Among the compelling metrics compiled by Professors Korsmo and Myers in their article on appraisal rights that has been approvingly cited by the Delaware Court of Chancery, they have highlighted two key trends which, taken together, demonstrate the sophistication of the investors now driving what appears to be a pronounced spike in appraisal rights cases. Thus, the first graph (view here) shows the sharp increase in the number of petitions filed over the past decade, and the second graph (view here) shows the sheer size of the dollar amounts at stake.

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.

 

In a forthcoming law review article expected to be published in 2015 in the Washington University Law Review, “Appraisal Arbitrage and the Future of Public Company M&A,” Charles Korsmo (Associate Professor at Brooklyn Law School) and Minor Myers (Associate Professor at Brooklyn Law School) report their findings showing a large uptick in the number of appraisal petitions being filed, as well as a marked increase in the size of the petitioners’ holdings and an increased level of sophistication among the filers themselves. The authors observe an increased use of arbitrage by which petitioners appear to invest in the target after the M&A deal is announced (for more about arbitrage, see our prior post here). While the authors note that the defense community has decried appraisal arbitrage as an abusive exercise of appraisal rights that ought to be suppressed, the authors argue that this criticism has it precisely backward and that the “new world of appraisal” should be welcomed and encouraged, as it ultimately provides an efficient means for benefiting minority shareholders and actually reducing the cost of raising equity capital.

Among the highly telling data points that Professors Korsmo and Myers collected for their analysis, they found that the value of claims in appraisal in 2013 was nearly $1.5 billion, a tenfold increase from 2004 and nearly 1% of the equity value of all merger activity in 2013. They attribute this surge in appraisal claims to the increased use of appraisal arbitrage in a manner that is transforming what this blog has repeatedly described as an underutilized shareholder remedy into a specialized investment strategy.