When a corporation is acquired for cash in a merger, Delaware, the corporate home of many public companies, generally provides stockholders with appraisal rights. Appraisal allows dissenting stockholders who comply with the requirements set forth in Section 262 of the Delaware General Corporation Law to seek a judicial determination of the “fair value” of their shares. Since 2004, the number of appraisal petitions has increased markedly. Although some petitions are filed by smaller stockholders who seek to extract the nuisance value of their holdings, a more notable trend has been the rapid spike in petitions filed by so-called “appraisal arbitragers.” Appraisal arbitrage typically involves investment funds purchasing shares after a merger is announced with the goal of pursuing an appraisal action and a ruling that the “fair value” is above the merger price.
Opponents of appraisal arbitrage have argued for changes that would dramatically curtail this practice. The proposed amendments currently before the Delaware legislature, however, touch upon but do not directly address the practice. Specifically, the amendments contain two changes: one that would reduce the pre-judgment interest corporations pay to petitioners, and another that would require the dismissal of smaller petitions.
Since 2007, interest on appraisal petitions accrues at 5% over the Federal Reserve discount rate from the effective date of the merger through the entry of judgment. Designed to compensate stockholders for having their capital stuck in the post-merger entity, many believe this change contributed to the growth of appraisal arbitrage by guaranteeing a significant rate of return. The proposed amendments would allow corporations to pay cash to petitioners, “[a]t any time before the entry of judgment in the proceedings.” After the payment, interest will continue to accrue at the statutory rate only on the difference between the amount paid and the fair value determined by the Court of Chancery. This change would reduce the settlement leverage of appraisal petitioners previously armed with the knowledge that their claim would be more valuable in the future.
Importantly for corporations responding to appraisal petitions, the bill’s synopsis provides that such a payment would not result in an inference that the amount paid, “is equal to, greater than, or less than the fair value of the shares to be appraised.”
Corporations thus need not worry that a payment would be used as evidence of fair value in the appraisal proceeding.
The second proposal would impose a de minimis requirement on appraisal petitions for stock listed on a national securities exchange. If enacted, the Court of Chancery would be required to dismiss appraisal petitions where less than 1% of the outstanding shares of the class or series entitled to appraisal actually perfect their appraisal rights, and, “the value of the consideration provided in the merger or consolidation” for the shares with perfected appraisal rights was less than $1 million. These provisions would not apply to certain short-form mergers under Sections 253 and 267 of the DGCL. The bill’s synopsis states that this proposal would minimize the risk that an appraisal petition, “will be used to achieve a settlement because of the nuisance value of discovery and other burdens of litigation.”
Whereas the proposed amendment relating to the accrual of interest would affect the incentives of every stockholder in evaluating whether to bring an appraisal petition, the de minimis requirement is unlikely to significantly affect appraisal arbitrage. Data collected by Professor Charles R. Korsmo of the Case Western Reserve University School of Law and Professor Minor Myers of the Brooklyn Law School indicates that the mean value of appraisal disputes between 2004 and 2013 was approximately $30 million. The professors also identify numerous appraisal arbitrage funds that file petitions valued in the millions of dollars, so these funds should meet the requirement. Consequently, the de minimis requirement will not deter the most frequent arbitragers from continuing their practice.
Notably, the proposed amendments come in the wake of two recent decisions by the Court of Chancery that refused to heighten standing requirements on appraisal petitioners.[1]Although opponents of appraisal arbitrage urged the Delaware legislature to impose the stricter standing requirements rejected in those decisions, the proposed amendments do not address the issue.
Overall, the proposed amendments are unlikely to radically change the existing practice of appraisal arbitrage. At most, they would curb incentives for arbitrage to a limited extent. And if adopted, the amendments would not affect existing petitions or pending transactions, as they would apply only to transactions consummated on or after August 1, 2015.
The views expressed in this article are not necessarily those of Seitz Ross or its clients.
[1] See In re Appraisal of Ancestry.com, Inc., 2015 WL 66825 (Del. Ch. Jan. 5, 2015); Merion Capital LP v. BMC Software, Inc., 2015 WL 67586 (Del. Ch. Jan. 5, 2015).