Hedge funds hot "appraisal" strategy for
deals may become a lot less appealing
BY TOM HALS
Thu Mar 19, 2015 6:25am EDT
(Reuters) - An
increasingly popular legal strategy that allows hedge funds to make
potentially lucrative bets on takeover deals, and get a return even if
they lose, may be about to become much less attractive.
strategy usually involves buying stock in a Delaware-incorporated company
that is being acquired and then filing a claim that gets a judge to
determine the fair price for the shares in a process known as appraisal.
The fund will argue in court that the deal value was unfairly low and it
should be paid a higher price.
annual interest rate of 5.75 percent currently accrues while a case is
pending, and a final judgment can take years, the strategy generates a
solid return even when the court rules the deal price was fair.
the top corporate lawyers in Delaware, where about two-thirds of Fortune
500 companies are chartered, are proposing an amendment to the law aimed
at removing the interest incentive if a case is lost. The lawyers’
proposals have traditionally been approved with little opposition by
Delaware’s state legislature.
hasn’t stopped the appraisal lawsuits from piling up. And there are signs
that given the low-return environment in financial markets, more hedge
funds and other investors may be filing appraisal suits.
and 2010 only about 5 percent of the deals in which Delaware chartered
companies were eligible for such claims were the subject of appraisal
rights cases. By 2013 this had increased to 17 percent, according to the
law firm Fried Frank.
days, funds affiliated with Third Point Reinsurance, Farallon Capital
Management and Muirfield Capital, among others, have filed appraisal
actions over the sale of pet products retailer PetSmart Inc, which closed
on March 11.
the funds concerned hold about 10.5 million shares of PetSmart, worth
about $870 million, likely making it the largest appraisal action ever,
according to Minor Myers, a professor at Brooklyn Law School.
the court eventually determines that the $83 per share that a consortium
led by European private equity firm BC Partners paid for PetSmart stock
was fair, interest will accrue at more than $50 million per year while
that decision is awaited, and will increase as time goes on because the
interest is compounded quarterly. In addition, the court could determine
the fair price should be much higher, giving the funds a big potential
does come with risks. Judges have ruled the fair price was below the deal
price in a small number of cases, and the hedge funds have to pay for
their lawyers and experts.
appraisal strategy has been pioneered in recent years by Merion Capital
LP, a hedge fund founded by Andrew Barroway. The former securities class
action lawyer got his start building Schiffrin & Barroway, now known as
Kessler Topaz Meltzer & Check, into a major player in federal securities
fraud class actions.
rights are not new. They originally emerged as protection for minority
investors as companies did away with universal shareholder approval for
certain corporate events.
appraisal of a deal had previously mainly been used by minority investors
who felt they were squeezed out of a deal decision by a controlling
shareholder. However, in recent years the claims have often come from
hedge funds seeking juicy returns.
handful of cases in the past few years Delaware judges have determined the
fair price was much higher than the deal price. In the sale of
entertainment company The Orchard Enterprises, a Delaware judge found the
fair price was 127.8 percent above the takeover price, according to a
client memo from Fried Frank. The interest during the two-year case tacked
on another 36.1 percent to returns.
proposal by the Delaware bar comes at a time when the state's lawyers are
seeking to preserve the state's leading role in corporate litigation while
responding to business demands to cut meritless shareholder lawsuits.
controversial proposals for changing Delaware corporate law will be
considered next month by the state's corporate lawyers. Some are designed
to prevent companies from adopting bylaws that force their legal costs
onto shareholders who sue and lose.
committee proposing the appraisal arbitrage amendment is reflective of
many types of corporate law specialists, including those who represent
investors as well as lawyers for companies they sue.
lawyers outside Delaware who represent companies have criticized the
appraisal proposal for not being tough enough on the hedge funds.
Norwitz, a top deal lawyer at Wachtell, Lipton, Rosen & Katz, which
advised PetSmart, said Delaware law should require that only investors who
were shareholders before the deal announcement be allowed to seek
appraisal. Many funds seeking appraisal rulings scoop up their stock after
the shareholder vote on the deal but just before it closes, which is a
constant irritant to the company defense lawyers who want proof of how the
shares held by the hedge funds were voted on the deal.
wrote in a blog post that the bar's proposals do not go far enough to
discourage the hedge funds. As he sees it, there is a danger that the
buyers of companies will pay less to all shareholders because they will
have to find the funds to pay off the hedge funds, who he referred to as
Delaware bar committee that drafted the appraisal proposal said in an
explanatory paper that buyers can negotiate conditions that would allow
them to back out if a certain number of appraisals are filed. The bar also
said corporate deals involving proper steps, such as testing the deal’s
price by seeking other potential buyers, are less likely to be the subject
PetSmart case, the funds asked the court to determine the fair value of
their stock and award them their costs associated with the suit.
In a class
action over the same deal, which was approved by about 75 percent of
PetSmart shareholders, investors have said PetSmart was worth more than
$100 per share. At that price, the BC Partners consortium could easily be
on the hook for more than $200 million in payments to the hedge funds,
spokesman declined to comment as did a lawyer for the funds in the case.
Tom Hals in Wilmington, Delaware; Editing by
Amy Stevens and