Last March, the Corporate Council of the Corporation Law Section of the Delaware State Bar Association released legislation proposing to amend Section 262 of the Delaware General Corporation Law in response to criticisms regarding whether the conduct of appraisal arbitrage is consistent with the intent of the appraisal statute. The first revision was intended to 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 was designed to provide a means by which respondents could limit the accrual of statutory interest on appraisal awards. Since taking effect August 1, 2016, however, practitioners have observed that the decision to exercise the option of limiting the accrual of statutory interest by making prepayments to shareholders seeking appraisal is not as simple as it seems.
The statute originally provided that unless the court found otherwise, interest on the amount adjudicated to be fair value accrued 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. While that provision has been maintained, it has been amended so that in addition, at any time before the entry of judgment, the respondent corporation may elect to pay an amount (of its own choosing) 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.
Accordingly, prepayment risk may deter petitioners motivated mainly by the opportunity to earn interest at the statutory rate, or those hoping to use the statutory rate to induce a quick settlement. On the other hand, as a petitioner’s capital may be locked-up in an appraisal action for up to two years or more, prepayments may actually serve as an inducement and source of financing for those otherwise deterred.
Deciding on the amount is equally perplexing. Factors underlying an appraisal claim that might be analyzed in making the determination include valuations considered by the board, the merger price and related market check. Regardless of how determined or what the amount may represent in the mind of the respondent, however, the petitioner or court may take it as an indication of the respondent’s fair value. Further, the amount may raise valuation conflicts if paid prior to completion of the respondent’s expert’s analysis.
Strategic issues aside, the decision to prepay may be equally influenced by a respondent’s financial position, growth and investment opportunities. Firms with healthy balance sheets and excess cash flow not otherwise deployable may find it worthwhile. Others may reject the approach as counterintuitive, or find the opportunity costs too high despite the statutory interest premium over current market rates. All things considered, then, respondents evaluating the prepayment option must weigh carefully whether the potential gain exceeds the potential costs of its unintended consequences.
Boris J. Steffen is a director at RSM US LP in Washington, D.C.