In appraisal, across the majority of states–and those countries we have reviewed–the main question is the “fair value” of a petitioner’s shares. Some courts and commentators have mixed “fair value” with a similar but economically distinct term: “fair market value.” But even if everyone agrees on what fair value means, that does not mean the law is uniform as to when fair value is being calculated. Consider: Delaware law tasks the court with determining the fair value of the shares as of the merger date. At the other end of the spectrum, California law requires a court to determine the fair value of shares immediately prior to the announcement of the merger. Two states’ laws thus deal with certain eventualities in very different ways. What if the deal takes a long time to close? For California, this makes no difference; the “interim events” between announcement and closing do not come into the analysis. But for Delaware, interim events can have great significance–just because management has struck a deal (including a price) months, sometimes many months, before closing does not mean that that price reflects the value of the company at closing. As an example, imagine an early-stage biotech company or a speculative gold miner. Deal price may be set and a shareholder vote taken; then the company receives FDA approval or a claim pans out, and at closing, the buyer receives the benefit of the increased value while shareholders do not. In larger deals, where numerous regulatory hurdles need to be cleared, the difference in the date of the fair value measure can mean the difference in measuring during a positive or a negative business cycle. So in any appraisal action, the “when” of fair value matters.
In the wake of the Dr Pepper decision that a reverse triangular merger does not carry appraisal rights and considering corporate counsel’s growing concern over appraisal petitions, one might wonder whether we will see a rush of reverse triangular mergers in order to try and thwart investor’s appraisal rights. Lawyers from Fried Frank say no in this Law360 piece [$$$]. At its core, the authors focus on the Chancery Court’s own, footnoted view that a rush to reverse triangular mergers is an “overstated” risk, because the structure has been known and employed before. The authors agree that there will not be a move toward this contorted merger structure (with a major caveat, covered below), writing this:
In our view, it is unlikely that the structure would be broadly used solely for the purpose of avoiding appraisal rights. We note that the structure involves the disadvantages of complexity (making it potentially impractical in any competitive bidding situation) and leaving an equity stub in the hands of the target public stockholders (a result that acquirers typically disfavor). Moreover, generally, with an exception possibly in the case of conflicted controller transactions, it would be inadvisable to structure a transaction based primarily on avoiding appraisal rights–given that appraisal claims are made only in a relatively low (and recently declining) percentage of transactions, that appraisal awards significantly above the deal price are made only rarely (recently, even more rarely), and that appraisal awards at (or even below) the deal price have been increasingly prevalent recently.
This is a notable analysis. The authors contend that the structure may be impractical when there are competitive bids (i.e., when appraisal is not particularly favored to begin with) and then draw an exception for conflicted-controller transactions (when appraisal would be favored because of issues with the deal process. Put another way, the reverse triangular merger structure may not be used when appraisal isn’t viewed as much of a threat to begin with. But does Dr Pepper open the door to using this anti-appraisal structure in the exact kind of deal where a significant appraisal uplift is possible, such as conflicted-controller transactions? The authors seem to acknowledge as much.
As appraisal risk continues to be meaningful in conflicted-controller transactions, the Dr Pepper structure might be attractive in these situations if the controller is prepared to leave some of the equity of the target company with the sellers. We note that the public equity stub could be eliminated through a reverse stock split following completion of the merger; however, there would be an issue whether that additional step might (1) convince the court to view the structure as an impermissible contrivance to avoid appraisal (thus leading to a different result than in Dr Pepper) and/or (2) raise fiduciary issues and affect the court’s review of the transaction under the “entire fairness” standard. … There are other, less complex structures that could be considered and that could render appraisal rights inapplicable, although, of course, any novel structure could raise business and practical issues and prompt legal challenges.
Like with the appraisal amendments and differing predictions of how those would affect appraisal filings, the impact of Dr Pepper on choice of deal structure remains to be seen.
In April 2018, shareholders of Dr. Pepper filed a lawsuit challenging a merger with Keurig – a deal they called convoluted and which was allegedly designed to deny them appraisal rights. One particular branch of that challenge, that the deal itself actually should have carried appraisal rights, was decided in June 2018 against the shareholders. Dr. Pepper shareholders will not have appraisal rights in this reverse triangular merger because, as the Delaware Chancery Court found, Dr. Pepper is merely the parent of the subsidiary merging with Keurig and not the “constituent corporation” the statute requires. A constituent corporation, the Court wrote, is one that is actually “being” merged or combined. Here, while Dr. Pepper’s original shareholders will end up as 13 percent minority shareholders in the combined entity, with Keurig shareholders owning the rest, the formalities of the merger are such that only a Dr. Pepper subsidiary is “being merged” – hence, no appraisal rights.
Further, the Court found that since an original Dr. Pepper shareholder would still be a Dr. Pepper shareholder (albeit, significantly diluted) after the ‘merger’ – the shareholder is not giving up their Dr. Pepper holdings, and thus, no appraisal rights.
Might this be a template for those seeking to avoid appraisal rights in the future? Perhaps. Though the Delaware court seemed concerned with the opposite effect: that applying appraisal rights in this instance may change the meaning of the appraisal statute for a relatively rare merger structure and specific set of facts. But with appraisal prominent in corporate counsel’s minds, perhaps a rare deal structure will become more common.
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.