Notice of Demand for Appraisal

Seven years ago this week, in Roam-Tel Partners v. AT&T Mobility, C.A. 5745-VCS (Del. Ch. Dec. 17, 2010), then-Vice Chancellor Strine held that in a short-form merger, a stockholder can revoke its prior waiver of its appraisal rights within the twenty-day statutory election period, absent any prejudice to the corporation.  In that case, the stockholder submitted to the company a letter of transmittal along with his stock certificates, but then changed his mind, returning their (uncashed) check and timely demanding appraisal.  The court compared his initial decision in accepting the merger consideration to that of submitting a proxy in a long-form merger, which is freely revocable at any time prior to the shareholder vote.

In such transactions, shareholders are thus permitted to reverse their tender and opt instead to appraise so long as they do not actually accept the merger consideration and submit a timely appraisal demand within the statutory period.

Eight years ago today, in DiRienzo v. Steel Partners Holdings L.P., No. 4506-CC (Del. Ch. Dec. 8, 2009), Chancellor Chandler reaffirmed the principle that the record holder requirements of Section 262(a) demand strict compliance.

The Chancery Court dismissed an appraisal petition on grounds that the appraisal demand was not made by a record holder listed on the company’s stock ledger.  The record holder, according to the court, was neither the party seeking appraisal nor his broker, but rather the central security depository, Cede & Company.  The court rejected petitioners’ argument that the company waived its right to object to the defective appraisal demand by submitting three letters to petitioners prior to the filing of the appraisal petition.  The court similarly rejected petitioners’ estoppel argument premised on the company’s alleged disclosure violations in the appraisal notice.

For beneficial owners, the takeaway from this case remains true today:  to be entitled to appraisal their record holders must submit an appraisal demand on their behalf.

The New York Law Journal recently ran an article, Looking Beyond Delaware: Exercising Shareholder Appraisal Rights in N.Y. [via ALM], which analyzes the New York appraisal statute and observes that while appraisal litigation has remained underutilized outside of Delaware, it is possible that with the uptick in Delaware appraisal New York will see more appraisal litigation in its courts as well. As the article shows, the New York appraisal statute deviates from Delaware’s and provides appraisal rights even beyond merger transactions, extending to share exchanges and all-asset dispositions as well.

 

In his second appraisal decision in as many months, Chancellor Bouchard faced the novel question of whether the Chancery Court can approve a settlement between the surviving company and certain non-appearing dissenters, who had never themselves filed or joined in an appraisal petition, if the terms of that settlement are unavailable to all of the dissenters who had perfected appraisal rights.  Under the Chancellor’s decision in Mannix v. PlasmaNet, Inc., the answer is yes.

Mannix was not a valuation decision but a procedural ruling.  The issue arose because Delaware’s appraisal statute is in certain ways similar to the class action device, in which one plaintiff serves as a representative in a lawsuit on behalf of all other similarly situated plaintiffs.  Specifically, the appraisal statute provides that one appraisal petition can serve as the “representative” appraisal action for all other dissenting shareholders, and that the fair value determination reached in that proceeding will be available to all dissenters who have perfected their appraisal rights even if they had not filed their own petition.  As the Chancellor is careful to note, however, there is “at least one notable distinction” between the procedures available in an appraisal proceeding and those in a class action: unlike in class actions, in which shareholders elect to “opt out” of the class to pursue individual claims, appraisal petitioners “opt in” to an appraisal proceeding before the litigation even begins by dissenting from the merger and perfecting their rights in the first place.

In Mannix, certain non-appearing dissenters – i.e., stockholders who neither filed their own petitions nor joined in another’s petition – had settled with the surviving Company and were now asking the Court for their appraisal claims to be released.  The settlement was conditioned on the non-appearing dissenters certifying that they were “accredited investors” under the federal securities laws, a necessary condition because the settlement consideration consisted of their receiving the surviving Company’s unregistered stock.  The Company made the same offer to the named appraisal petitioner (Mannix), who rejected it.

Chancellor Bouchard rejected both of the petitioner’s challenges to the settlement.  The petitioner first argued that the Company could not condition a settlement on a dissenter’s status as an accredited investor, since not every non-appearing dissenter may qualify as accredited.  The Chancellor held that this argument was unsupported by any law or precedent and distinguished two earlier appraisal cases that had raised the specter of a “buy off,” whereby the named appraisal petitioner settles the proceedings to the benefit of himself and the Company, but to the detriment of all other non-appearing appraisal petitioners that he was in effect representing.  Chancellor Bouchard found that these concerns were not before him, where any purported “buy off” – if there even was one – was being undertaken by a non-appearing dissenter, and thus would have no effect whatsoever on Mannix’s ability to prosecute his own appraisal action on behalf of himself and any other non-appearing dissenters who remained.

The Chancellor drew another analogy to class action settlements, citing former Chancellor Allen for the proposition that “a defendant in a putative [i.e., pre-certification] class action is readily permitted under the law to settle a class claim with non-representative class members.”  Likewise, the surviving company in an appraisal proceeding is similarly able to settle directly with non-appearing dissenters.

In general, in making these references to the class action vehicle, the Chancellor made a point of showing how appraisal rights are also representative actions, albeit in different form, and that the statute in fact encouraged the notion of representation by requiring that only one appraisal petition be filed – whether by the surviving corporation itself or by a former stockholder – thereby entitling all former stockholders who perfected their appraisal rights to receive “fair value” even if they did not file a petition themselves.  Indeed, the court noted that the right to appraisal ceases if all interested persons failed to file a petition for appraisal within the statutory 120-day period following consummation of the transaction.

The Chancellor was also unmoved by the petitioner’s second argument, that settling non-appearing dissenters out of an appraisal case would “undercut the economics of the appraisal proceeding” by reducing the total shares at issue and, accordingly, the aggregate recovery available in the proceeding.  The court found that the petitioner happened to be the first shareholder to file an appraisal demand, and thus had already accepted the risk from day one that he might end up being the only one to so file, even though that risk never came to pass.  The Chancellor also observed that if he were to hold otherwise, it would give named appraisal petitioners a “hold-up right” to block any settlement, which was not envisioned by the appraisal statute.

The transaction is also notable for its incredibly small size: the total merger consideration for this deal after adjustments was just $114,000, or six-tenths of a penny for each of the 19,307,715 shares of outstanding PlasmaNet stock, and the named petitioner brought this action seeking appraisal of his 1,700 shares.

The Chancery Court granted summary judgment in favor of Dell against a number of stockholders who duly noticed their appraisal demands but whose stock certificates had been retitled before the effective date of the merger to their own custodians’ nominees. As is typical for an appraisal challenge, DTC certificated the dissenting stockholders’ shares into the name of its nominee, Cede. But the beneficial owners’ custodians then took the added step of directing DTC to retitle the shares to the name of their own nominees, which change took place prior to the consummation of the merger. The court ruled that this ostensive break in record ownership violated the continuous holder requirement and thus disqualified those beneficial owners from proceeding with their appraisal case.

This ruling dismisses almost a million shares from the Dell appraisal case. Shares that were certificated in the name of Cede, without a further name change, are unaffected by this decision and the rest of the claims remain pending before the court. The ruling only affects those holders whose custodians changed the designee out of Cede’s name and into their own nominees’ names. Interestingly, the court found it irrelevant that the funds themselves were unaware of the retitling of their shares, a process which is undertaken by the custodian without the beneficial owner’s knowledge or consent. Thus, Vice Chancellor Laster found that once a shareholder chooses to hold its shares through intermediaries, it assumes the risk that the intermediaries might take an action against its interests.

Vice Chancellor Laster makes very clear that he felt constrained by Delaware case law to reach this result and that “were it up to me,” a better interpretation of the term “stockholder of record” in the appraisal statute would include the DTC participant list (i.e., the brokers and custodians, not just Cede). Under federal law, Cede is not the record holder, the DTC participants are deemed to be the holders, and the Vice Chancellor would have followed federal law if he did not think that Delaware law so clearly deems only Cede to be the owner of record. In fact, he directed much of his opinion to the Supreme Court itself and seems to want to be reversed. The legislature could conceivably take action first, and contemplating that very possibility, the Vice Chancellor also stated that he did not want to be overridden by the legislature and that there should not be a legislative cure to an issue of statutory construction.

The opinion provides a very detailed account of the process by which shares are held in fungible bulk and then re-certificated by DTC, and how Congress directed the SEC to immobilize share certificates through a depository system in response to the unworkable situation that had arisen under the former paper trading framework. The decision also lays out a comprehensive history of the record holder requirement, from 1899 to the present, in the course of which the court touched on appraisal arbitrage: on the one hand, the court said that including the DTC participants would bring greater clarity to the question of how particular stockholders may have voted. But at the same time, the Vice Chancellor made very clear that he did not thereby intend to undercut the practice of appraisal arbitrage, and as a policy matter he did not understand why critics of appraisal arbitrage oppose the transfer of appraisal rights when the commercial marketplace generally favors the transfer of property, including something as likely to result in an assignment of a litigation claim as a defaulted loan.

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.

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.

 

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.