Are Appraisal Cases to Decline?
Among the most-discussed issues in corporate law today is whether appraisal actions should be curtailed. Triggered by above-merger price awards after deals were shopped in the market, the argument is that the appraisal process is being used unfairly and sometimes ends in a home-run result for plaintiffs. In response to those concerns, Delaware recently amended its appraisal statute to address some of the perceived abuses. But, before the reformers claim success too soon, recent developments may actually increase appraisal actions. First, some background is helpful in understanding these changes.
Appraisal actions substantially increased over the last four years. In part, that increase may have been caused by the combination of the very low interest rates available to investors generally and the 5 percent over the prime interest rate that the Delaware appraisal statute provides to appraisal petitioners as part of the appraisal judgment. After all, if the stockholder only recovers an appraisal award equal to the merger price, an additional 5 percent interest on that recovery is not a bad investment.
Additionally, appraisal cases are hard to successfully defend economically. Typically, an appraisal trial involves conflicting testimony of so-called experts whose valuations for the defendants are seldom much less than the merger price and always much higher for the petitioners. That generates large lawyer and expert witness fees. The critics claimed these costs lead to “appraisal blackmail” where small claims are filed to extract a settlement based on the cost of defense, if not the merits.
Delaware sought to address these problems in two ways. First, the defending company may now pay the appraisal petitioner the amount the company is willing to concede is due soon after the appraisal case is filed. That effectively cuts off the accrual of interest on that amount. Formerly, a pre-award payment to limit the accrual of statutory interest was not permitted absent the petitioner’s consent. Second, for publicly traded companies, the number of shares seeking appraisal must exceed one percent of the stock eligible for appraisal or the consideration offered for those shares must exceed $1 million. That will eliminate small appraisal petitions that are thought to be economically unjustified.
The question addressed here is will these changes to Delaware law reduce appraisal litigation. There is some reason to doubt that will occur. The recent returns earned for investors by seeking appraisal have generated a new business to take advantage of those opportunities. Firms are starting up that seek to aggregate stock that has the right to seek appraisal. Coupled with appraisal arbitrageurs who buy stock just to seek appraisal, these new businesses (“appraisal aggregators”) may actually generate more appraisal litigation.
These appraisal aggregators operate like this. They monitor mergers or any other transaction that will generate the right to appraisal among stockholders. By then checking the holding of their institutional clients (such as pension funds) to see if they hold stock with appraisal rights, they are able to pull together stockholders whose total holdings justify the costs of appraisal proceedings. Plaintiff law firms exist that are both willing and capable of doing a preliminary analysis of whether an appraisal action will generate an above-merger price award. Together these firms are then pitching clients on the rewards to be gained by acting together to demand appraisal.
Nor are those clients much troubled by the elimination of the five percent interest award as part of the appraisal judgment if the company tenders the merger consideration upon filing of an appraisal petition. Most of the large institutional investors prefer to keep their funds actively invested anyway, if only because they optimistically expect to earn above five percent even in today’s low interest rate environment. Thus, they will file for appraisal even if there is no guaranteed high rate of interest on their investment.
The mathematics of this process may encourage appraisal filings. A stockholder who qualifies for appraisal is then only denied receipt of the merger consideration for 60 days at most. Before that time expires, he can change his mind and accept the merger price. If the “appraisal aggregators” can then accumulate a sufficient number of like-minded stockholders to seek appraisal, the appraisal petition will likely generate a payment by the company of the merger consideration soon thereafter to avoid interest. Thus, the stockholders get their investment back and are still in the game to seek an appraisal award that generates a profit. Under these circumstances, it even may make sense to buy stock upon the merger announcement to assert appraisal rights.
Of course, there are costs to litigating an appraisal action. Depending on the nature of the business, fees and expenses, including expert costs, can be in the millions. Those costs can be recovered if the appraisal award reflects only a modest increase over the merger price when the dollar value of the stock at issue is sufficiently high. Recent awards of over 10 percent above the merger price on stock worth much more than $10 million (calculated at the merger price) may encourage such investment.
It is too soon to tell if appraisal litigation will be affected by the recent changes to Delaware law. There are counter-forces at work to increase appraisal actions. The ability of defendants to cut off an above-market interest expense increases the risk to appraisal petitioners. At the same time, if the appraisal aggregators see a real profit available to their clients based on their assessment of whether the merger price reflects fair value, they may proceed in any event. Time will tell which wins out.