The 27th Annual Tulane Corporate Law Institute was held on March 19 and 20 in New Orleans. As in prior years, panelists included preeminent M&A, financing and securities practitioners and members of the Delaware judiciary, as well as prominent investment bankers, proxy solicitors, public relations advisors and journalists. During the coming days, we will highlight in a series of posts three issues among the many topics discussed during the conference. Today’s topic: appraisal arbitrage and recently proposed amendments to DGCL § 262.
Appraisal rights have been exercised with increasing frequency in recent years: in 2013, 17% of takeovers of Delaware corporations were subject to appraisal claims, compared with only 5% in 2010. The increased prevalence of appraisal claims has been driven in part by the perceived absence of any risk that the Delaware Court of Chancery will find “fair value” to be less than the transaction price, since the Court has done so only once since 2010. Further motivation has resulted from the above-market interest rate stipulated by DGCL § 262(h), pursuant to which interest accrues at 5% over the Federal Reserve discount rate and is compounded quarterly. Many stockholders therefore conclude that the risks presented by dissenting are low considering the possibility that “fair value” will be found to exceed the transaction price and, especially in the case of smaller claims, the likelihood that the defendants will settle to avoid the expense and burdens of litigation.
Perhaps more importantly, the Court of Chancery decisions in In re Appraisal of Transkaryotic Therapies, Inc., C.A. No. 1554-CC (Del. Ch. May 2, 2007), In re Appraisal of Ancestry.com, Inc., C.A. No. 8173-VCG (Del. Ch. Jan. 5, 2015) and Merion Capital LP vs. BMC Software, Inc., C.A. No. 8900-VCG (Del. Ch. Jan. 5, 2015) have established that shares acquired following the record date for the stockholder vote approving the transaction may nevertheless be eligible for appraisal, without any requirement that their holders establish that the shares had not been voted in favor of the transaction. These decisions have opened the door for what has become the multi-billion dollar business of “appraisal arbitrage”, in which investors acquire shares for the purpose of seeking appraisal, with the goal of benefiting from the low risk associated with an appraisal proceeding, the minimum return guaranteed by DGCL § 262(h), and the potential upside in the event of a favorable judgment or settlement.
On March 6, 2015, the Council of the Corporation Law Section of the Delaware State Bar Association proposed two amendments to DGCL § 262. These amendments were subsequently approved by the Executive Committee of the Delaware State Bar Association, but require legislative approval before becoming law:
- The first amendment would impose a de minimis exception requiring the dismissal of appraisal claims unless, immediately prior to closing, either (1) more than 1% of the outstanding shares are entitled to appraisal or (2) the value of the merger consideration for the shares entitled to appraisal exceeds $1 million. The amendment would apply only in respect of shares that are listed on a national securities exchange. Although this amendment may eliminate some nuisance appraisal claims that are brought solely for their settlement value, it is unlikely to impact the investment funds engaging in appraisal as a line of business.
- The second amendment would permit pre-payment by the corporation to the appraisal claimant of any portion of the transaction price, thereby limiting the principal on which interest will accrue to the amount by which the ultimate appraisal judgment exceeds the portion that was pre-paid. The amount pre-paid cannot be clawed back even if the Court of Chancery determines the “fair value” to have been below the amount pre-paid.
Other amendments that panelists at the Tulane Corporate Law Institute and other commentators have suggested include:
- reducing the statutory interest rate;
- making the record date the key eligibility date for seeking appraisal, or requiring appraisal claimants to demonstrate that their shares were not voted in favor of the transaction; and
- expressly empowering the Delaware judiciary to consider the transaction price in its determination of fair value where the sale process was not flawed.