Investors challenging the deal prices reached in mergers and acquisitions may find it harder to get higher share valuations because of recent Delaware state court decisions, corporate governance attorneys say.
The decisions by the Delaware Supreme Court have reduced incentives for shareholders to bring appraisal claims against most deals, according to attorneys and law professors interviewed by Bloomberg Law. They may also have the potential to further lower the number of appraisal actions filed.
The 2017 rulings “considerably narrowed” the upside of most future appraisal claims, said Lawrence Hamermesh, a professor at Widener University who specializes in Delaware law. They make it even more likely that “appraisal litigation and appraisal arbitrage won’t be as attractive as they have been in the past.”
Investors filed 62 petitions challenging 34 deals in 2017, compared with 77 petitions challenging 48 deals in 2016, Bloomberg Law data show. The fall in such actions comes after years of steady increases.
The state high court will soon have another chance to clarify its position on appraisals, as it is set to hear a claim brought by former stockholders of telecommunications company Clearwire Corp.
In that case, a group of investors claimed the company was undervalued when it was acquired by Sprint Nextel Corp. for $5 per share in 2013, and they have appealed the chancery court’s ruling that “fair value” was $2.13 per share. Oral argument is scheduled for March.
Delaware’s appraisal statute allows a target company’s stockholders that object to, or don’t participate in, a merger to ask the chancery court to assess the fair value of their shares. It gave rise to what’s known as appraisal arbitrage, where investors snap up blocks of shares in a company after it announces a merger, with the intent to file appraisal petitions once the deal closes.
The fall in appraisal cases in 2017 may be due in part to a law enacted by the Delaware Legislature in August 2016 that lowered shareholder payouts by giving companies the option of paying appraisal claimants upfront to prevent the accrual of interest.
The supreme court’s “blockbuster” 2017 rulings, however, will “go a long way in determining the volume and character of appraisal litigation” going forward, Hamermesh said.
In the first, DFC Global Corp. v. Muirfield Value Partners LP, the court said the deal price reached by the merging companies should be given significant weight in appraisal actions unless the sale process wasn’t robust or involved conflicts of interest.
The court “put a lot of weight on a good, clean process for [companies to] reach a deal,” said Ann Lipton, a Tulane University business law professor.
In the second case, Dell Inc. v. Magnetar Global, the supreme court partially reversed the chancery court’s opinion that the “fair value” of each Dell share was $17.62, almost a 30 percent increase from the deal price.
The lower court gave enough consideration to Dell’s market value and deal price, the supreme court said, but erred in its decision to rely solely on a discounted cash flow analysis. This claim differed from DFC in that it involved a management-led buyout rather than a third-party buyout.
The expectation was that the supreme court might not put as much weight on the deal price, “given that there are so many inherent conflicts involved with management buyouts,” Lipton added. “But they didn’t. Once again, they focused on what they thought was a reasonably clean process and then put tremendous weight on the deal price.”
Appraisals After Dell, DFC
“The Dell case is obviously a blow to plaintiffs seeking to bring appraisal cases,” said Jill Fisch, a business law professor at the University of Pennsylvania. It “partially closed the door” on these claims, but what isn’t known is how closely judges will want to assess the deal process moving forward, she added.
A recent memo from law firm Fried, Frank, Harris, Shriver & Jacobson LLP suggests Dell and DFC are likely to reduce appraisal litigation overall, with claims being “driven to those cases where a remedy is most appropriate.” It also posits that there could be a “depressing effect on appraisal results generally,” and that there remains ambiguity about what constitutes a “robust” sale process.
For appraisal claims, the chancery court is tasked with determining the going concern value of a target company’s shares, and historically it has used its own methods—specifically a discounted cash flow analysis—to pinpoint what it considers a fair price. But the supreme court’s recent opinions are likely to discourage the chancery court’s sole reliance on its own calculations.
“Courts will always review the discounted cash flow analysis and consider whether it’s reliable in a particular case,” said Scott Luftglass, a partner with Fried Frank who represents corporations in deal-related litigation.
“But there is now a broader recognition that to focus solely on the [discounted cash flow] can be dangerous,” he added. “I think judges will compare and contrast the different valuation methodologies.”
With Delaware courts primed to give more recognition to prices negotiated by merging companies, some attorneys are questioning the effect on stockholders’ right to appraisals.
Mark Lebovitch, a partner with Bernstein Litowitz Berger & Grossmann LLP who represents investors bringing appraisal claims, told Bloomberg Law that the courts’ decisions have affected certain shareholder protections.
“Delaware law historically found a reasonable balance between protecting investors and the legitimate interests of directors and corporate acquirers,” Lebovitch said. But, now, he added, “the pendulum has swung so far that shareholders might not feel like they have sufficient tools to hold accountable and deter disloyal insiders and overreaching bidders.”
Investors might have more luck bringing appraisal claims against deals involving privately held companies, or against public companies in markets less efficient than the major U.S. stock exchanges, Tulane’s Lipton said.
She also said deals with defects in their merger processes would probably be better targets for appraisal claims. This suggests appraisal is filling the space once occupied by fiduciary-duty litigation, she added.
“I think there remain a lot of questions about how much weight you should put on corporate investors to be the police of corporate behavior,” Lipton said.
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