Effort to Protect Shareholders May End Up Hurting Them
STEVEN DAVIDOFF SOLOMON
MAY 24, 2016
An overhaul in shareholder rights is
coming as Delaware seeks to curtail a strategy that has grown popular
with hedge funds. The question is whether shareholders or companies
Right now, shareholders of a company
that is the target of a corporate takeover can protest the price being
paid by petitioning a court to appraise the value of their shares. The
court will order the merged company to pay the shareholders fair
value, which may be greater or less than the amount paid in the deal,
plus any interest that accumulated during the court’s deliberation,
which often takes years.
Appraisal rights originally came to be as a compromise. Mergers used to
require the approval of 100 percent of shareholders. That gave power to
shareholders who wanted to block deals by being holdouts. Appraisal rights
were adopted to reduce the minimum deal approval threshold to a majority.
That way, a shareholder could dissent from the takeover but not stop it.
The ability to exercise appraisal rights has always been convoluted and
difficult, however. In Delaware, appraisal rights are usually available only
if the deal price is paid in cash, not stock. This means there are ways to
avoid setting off appraisal rights. Remember Bear Stearns’s acquisition by
JPMorgan Chase in 2008? JPMorgan paid for the deal with stock instead of the
measly cash amount it could have used, avoiding appraisal rights.
Exercising appraisal rights can also be risky for shareholders. If the court
found that the acquirer had overpaid, the shareholder seeking the appraisal
would receive less than other shareholders got in the deal. And lengthy
court proceedings required costly experts to opine on the fairness of the
Because of these issues, shareholders seldom exercise appraisal rights.
That all changed after a
case in Delaware eight years ago made it
easier to exercise appraisal rights and incited a boom in appraisal
arbitrage, a strategy in which a fund buys shares just before a merger
closes in order to exercise the appraisal rights. Hedge funds like Merion
Capital, Merlin Partners and Quadre Investments arose specializing in the
This was a problem for companies incorporated in Delaware, and thus the
overhaul efforts began.
proposal last year in Delaware limited appraisal rights to holders of $1
million or more of a company’s stock or 1 percent of the outstanding shares,
whichever was less. Another proposal also took aim at the accumulated
interest by allowing companies to
prepay the acquisition amount and
eliminate interest accrual.
These proposals died in the Legislature last year as a
debate erupted over whether they went far enough or
too far in limiting appraisal. They were revived this year, and
just passed the Delaware House of
Representatives. They appear destined to become law.
The question is what effect these changes will have on appraisal rights. In
just-released study, four professors,
including Wei Jiang at Columbia University and Randall Thomas at Vanderbilt
University, looked at past appraisal actions to predict what would happen.
First, the authors found that hedge funds dominate appraisal cases. Actions
by hedge funds make up three-quarters of the volume measured by dollars for
appraisal actions in the last few years. Seven funds accounted for a
majority of this volume.
Second, the study found that appraisal cases seem to serve some corrective
function. Appraisal rights are exercised more often when there is a conflict
with shareholders, as in a management buyout or
private equity deal, or when there is a
lower deal premium.
Finally, the professors found that if past filing patterns hold, the new
appraisal rules would significantly restrict appraisal actions. The authors
predict that the $1 million minimum will knock out a quarter of these
actions. And allowing for an interest rate cutoff could eliminate another
significant number of filings.
These changes are on top of a court crackdown that also limits investors
seeking appraisals by setting the price paid by the acquirer as the amount
to be awarded in an appraisal proceeding unless it can be shown that the
sale process went awry.
The proposed changes may backfire, however. Rather than discourage appraisal
petitions, the elimination of interest accrual through prepayment may
actually spur more appraisal actions because hedge funds would be paid
sooner and be able to use that money to bring more appraisal actions.
In addition, the $1 million minimum seemingly unfairly knocks out small
shareholders but not professional hedge funds. There should be a remedy for
a small shareholder who feels ill-treated.
Perhaps more important, legislators have not assessed whether the proposals
uphold the intent of appraisal rights, which was to protect shareholders. In
Delaware courts, it is hard to challenge a deal that was negotiated with
good process. Appraisal rights could be the only remedy for shareholders in
deals that did not have a great price. Absent the threat of appraisal
proceedings, buyers and sellers might lose the incentive to pay a fair
price, instead paying a price that was just high enough.
The overhaul also does not fix the problems with appraisal actions. They are
still not available for stock deals, allowing companies to bypass this
option easily. There will still be battles in court over the price of a deal
in front of judges who are not trained in these issues. And these revisions
may not even deter hedge funds from exercising appraisal rights, the
ostensible impetus for these changes.
All of this speaks caution. After all, it seems funny that now that
shareholders want to use appraisal rights, there is a push to try to end it.
Does that seem right?
Deal Professor: Steven Davidoff
Solomon is a professor of law at the University of California, Berkeley. His
columns can be found at nytimes.com/dealbook.
version of this article appears in print on May 25, 2016, on page B3 of the
New York edition with the headline: Delaware Effort to Protect Shareholders
May Hurt Them.
The New York Times Company