DealLawyers.com Blog

May 10, 2007

Appraisal Rights: Delaware Chancellor Weighs In

From Travis Laster: Last week, in In re: Appraisal of Transkaryotic Therapies, Inc., Chancellor Chandler of the Delaware Court of Chancery addressed a technical issue under the appraisal statute that has important implications for mergers and acquisitions practice. [We have posted a copy of the opinion in our “Appraisal Rights” Practice Area.]

The technical question presented was whether a beneficial stockholder who acquires shares in the open market after the record date for the vote on a merger, and who therefore cannot establish how the beneficial holder of the shares on the record date voted on the merger, nevertheless can assert appraisal rights for those shares. In the Transkaryotic case, the appraisal petitioners sought appraisal for nearly 11 million shares, of which over 8 million were acquired after the record date. Cede & Co, the record holder, voted sufficient shares against the merger to cover the entire appraisal class and submitted a proper demand for appraisal.

Applying Delaware Supreme Court authority, the Chancellor held that the appraisal statute is only concerned with the record holder of shares. The beneficial holder lacks standing to demand appraisal or to bring an appraisal petition. Accordingly, so long as the number of shares not voted in favor of the merger by Cede is sufficient in number to cover the shares for which appraisal is sought, the Court will not inquire into the voting of the shares by the actual beneficial holder on the record date.

As a practical matter, this ruling allows an investor who believes a merger fails to provide “fair value” (as defined under the appraisal statute) to buy shares following the record date, or to increase its position, and then seek appraisal for the entire position. Because a significant percentage of the outstanding shares are usually unvoted, “dead shares,” it is unlikely that a stockholder would be prevented from pursuing appraisal for the after-acquired shares. The Chancellor noted the public policy issue raised by the potential for hedge funds or other market players to arbitrage transactions using appraisal and concluded
that it was an issue best left to the General Assembly.

I doubt that sophisticated players will actually have the incentives necessary to make regular use of the opportunity to arbitrage transactions through appraisal. Given the significant cost of an appraisal proceeding, only a stockholder with a position having a seven-figure upside is likely to be able to make the transaction costs of appraisal litigation worthwhile.

In addition, although interest awards in appraisal often are in the vicinity of 10% and are compounded monthly or quarterly, that rate of return is likely to be unattractive to a hedge fund or market participant operating with a 20% or higher hurdle rate. Moreover, meaningful appraisal awards historically have been achieved most frequently in transactions involving controlling stockholder squeeze-outs. So long as Kahn v. Lynch remains the law, an entire fairness breach of fiduciary duty proceeding will provide a more attractive remedy.

It also bears noting that the opportunity to arbitrage via appraisal is not a new development but rather has long existed under the language of the statute. Instances of market participants using appraisal to arbitrage deals have occurred, but they have not been commonplace.

As a result, while the Chancellor’s decision confirms the opportunity for market players to use appraisal as an arbitrage tool, the number of situations where it will provide the superior option is likely to be small. Practitioners nevertheless should take into account this possibility when advising clients on transactions. The counseling point is particularly relevant to acquirors, who ultimately pay the appraisal award and for whom appraisal creates uncertainty as to aggregate transaction cost.