May 8, 2019

Appraisal: Delaware Supreme Court Gets Mixed Reviews for Aruba

The early reviews on the Delaware Supreme Court’s Aruba Networks decision are coming in – and they’re mixed.  Academics have a lot of questions about the theoretical basis for the Court’s endorsement of a “deal price minus synergies” approach to appraisal in most settings. Here’s an excerpt from Prof. Ann Lipton’s take:

The problem is, this standard (1) gets further away from DFC’s description of appraisal as providing sellers with “what … would fairly be given to them in an arm’s-length transaction,” and (2) introduces the very uncertainty and judge-imposed economic evaluation that Dell and DFC seemed to want to avoid.  (As Brian Quinn put it, “People understand that ‘deal price minus synergies’ is mumbo-jumbo, right? It’s just a guess. It’s not scientific.”)

But the worst thing about this standard is it how pointless it is.  An analysis that defers to deal price so long as the process is “Dell compliant” at least has a purpose, namely, as a backdoor mechanism of policing compliance with fiduciary duties.  An analysis that looks solely at market price (absent reason to think market price is unreliable) moves appraisal into the box of providing liquidity, which is a reasonable place for it to be.

But a deal-price-minus-synergies test serves no purpose at all.  It doesn’t have anything to do with liquidity, and it doesn’t protect against flawed processes, since a court will probably find enough synergies to suggest that the flawed process still resulted in some add above standalone value.

On the other hand, if you’re a buyer trying to get a deal done as cost-effectively as possible, the Aruba Networks decision is very good news. That’s because, as this excerpt from a recent Dechert memo explains, it strikes another significant blow against appraisal arbitrage:

Though the decision does not mandate a “deal price minus synergies” standard in all statutory appraisal proceedings, absent a showing of deficiencies in the process that led to the deal price or other unusual circumstances, merger consideration less synergies will be viewed as strong—and likely  conclusive—evidence of fair value.

Accordingly, Aruba Networks will likely further limit appraisal arbitrage activity by investors who purchase shares of a target after a transaction is announced and then commence an appraisal proceeding seeking to recover a premium above the deal price. Because fair value must exclude deal synergies, which can be substantial, Aruba Networks shows that stockholders exercising appraisal rights face a substantial risk of receiving less than the deal price.

Appraisal is a messy & cumbersome process that – for a time – was turned very effectively into another way for hedge funds to bet on one side or the other of a deal at the Wall Street casino. Personally, I’m not inclined to shed any crocodile tears for those funds if they find their roll of the dice much riskier now.

But on the other hand, for the past decade, Delaware has increasingly funneled merger litigation into a path that leads to appraisal as the preferred, if not sole, remedy for shareholders unhappy with a merger.  And if that’s now essentially a dead end except in extraordinary circumstances, it’s just another reason for plaintiffs to say “I’ll see you in federal court.”

John Jenkins