Thomas H. Kramer
Two recent decisions from the Court of Chancery of Delaware have generated calls for legislative action to revise Delaware’s appraisal statute, 8 Del. C. § 262. Appraisal, once a relatively obscure statutory remedy for the loss of minority shareholder rights in majority-rules corporate mergers, now occupies a rapidly increasing portion of Delaware’s dockets. Under Delaware’s appraisal statute, dissenting shareholders may perfect their rights to appraisal even if they purchase their shares after the announcement of a merger. The Court of Chancery decisions, In re Appraisal of Ancestry.com, Inc., and Merion Capital LP v. BMC Software, Inc., permit such late arrivals to assert appraisal rights notwithstanding an inability to show conclusively that their share’s previous owners did not vote for the merger. Under these rules, savvy investment funds size up the prospects for an appraisal award after a merger announcement and buy up shares of the target company, angling for a significant increase in the value of their investment after bringing an appraisal action to obtain a judicial determination of fair market value. Such an action is now frequently called “appraisal arbitrage,” despite its lack of any real resemblance to true arbitrage.
Arbitrage is traditionally understood to involve the simultaneous buying and selling of identical (or nearly so) commodities or financial instruments in an effort to capture the difference in their prices without risk; classic arbitrage is sometimes called “riskless” arbitrage. In the context of corporate mergers, this has been achieved by taking a “long” position in the (undervalued) acquisition target simultaneously with an equivalent “short” position in the acquirer, with the expectation of capturing the difference in values upon consummation of the merger. As merger agreements can fail, this strategy bears risks, and has come to be known as “risk” arbitrage. “Appraisal arbitrage” typically involves only the purchase of shares of the acquisition target, without a counterbalancing negative position in the acquirer, and is thus not really arbitrage at all. So, the word arbitrage, having joined a long list of pejoratives applied in the description of financial pursuits–“‘insider’ trading, ‘junk’ bonds, ‘leveraged buy-outs,’ ‘hostile’ takeovers, ‘poison pill’ defenses, ‘greenmail,’ and those old favorites, ‘speculation’ and ‘profiteering,’”–is probably retained for its negative connotations by those opposed to the practice.
And opposition there is. Alison Frankel of Reuters says, “It’s easy to understand why the whole idea of appraisal arbitrage – which is increasingly the province of deeply sophisticated and well-financed hedge funds, mutual funds and insurance companies – provokes spasms of fear and skepticism among promoters of the long-term-value theory of investing. Appraisal arbitrageurs buy shares not because they believe in a company and its board but because they specifically want to sue it.” Appraisal claims in Delaware for 2013 approached $1.5 billion; having found no relief in the Court of Chancery, the targets of appraisal litigation are now asking for relief from the legislature.
The most pointed calls for change arrive, not surprisingly, at the courtesy of attorneys representing the losing side in Ancestry. On the Columbia Law School’s Blue Sky Blog, Trevor Norwitz of Wachtell Lipton asserts an “urgent need for legislative reform in Delaware to ameliorate the risk that appraisal arbitrage – now a multibillion dollar industry – poses to transactional vitality and shareholder value.” Theodore Mirvis, also of Wachtell Lipton, takes to the Harvard Law School corporate governance blog to complain of a “troubling expansion of stockholder appraisal rights” and the absence of any “legitimate policy objective” in the recent Chancery decisions. The defendants’ angst is understandable, as there is a lot of money at stake, but their arguments demand a rather narrow view of shareholder value and policy objectives.
For minority shareholders, perhaps especially those at risk of expropriation in an abusive merger transaction, appraisal litigation could provide exactly the kind of “transactional vitality” they would otherwise be missing. In a forthcoming paper, Charles Korsmo and Minor Myers analyze the results of appraisal litigation in Delaware and conclude that the practice might be more beneficial than not. Their finding that appraisal petitions tend to target mergers with low premium values and going-private transactions (a point conceded by Trevor Norwitz) suggests that “appraisal arbitrage focuses private enforcement resources on the transactions that are most likely to deserve scrutiny, and the benefits of this kind of appraisal accrue to minority shareholders even when they do not themselves seek appraisal.”
The issues at play in the recent Chancery decisions involve the minutiae of perfecting a right to appraisal when the stockholder has bought in after the record date for a merger. The defendants in Ancestry and BMC sought a holding that because the plaintiff’s shares were purchased from record holder which held shares in fungible bulk, the plaintiff could not prove the shares had not been voted for the merger; such a holding would foreclose the ability of most investors to obtain appraisal if they bought in after a merger announcement. In ruling against the defendants, the Court of Chancery stated that the plain language of the statute did not support such a finding, and that “appraisal rights are a creation of the legislature, not judge-made law, and are ‘not determined with reference to a stockholder’s purpose.’”
Chancellor Glasscock’s decision to avoid tinkering with § 262 seems right: the fundamental policy goal of § 262, namely, the protection of minority shareholders who have lost the protection of unanimous consent requirements for corporate control changes, likely never included judgments about the appropriateness of shareholder intentions beyond the obvious maximization of return on investment. Asking the legislature to change § 262 now seems premature; if Korsmo’s and Myers’ findings hold, appraisal litigation may be doing more good than harm.
Appraisal “arbitrage” could use a better name, but at this point there isn’t a strong case for another revision of § 262. Let’s watch and see what happens.
Thomas H. Kramer, Pharm.D. is a pharmacist, patent agent, and J.D. candidate at Widener School of Law.
Suggested Citation: Thomas H. Kramer, Appraisal “Arbitrage”: Give It Another Name, But Let It Continue, Del. J. Corp. L (Mar. 8, 2015), www.djcl.org/blog.