Stockholder Appraisal Actions Present an Attractive Litigation-Based
Strategy for Hedge Fund Managers
By Ben Quarmby and Hassan A. Shah
Hedge fund managers are increasingly turning to a long-underused
litigation-based mechanism to generate investment returns. That
mechanism – the Delaware stockholder appraisal action – allows
managers controlling shares in a company targeted for merger or
consolidation to significantly increase the value of those shares
through a pure litigation play.
In a guest article, Ben Quarmby and Hassan A. Shah, a partner and an
associate, respectively, at MoloLamken, review how appraisal actions
work and describe some recent results. The article then discusses the
advantages of using appraisal over traditional stockholder litigation,
as well as some recent legislative and judicial pushback. Finally, the
authors consider the potential opportunity that shareholder appraisal
actions present for hedge fund managers and other asset managers.
For additional insight from Quarmby, see “Measures
Hedge Fund Managers Can Implement to Maximize Protection of Their
Trade Secrets” (Dec. 6, 2012). For commentary from other
MoloLamken practitioners, see “FCPA
Considerations for the Private Fund Industry: An Interview With Former
Federal Prosecutor Justin Shur” (May 23, 2014); “How
Private Fund Managers Can Manage FCPA Risks When Investing in Emerging
Markets” (Jan. 10, 2013); and “Political
Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can
Avoid Potential Pitfalls” (Apr. 5, 2012).
How Appraisal Works
Section 262(a) of the Delaware
appraisal statute allows a stockholder willing to temporarily forgo
the consideration to which it is entitled following a merger to file
an action seeking the fair value of its shares based on a judicial
appraisal. The appraisal is a determination of the acquired company’s
fair value as if it had continued to operate as a standalone going
The Delaware appraisal remedy is available to “[a]ny stockholder of a
[Delaware] corporation” who:
(a) owns shares of stock on the date the stockholder demands an
appraisal from the corporation;
(b) continues to hold the shares through the effective date of the
merger or consolidation; and
(c) neither votes in favor of the merger or consolidation nor
executes a written consent in favor of
It is invoked in transactions where stockholders will be cashed out in
a merger, and it may also be available in limited circumstances where
the transaction consideration is stock.
Following the announcement of a merger, a stockholder must deliver a
written demand for appraisal of the stockholder’s shares to the
corporation. Once the merger has closed, the stockholder may then file
an appraisal petition in the Delaware Court of Chancery, demanding
that the court conduct an independent determination of the value of
its shares. The stockholder then can seek targeted discovery about the
corporation’s financial statements and business plans. If the matter
proceeds to trial, competing experts provide evidence of the fair
value of the petitioner’s shares.
Stockholder appraisal actions are not new. But they have become
increasingly popular with hedge fund managers. As a result, Delaware
has seen a very significant uptick in the number of appraisal actions
filed since 2012-2013.
Preliminary analyses of the stockholder appraisal market by leading
academics suggest that the value of claims in appraisal in 2013 was
approximately $1.5 billion, “a tenfold increase from 2004 and nearly
one percent of the equity value of all merger activity in 2013.”
That hedge fund managers should find appraisal actions attractive is
no surprise; the potential upside can be significant. In an analysis
of all post-trial decisions from 2010-2014, appraisal fair value
determinations exceeded the merger price in all but two cases – with
the awards representing premiums over the merger price ranging from
8.5% to 149% (with an average of 61%).
By way of example:
When Innovative Communications Corp. was bought by its majority-owned
subsidiary, Emerging Communications, Inc., Greenlight Capital LLC was
awarded a fair value decision of approximately 270% over the per share
merger consideration of $10.25 per share.
After the closing of the leveraged buyout of American Commercial
Lines, Inc., IQ Holdings sought an appraisal challenging the merger
consideration of $33.00 per share. Following a trial, IQ was awarded
fair value of $38.16 per share – an added value of more than 15% over
the merger price.
In fact, given the potential for such returns, some asset managers
have started to raise investment funds focused primarily or
exclusively on employing the appraisal action as the method of
implementing the funds’ investment strategies.
Advantages Over Traditional Stockholder Litigation
Stockholders have historically relied on derivative class action
litigation to challenge mergers. The appraisal action, however,
presents a number of advantages over traditional stockholder
An Investor Can Purchase a Claim
To bring an appraisal action, a stockholder need not hold the stock on
the date the merger is first made public. An investor can purchase
stock following the merger announcement but before the close of the
merger and still be entitled to an appraisal.
In a derivative action, by contrast, the putative plaintiff must
already be a stockholder at the time of the alleged harm.
An Investor Has Greater Control Over an Appraisal Action
A classic breach of fiduciary duty derivative action proceeds as a
class action, with plaintiffs’ counsel directing the litigation. That
arrangement can interfere with (and even undermine) the actual goals
of aggrieved stockholders.
By contrast, an appraisal action proceeds directly between the
individual stockholder and the corporation, enabling the stockholder
to exert far greater control and influence over the litigation.
Appraisal Is a Streamlined Remedy
Challenges based on pleading standards – both at the motion to dismiss
and summary judgment stages – do not exist in appraisal actions. A
petitioner is entitled to discovery that is relevant to the fair value
determination and will have his day in court. The timeline for
appraisal is therefore significantly streamlined relative to
traditional civil litigation, and can quickly proceed from petition to
a post-trial decision in 18-24 months.
Appraisal Offers Limited Downside
The merger price generally acts as a floor on the fair value decision.
Even if a court only awards the merger price as fair value, a
stockholder is also entitled to interest on that determination. The
statutory interest rate is 5% over the discount rate, which is
relatively plaintiff-friendly in the current low interest rate
environment. Moreover, to the extent a stockholder has financed a
portion of its shares, it can achieve a levered return on equity in
excess of the statutory interest rate.
Of course, there are limitations to the appraisal action. It is
customarily employed when the consideration is cash. It would not
apply when the consideration is entirely publicly traded stock (the
“market-out exception” under 8 Del. C. § 262(b)(1)), which is a
favored currency of strategic purchasers. It also requires that the
plaintiff control enough shares at the outset to justify the
litigation costs associated with the challenge. And, as is the case
with any litigation, ultimate outcomes and timing can never be
guaranteed. However, as the examples above show, the mechanism has
already proven to be worthwhile for many investors, including hedge
Recently, there has been some degree of backlash against appraisal
actions. The Delaware legislature and courts have both shown interest
in limiting their scope.
Proposed Legislative Amendments
The Delaware General Assembly, for example, considered proposed
amendments to the appraisal statute that would have imposed
significant limitations. Under the proposed amendments, a stockholder
would have been able to seek appraisal only if: (1) the total number
of shares entitled to appraisal exceeded one percent of the
outstanding shares that could have sought appraisal; (2) the value of
the merger consideration for the total number of shares entitled to
appraisal exceeded $1 million; or (3) the merger was a
The proposed amendments also would have permitted a corporation to cut
off the accrual of interest by paying the stockholder an amount chosen
by the corporation (presumably the merger consideration). The
stockholder would then only be entitled to interest on the difference
between the amount previously paid by the corporation and the eventual
fair value determined by the court.
While the amendments were not adopted in 2015, similar legislative
Courts have pushed back as well. In some recent appraisal cases, the
Court of Chancery has invoked the merger price as the best measure of
fair value. Factors that courts consider when they have relied on the
merger price include (1) whether the target corporation engaged in a
broad market auction; (2) whether the transaction process was free of
decisional conflicts; and (3) whether deal protections designed to
discourage topping bids were employed.
Also, while the merger price has generally served as a floor for fair
value, there is now some indication that the court may be more
receptive to awarding fair value below the merger price (generally in
a case involving a strategic acquirer where synergies are removed from
the fair value determination).
Despite these recent trends, the opportunity that appraisal actions
presents for stockholders and hedge fund managers remains immense. The
mergers and acquisitions market is forecast to remain “powerful”
according to Wall Street.
Investment returns generated by deploying stockholder appraisal
actions can also be significantly greater than those achieved through
traditional investment strategies, particularly in light of recent
stock market performance. Even with the recent legislative and
judicial pushback, a stockholder’s downside remains quite limited.
Finally, appraisal remains attractive due to its straightforward
procedure, as compared to traditional litigation. The timeline to a
decision thus makes such actions more tenable for investors with
constrained litigation budgets and investment horizons.
As it stands, the stockholder appraisal landscape is therefore one of
tremendous opportunity. In the right case, an investor surveying
merger arbitrage can analyze a proposed deal following a merger
announcement, acquire the necessary stock, retain counsel, trigger
litigation and obtain a judgment – all within the space of 18-24
months – in many successful cases obtaining double-digit returns with
Mr. Quarmby and Mr. Shah are partner and associate, respectively, at
the national litigation boutique MoloLamken LLP. Mr. Quarmby’s
practice focuses on business litigation and intellectual property. Mr.
Shah’s practice focuses on business litigation and appellate practice.
8 Del. C. § 262(a).
Charles R. Korsmo and Minor Myers,
Appraisal Arbitrage and the Future of
Public Company M&A, 92 Wash. U. L. Rev. 1551, 1553
Philip Richter, et al.,
Why Delaware Appraisal Awards Exceed
the Merger Price, Harvard Law School Forum on Corporate
Governance and Financial Regulation (Sep. 23, 2014).
In re Appraisal of Transkaryotic
Therapies, Inc., C.A. No. 1554-CC (Del. Ch. May 2,
8 Del. C. § 327.
Merion Capital LP v. BMC Software,
Inc., C.A. No. 8900-VCG (Del. Ch. Oct. 21, 2015) (fair
value was merger price);
Merlin Partners LP v. AutoInfo, Inc.,
C.A. No. 8509-VCN (Del. Ch. Apr. 30, 2015) (same);
Huff Fund Inv. P’ship v. CKx, Inc.,
C. A. No. 6844-VCG (Del. Ch. Nov. 1, 2013) (same);
In re Appraisal of Ancestry.com, Inc.,
Cons. C.A. No. 8173-VCG (Del. Ch. Jan. 30, 2015) (same).
LongPath Capital, LLC v. Ramtron Int’l
Corp., C.A. No. 8094-VCP (Del. Ch. Jun. 30, 2015) (fair
value of $3.07 per share compared to merger price of $3.10 per share).
Mattioli, Big Banks: Pace of M&A Deals Will Still Be Strong in 2016,
The Wall Street Journal (Jan. 20, 2016).
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The Hedge Fund Law Report.