We’ve posted before about the article by Professors Charles Korsmo and Minor Myers analyzing the recent surge in appraisal activity.  These co-authors have prepared a new draft article to be published in the Delaware Journal of Corporate Law, proposing reforms for appraisal litigation.  Based on their latest research the authors stand by their prior conclusion that appraisal plays a “salutary if small role” in M&A practice.

The new article expands their data set to include 2014 (the prior study ranged from 2004 to 2013), and the authors provide updated charts showing the number of appraisal petition filings by year (Figure 2 on pages 14-15) and the percentage of equity value in appraisal by year (Figure 3 on page 16).  Some new metrics include a useful summary of appraisal trial outcomes for public company common stock (Figure 6 on page 22) and descriptive statistics of transactions challenged in appraisal to show which deals attract the most appraisal litigation (Table 1 on page 11).  It is this study that the authors use to demonstrate that the only independent variables in M&A transactions that have a statistically significant effect are the merger premium residual and the presence of insider participation: in other words, the lower the premium residual, the higher the likelihood of appraisal.  And appraisal is more likely to occur when an insider participates in the purchase.  See pages 10-12.

Given these observations, the authors conclude that “appraisal petitioners focus their resources on meritorious claims.”  This conclusion impels the authors to reject the reforms suggested by both respondent companies and deal advisors to limit or eliminate appraisal arbitrage, though they do suggest a less drastic compromise in setting the record date at least 20 days after mailing of the appraisal notice, giving stockholders material disclosures prior to the record date.

In addition, the authors propose other reforms to improve the effectiveness of appraisal, including (i) requiring disclosure of more financial information in M&A transactions subject to appraisal; (ii) eliminating the “irrational” exemption for all-stock transactions; and (iii) adopting a de minimis requirement.  Finally, the authors hint at improvements to the system of awarding interest in appraisal cases, but plan to develop that suggestion more fully in a separate article.

**Update: Korso and Meyers preview their article at the Columbia Law BlueSky Blog.

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.

The July 2015 article “Appraisal Arbitrage – Is there a Delaware Advantage?” by Gaurav Jetley and Xinyu Ji of the Analysis Group analyzes the extent to which economic incentives have improved for appraisal arbitrageurs in recent years, which the authors believe helps explain the “observed increase” in appraisal activity.  The article concludes that appraisal arbitrageurs enjoy an economic benefit by delaying their investment until after the record date, as they are privy to better information about the target’s value while minimizing their exposure to the risk of deal failure.  The study also finds that the Delaware Chancery Court utilizes a lower equity risk premium than do the financial advisors handling the deal itself, resulting in another benefit to arbitrageurs (and, one would think, historical holders as well).  Finally, the authors conclude that the statutory interest rate more than compensates appraisal petitioners for the time value of money.

Based on these findings, the authors propose several policy recommendations, including (i) a limitation on the arbitrage strategy by reducing stockholders’ ability to seek appraisal for shares acquired after the record date, and (ii) enactment of the proposal by the Council of the Delaware Bar Association’s Corporation Law Section (which the Delaware legislature has not enacted) to allow appraisal respondents to prepay claimants some portion of the merger consideration in order to limit the interest accruing during the pendency of the case.  On this latter point, the authors likewise acknowledge that allowing such prepayment is tantamount to funding claimants’ appraisal actions, thus potentially spurring on funds to increase their arbitrage strategy as they can redeploy such prepaid capital to the next case.

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.

Professors Korsmo and Myers have once again lauded the benefits of appraisal litigation and chastised its critics for pressuring the Delaware bar council to reconsider its recent decision not to limit or eliminate appraisal arbitrage.  In their latest piece, the authors reaffirm their findings that appraisal cases comprise that rare form of shareholder suit “where the merits actually matter.”  They suggest that the emergence of appraisal arbitrage specialists should be “reassuring, not shocking” to the deal community, as it evidences “beneficial specialization” that allows shareholders unfamiliar with the appraisal process to cash out, sometimes at a premium to the merger price, without being forced to accept an undervalued deal or to prosecute appraisal rights for themselves.

As we’ve previously posted, the Corporation Council of the Delaware bar had taken up the question of whether to ban or curtail appraisal arbitrage, and more recently decided to take no such action after determining that the practice had no discernable negative effects on mergers and acquisitions and, if anything, continued to protect shareholder value.  See our prior posts here and here.  In addition, as we recently noted here, Chief Justice Strine of the Delaware Supreme Court tends to agree with that position and believes that the concern over appraisal arbitrage is overblown.  As the Wall Street Journal reported this week, a group of law firms that typically represent parties to M&A deals strongly disagrees with the Council, and has sent a letter to the Council questioning its findings.  The headline-grabbing quote from the letter — that appraisal arbitrage is both “unseemly” and “rampant” — challenges the Council’s determination that there has been no recent uptick in frivolous or speculative appraisal litigation.  It is not apparent that the letter provides competing statistics to contest the Council’s findings, such as that in 2013, representative litigation occurred in more than 90% of public M&A, while only 17% of the appraisal-eligible transactions resulted in Delaware appraisal litigation.  Rather, the letter seems grounded on a policy rationale that the appraisal statute was not intended to enable those who purchase shares after the public announcement of a deal, or at least those who bought after the record date for the vote, to seek appraisal.  Given the Delaware courts’ finding to the contrary and their refusal to impose a share-tracing requirement that may impede appraisal rights of stockholders who purchased their shares after the vote, the letter-writers are taking their case to the legislature.

The current Delaware legislative session ends on June 30, so whatever changes, if any, are to be made to the appraisal remedy this year will need to take place before then.  We’ll keep you posted.

We posted earlier this week regarding a white paper written by the Council of the Corporation Law Section of the Delaware state bar, which was issued alongside the Council’s proposed amendments to Delaware’s appraisal statute.  The Council had considered amendments to address the practice of appraisal arbitrage, but ultimately did not make any recommendations to eliminate or limit that practice.  One reason the Council decided not to act to curtail appraisal arbitrage is that it perceived certain concerns expressed over the negative effects of arbitrage to be overblown, as the Council reviewed data from studies of appraisal arbitrage that did not indicate a material uptick in speculative or frivolous appraisal litigation.  The following additional findings from the white paper further explain why the Council has suggested that the Delaware legislature not hinder appraisal arbitrage:

  • Default fiduciary duties may not suffice to ensure that merger prices reflect the fair value of a target company’s shares, especially in deals such as buyouts by a controlling stockholder and other transactions that are not subject to a market check.  In light of the fact that appraisal is a necessary remedy to protect shareholders, it would be much less effective if the appraisal statute were amended to curtail the ability to transfer that right.  The law generally looks favorably on the assignment of financial claims, and there is no principled basis to depart from that position in the appraisal context.
  • Appraisal actions tend to target two species of deals: conflict transactions and those involving questionable pricing.  In both of these instances, which in the Council’s words have “a greater potential for unfairness,” the appraisal award is often a premium (significant, in many cases) to the merger price.
  • “Appraisal cases attacking the merger consideration in non-conflict transactions are fewer in number and often result in appraisal results below or near the merger consideration.”
  • “To the extent that the buyer in a merger has concern about an increased number of merger claimants and the overall cost of the transaction, the buyer can negotiate an appraisal-out condition (e.g., a right not to close the merger if more than a specified percentage of shareholders dissent and demand appraisal).  The fact that such appraisal-out conditions remain fairly rare suggests that the availability of appraisal arbitrage is not a significant factor in the market.”

At least one commentator who represented the respondent in the Ancestry.com case and who had (unsuccessfully) requested the Chancery Court to disallow arbitrage in that case has been extremely critical of the Council’s determination not to limit appraisal arbitrage.  We will continue to monitor developments in the state legislature and report on the assembly’s reaction to the Council’s proposal.

We posted last week about new legislative amendments to the appraisal remedy proposed by the Council of the Corporation Law Section of the Delaware state bar association, an influential group of Delaware lawyers.  The amendments were accompanied by an explanatory white paper explaining the rationale behind those recommendations that the Council made, and of note, those it did not make.  In particular, the Council did not advance a proposal to limit or eliminate outright appraisal arbitrage.  We have posted previously about so-called appraisal arbitrage, in which professional investors purchase shares ‒ with attendant appraisal rights ‒ after the terms of a merger are announced but before the deal closes.  See here, here, and here.

By way of background, the Council had created a subcommittee in February 2014 to consider the desirability of amendments to the appraisal statute.  As the Council’s report explained, the very creation of the subcommittee arose in part because of the increasing use of appraisal arbitrage and resultant commentary as to whether arbitrage was consistent with the intended purpose of the appraisal statute.  As the Council further reported, several considerations led the subcommittee to recommend, and the Council to conclude, that the appraisal statute should not limit appraisal rights to shares held before the public announcement of a proposed transaction.  In specific, the Council found that appraisal arbitrage is not contrary to the “balance” envisioned by the Delaware appraisal remedy, which the Council identified to be “the ability of corporations to engage in desirable value enhancing transactions and the ability of dissenting stockholders to receive fair value for their holdings.”  One of the primary factors behind this finding was the Council’s determination that appraisal arbitrage ‒ and appraisal litigation more generally ‒ does not encourage frivolous litigation.  As the Council found: “Unlike the case of representative litigation, which occurs in more than 90% of the public mergers and consolidations, only 17% of the appraisal eligible transactions during 2013 resulted in appraisal litigation in Delaware.”

We will post some additional highlights from the Council’s report later this week.

The Corporation Council of the Delaware bar released proposed amendments to Delaware’s General Corporation Law last week.  Among the various proposals, ranging from fee-shift provisions to forum-selection clauses in corporate bylaws, the committee proposed two changes to Delaware’s statutory appraisal remedy: first, to bar appraisals by shareholders holding 1% or less of the outstanding stock of a public company if the value of their shares is $1 million or less as based on the merger price; and second, to allow acquiring companies to stop the statutory interest on at least a portion of the disputed amount by permitting them to prepay a cash amount, in whatever amount they may choose.  The proposed amendments to the appraisal statute are here, and the Corporate Council’s white paper explaining the amendments is here.

The legislature has not yet approved or even considered these proposals; we’ll post about any developments in that regard.  In the meantime, the first such proposal will not likely have much of a practical impact, as there are not too many petitions, if any, brought by stockholders with such a small position.  After all, a holder of a $1 million stake would not have sufficient economic incentive to bring an appraisal petition in the first place, given the expert and other litigation costs incurred in pursuing such a claim.  It presents a limitation on such a rare class of cases so that the proposal will have precious little consequence.  But that does not mean the legislature will readily take up the measure.  There may be a concern among some legislators that once an effort is underway to eliminate “small” claims, future proposed amendments could take aim at cutting off larger claims.  As to the second proposed amendment, the option of allowing respondent companies to make cash prepayments might have interesting results; it could encourage companies to prepay significant amounts, even up to the full merger price, just to stop the interest clock, which in turn could actually encourage more appraisal claims by inviting challenges from otherwise-reluctant stockholders concerned about having their capital locked up during the pendency of the appraisal proceeding.

Significantly, the proposals do not include an amendment to eliminate or limit appraisal arbitrage; we’ll post more about that issue in the coming days.