The Delaware Supreme Court recently decided that an agreement (sometimes referred to as a “drag along”) to waive prospectively statutory appraisal rights is fully enforceable against the common stockholders who made such agreement in the circumstances described below. In doing so, the Court in Manti Holdings, LLC et al. v. Authentix Acquisition Company, Inc. ("Manti") rejected the petitioners’ claim that an advance waiver of appraisal rights by common stockholders is per se against public policy and unenforceable as a matter of the Delaware General Corporation Law ("DGCL").[i] Based on its facts, the Manti decision provides welcomed confirmation from the highest Delaware Court of practices that the venture capital world has relied on for years.
Statutory Appraisal Rights of the DGCL
Appraisal rights are a feature of the corporation law of the state in which a company is incorporated. In general, these statutory appraisal rights entitle a stockholder who has not voted in favor of a specified sale of the company to forgo the price being paid by the acquirer and instead seek a post-closing judicial determination of the fair value of his or her shares, if certain procedural conditions are met. Such a judicially determined value can be greater, equal or lesser than the acquirer’s price, and the appraisal rights petitioner is required to accept the outcome (i.e., no optionality to take the acquirer’s price if the judicially determined value turns out to be lower).
Section 262 of the DGCL provides appraisal rights with respect to the sale of a Delaware corporation that is structured as a merger where the approval of the target corporation’s stockholders is required under the DGCL and the merger consideration is cash (or stock, unless the “market-out exception” applies). The purpose of these appraisal rights is to protect minority stockholders who do not vote in favor of a merger from being squeezed out by the controlling stockholders for an unfair value.
Drag-Along Rights and Facilitating Venture Investment in Private Companies
Drag-along rights obligate stockholders to agree upfront to a future sale of the company if approved by the board of directors and the controlling stockholder(s) at the time, and if other conditions are satisfied, thereby preventing the minority stockholders from obstructing such a sale, even when the minority stockholders would receive no merger consideration pursuant to the waterfall provision in the company’s certificate of incorporation. Without having this control, venture investors might be reluctant to make new investments, which would be detrimental to private companies seeking capital and their existing stockholders.
Specifically, in the event of a sale of the company, drag-along rights require stockholders (i) in the case of a stock purchase agreement, to sell their shares to the third party in the same proportion, and on the same terms, as the controlling stockholders, (ii) in the case of a merger, to vote for the merger, thereby making them ineligible to pursue appraisal rights under Section 262 and (iii) to refrain from exercising any applicable appraisal rights. While the latter may seem superfluous given that clause (ii) would have the same effect, it is needed because, as a practical matter, many private companies approve mergers by the written consent of their controlling stockholders only (assuming they represent the requisite approval under the DGCL and the certificate of incorporation). Therefore, minority holders often do not actually cast the favorable votes for the merger that would be necessary to disqualify them from exercising appraisal rights with respect to such merger.