William J. Burton
In two recent opinions, the Delaware Court of Chancery wrestled with an important question regarding appraisal litigation. Namely, the court faced the issue of whether under 8 Del. C. § 262, a beneficial owner who acquires shares after the record date must prove that each of its specific shares, for which it seeks appraisal, was not voted in favor of the merger. This issue specifically relates to, and is of particular concern for, those who engage in what has become known as “appraisal arbitrage.” Appraisal arbitrage is a phrase that has been used to denote an investment strategy “whereby an investor acquires an equity position in a cash-out merger target with the specific intention of exercising the statutory stockholder appraisal right found in 8 Del. C. § 262.” The investor, or arbitrageur, gains a positive return on investment when, “in the subsequent appraisal action the court awards the appraisal petitioners what the court determines to be the fair value of the target,” which is over and above what was offered in the merger transaction.
In Merion Capital LP v. BMC Software, Inc., the Court of Chancery was faced with an arbitrageur, Merion Capital LP (“Merion”), who began purchasing shares of BMC Software, Inc. (“BMC”) on the public market after a merger agreement was signed between Boxer Merger Sub Inc. and BMC. The Court of Chancery held that the General Assembly did not intend to impose an additional standing requirement, or “share-tracing requirement,” for appraisal petitioners and that it was not within the judiciary’s power to create one. Such a requirement would force a beneficial owner to show that “each share it seeks to have appraised was not voted by any previous owner in favor of the merger.”
Similarly, in In re Ancestry.Com, Inc., Merion began purchasing shares of Ancestry.com (“Ancestry”), four days after the record date of a merger between Permira Advisors and Ancestry. Ancestry argued in favor of a share-tracing requirement, but the Court of Chancery held that such a requirement was not included in the appraisal statute and that to add the requirement “would be to exercise a legislative, not a judicial, function.”
Despite the findings of the Court of Chancery, I believe that a share-tracing requirement should be imposed on appraisal litigants. Properly addressing this issue requires an examination of the origin and evolution of the appraisal statute—8 Del. C. § 262. The appraisal statute has its origins at common law, where mergers could only occur upon a unanimous favorable vote of a corporation’s stockholders. The requirement of unanimity created a situation in which stockholders had a veto power that “made it possible for an arbitrary minority to establish nuisance value for its shares by refusal to cooperate.” To deal with this problem, the Delaware General Assembly provided that a merger, or fundamental change, could occur by less than a unanimous vote of stockholders. At the same time, the General Assembly created an appraisal remedy “to compensate dissenting stockholders for their loss of the ability to block mergers.”
The origin of the appraisal statute supports an implied share-tracing requirement. Such a requirement must be implied because as the Court of Chancery properly noted, “noticeably absent from [the language of the statute] is an explicit requirement that the stockholder seeking appraisal proves that the specific shares it seeks to have appraised were not voted in favor of the merger.” Without such a requirement, a potential investor like Merion could purchase most or all of the corporation’s outstanding shares after the record date and then seek appraisal for those shares, even though the record-date holder voted in favor of the merger. Essentially, without such a requirement, the appraisal statute can be used as an investment tool for arbitrageurs as opposed to a statutory safety net for objecting stockholders. Accordingly, not having an implied share-tracing requirement flies in the face of the origins of the appraisal statute because it was designed to compensate dissenting stockholders by providing them an appraisal right and not to provide third parties an investment tool. Notably, however, the Court of Chancery disregarded this concern in both Merion Capital and In re Ancestry.com as it was not before the court in either case.
There are other concerns that warrant an implied share-tracking requirement. It has been anticipated that without such a requirement, and in the wake of the recent decisions, more appraisal suits will appear. A greater number of appraisal suits is normally bad for mergers, as the cost of potential litigation has to be accounted for in determining whether to proceed with such transactions. With additional costs from seemly inevitable appraisal litigation, many companies may choose not to merge with or acquire other companies, and as a result, potential economic growth will be stifled. Similarly, many post-merger lawsuits are filed merely for their nuisance value, the prevention of which was one of the reasons why the appraisal statute was created in the first place. Additionally, those who purchase shares after the record date seemingly do so in bad faith because they know the merger price per share and willingly purchase shares with such knowledge. As a result, such shareholders should be estopped from demanding appraisal rights.
Based on the concerns inherent in appraisal arbitrage and the Court of Chancery continuously noting that any potential solution rests in the hands of the legislature, the legislature must act to right this wrong. One such solution can be found in 8 Del. C. § 327, which governs a stockholder’s right to bring a derivative suit. In this statute, bringing an action requires that it must be “averred in the complaint that the plaintiff was a stockholder of the corporation at the time of the transaction of which such stockholder complains.” Accordingly, the legislature should add a provision to the appraisal statute that requires a plaintiff bringing an arbitration action to be a stockholder at the time of the transaction and not simply a post-transaction purchaser. Alternatively, the legislature should add into the appraisal statute specific language that imposes a burden on the plaintiff to show that each share for which they seek appraisal did not vote in favor of the merger. Ultimately, the latter alternative approach is the more favorable approach, as it is possible for those who engage in appraisal arbitrage to buy one share in every company that potentially faces a merger in order to be a stockholder at the time of the transaction.
William Burton is the Volume 40 Internal Managing Editor of the Delaware Journal of Corporate Law. William also serves as Wolcott Fellow to the Honorable Karen L. Valihura of the Supreme Court of Delaware.
Suggested Citation: William J. Burton, Putting a Stop to Appraisal Arbitrage, Del. J. Corp. L (Mar. 5, 2015), www.djcl.org/blog.