October 11, 2018

Delaware Chancery Okays Contractual Appraisal Waivers

This Pepper Hamilton memo reviews the Chancery Court’s recent letter opinion in Manti Holdings LLC v. Authentix Acquisition Co., (Del. Ch.; 10/18), in which Vice Chancellor Glasscock held that shareholders may validly waive appraisal rights by contract.

The case involved minority shareholders who had agreed to customary “drag along” provisions giving the majority shareholders the ability to compel a sale of the minority’s shares in any sale transaction approved by a majority of the outstanding shares. The drag along language also included an agreement to refrain from exercising appraisal rights. The plaintiffs argued that this waiver of appraisal rights was unenforceable. This excerpt from the memo discusses those arguments and the Vice Chancellor’s response:

First, the plaintiff stockholders made a number of textual arguments regarding the language of the drag-along provisions. For instance, because the drag-along provisions stated that the stockholders were to “refrain from exercising” their appraisal rights, as opposed to “waiving” those rights, the plaintiffs maintained that their appraisal rights did not extinguish. According to the plaintiffs, the provisions merely obligated them to delay the exercise of those rights until after closing. The court disagreed, finding that reading to be an unreasonable interpretation of the provision. Although the use of the word “waive” might have been clearer, the court ultimately held that the use of the term “refrain” unambiguously extinguished the stockholders’ appraisal rights.

Second, the plaintiff stockholders argued that the drag-along rights, if construed to include an appraisal waiver, were unenforceable because they violated section 151(a) of the DGCL. As a general rule, holders of common stock in a Delaware corporation are entitled to appraisal rights in accordance with section 262. Further, section 151(a) requires that limitations on classes of stock must be set out in, or derived from, the corporation’s certificate of incorporation. Thus, the plaintiffs argued that to be enforceable, a waiver of appraisal rights must appear in the certificate of incorporation pursuant to section 151(a), and that appraisal rights cannot be waived by contract, such as a stockholder agreement.

The court disagreed, finding that enforcement of the appraisal waiver in the stockholder agreement is “not the equivalent of imposing limitations on a class of stock.” It reasoned that the stockholder agreement “did not transform the [plaintiffs’] shares of stock into a new restricted class.” Rather, “individual stockholders took on contractual responsibilities in return for consideration,” which included refraining from seeking appraisal.

The memo notes that this decision provides increased certainty to private equity & venture investors that incorporate drag along provisions & appraisal waivers into their investor agreements. But it also points out that the case demonstrates plaintiffs’ continued willingness to challenge the terms of these arrangements, and the importance of careful drafting.

John Jenkins