Appraisal Actions May Be The Next Frontier For
Law360, New York (April 20,
2017, 4:07 PM EDT) -- Delaware’s Supreme Court will soon decide if lower
courts properly determined that both
Dell Inc.’s $24.9 billion management-led buyout and DFC Global Corp.’s
$1.3 billion buyout were priced too low, potentially leading more
companies to try appraisal litigation as an investment strategy.
In the Dell case, the state’s Chancery Court had added roughly $7 billion
to founder Michael Dell and private equity firm
Silver Lake Partners’ purchase price, while the DFC case saw the court
add about $100 million to Lone Star Fund VIII’s purchase price.
Instead of ascribing significant weight to the agreed deal price, which in
both cases was the result of a typical bidding process, the courts have
leaned more heavily on analysis tools such as the discounted cash-flow
model, among others, to determine fair value for the deals.
However, failing to place significant weight on the deal price in the
outcome of these appraisal determinations could create a situation where
shareholders would be emboldened to use the process as an investment
strategy, by seeking out undervalued deals and using the courts to add
value, DFC argued.
And experts say the process has already become an investment strategy for
certain, sophisticated parties.
“Over the years there has been greater certainty in the way courts looked
at appraisal actions in terms of valuation methodologies. The outcomes
become more predictable,” said David Margules, a partner at
Ballard Spahr LLP. “Clearly the predictability of the outcome is
critical to any investment strategy.”
There were 16 appraisal actions with claims of $129 million filed in
Delaware in 2012, and by 2016 there were 62 valued at $1.9 billion,
according to Wall Street Journal data. Currently, private equity research
Preqin tracks 115 hedge funds, which manage about $19.5 billion that
employ appraisal arbitrage as an investment strategy.
Minor Myers, a professor at Brooklyn Law School who does research on
appraisal arbitrage, said that since 2011 he has seen more filings, more
equity value demanding appraisal and more specialized petitioners.
The current appraisal regime in Delaware stems from a basic common-law
protection of property rights. Before the system, shareholders would have
to vote unanimously in favor of a merger for it to go through, Margules
By the 1980s the idea became one of fair value — if a shareholder is going
to be forced to give up ownership, then he or she must be compensated at
fair value. As the court began to see more of these cases, it got better
and better at valuing companies, he continued.
“As greater and greater clarity arose, you could look at a set of cash
flow projections and with greater certainty predict where the court was
likely to come out in a valuation exercise,” Margules said.
For Myers, what strikes him about the recent rise in appraisal actions are
the parties bringing the cases. They seem to be a mix of finance and legal
professionals who have a knack for identifying deals that are ripe for
“The people who are engaged in appraisal tend to target a set of
transactions that generally have abnormally low deal prices,” Myers said.
“It frames how they look at this.”
This approach shows that appraisal challengers are drilling down and
looking for cases with real potential to win, rather than taking on a
scattershot approach, he argued in a 2015 research paper published in the
Washington University Law Review. The study showed that between 2004 and
2013 only about 7.5 percent of the 1,168 appraisal-eligible transactions
had been brought up for appraisal remedies, whereas more than 58 percent
of those deals had been challenged in fiduciary class actions, a common
type of litigation in which shareholders claim company directors breached
their duties to investors in the sale process by failing to secure the
However, Brad Davey, a partner at
Potter Anderson & Corroon LLP, disagreed. He said many of the cases,
especially those with smaller price tags, are just like fiduciary claims
and, as such, represent the latest trend in nuisance suits. In many cases,
it is more expensive to go through the trial process than it is to simply
settle, and the concern is that appraisal is becoming a tax on deals, he
“At the bottom end of the scale, the settlement value is not created
because of the strength of the claim, it’s created thanks to the cost of
litigation,” Davey said.
Even with larger deal prices, Davey said, recent decisions in fiduciary
merger cases have made appraisals seem much more attractive to those
“There are fewer financial incentives for entrepreneurial plaintiffs’
counsel to pursue fiduciary [mergers and acquisitions] litigation,” Davey
said. “Appraisal is a place where they are ending up.”
But as the dust settles, Myers said, he doesn't expect a huge number of
new players to jump into the space; the investment isn’t particularly
attractive, and the opportunities are few and far between. Also, picking
the right deals to challenge is a harder skill than people think, Myers
“The other thing about the risk is that a lot of [other] investments, even
if you pick them correctly, also promise much bigger returns to offset
that [risk],” Myers said. “The best case scenario in a lot of these
[appraisal] cases is like 15 or 20 percent annualized, and that’s good.
“You’re never going to triple your money or quadruple your money or 10
times your money the way that in riskier spaces you often do.”
--Editing by Edrienne Su.
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