The Delaware Supreme Court held oral argument this morning on the Aruba appeal. The full argument can be watched here. The judges remained silent throughout the argument and did not put a single question to the lawyers, offering no insight as to what the Court might be thinking. We are standing by for a ruling and will post it here when available.
Law360 [$$] ran this piece today, Are Delaware Courts Last To Believe In Efficient Markets?, discussing Delaware Chancery’s Aruba decision, its treatment of the efficient market hypothesis, and the Supreme Court’s upcoming hearing of the appeal, which will take place this Wednesday, March 27, 2019.
The Cornerstone Report finds that despite concerns over “the subjectivity of DCF models,” the methodology remains the primary tool for valuing targets in a Delaware appraisal. Petitioners continue to “overwhelmingly” rely on DCF analyses (94% of the cases) while occasionally also providing a comparables analysis (35% of the cases). Respondents continue to rely on DCF analyses “in the vast majority of the cases” but also have relied on merger price, in part or entirely, approximately one-third of the time. Delaware courts have continued to focus on DCF analysis, utilizing it in 59% of the opinions issued between 2006 and 2018. No recent opinion relied on a comparables analysis. Accordingly, while concerns over objectivity persist, the DCF continues to be the primary tool employed by litigants and the courts to determine the fair value of corporations in appraisal cases.
We’ve posted before about Cayman Appraisal actions. The Cayman Islands remain an active jurisdiction for appraisal actions; and with appraisal actions comes valuation questions. Cayman firm Collas Crill has issued an explanatory note on valuation methods in the Cayman Islands, discussing the discounted cash flow (DCF) and market-based approaches taken by Cayman courts. As others have noted, Cayman courts often look to Delaware court decisions for persuasive authority when dealing with their own appraisal disputes, and this note suggest this may continue with Cayman courts considering “Dell compliance” – examining the merger process when determining the appropriate valuation method.
** Lowenstein Sandler LLP does not practice in the Cayman Islands.
The Cornerstone Report provides several data points concerning the frequency of court awards above merger price in appraisal actions as well as the size of the premiums and distinctions between results involving public and private companies. Between 2006 and 2018, Cornerstone reports 34 appraisal cases that went to trial; 16 resulted in awards above deal price and 18 resulted in awards at or below deal price. Across all 34 cases, on average, the premium to deal price was 18%. Among the 16 cases where a premium to deal price was awarded, the average was 47%. The Cornerstone Report also provides that the results for appraisal cases differed depending on whether the target was publicly or privately held. The average premium awarded in an appraisal concerning a public corporation was 8% while those involving privately held entities was 47%. In other words, the Cornerstone Report describes substantial variation in the premiums to deal price awarded in appraisal actions.
We discussed the Cornerstone Report’s data on appraisal activity previously.
According this report from Cornerstone Research, the number of mergers where appraisal was demanded has returned to levels seen in 2012-2015, demonstrating a further decline from the spike in appraisal in 2016. We covered the start of the reversion in 2017 previously. To begin, a caution. This is a raw numerical comparison of the number of mergers where an appraisal petition was filed across years – it does not necessarily quantify the percentage of mergers where a petition was filed, no less specifically Delaware mergers, no less Delaware mergers where the nature of the consideration and size of the company suggests an appraisal petition may have been possible. As a simple example – if more stock for stock deals are occurring, appraisal will be less likely, because in Delaware appraisal is not available in pure stock for stock deals. With that said, there is a general view that recent cases have diminished the appetite for appraisal cases; but this may be missing the thrust of those cases and of the movement in the appraisal world more generally. Two trends we have written about before: the increasing relevance of sales process and the increasing cohabitation of appraisal actions with the space usually occupied by breach of fiduciary duty actions may have created a bifold reaction – less appraisal on mergers where the process is more defensible, and/or higher premia for mergers where the process is less defensible. Recent scholarship has linked appraisal and other shareholder protections to higher merger premia for shareholders.
Appraisal is, like much of corporate law and finance in general, becoming more multi-jurisdictional (within the US) and more global in general. Thus what Cornerstone also does not capture is the filing of appraisal petitions in other states (such as Florida) or around the world. That is not to say that the incidence of appraisal is increasing; but as has been observed before, despite predictions of the death of appraisal, it continues to be a viable shareholder remedy.
As in other jurisdictions, there are in Mexico a number of corporate agreements or resolutions that may affect, in whole or in part, directly or indirectly, a certain group of equity holders. This group is usually defined as the one that has a smaller equity participation when compared with the controlling shareholders. The noncontrolling group is commonly referred to as the “Minority Shareholders.” Mexican corporate law provides for “Minority Rights,” for the protection of certain minimum rights in their favor that are exempt from an otherwise controlling interest decision.
Minority Rights are governed by Mexican law, specifically by the General Law of Commercial Companies (“LGSM”). Minority Rights are classified according to the percentages jointly or individually held by the Minority Shareholders, including the following:
(i) Thirty-three percent (33%): Right to issue a call for a General Shareholders Meeting (LGSM article 184).
(ii) Twenty-five percent (25%): Appointment of a director (LGSM article 144); filing of a liability action against directors (LGSM article 163); postponement of a corporate vote (LGSM article 199); and judicial opposition to decisions adopted by a Shareholders’ Meeting (LGSM article 201).
(iii) Twenty percent (20%): Spin-off objection (LGSM article 228 bis).
(iv) Ten percent (10%): Appointment of a director in a board of three or more members (LGSM article 144).
As a consequence of these rules, there is no specific rule under Mexican law that governs the economic valuation of shares/equity interests in the context of equity holders proceeding to withdraw/separate from the respective company. Thus, unlike other jurisdictions, there is no regulation in Mexico, for example, permitting Minority Shareholders to exercise their separation right from the partnership while triggering a valuation of their shares/equity interests. Such right is particularly not in existence in the context of potential disputes with the controlling shareholders. The LGSM is simply silent on these issues.
The above notwithstanding, at the statutory level, there are some provisions that may actually trigger the performance of stock valuation (not necessarily in favor of a given group of shareholders):
- LGSM article 141 states that if the value of assets contributed to the company for the issuance of stock decreases within a two-year period, then the corresponding shareholder must pay the missing value to the company; hence, in order to ascertain whether the corresponding assets’ value decreased, an appraisal would need to be prepared; and
- Securities Market article 108 provides that a company with an offering that is cancelled must make a public offer of such securities; to this end, as deemed necessary to protect investors, the National Securities and Banking Commission must request a valuation by an independent expert with the purpose of setting the offer price.
A nonbinding regulation called “Code of Principles and Best Corporate Governance Practices,” issued by the Business Coordinating Council (Consejo Coordinador Empresarial), sets forth a number of useful rules for corporate interaction. However, they do not go as far as requiring stock valuation, or formulas considering it as an alternative to settle disputes that may arise between shareholders/members.
As a result of the lack of regulation on the use of shares/equity interests valuation as a tool to facilitate settlement of shareholder disputes, in Mexico the solution has been the execution of shareholder agreements; the provisions of which may be incorporated in the bylaws. Some common contractual provisions include valuation formulas of shares/equity interests to set a fair price for shares/equity interests in order to, for example, separate from the partnership in the event of a dispute with the controlling shareholders. These disputes are commonly triggered by the adoption of resolutions that involve capital stock increases, nondistribution of dividends, mergers or other complex corporate transactions, etc. In all these cases, while the resolutions themselves may be legal, they may contravene the interests of minority shareholders.
Finally, other good examples of cases where the appraisal of shares/equity interests is often used as a tool are those designed to set a fair purchase price of shares/equity interests of conflicting shareholders. Those rules often refer to rather complex formulas for appraisals, as well as expert opinions. However, there are also more simple, standardized and proven systems, such as call options, put options, purchase offers with the possibility of counteroffers (known as “Russian roulette”), purchase-sealed envelope bids (known as “Texas shoot-out”), sale-sealed envelope bids (known as “Mexican shoot-out”) or auctions. In all cases the idea is that through the neutral mechanism of a self-appraisal no one is able to abuse the system because the other side may buy or sell equity at the proposed equity value.
These are the rules that exist concerning equity valuation in Mexico. As you may gather, the statutory options are limited, while the practice is that any such structures are more often found in shareholders’ agreements and other corporate contractual options.
** Lowenstein Sandler LLP thanks Juan Francisco Torres Landa, Omar Guerrero Rodríguez, Angel Domínguez and Fernando Medina of Hogan Lovells Mexico for their contribution to this blog. You can find more on Mr. Torres-Landa’s practice here and read more on Mr. Guerrero’s practice here.
Delaware law firm Morris James has put out a list of the “Top Ten” 2018 developments in Delaware corporate law, and lists two appraisal cases, Aruba, and Dr. Pepper as #10 and #1, respectively. As with many 2018 appraisal retrospectives, Morris James sees further developments still to come in 2019, in particular important appeals to the Delaware Supreme Court and further clarification of some key holdings from the past couple years.
African law firm Cliffe Dekker Hofmeyr (CDH) has written an extensive summary of South African appraisal law – often referred to as Section 164. CDH notes that (like in Delaware) in South Africa, appraisal rights are available for many major corporate acts; that the process for seeking appraisal is technical and formalistic; and that the fair value determination is timed to when the applicable resolution about the corporate action was approved. (We’ve posted before that the ‘when’ regarding fair value is a critical issue.) CDH also notes that Section 164 does not provide a specific mechanism for the fair value determination – something courts in the US have wrestled with as well.
Some appraisal actions can have a long tail. In 2015, Verizon agreed to buy AOL. Shortly thereafter, some AOL shareholders demanded appraisal. The case worked its way through the Delaware Court system – something we covered on a few occasions. Ultimately, petitioners were awarded 2.6% below merger price. We covered some commentary discussing the AOL case in the context of other cases, including Dell.
Now the AOL appraisal case has resulted in a malpractice action against petitioners’ expert [from Law360, $$$]. The AOL Petitioners (now malpractice-Plaintiffs) allege that the expert they hired harmed their case, giving Respondent AOL ammunition as a result of emails and other message the expert sent to others, suggesting Petitioners had a poor case and that the expert allegedly held a “grudge” against Verizon for not hiring him. According to Petitioner-Plaintiffs, the result was that they had to drop the expert and rely on Respondent’s expert, which contributed to the award of below merger price. Plaintiffs are seeking damages for the lost value.