing citations to court cases going back more than 10 years, validating the fact that appraisal rights are an historical phenomenon dating back to Delaware’s corporations law from the 19th century and were not simply invented in 2007 — when the Transkaryotic case was decided — as some people, particularly in New York, seem to believe.  This was a not-so-subtle swipe at the critics of appraisal arbitrage, who have derided the Delaware courts, and more recently the Delaware state assembly, for failing to limit or eliminate the emerging practice of appraisal arbitrage, as we have repeatedly posted about in recent months.

Based on this Reuters piece summarizing the May 11 hearing and Dell’s brewing challenging to T. Rowe’s ability to proceed, it appears that T. Rowe may try to justify its entitlement to proceed by invoking the arbitrage cases to suggest that there were enough appraisal-eligible shares to allow it proceed, although it clearly faces an uphill battle.  Ordinarily, if a shareholder votes “for” the transaction, it’s game over for its appraisal claim.

As reported in USAToday, T. Rowe Price, the third largest shareholder in Dell, Inc., has been pursuing an appraisal case to recover more than the $13.75 per share merger price. However, it has now come to light that T. Rowe actually voted “for” the 2013 take-private deal by the company’s founder, thus threatening its ability to pursue appraisal. Indeed, one of the key steps in perfecting appraisal rights is voting against the proposed transaction, or at least abstaining from the vote, but in all events refraining from actively voting for the deal outright. Whether T. Rowe is permitted to continue in the case has not yet been decided by the Delaware chancery court.

We recently posted about the two related January 5, 2015 arbitrage decisions, in which the Delaware Chancery Court refused to impose share-tracing requirements or other obligations on beneficial stockholders and reaffirmed that only record owners bear the burden to no-vote their shares and otherwise perfect their appraisal rights. This week the lawyers defending Ancestry.com, whose arguments were rejected by the Court, have posted this blog calling for legislative reform of the appraisal rights statute to remedy what they perceive to be a “troubling expansion” of stockholder appraisal rights.

In two separate rulings on January 5, 2015 — In re Appraisal of Ancestry.com., Inc., and Merion Capital LP v. BMC Software, Inc., both by Vice Chancellor Glasscock — the Delaware Chancery Court reaffirmed the legitimacy of the appraisal arbitrage strategy and refused to impose share-tracing requirements or other obligations on the beneficial stockholder, continuing to require only of the record owner that it perfect appraisal rights by not voting in favor of the deal and making a timely demand for appraisal. News of these rulings has already been widely reported, including by Reuters and The Wall Street Journal.

We’ve posted before about arbitrage opportunities in appraisal rights and the increased utilization of this strategy by professional investors. Indeed, we had been awaiting the Chancery Court’s ruling in Ancestry.com, as it presented the first opportunity since the Delaware appraisal statute was amended in 2007 to decide whether the Court’s prior ruling in Transkaryotic would remain good law in light of that amendment.

Both new cases address the practice of so-called appraisal arbitrage, in which an investor buys the target company’s stock after a merger announcement. In the Ancestry.com case, the Court rejected the company’s argument that given the 2007 amendment to the appraisal statute — by which Delaware’s legislature expressly permitted beneficial owners to file appraisal petitions directly on their own behalf — the beneficial owner should be required to show that its predecessors did not vote in favor of the merger, and if it cannot do so, it lacks standing. The Court held that under a plain reading of the statute, it remains the record holder alone who must have no-voted the shares for which it seeks appraisal; the statute does not impose any requirement on a stockholder to demonstrate that previous owners also refrained from voting in favor. In other words, the Court affirmed Chancellor Chandler’s previous ruling in Transkaryotic that the actions of the beneficial holders are irrelevant in appraisal actions, and the Court thus refused to adopt the company’s proposed share-tracing requirement. As a matter of procedure, the Court denied the company’s motion for summary judgment on this issue; the appraisal decision itself has not yet been made and will issue separately.

The ruling in Ancestry.com is thus the first decision to uphold appraisal arbitrage after the 2007 statutory amendment was made; Transkaryotic, which first permitted arbitrage, was decided in 2007 prior to the amendment. The ruling in Transkaryotic was based in large part on Chancellor Chandler’s accounting for the fact that in a typical situation the owner of stock certificates, such as Cede & Co. — which is usually the nominal owner of shares that are on deposit with the Depository Trust Company — holds their shares in an undifferentiated manner in “fungible bulk,” and so no shareholder has ownership rights to any particular share of stock. Vice Chancellor Glasscock’s new ruling continued to recognize that reality and found nothing in the 2007 amendment to Section 262 to suggest that the Delaware legislature intended to require beneficial owners who made post-record-date purchases to show that their specific shares were not voted in favor of the merger. In fact, the Court found Ancestry.com’s proposed requirement to contradict and be invalidated by the Court’s prior approach in Transkaryotic.

The action in Merion Capital v. BMC Software was brought by Merion Capital, a self-described “event-driven investment” fund that specializes in appraisal arbitrage. The stockholder in that case faced a unique problem because Cede refused to make its appraisal demand on its behalf, so Merion was forced to have its holdings in BMC stock withdrawn from the “fungible mass” at DTC/Cede and registered directly with BMC’s transfer agent, Computershare. Merion thus sought to become its own record holder as well, and the Court found that it succeeded in doing so and properly made demand. BMC challenged Merion’s standing by saying Merion needed to prove that each share it seeks to have appraised was not voted by any previous owner in favor of the merger. The Court rejected BMC’s challenge and found that Merion succeeded in showing that it had not voted the shares in favor of the merger; as it did with Ancestry.com and Transkaryotic, the Court held that nothing in the statute requires a stockholder to prove that the specific shares it seeks to appraise were not voted in favor of the merger.

These rulings clearly reaffirm the validity of appraisal arbitrage, at least as a legal matter. Of course, as a practical matter, that strategy remains subject to the very real risk that the number of shares presented for appraisal actually outnumbers the number of no-voted shares eligible for appraisal, causing the appraisal action to be oversubscribed. The Court refused to make any pronouncement on how it might rule in such an overappraised situation, since it was not presented with those facts in either of these two cases.

 

In a forthcoming law review article expected to be published in 2015 in the Washington University Law Review, “Appraisal Arbitrage and the Future of Public Company M&A,” Charles Korsmo (Associate Professor at Brooklyn Law School) and Minor Myers (Associate Professor at Brooklyn Law School) report their findings showing a large uptick in the number of appraisal petitions being filed, as well as a marked increase in the size of the petitioners’ holdings and an increased level of sophistication among the filers themselves. The authors observe an increased use of arbitrage by which petitioners appear to invest in the target after the M&A deal is announced (for more about arbitrage, see our prior post here). While the authors note that the defense community has decried appraisal arbitrage as an abusive exercise of appraisal rights that ought to be suppressed, the authors argue that this criticism has it precisely backward and that the “new world of appraisal” should be welcomed and encouraged, as it ultimately provides an efficient means for benefiting minority shareholders and actually reducing the cost of raising equity capital.

Among the highly telling data points that Professors Korsmo and Myers collected for their analysis, they found that the value of claims in appraisal in 2013 was nearly $1.5 billion, a tenfold increase from 2004 and nearly 1% of the equity value of all merger activity in 2013. They attribute this surge in appraisal claims to the increased use of appraisal arbitrage in a manner that is transforming what this blog has repeatedly described as an underutilized shareholder remedy into a specialized investment strategy.

 

An interesting question first addressed many years ago has just resurfaced: can a shareholder seek appraisal rights for shares it acquires after the merger is announced and even after the record date that is set for voting on whether to approve the proposed M&A transaction? Historically the Delaware court said yes, subject to certain other conditions being met, but that may not be the last word on the subject. The New York Times recently blogged about a new case currently before the Delaware courts arising from the buyout of Ancestry.com, showing that this issue is timely again.

First, some background: in 2007, the Delaware Chancery Court opened the door to arbitrage possibilities by its ruling in the appraisal rights case of Transkaryotic Therapies, Inc. In that proceeding, the court permitted a shareholder to exercise appraisal rights for shares acquired after the record date but before the merger vote, provided that the record holder had timely notified the issuer, pre-vote, of a sufficient number of “no” votes or abstentions to cover the number of newly acquired shares being put up for appraisal. The court recognized that owners of stock certificates, such as Cede & Co. — which is typically the nominal owner of shares that are on deposit with the Depository Trust Company, hold their shares in an undifferentiated manner in “fungible bulk,” and so no shareholder has ownership rights to any particular share of stock. Accordingly, there is no voting history attached to any particular share of stock or beneficial owner; all that matters is that the record holder vote no or abstain with respect to a sufficient number of shares to cover the newly acquired shares for which a petitioner wants to seek appraisal.

There are limits as to how late a stockholder may acquire shares for purposes of appraisal; naturally, shares bought after the merger vote, even if acquired before the merger consummation or closing date, won’t count toward appraisal, as they are acquired too late and without sufficient notice to the company.

To illustrate the point, let’s assume that a shareholder currently owns five shares in XYZ Company and an announcement is made on June 10 that ABC Company will be acquiring XYZ. XYZ will be conducting a shareholder meeting regarding the proposed merger on July 1, based on a record date of June 20. Now let’s assume that after the deal is announced and before the July 1 shareholder meeting, our shareholder directs Cede to provide notice to XYZ Company that she will be dissenting with respect to her five shares. Cede then follows those instructions, as well as the directions it receives from all the other beneficial owners for whom it holds shares, and Cede goes ahead and provides notice to the company for all the “no” votes that it has been directed to give. Let’s further assume the total of “no” votes is 100, and in addition to those votes, there are 50 abstentions, so the total number of shares “eligible” for an appraisal demand is 150.

If our shareholder later buys five more shares after the June 20 record date but prior to the July 1 merger vote, she can still seek appraisal for her new total of 10 shares out of the 150 eligible shares for which Cede has given notice. If, however, other dissenting beneficial owners for whom Cede also holds have tendered 145 shares for appraisal, then our shareholder can seek appraisal for only five of her shares, not for the other five in excess of the 150 total eligible shares.

The Transkaryotic opinion back in 2007 was issued by the Delaware Chancery Court, and the rule in this case has not yet been affirmed or otherwise opined on by the Delaware Supreme Court; it is indeed the standing principle today but could become more controversial and may well be revisited if it reaches the Supreme Court and they see things differently. And now that Ancestry.com seems to be taking a run at challenging the Transkaryotic ruling, based in part on a change in the appraisal statute since the time that that case was decided, the Delaware courts may take up this issue again. We’ll watch this case as it proceeds and post any new developments here.