Appraisal Claims Dismissed Due to Custodial Banks' Technical Acts
Despite being a court of equity, there are certain instances where the Delaware Court of Chancery demands "strict compliance" with procedural provisions irrespective of the potential for an inequitable outcome. For example, stockholders are required to strictly comply with the provisions of Section 220 of the Delaware General Corporation Law when seeking books and records from a Delaware corporation; see Central Laborers Pension Fund v. News Corp., 45 A.3d 139, 145 (Del. 2012). Stockholders seeking appraisal of their shares pursuant to Section 262 of the DGCL are similarly required to strictly comply with the procedural provisions of the code. Where the form and manner mandated by Delaware law is not satisfied, the Court of Chancery will dismiss a stockholder's request for appraisal. What makes the case discussed herein more interesting is that the stockholder does not need to be directly responsible for the procedural failure in order for the court to dismiss the appraisal action.
In In re Appraisal of Dell (Del. Ch. Jul. 13, 2015), the appraisal petitioners were composed of five institutions that beneficially owned common stock of Dell (collectively referred to as the "funds"). Following Dell's announcement of a going-private transaction, the funds rejected the proposed merger consideration for 922,975 shares of common stock they collectively held. Instead, the funds chose to exercise their right to demand appraisal of their nearly 1 million shares pursuant to Section 262 of the DGCL. Because the funds held their shares in street name through custodial banks, they caused Cede & Co., the legal title holder of the funds' shares, to demand appraisal for their shares. As described in great detail in Vice Chancellor J. Travis Laster's opinion, the process to perfect the funds' appraisal rights necessitated the Depository Trust Co. (DTC) to have Dell's transfer agent issue certificated shares in Cede's name. Next, DTC contacted the funds' custodial banks in order to deliver the funds' certificated shares. However, the custodial banks instructed Dell's transfer agent to issue the certificated shares in the name of the custodial banks' nominees, rather than Cede. So while the funds remained the beneficial owners of the shares, the custodial banks' nominees were now the legal owners, rather than Cede.
Delaware's appraisal statute requires, among other things, that for appraisal rights to be perfected there cannot be a change in the stockholder of record of the subject shares from the date of the appraisal petition through the effective date of the merger. This is commonly referred to as the continuous holder requirement. Moreover, in its opinion the court notes that Delaware precedent explicitly holds that it is the "record holder—not the beneficial owner—[that] is subject to the statutory requirements for showing entitlement to appraisal and demonstrating perfection of appraisal rights under Sections 262(a) and (d)." Dell opposed the funds' appraisal petition on the basis that the record holder of the subject shares changed after the time of the appraisal demand and before the effective date of the merger. In its analysis, the court notes that there was no dispute amongst the parties that the funds continuously held the subject shares as beneficial owners through the effective date of the merger. There was also no dispute that the funds' custodial banks held the shares on behalf of the funds through the effective date of the merger. However, the court found that the funds' shares did change record holders during that time period, from Cede to the funds' custodial banks' nominees. Despite arguing that the funds did not knowingly approve of the changes of record holders of the shares, the court held that the funds assumed the risk since the funds' agreements with their custodial banks permitted the custodial banks to retitle the shares. As a result, the court reluctantly granted summary judgment in favor of Dell, dismissing the funds' appraisal claims for almost 1 million shares of Dell common stock.
Presently, the weight of this decision falls upon stockholders who hold their shares through custodial banks. Where custodial banks hold shares for beneficial owners, like the funds, their agreements with the beneficial owners may allow them to retitle certificated shares. Because of this, Delaware practitioners should be aware that such an issue may exist and, if representing a stockholder, work with the custodial banks during the process to attempt to avoid any retitling of the shares that may affect the shares' record holder status. Those practitioners representing companies opposing appraisal may find this decision enlightening as it outlines a potential vulnerability in appraisal petitioners. This opinion is also notable for the vice chancellor's thorough historical discussion of share immobilization and his proposal for a potential "different approach," which would interpret "stockholder of record" as being inclusive of DTC's participant list. DTC's participant list typically includes the identities of the brokers and custodians, not just the record holder, which, in most cases, is Cede. The vice chancellor noted that the proposed "different approach" is consistent with federal law, where the DTC participant list is used to ascertain the record holder of shares. Should the court's ruling be appealed, we may learn whether the Delaware Supreme Court agrees with the vice chancellor's "different approach."