Reforming Modern Appraisal Litigation

In recent years, the stockholder’s appraisal remedy in Delaware has transformed from a little-noted feature of stock ownership to a potent option for dissenting shareholders.  It’s also become a topic of heated debate. In our prior work, we have documented the recent increase in appraisal activity, largely driven by a group of specialist funds that have been called appraisal arbitrageurs. We have shown that these appraisal specialists focus their resources on a small number of transactions and that those transactions exhibit proxies for legal merit: abnormally low merger premia and insider involvement.

Our new article updates this picture through the end of 2014, demonstrating that appraisal claims in Delaware continue to exhibit multiple proxies for legal merit. Appraisal claims are also rare among stockholder suits, accounting for only one out of every twenty merger-related lawsuit filings.  The outcomes of appraisal petitions are also notable: a far larger percentage of claims go to trial than, for example, merger class actions, suggesting that appraisal petitioners are unusually dogged in pressing their claims. Trial results from public company appraisal petitions have on average awarded a slight premium to the dissenting group. The median outcome is less than a 2% premium to the merger price, and the mean outcome is a premium of slightly more than 10%. These results suggest that modern appraisal litigation plays a salutary if small role in M&A practice—a system of private enforcement that is working well, if substantially short of its full potential.

The rise of modern appraisal has naturally prompted a re-evaluation of the appraisal remedy and consideration of possible reforms. In late 2014 and early 2015, Delaware’s blue-ribbon corporate reform group—the Council of the Corporation Law Section of the Delaware State Bar Association—examined the appraisal statute and proposed only modest changes, intended to prevent interest rate arbitrage and the bringing of small claims for nuisance value. We regard the proposed changes as positive on balance, and at worst benign.

In spite of—or perhaps because of—appraisal’s empirical virtues, the increase in activity has sparked a backlash among a group of defendants and deal advisors. These critics have pressed Delaware policymakers to consider an amendment to the appraisal statute that would curtail appraisal activity in two principal ways. First, they want the state to reduce the statutory interest rate. Second, they have pressed for an amendment that would deprive beneficial owners of appraisal rights if they were not beneficial owners on a record date set by the target board, overturning a line of Delaware case law that stretches back half a century. In practice, this would limit the utility of the appraisal remedy and the beneficial effects of trading in appraisal-eligible shares.

Very little substantive argument has been offered publicly to justify the deal lawyers’ amendment, but in our new article we attempt to engage with what we regard as the most plausible arguments in its favor: that appraisal arbitrage enriches dissenters at the expense of other stockholders and threatens the vitality of the deal market. These arguments are without empirical support and as a matter of theory cannot withstand sustained scrutiny.

As a threshold issue, appraisal arbitrage—whereby specialist funds buy up stock after a problematic merger is announced, with the intention of seeking appraisal—should not be troubling. It is merely one of many types of transfer of legal claim, and the driving economic logic is the same: the transfer of claims to parties who—via greater expertise, economies of scale, and diversification—can vindicate the underlying legal rights more effectively and thus make the claims more valuable, benefiting the claim-seller and purchaser alike. If a stockholder has a right to bring an appraisal petition by virtue of her stock ownership, there is nothing unusual or repugnant about empowering her to alienate that right along with the stock. Even minority shareholders who do not themselves seek appraisal can benefit from the presence of appraisal specialists, both by selling their shares to them on the open market and from the deterrence of opportunistic transactions that a credible threat of appraisal can provide. For example, Carl Icahn’s threat to pursue his appraisal rights against Dell is said to have generated an additional $400 million in value for minority shareholders.

Nor do appraisal claims—which as noted are infrequent, especially by comparison to the ubiquitous fiduciary duty class action—constitute a threat to the deal market. Merger parties control the appraisal liability they face, as deal advisors themselves occasionally acknowledge. The surest way to avoid appraisal liability is to see that the target ran a reasonable sales process and got the best price available. Appraisal specialists must put substantial money at risk and focus on strong claims; if the claim is not strong, it will not attract their attention. It is precisely the threat of appraisal liability, in other words, that should prevent acquirers from holding back value in merger negotiations. And given the litigation patterns we document—where appraisal petitions focus on abnormally low merger premia and on insider deals—it is safe to assume that any transaction deterred by appraisal liability is a transaction that ought to be deterred and constitutes evidence of the system working well.

In the final analysis, the effort to alter Delaware’s appraisal statute stands, at best, as a misguided effort to promote bad policy or, at worst, as a deliberate attempt to scuttle the only serious merger-related remedy available to stockholders of Delaware firms. The Delaware legislature never acted on the appraisal-related proposals from the Council in 2015, and many have suggested that the Council should revisit the issue again.  Given the influence of the deal advisors in Delaware, the Council will surely reexamine the proposals for radical change. The Council should reject them.

We propose an alternative set of reforms that would enhance the effectiveness of the appraisal remedy. Delaware should require disclosure of more financial information in appraisal-eligible transactions; eliminate the irrational exemption for all-stock transactions; and adopt a de minimis requirement. We address issues relating to the interest rate in a separate forthcoming paper. Lastly, we offer a simple way to meet the demand of the deal advisors—that appraisal eligibility be tied to a record date set by the board—without forsaking the governance virtues of an active appraisal market: Delaware law should require that any applicable record date be set for not earlier than 20 days following the mailing of notice of appraisal rights. This would ensure that stockholders and other market participants are able to see crucial disclosures before the record date. It thus represents a sensible compromise by meeting the deal advisors’ stated goals without destroying the policy benefits of appraisal.

The preceding post comes to us from Charles Korsmo, Associate Professor of Law at Case Western Reserve University School of Law, and Minor Myers, Professor of Law at Brooklyn Law School. They are the principals of Stermax Partners, which provides compensated advice on stockholder appraisal and manages appraisal-related investments, and they have economic interests in the outcome of appraisal proceedings.  The post is based on their recent paper, which is entitled “Reforming Modern Appraisal Litigation,” forthcoming in the Delaware Journal of Corporate Law and available here.