For over a decade now there has been increasing debate among legal practitioners regarding the practice of appraisal arbitrage, in which investors acquire the shares of the target firm in a merger, after the record date, with the intention of petitioning for appraisal. In the ensuing appraisal proceedings, valuation experts for the petitioner and respondent are called on to testify as to their opinion of the fair value of the target. Upon hearing this evidence, which may include competing discounted cash flow, guideline public company and merger price less synergy analyses proffered by the experts, the Court of Chancery is to determine the fair value of the shares, taking into account all relevant factors.
In response to commentary regarding whether the conduct of appraisal arbitrage is consistent with the intent of the appraisal statute, the Corporate Council of the Corporation Law Section of the Delaware State Bar Association released legislation on March 16, 2016, that proposes to amend Section 262 of the Delaware General Corporation Law (DGCL). Under the amendments, Section 262, which governs appraisal rights, would be revised in two key aspects. The first would limit the right to bring an appraisal action against a publicly traded company if the interest was de minimis as compared to the number of outstanding shares or the value of the merger consideration, or structured as a short-form merger. The second would provide a means by which respondents could limit the accrual of statutory interest on appraisal awards.
The de minimis limitation provides that if immediately before the merger, the shares of the class, or series of stock, of the respondent corporation, were listed on a national securities exchange, the Court of Chancery may dismiss an appraisal proceeding unless (1) the total number of shares entitled to appraisal exceeds 1 percent of the outstanding number of shares in the class or series entitled to appraisal, (2) the value of the merger consideration for the total number of shares entitled to appraisal exceeds $1 million, or (3) the merger was accomplished as a short-form merger under Sections 253 or 267 of the DGCL. The rationale underlying the de minimis limitation is to preclude shareholders that have minimal holdings from demanding appraisal where the respondent may be willing to settle simply to avoid the costs associated with litigation, including discovery, retaining valuation experts and other burdens. Short-form mergers are exempt from the exception, however, as appraisal may be the only suitable remedy given that shareholder approval is not required using the structure.
The proposal to limit the accrual of statutory interest does so by giving respondent corporations the option of making an early payment. Implemented with the intention of simplifying appraisal proceedings and limiting the amount of time spent by the court, the parties and the experts in determining an appropriate rate of interest, the statute currently provides that unless the court finds otherwise, interest on the amount adjudicated to be fair value accrues at a rate of 5 percent over the Federal Reserve discount rate (including any surcharge), compounded quarterly, from the effective date of the merger through the date of payment of the judgment. By comparison, the Corporate Council amendment proposes that at any time before the entry of judgment, the respondent corporation may pay an amount in cash to each stockholder entitled to appraisal. Thereafter, the accrual of interest will be limited to the sum of (1) any difference between the amount of cash paid and the fair value of the shares, and (2) interest accrued up until the cash payment, unless paid at that time. Though the Council did not find empirical evidence to support the existence of interest arbitrage, the amendment is intended to address the concern that the statutory interest rate encourages the strategy given that the statutory rate has exceeded money market and government yields for some time.
If adopted by the General Assembly, the amendments to the statute would be effective for transactions closed under agreements entered into on or after August 1, 2016. Pending litigation would not be affected.
Boris J. Steffen is a director at RSM US LLP in Washington, D.C.
Keywords: expert witnesses, litigation, appraisal rights, valuation experts, fair value, statutory interest, interest arbitrage, Court of Chancery, Delaware General Corporation Law