June 7, 2017
Is Appraisal Arbitrage Past Its Prime?
Once again, some corporate lawyers are complaining that the Delaware
courts are too good to stockholders or, more often, plaintiffs’
lawyers. In the more recent past, those complaints focused on merger
litigation that led to disclosure-only settlements. Now the outcry is
over so-called appraisal arbitrage. But, just as the Delaware courts
eventually curbed disclosure-only settlements in merger litigation,
the more recent appraisal decisions are making appraisal litigation
much less attractive. In just five days, two Court of Chancery
decisions dealt major setbacks to appraisal arbitrage.
To set those decisions in context, it helps to first briefly review
the contours of appraisal litigation. Since 2007, Delaware law
provides a statutory interest rate for appraisal awards of five
percent over the Federal Discount Rate. As interest rates subsequently
declined, even just a five percent rate was an attractive investment
return. At least partly for that reason, there was a sharp increase in
appraisal litigation over the last few years.
Adding to the attraction of appraisal litigation, some large awards in
excess of the merger price also encouraged investors to buy a target
company’s stock after a merger announcement for the express purpose of
filing for appraisal. This rise in appraisal arbitrage was denounced
on many grounds. In 2016, Delaware reacted by amending the appraisal
statute to not permit appraisal for de minimis claims and to
permit a cutoff of interest by paying petitioners some or all of the
amount in dispute before judgment was entered.
Nonetheless, appraisal litigation remained both costly in fees and
expenses, and also risky in outcome. In almost every appraisal case,
the petitioners would offer a well-qualified expert who based on a
discounted cash flow analysis testified the fair value of the target
corporation was well above the deal price. While petitioners did not
always get all they wanted, in a large majority of cases the appraisal
award was more than the deal price, giving a good profit to any
The criticism of that result reached its zenith after the decision in
In re Appraisal of Dell, Inc., 2016 WL 3186538 (Del. Ch. May
31, 2016). Dell awarded petitioners $17.62 per share, a 28%
significant increase over the $13.36 per share deal price. Moreover,
Dell also found that the merger price was the product of a fair
process with a vigorous market check. How, then, the critics howled,
would the fair value be more than what the market would pay? The
Dell decision is now on appeal.
In terms of the future of appraisal litigation, Dell may still
prove to be unique, regardless of the outcome in its appeal. For there
are several post-Dell decisions that now make appraisal
litigation less attractive. As these decisions illustrate, when the
Court of Chancery has reason to doubt that a discounted cash flow
analysis is properly supported, the deal price will be given great
weight. See, e.g., Merion Capital LP v. Lender Processing Services,
Inc., 2016 WL 7324770 (Del. Ch. December 16, 2016) and In re
Appraisal of PetSmart, Inc., 2017 WL 2303599 (Del. Ch. May 26,
With that background, the decision in In re Appraisal of SWS Group,
Inc., C.A. 10554-VCG (Del. Ch. May 30, 2017) is worth a look. For
the SWS decision did use a discounted cash flow analysis, but
still concluded that the fair value of SWS stock was significantly
below the deal price. As a result, the Petitioners in SWS
lost money if they purchased their SWS stock at the merger price and
incurred substantial litigation expenses in doing so. How, then, could
that have happened?
There are several keys to the result in SWS. To begin with, all
DCF analysis started with projections of cash flows and then adjust
those projections, applying a terminal growth rate and a discount
rate. For the reasons stated in the opinion, the Court eventually
calculated a DCF analysis that came out lower than the merger price.
Hence, the first point of SWS is that there is always risk in a
battle of experts. Petitioners can lose that battle.
Second, the court was unimpressed by the deal price. SWS was an
attractive target because an acquiror could achieve substantial cost
savings in SWS banking business that would lead to higher
profits than SWS could achieve on its own. Those “synergy values” were
considered to be possible only through the merger with a similar
business. But as the Delaware appraisal statute precludes including
“any element of value arising from the accomplishment or expectation
of the merger”, those synergy values in the deal price were not
counted in deciding SWS’s fair value.
It is this last lesson from SWS that may prove most important.
Almost any merger with a strategic buyer will possibly have synergies
for the combined entity. If those benefits arising from the merger are
always to be excluded, then the deal price may actually set as a cap
on value and the final judgement will likely be less than the deal
price. In short, SWS signals a danger for appraisal
arbitrageurs in synergies-driven mergers.
This does not necessarily follow. What constitutes a synergy-driven
merger is not always clear under Delaware law. It may well be that
even if a company lacks the ability to realize all the value of its
assets by itself, that value is still there. To let the buyer take all
the synergies in such a case by excluding that value from the
appraisal award does not seem fair. We will see if SWS leads to
that result and what will be its impact on appraisal.
DISCLAIMER: Because of the generality of this update, the information
provided herein may not be applicable in all situations and should not
be acted upon without specific legal advice based on particular
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