M&A Deal Price Challenges Spiking in Delaware

By Michael Greene, Bloomberg BNA

The Delaware Chancery Court is seeing a surge in shareholder lawsuits asking it to assess the “fair” market value of merger targets, including Towers Watson & Co. and Jarden Corp.

Since 2012, Delaware appraisal lawsuits have risen 267 percent, to a high of 77 in 2016, according to an analysis of Bloomberg Law data. The number of deals targeted by the suits has risen 140 percent over the same period, reaching a high of 48 deals challenged last year. The 2016 statistics are even starker given that mergers and acquisitions involving U.S. companies fell in 2016, after a blockbuster 2015.

Appraisal actions can take years to resolve and cost millions of dollars to defend, adding to the costs of M&A in Delaware, where half of all U.S. public companies are incorporated.

A new state law intended to curb such actions hasn’t yet had an impact. It went into effect in August.

“My expectation is that there will continue to be a steady increase in appraisal cases being filed in the chancery court,” said Lee Rudy, a Radnor, Pa.-based partner at Kessler Topaz

Meltzer & Check LLP, who represents clients in M&A transactions. Some corporate attorneys say more changes should be made to the state appraisal law, former Delaware Supreme Court Chief Justice Myron T. Steele told Bloomberg BNA. Steele, now a partner at Potter Anderson & Corroon LLP in Wilmington, Del., added that he didn’t have a position on whether more legislation is needed.

Matthew J. O’Toole, chair of the Delaware State Bar’s Corporation Law Council, told Bloomberg BNA in a Jan. 11 statement that it’s not clear whether the council will propose appraisal-related legislation in 2017.

“The council is continuing its regular review of the appraisal statute in light of last year’s statutory amendments and evolving case law and practice,” he said. O’Toole is a Wilmington-based partner at Potter Anderson.

Delaware’s General Assembly typically doesn’t alter the state’s corporate law unless such changes are recommended by the state bar’s Corporation Law Section, which is governed by the council.

Under the Delaware General Corporation Law’s appraisal provision, shareholders that choose not to participate in a merger can ask the chancery court to assess a “fair value” for their shares.

The law has given rise to an emerging industry of hedge funds that buy large amounts of a Delaware company’s shares after it announces it is being acquired, intending to challenge the parties’ agreed-upon deal price in the chancery court. Appraisal petitioners are awarded interest on the court’s appraisal determination at 5 percent over the Federal Reserve discount rate, compounded quarterly. The interest on the claims accrues from the effective date of the merger until the judgment is paid.

The August amendments require the chancery court to dismiss certain appraisal proceedings. They also give Delaware corporations the option of making a payment to appraisal claimants to prevent the accrual of interest.

A case pending before the Delaware Supreme Court—DFC Global Corp. v. Muirfield Value Partners LP—may provide M&A practitioners and corporate counsel with some help by clearing up a key question: When should the chancery court defer to the parties’ negotiated price when appraising M&A deals?

“Recent case law developments have begun to provide more guidance in the appraisal law area, and a potential ruling in the DFC Global appeal could offer further clarity,” Edward Micheletti, a Wilmington-based partner at Skadden, Arps, Slate, Meagher & Flom LLP, who represent clients in deal litigation matters, told Bloomberg BNA.

In July 2016, the chancery court found that DFC Global Corp.’s shares were undervalued when the financial services provider was acquired in 2014 by private equity firm Lone Star Funds for $366 million. Although it agreed that the price was negotiated at arm’s length, the court concluded that the transaction price wasn’t the best indicator of fair value because the deal was struck “during a period of significant company turmoil and regulatory uncertainty.”

In its appeal to the Supreme Court, DFC argued that the ruling would undermine confidence in Delaware appraisal actions.

Nine law school professors filed an amicus brief in support of DFC, saying that ignoring arm’s-length sale processes “imposes the prospect of costly and unpredictable appraisal litigation on all transactions, which distorts market behavior.”

No matter how skilled Delaware judges are at understanding the valuation process, they shouldn’t be substituting their own analysis over whether something is a good business decision, said University of Pennsylvania professor Jill Fisch, who teaches and writes about corporate law. “That’s the idea behind deferring” to a transaction price that’s reached after the parties have negotiated at arm’s length, and where there aren’t any conflicts of interests, said Fisch, who isn’t involved in the DFC litigation.

However, a recent study by University of Virginia law professor Albert Choi and Columbia University law professor Eric Talley found that deferring to the parties’ negotiated price may not be optimum. That rule “is defensible on economic grounds only in relatively narrow set of circumstances that can be demanding, in practice, to meet,” their paper says.

Meanwhile, appraisal cases are largely fact-intensive, and judges often have to plow through widely divergent expert valuations.

The takeaway from recent rulings is that the chancery court will look at appraisal cases the way they look at other kinds of merger challenges, Rudy said. If the transaction was the result of a fair process, the court will be more receptive to an argument that the price agreed to by the parties is the fair market value, he said.

“However, I don’t think you can draw a bright-line rule,” Rudy said. “The court is still open to the idea that a fair process can lead to an unfair price.”

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