Between 2010 and 2016, the number of shareholder appraisal actions filed in Delaware courts increased every year, but in 2017 and again in 2018, the number of appraisal actions declined, according to a recent report from Cornerstone Research. The decline arguably is a result of recent Delaware Supreme Court decisions in which the court reversed lower court rulings holding that the fair value exceeded the deal price and instead indicated that the deal price should be given substantial weight, at least where the sales process was “robust.” The report, entitled “Appraisal Litigation in Delaware: Trends in Petitions and Opinions, 20016-2018” can be found here. Cornerstone Research’s February 13, 2019 press release about the report can be found here.
In an effort to protect minority shareholders who may feel they are being compelled to give up their shares without their consent, various states, including in particular, Delaware, have created a remedy for “dissenting shareholders,” allowing them to seek a judicial appraisal of the fair value of their shares. Under Delaware General Corporations Code Section 262, subject to certain conditions and qualifications, any shareholder voting against a merger on the grounds that the consideration is inadequate “shall be entitled to an appraisal by the Court of Chancery of the fair value of the stockholder’s shares of stock.” If the Chancery Court concludes that the deal price offered is too low, the shareholder is entitled to recover the adjusted amount plus interest. The court may also award the shareholder his or her attorney’s fees and experts’ fees. The basics of a Delaware Appraisal Rights proceeding are described in detail on the Appraisal Rights Litigation Blog (here).
The Number of Appraisal Actions: Appraisal rights actions are of course not new. However, for several years running, the number of Delaware appraisal actions filed increased significantly. According to the report, the number of Delaware appraisal petitions rose steadily after 2009, peaking at 76 in 2016. As discussed in the Cornerstone Research report, the increase in the number of petitions followed the recent rise of appraisal arbitration, in which investors purchased shares in the target company after the deal announcement and then contested the deal price in a subsequent transaction. As detailed elsewhere, among the attractions to investors in pursuing this strategy for much of this period is the relatively advantageous statutory interest rate; in 2016, the Delaware legislature amended the law to allow defendants to pre-pay anticipated amounts due as a way to cut-off the accrual of statutory interest.
However, the number of appraisal petitions declined to 60 in 2017 (a decrease of 21 percent), and declined again in 2018 to only 26 (a further decrease of 57 percent. The number of merger transactions that attracted at least one appraisal petition peaked at 47 in 2016, but decreased to 34 in 2017 (a decline of 28 percent), and decreased further to 22 in 2018 (a further decrease of 35 percent). The decline follows two recent Delaware Supreme Court decisions emphasizing that greater weight should be given in appraisal actions to the deal price (as well as the changes concerning the accrual of pre-judgment interest).
There were a total of 433 appraisal petitions filed in Delaware between 2006 and 2018, relating to 320 unique merger transactions. During that period, there were a total of 34 cases decided following trials by the Chancery Court and the Delaware Supreme Court. The average case took over two years from the filing of the petition to the beginning of trial, and the average time from trial to the issuance of the initial opinion was approximately six months. The average trial lasted five days.
The Track Record of Trial Results: The results in these cases show a wide variation, where the premiums to deal price awarded ranged from a negative 57 percent to a positive 158 percent. Of the 34 deals that went to trial between 2006 and 2018, 16 resulted in awards above the deal price and 18 resulted in awards at or below the deal price. The average premium to deal price across all 34 opinions was 18 percent, with eight cases with awards below the deal price, ten cases in which the deal price was accepted as fair value, and 16 cases with awards above the deal price. Among these 16 cases, the average premium was 47 percent.
Components of the Trial Outcomes: The three main methodologies used to determine fair value were discounted cash flow (DCF) analyses, valuation based on comparables, and reliance on the deal price. Between 2006 and 2017, the Delaware courts relied exclusively on DCP analyses and the deal priced to determine fair value.
The decisions have also shown that the Delaware Courts place a strong emphasis on whether the merger was the result of a robust, arm’s-length process. The courts found that where the deals involved eitheran auction or “go-shop” process, the transaction evidences a “robust” sale process. In transactions that included an auction or go-shop process and the acquiring firm was not a related party, the average premium to deal price awarded was 1 percent and the median premium was 0 percent. In transactions without an auction or go-shop process and where the acquirer was a related party, the average premium to deal price awarded was 47 percent, with a median of 33 percent.
Concentration of Claims Among Repeat Players: Among the more interesting analyses reflected in the report is its discussion of the concentration of appraisal litigation activity among a small group of repeat petitioners, and of repeat petitioners’ and respondents’ counsel. The top ten petitioners during the period reflected in the report were responsible for more than half of all filings (254 out of 433) between 2006 and 2018. The concentration among petitioners was largely driven by hedge funds and private equity firms that actively pursued an appraisal arbitrage strategy. Among these top ten petitioners, many were represented by the same counsel; most filed over 90 percent of their petitions with same legal counsel. The top ten petitioner law firms were represented in 98 percent (423 out of 433) of all petitions between 2006 and 2018. The top ten respondent law firms were involved in 77 percent (332 out of 433) of all petitions over the same 13-year period.
The report’s analyses showing the decline in 2017 and 2018 in the number of appraisal action filings after years of annual increases is something of a relief. These actions, and the ancillary disputes they inevitably led to, were, during the period of increasing filings, becoming more than just a peripheral concern.
Indeed, as I detailed in prior posts (most recently here), the rise in the number of appraisal actions led directly to an increase in the number of related insurance disputes, where the defendant companies sought to have their insurers indemnify them for the costs of defending these actions, and perhaps even parts of the subsequent awards (if any), depending on what was alleged in the petition.
As I have also detailed, the D&O insurance issues arising from these kinds of disputes involved a number of tricky issues, and resolving these kinds of disputes can be vexing.
The news that the number of appraisal actions has declined in recent years is a rare bit of litigation frequency good news in the world of D&O liability. As I have documented elsewhere, the number of securities lawsuits generally has been increasing dramatically since 2016; a large factor in this increase has been the growth of federal court merger objection litigation. The fact that one (albeit relatively small) part of the merger-related litigation world is showing a decrease in the number of lawsuits filed is a rare bit of good news.
The report’s analyses of the concentration of these kinds of claims among a small group of petitioners and of petitioners’ and respondents’ counsel is one of many things these days that suggests that the world of Delaware corporate litigation involves a sort of inner priesthood of participants familiar with and enriched by the rituals and practices. Anything that can undercut the development of ingrained processes that result most specifically in the enrichment of the repeat participants is all to the good, as far as the rest of the world is concerned.
Appraisal arbitrage, where investors purchase target company shares after the deal announcement, strikes me as a particularly cynical distortion of a mechanism that ostensibly exists to protect committed company shareholders (and not simply to enrich opportunistic investors with a stake only in the litigation itself and not with anything else having to do with the company). Anything that reduces claims frequency associated with routine corporate transactions such as M&A activity is all to the good as well, particularly where the case that the litigation serves to protect the interests of committed shareholders is less than compelling.