No Proof of Wrongdoing Needed

In a recent article on PolicyHolder Pulse attorneys from Pillsbury explore whether Directors and Officers (“D&O”) insurance covers, or could be considered to cover, Delaware appraisal claims.  Critical to this analysis is whether an appraisal case raises issues of “Wrongful Acts” by the Board – including, for example, collusive behavior, or other process defects.  The Pillsbury authors note that appraisal claims are often (though not always) coupled with breach of fiduciary duty claims (something that occurred in Dole), which involve claims of wrongdoing.  Of course no proof of wrongdoing, or even of defective process, is necessary for a successful appraisal action.  They also suggest Securities Claim coverage may be available, depending on the terms of the specific policy.  D&O Diary, after discussing the arguments made, summarizes the article as finding that there “may be substantial grounds” for arguments in favor of coverage.

In a recent podcast, the Columbia Law School BlueSky Blog features Delaware Vice Chancellor Laster – whose appraisal decisions we have covered repeatedly – discussing the appraisal remedy.  While the entire podcast is certainly worth a listen, some important topics include the history of appraisal (~1:30); when markets may depart from fair value (~5:50); how appraisal may act as a reserve price (~9:30); the discovery burden in appraisal (~14:20); interest rates and the relevance of interest (~21:30); how to determine fair value (~23:30); and the future of appraisal (~29:00).

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.

Last week, the Delaware Court of Chancery issued an opinion in In re Orchard Enterprises, Inc. Shareholder Litigation (Del. Ch. Aug 22, 2014) concerning an application for attorneys’ fees (we have previously posted about a significant 2012 decision in that same case by former Chancellor Strine). We found the court’s latest decision noteworthy for two reasons. First, the court reaffirmed the principle that an appraisal action brought by an individual shareholder seeking a judicial determination of the fair value of its stock as of the merger date is an entirely separate animal from a shareholder class action in which the plaintiffs allege director misconduct in connection with the price or process leading up to the transaction. Second, the court cited approvingly an upcoming law review article that highlights statistically the benefits of the appraisal process.

In 2010, The Orchard Enterprises, Inc., was acquired by its controlling shareholder for $2.05 per share in cash. Following the merger, several shareholders pursued an appraisal action, which resulted in a judicial determination that the fair value of Orchard was $4.67 per share. After the appraisal action concluded, another shareholder who had not exercised his appraisal rights brought a class action against the board for breach of fiduciary duty. The class action settled before trial. Counsel for the appraisal shareholders objected to the settlement, arguing that they should be reimbursed from the class action settlement for the fees they incurred in the appraisal action because their efforts contributed to the settlement of the class action. Vice Chancellor Laster acknowledged that the appraisal shareholders “raised the bar” for the company by demonstrating that the fair value of Orchard stock was more than double the merger consideration. However, the court ruled that appraisal counsel was not entitled to reimbursement for its fees because the appraisal action was brought on behalf of individual shareholders, not on behalf of all of Orchard’s shareholders.

In a prior post, we observed how former Chancellor Strine (now Chief Justice of the Delaware Supreme Court) repeatedly took the time to clarify the important but often overlooked distinction between fiduciary duty claims and appraisal rights actions. Vice Chancellor Laster has now followed suit in Orchard when he declined to apportion part of the class action settlement to pay the attorneys’ fees incurred by the successful appraisal petitioners. According to the Vice Chancellor, as unsecured creditors who elected not to accept the merger consideration, appraisal petitioners may have interests that conflict with shareholders pursuing breach of fiduciary duty claims after selling their shares in the merger. Moreover, unlike class plaintiffs (who frequently own only a small stake in the company), appraisal petitioners typically have significant holdings that they believe have been undervalued, so they do not need to be offered an additional incentive (such as the reimbursement of attorneys’ fees) in order for them to seek court intervention.

We also recently blogged about a forthcoming law review article by Professors Charles Korsmo and Minor Myers of Brooklyn Law School, which is expected to be published in the Washington University Law Review in 2015. In that article, the authors laud the appraisal process because it ultimately provides an efficient means for benefiting minority shareholders and reducing the cost of raising equity capital. In the new Orchard decision, Vice Chancellor Laster cited this article and expressly recognized that the effect of an appraisal rights petition “may well be a net positive” because the process “reduces agency costs when compared to traditional class actions and results in a more efficient corporation law.” This is a highly significant reaffirmation of the unique and valuable role that appraisal actions will continue to play in enhancing shareholder value.

 

Among the thirty-five appraisal rights opinions written by Chancellor Strine over the past decade are some of the most cited and comprehensive treatments of the appraisal rights remedy to date. On January 29, 2014, the Delaware General Assembly unanimously confirmed Chancellor Strine’s appointment to the Delaware Supreme Court, where he will also become the court’s next chief justice, further underscoring the already significant deference his decisions have come to receive.

Among the several themes within Chancellor Strine’s vast appraisal rights jurisprudence, two are particularly striking: (i) Chancellor Strine repeatedly took the time to clarify the important but often overlooked distinction between fiduciary duty claims alleging director misconduct, as opposed to appraisal rights actions, which do not involve any accusation of wrongdoing. In addition, (ii) Strine repeatedly emphasized that the courts were required by law to reach “independent” determinations of a stock’s fair going concern value.

This past year, in In re MFW Shareholders Litigation, 67 A.3d 496 (Del Ch. 2013), Chancellor Strine once again spelled out the fundamental difference between (a) fiduciary duty claims brought by shareholders criticizing the board’s conduct in respect of the process or the price of an M&A transaction, on the one hand, and (b) appraisal rights cases involving a purely financial valuation, which does not raise any question of director misconduct. The appraisal rights proceeding requires the court to determine solely the appropriate valuation of the company as a going concern, which value the shareholder believes was not accurately reflected by the acquirer’s purchase price.

Indeed, eight years ago in Delaware Open MRI Radiology Associates v. Kessler, 898 A.2d 290 (Del. Ch. 2006), then-Vice Chancellor Strine provided a more detailed description of the court’s task in deciding an appraisal rights case, with particular emphasis on the fact that the court was duty-bound to make an independent determination of value, a consistent theme in his rulings:

My task in addressing the appraisal aspect of the case is easy enough to state, if more difficult in practice to accomplish with any genuine sense of reliability. Put simply, I must determine the fair value of [the company’s] shares on the merger date and award the [shareholder] a per-share amount consistent with their pro rata share of that value, supplemented by a fair rate of interest, regardless of whether that amount is greater or less than the merger price. Fair value is, by now, a jurisprudential concept that draws more from judicial writings than from the appraisal statute itself. In simple terms, to reach a fair value award, I must determine [the company’s] value as a going concern on the merger date and award the [shareholder] the percentage of that value that tracks its […] pro rata interest in [the company] on that date. In valuing [the company], I may consider all relevant, non-speculative factors bearing on its value as of the merger date. That includes the input provided to me by the contending parties’ experts. But I cannot shirk my duty to arrive at my own independent determination of value, regardless of whether the competing experts have provided widely divergent estimates of value, while supposedly using the same well-established principles of corporate finance. Such a judicial exercise, particularly insofar as it requires the valuation of a small, private company whose shares do not trade in a liquid and deep securities market, using a record shaped by adversaries whose objectives have little to do with reaching a reliable valuation, has at best the virtues of a good-faith attempt at estimation. That is what I endeavor here [emphasis added].

To further underscore the distinction between an appraisal rights case and a fiduciary duty claim challenging the board’s conduct, Strine further clarified in Kessler as follows: “[u]nlike a statutory appraisal action, the success of an equitable action premised on the assertion that a conflicted merger is unfair ultimately turns on whether the court concludes that the conflicted fiduciaries breached their duties.” In an appraisal action, in contrast, there is no comparable question before the court of whether director misconduct was to blame for a low buyout price; the court simply undertakes a valuation analysis.

In MFW, while addressing the various remedies available to minority shareholders in a fiduciary duty action who claim to have suffered harm as the result of a coercive tender offer, Strine once again underscores the fact that even if those shareholders were to fail to meet their burdens of proof in that action, their litigation rights are not extinguished, because they may also exercise appraisal rights as long as they voted no to the merger. And he further emphasized the effectiveness of the appraisal rights remedy: “[a]lthough appraisal is not a cost-free remedy, institutional ownership concentration has made it an increasingly effective one, and there are obvious examples of where it has been used effectively.” For those “obvious examples” he cites Golden Telecom, Inc. v. Global GT LP, 11 A.3d 214 (Del. 2010) (affirming appraisal remedy award of $125.49 per share, as opposed to merger consideration of $105 per share); Montgomery Cellular Hldg. Co. v. Dobler, 880 A.2d 206 (Del. 2005) (affirming appraisal remedy award of $19,621.74 per share for stockholders in short-form merger, as opposed to $8,102.23 per share in merger consideration); and M.G. Bancorporation, Inc. v. Le Beau, 737 A.2d 513 (Del. 1999) (affirming appraisal remedy award of $85 per share for dissenting minority stockholders in short-form merger, as opposed to merger consideration of $41 per share).

Building on Strine’s long-standing recognition that courts must make independent determinations of value, in the Golden Telecom case, the Delaware Supreme Court affirmed then-Vice Chancellor Strine and rejected the company’s challenge to his appraisal decision, in which Strine had refused to defer to the merger price as a measure of fair value. As the Supreme Court held, the appraisal statute “unambiguously calls upon the Court of Chancery to perform an independent valuation of ‘fair value’ at the time of a transaction. . . . Requiring the Court of Chancery to deter — conclusively or presumptively — to the merger price, even in the face of a pristine, unchallenged transactional process, would contravene the unambiguous language of the statute and the reasoned holdings of our precedent.”

Likewise, in In re Orchard Enters., Inc. (Del. Ch. July 18, 2012), Chancellor Strine explained that appraisal actions are unique in that both parties bear the burden of proving their respective valuations by a preponderance of the evidence. But consistent with his prior cautions, he found that the court has discretion to select one of the parties’ valuation models or create its own, but in all events, “the court may not adopt an ‘either-or’ approach to valuation and must use its own independent judgment to determine the fair value of the shares.”

With his promotion to Chief Justice, these important themes in Strine’s body of case law will likely take on greater significance.

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Note: This Blog has previously addressed several of the decisions discussed in this post, including Golden Telecom (August 7, 2013, post); MRI Radiology Assocs. v. Kessler (October 16, 2013, post); and Orchard Enterprises (September 13, 2013, and August 7, 2013, posts).

As discussed in our very first post, back in July of this year Carl Icahn famously encouraged his fellow shareholders in Dell Inc. to exercise their appraisal rights rather than cash out and accept the offer on the table from Michael Dell in his bid to take his namesake company private. This week, on September 9, 2013, Mr. Icahn sent another letter to Dell stockholders, announcing his decision not to defeat Mr. Dell’s take-private proposal after acknowledging that too many obstacles to his counter-proposal stood in his path.

Importantly, however, despite Icahn’s throwing in the towel on any competing proposal to Michael Dell’s, he repeated his opposition to that offer and trumpeted once again his intention to seek appraisal rights for his shares in the company. This is especially significant because Icahn had brought a lawsuit in Delaware Chancery Court claiming that the Dell directors breached their fiduciary duties in renegotiating the buyout deal with Michael Dell and undertaking other actions such as adjusting the record date for determining which shareholders were eligible to vote. In rejecting Icahn’s initial challenges, the Delaware Chancellor validated the board’s procedures and indicated skepticism over any breach of fiduciary duty claims. And yet Icahn — quite correctly — still remains undaunted in pursing his appraisal rights, knowing full well that the apparent lack of a breach of fiduciary duty in no way suggests that the merger price is inherently fair. After all, fiduciary duty and appraisal rights are two totally different animals.

In short, the issue at stake in an appraisal proceeding is not whether the board acted improperly but whether the merger consideration short-changes shareholders by giving them less than the fair value of their shares. Icahn clearly continues to believe that the company is worth more than the deal price suggests, and the Delaware Court’s statements to date about the deal process says nothing about the shares’ true value.