The past few years have been a time of tremendous change in Delaware merger litigation. Those changes include the further development of substantive doctrines under Corwin and MFW (discussed further in Sections II and III, respectively), which provide defendants with strong bases for dismissing many complaints. At the same time, appraisal litigation has expanded in Delaware and provided stockholders with a different angle of attack on the adequacy of the merger price. The Delaware Supreme Court has issued several key rulings on appraisal issues and is expected to provide further guidance on appraisal rights in the coming year.
II CLEANSING EFFECT OF INFORMED, UNCOERCED STOCKHOLDER VOTE
During the past few years, the Delaware courts have underscored the deference afforded to merger transactions approved by an informed, disinterested and uncoerced stockholder vote. In Corwin v. KKR Financial Holdings,2 the Delaware Supreme Court unanimously affirmed the Court of Chancery's dismissal of a post-closing damages action, holding that the business judgment rule applies in post-closing damages suits involving mergers not subject to entire fairness and that have been approved by a fully informed, uncoerced majority of the disinterested stockholders.3 The court explained that it is reluctant to interfere with a stockholder decision on approving a merger, because '[w]hen the real parties in interest – the disinterested equity owners – can easily protect themselves at the ballot box by simply voting no, the utility of a litigation-intrusive standard of review promises more costs to stockholders in the form of litigation rents and inhibitions on risk-taking than it promises in terms of benefits to them'.4 Since Corwin, the Court of Chancery has repeatedly dismissed post-closing challenges to non-controller stockholder-approved transactions at early stages of the litigation.5
The Delaware courts extended this protection to transactions that are 'approved' by fully informed, uncoerced stockholders tendering a majority of shares in a two-step merger pursuant to Section 251(h).6 In finding that the business judgment rule applied, the Court of Chancery held that the tendering of a majority of shares in a two-step merger pursuant to Section 251(h) 'essentially replicates a statutorily required stockholder vote in favor of a merger', and thus would invoke the same highly deferential standard of review as a 'vote in favor of a merger by a fully informed, disinterested, uncoerced stockholder majority'.7
The Court of Chancery has cautioned that this cleansing effect will apply only when the stockholder vote is not coerced and is fully informed.8 It has also cautioned that not all conduct may be cleansed by a stockholder vote: 'The policy underlying Corwin . . . was never intended to serve as a massive eraser, exonerating corporate fiduciaries for any and all of their actions or inactions preceding their decision to undertake a transaction for which stockholder approval is obtained'.9 Future cases will continue to develop a framework for determining whether certain disclosed acts or omissions are so problematic, or certain deal structures so coercive, that they cannot be cleansed through approval by stockholders.
III 'GOING PRIVATE' TRANSACTIONS WITH CONTROLLING STOCKHOLDERS
The Delaware courts have clarified certain issues regarding the framework adopted in Kahn v. M&F Worldwide Corp (MFW) for reviewing 'going private' transactions by controlling stockholders.10 In In re Books-A-Million, Inc Stockholders Litigation, the Court of Chancery applied MFW and found that a controlling stockholder's proposal to take a company private had complied with the conditions set forth in MFW, which subjected it to the business judgment level of review.11 The case demonstrated that defendants may prevail on a motion to dismiss, even where the transaction involves a controlling stockholder, and thus avoid costly and time-consuming discovery and a trial.
Books-A-Million also confirmed that a controlling stockholder has no obligation to sell its shares or otherwise facilitate a third-party offer. Nor does a controlling stockholder breach its fiduciary duties simply by offering to acquire the minority's shares – even at a price lower than might be available from a third-party bidder – so long as the price offered is within a rational range.12 The Court of Chancery noted that although special committees are not required to solicit offers from third parties in the face of a statement by the controlling stockholder that it is not willing to sell its shares, a 'committee goes one better when it takes the additional step of gathering additional information through a market canvas' because any third-party offer 'would be a data point in any post-closing appraisal action, giving the [controller] a reason to bump their offer'.13 The Delaware Supreme Court affirmed Books-A-Million in a one-page Order.
In In re Martha Stewart Living Omnimedia, Inc Stockholders Litigation, the Court of Chancery extended the standard set forth in MFW to transactions involving the sale of a controlled company to a third party, even when the controlling stockholder receives disparate consideration for its shares.14 The court rejected the plaintiffs' position that the MFW procedural protections must be in place at the outset of negotiations between the controlled company and the third party, holding instead that the trigger for the MFW protections is the beginning of negotiations between the controlling stockholder and the third party for additional consideration, which is when the potential conflict with the minority stockholders emerges.15 The Martha Stewart decision shows that significant incentives exist for controlling stockholders and directors to insist on procedural protections that allow the parties to replicate arm's-length bargaining.
IV APPRAISAL RIGHTS
For many years, practitioners considered appraisal to be a 'sleepy' topic, but it has recently become a key doctrinal battleground in Delaware courts.16 Section 262 of the Delaware General Corporation Law provides stockholders with the right to demand a judicial appraisal of the 'fair value' of their stock.17 To exercise appraisal rights a stockholder must:
- deliver a written demand prior to the vote;
- not have voted in favour of the transaction;
- continuously hold the stock through closing; and
- perfect appraisal rights after closing.18
With the developments in Delaware merger litigation disfavouring disclosure-only settlements and clarifying the standards for dismissal of complaints (as discussed above), plaintiffs have increasingly looked to appraisal actions as a backstop for pricing imperfections.19 Furthermore, because a stockholder need not have owned the shares as of the deal announcement or even as of the record date for the vote,20 hedge funds began to engage in appraisal arbitrage, where they would buy shares just before a merger closed to exercise the appraisal rights.21 Appraisal offered the opportunity for a potentially large payoff if the transaction was found to be undervalued or if the company settled the case above deal price. It also allowed a petitioner to collect prejudgment interest pegged at the prevailing Federal Reserve discount rate, plus 5 per cent (compounded quarterly), while the action resolved itself.22 That offered higher risk-adjusted rates of return compared to similar investments, even if the nominal appraisal valuation came in at or slightly below the deal price.
To combat appraisal arbitrage, certain provisions of the Delaware General Corporation Law governing appraisal proceedings were amended in June 2016. First, appraisal claims in respect of less than 1 per cent of the total outstanding shares of any class or less than US$1 million in consideration will now be dismissed, except if the transaction is a short-form merger.23 Second, corporations may now make preliminary payments in respect of appraisal claims, thus cutting off statutory interest on the amount of the preliminary payment.24 However, the General Assembly did not adopt other proposals intended to reduce 'appraisal arbitrage', such as preventing investors who purchase their shares after the announcement of a merger agreement from exercising appraisal rights.
The statute provides the Court of Chancery with wide discretion in how to determine 'fair value' in appraisal proceedings, imposing only two requirements. Under the statute, the court must (1) 'take into account all relevant factors'; and (2) 'exclu[de] any element of value arising from the accomplishment or expectation of the merger'.25 Over several cases, the Court of Chancery had expressed a strong preference for reliance on the merger price to determine 'fair value' for the purposes of the appraisal proceeding.26 In late 2017 and early 2018, the Delaware Supreme Court issued several appraisal decisions giving additional guidance about how the Court of Chancery should conduct the appraisal valuation.
First, in DFC Global Corp v. Muirfield Value Partners, LP, the Delaware Supreme Court concluded that the Court of Chancery's determination that the company's fair value was 7.5 per cent higher than the deal price was not supported by the record, which showed a robust and conflict-free sale process.27 The court explained that the standard for deferring to the trial court's determination of fair value is whether it 'has a reasonable basis in the record and in accepted financial principles relevant to determining the value of corporations and their stock'.28 Applying that standard, Chief Justice Strine concluded that neither the regulatory risks facing the company nor the mere fact that a private equity buyer won the transaction made the deal price any less reliable an indication of fair value.29 Nonetheless, the court declined to establish a bright-line rule in favour of deferring to the deal price in arm's-length mergers, reasoning that the text of the appraisal statute empowers the Court of Chancery to determine fair value by taking 'all relevant factors' into account.30 The Court reversed and remanded the case, noting that the Chancellor 'may conclude that his findings regarding the competitive process leading to the transaction, when considered in light of other relevant factors, . . . suggest that the deal price was the most reliable indication of fair value'.31
Then, in Dell, Inc v. Magnetar Global Event Driven Master Fund Ltd, the Delaware Supreme Court applied the standard set forth in DFC to hold again that the record did not support the Court of Chancery's decision to assign no weight to the deal price in determining the company's fair value.32 As the court explained, it appeared instead that 'the deal price deserved heavy, if not dispositive, weight' based on the record, which included 'evidence of market efficiency, fair play, low barriers to entry, outreach to all logical buyers, and the chance for any topping bidder to have the support of [the CEO's] own votes'.33 The court disagreed with the trial court's conclusion that the deal price does not reflect fair value in management-led buyouts because of (1) structural issues, (2) risks resulting from asymmetries in information and (3) management's inherent value to the company, noting based on the record that those features were absent from the transaction in question.34 As in DFC, the court in Dell again rejected a 'private equity carve-out' from using the deal price as a reliable indication of fair value.35 Remanding the case, the court noted that the Vice Chancellor had the discretion 'to enter judgment at the deal price if he so chooses, with no further proceedings'.36
Other recent appraisal decisions have shown that there is a material risk that the court will determine fair value to be not just at the deal price, but lower than the deal price, even in an arm's-length merger.
In Merlin Partners, LP v. SWS Group, Inc, the Delaware Supreme Court summarily affirmed the decision of the Court of Chancery to value SWS at US$6.38 per share, which was 8 per cent below the merger price.37 The Court of Chancery had noted that 'the fact that my DCF analysis resulted in a value below the merger price is not surprising: the record suggests that this was a heavily synergies-driven transaction'.38
In Verition Partners Master Fund, Ltd v. Aruba Networks, Inc, the Court of Chancery found that the deal price was the product of an uncompetitive and flawed process, and then determined that fair value was significantly below deal price because the merger resulted in substantial synergies.39 Instead of relying on a discounted cash flow (DCF) analysis or attempting to back out synergies, the court found fair value to be equal to the pre-announcement market trading price of the public shares, which was 30 per cent below the deal price.40
In In re Appraisal of AOL, Inc, the Court of Chancery valued AOL at US$48.70 per share, which was about 3 per cent below the deal price.41 As a result of flaws in the negotiation process, the court gave deal price no weight at all; instead, the court relied on its own DCF analysis and used deal price as a 'check' on that result. The court observed that the lower valuation was likely because the deal price included synergies that were not considered part of the company's fair value as a stand-alone enterprise. Furthermore, the court said it had not considered the unaffected market price, as in Aruba, because the parties had not argued for reliance on it.
We expect that Dell and DFC will continue to reduce appraisal risk for most arm's-length mergers going forward, including management-led buyouts and deals with financial sponsors.42 Subject to the result of any appeal from these decisions, Aruba and AOL continue the trend of substantially reducing appraisal risk for buyers of public companies.43
The court remains more likely to reject the deal price as persuasive evidence of fair value in arm's-length mergers involving a seriously flawed sale process, or in non-arm's-length mergers such as controller transactions, squeeze-outs and certain management buyouts. But even in those circumstances, the court may find that fair value is either above or below the deal price. In ACP Master, Ltd v. Sprint Corp (Clearwire), the Court of Chancery ruled that the fair value of the company was less than half the actual deal price.44 The Court of Chancery did not consider the deal price in determining the company's fair value because the transaction involved a buyout by a controlling stockholder, the deal price was inflated by synergies from the transaction, the parties had not asked the court to give weight to the deal price and the record contained other reliable evidence of fair value.45 The Delaware Supreme Court affirmed the decision without discussion.46 Furthermore, the Court has yet to confront an argument that deal price should be given some weight in an appraisal action involving a controlling stockholder buyout if the transaction complied with the requirements set forth in MFW.47 We expect the Delaware Supreme Court will provide additional guidance regarding appraisal in future opinions.
1 Roger A Cooper and Meredith Kotler are partners and Vanessa C Richardson is an associate at Cleary Gottlieb Steen & Hamilton LLP.
2 Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015).
3 In re KKR Financial Holdings LLC S'holders Litig, 101 A.3d 980, 1003 (Del. Ch. 2014); see also Singh v. Attenborough, 137 A.3d 151, 151-52 & n.3 (Del. 2016) (reiterating that stockholder approval has a cleansing effect on a merger transaction and makes it subject to the irrebuttable business judgment rule, extinguishing all claims except for waste).
4 Corwin, 125 A.3d at 313.
5 See, e.g., In re Cyan, Inc S'holders Litig, C.A. No. 11027-CB, 2017 WL 1956955 (Del. Ch. 11 May 2017); In re Paramount Gold & Silver Corp S'holders Litig, C.A. No. 10499-CB, 2017 WL 1372659 (Del. Ch. 13 Apr 2017); In re Columbia Pipeline Group, Inc S'holders Litig, C.A. No. 12152-VCL (7 Mar 2017) (ORDER); In re Merge Healthcare Inc S'holders Litig, C.A. No. 11388-VCG, 2017 WL 395981 (Del. Ch. 30 Jan 2017); In re Solera Holdings, Inc S'holders Litig, C.A. No. 11524-CB, 2017 WL 57839 (Del. Ch. 5 Jan 2017).
6 In re Volcano Corp S'holders Litig, 143 A.3d 727 (Del. Ch. 2016), aff'd 2017 WL 563187 (Del. 9 Feb 2017) (TABLE).
7 Id. at 744, 747.
8 Appel v. Berkman, 180 A.3d 1055 (Del. 2018) (determining that stockholder vote was not adequately informed and thus did not have cleansing effect); Sciabacucchi v. Liberty Broadband Corp, C.A. No. 11418-VCG, 2017 WL 2352152, at *2 (Del. Ch. 31 May 2017) (determining that plaintiff adequately pleaded that a vote was structurally coercive, and refusing to dismiss); In re Saba Software, Inc S'holders Litig, C.A. No. 10697-VCS, 2017 WL 1201108, at *8, 14 (Del. Ch. 31 Mar 2017, revised 11 Apr 2017) (determining that plaintiff adequately pleaded that a vote was coerced and was not fully informed, and refusing to dismiss).
9 In re Massey Energy Co, 160 A.3d 484, 507(Del. Ch. 4 May 2017).
10 Kahn v. M&F Worldwide Corp, 88 A.3d 635, 645 (Del. 2014) (holding that business judgment rule would be operative standard of review if transaction satisfied these requirements: '(i) [from the beginning of negotiations,] the controller conditions the transaction on the approval of both a Special Committee and a majority vote of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitely; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority').
11 In re Books-A-Million, Inc S'holders Litig, C.A. No. 11343-VCL, 2016 WL 5874974 (Del. Ch. 10 Oct 2016).
12 Id. at *15-16.
13 Id. at *18.
14 In re Martha Stewart Living Omnimedia, Inc S'holders Litig, No. 11202-VCS, 2017 WL 3568089, at *2 (Del. Ch. 18 Aug 2017).
15 Martha Stewart, 2017 WL 3568089, at *18 and 19; see also In re Synutra Int'l, Inc, 2018 WL 705702 (Del. Ch. 2 Feb 2018) (holding that transactions will satisfy the MFW requirements and receive business judgment review so long as the protections are in place before negotiations begin).
16 Victor Lewkow, 'A Sleepy Topic: The Return of Appraisal Rights', The M&A Journal, Vol. 17 No. 6, https://www.clearygottlieb.com/-/media/organize-archive/cgsh/files/2017/publications/the-ma-journal-a-sleepy-topic-the-return-of-appraisal-rights-05-23-17.pdf; see also Guhan Subramanian, Appraisal After Dell – The Corporate Contract in Changing Times: Is the Law Keeping Up?, U. Chicago Press 1 (2 Jan 2018), https://ssrn.com/abstract=3095164.
17 In general, holders of listed stock (or stock held by more than 2,000 holders of record) have appraisal rights if they are required to accept as merger consideration anything other than (1) stock of the surviving company, (2) listed stock of any other corporation or (3) cash in lieu of fractional shares. 8 Del. C. Section 262(b).
18 8 Del. C. Section 262.
19 See Matthew D Cain, et al, 'The Shifting Tides of Merger Litigation', 71 Vanderbilt Law Review, 603 (13 Mar 2017), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2922121 (finding that '[b]oth 2015 and 2016 were record years with respect to both the number of deals challenged and number of petitions filed'); Charles R Korsmo and Minor Myers, 'Appraisal Arbitrage and the Future of Public Company M&A', 92 Wash. U.L. Rev. 1551, 1553 (2015) (describing a tenfold increase in appraisal litigation from 2004 to 2013).
20 In re Appraisal of Transkaryotic Therapies, Inc, 2007 WL 1378345 (Del. Ch. 2 May 2007).
21 Wei Jiang, et al, 'Appraisal: Shareholder Remedy or Litigation Arbitrage?', 59 J Law & Econ. 697 (2016) (finding actions brought by hedge funds made up three-quarters of appraisal volume measured by dollars).
22 8 Del. C. Section 262(h). Note that amendments to the statute in 2016 permit the company to prepay some amount of the consideration to the petitioner in cash, which would cut off further interest on that amount.
23 8 Del. C. Section 262(g).
24 8 Del. C. Section 262(h).
26 See, e.g., In re Appraisal of PetSmart, Inc, C.A. No. 10782-VCS, 2017 WL 2303599 (Del. Ch. 26 May 2017) (deferring to deal value where the deal price was the product of a process reasonably designed and appropriately implemented to achieve a fair value); Merion Capital LP v. Lender Processing Servs, Inc, C.A. No. 9320-VCL, 2016 WL 7324170, at *33 (Del. Ch. 16 Dec 2016) (giving '100% weight to the transaction price' where '[t]he Company ran a sale process that generated reliable evidence of fair value'); Huff Fund Inv. P'ship v. CKx, Inc, C.A. No. 6844-VCG, 2013 WL 5878807, at *15 (Del. Ch. 1 Nov 2013), aff'd, No. 348, 2014, 2015 WL 631586, (Del. 12 Feb 2015) (finding 'the sales price to be the most relevant exemplar of valuation available'); In re Appraisal of Ancestry.com, Inc, C.A. No. 8173-VCG, 2015 WL 399726 (Del. Ch. 30 Jan 2015) (same).
27 DFC Global Corp. v. Muirfield Value Partners, LP, 172 A.3d 346, 349 (Del. 2017) (finding market price to be the best evidence of fair value, at least in open, competitive and conflict-free mergers).
28 Id. at 348 and 349.
29 Id. at 372 to 376.
30 Id. at 348 and 349.
31 Id. at 351.
32 Dell, Inc v. Magnetar Global Event Driven Master Fund Ltd, 177 A.3d 1, 32 (Del. 2017).
33 Id. at 32, 35.
34 Id. at 30 to 34.
35 Id. at 28 to 31.
36 Id. at 44.
37 In re Appraisal of SWS Group, Inc, C.A. No. 10554-VCG, 2017 WL 2334852 (Del. Ch. 30 May 2017), aff'd, Merlin Partners, LP v. SWS Group, Inc, 2018 WL 1037477 (Del. 23 Feb 2018) (ORDER)).
38 Id. at *18.
39 Verition Partners Master Fund, Ltd v. Aruba Networks, Inc, No. CV 11448-VCL, 2018 WL 922139 (Del. Ch. 15 Feb 2018). The court found several issues with the sale process that led it to conclude that Aruba could have obtained a higher price, including that HP knew it had no competition for Aruba and that Aruba's bankers 'catered' to HP and were 'less effective negotiators than they might have been'. Id. at *42 and 43. Noting, however, that Dell makes clear that '[t]he issue in an appraisal is not whether a negotiator has extracted the highest possible bid' but 'whether the dissenters got fair value and were not exploited'. Id. at *36, 44, the court determined that the transaction 'looks like a run-of-the-mill third-party deal' and '[n]othing about it appears exploitative'. Id. at *38.
40 Id. at *53 and 54 (finding that unaffected market price provided the most straightforward and reliable method for determining fair value as a going concern, because it 'provides a direct measure of the collective judgment of numerous market participants', as to the fair value of the shares exclusive of any element of value arising from the merger, whereas the deal-price-less-synergies method is 'messy and provide[s] ample opportunities for error').
41 In re Appraisal of AOL, Inc, C.A. No. 11204-VCG, 2018 WL 1037450 (Del. Ch. 23 Feb 2018).
42 Victor Lewkow, Meredith E Kotler and Mark E McDonald, 'Delaware Supreme Court's Dell Decision Further Reduces Appraisal Risks for Buyers', Cleary M&A and Corporate Governance Watch Blog (18 Dec 2017), https://www.clearymawatch.com/2017/12/delaware-supreme-courts-dell-decision-reduces-appraisal- risks-buyers/.
43 Meredith E Kotler, Mark E McDonald and Vanessa C Richardson, 'Delaware Court of Chancery Finds Fair Value in Appraisal Case To Be Unaffected Market Price', Cleary M&A and Corporate Governance Watch Blog (21 Feb 2018), https://www.clearymawatch.com/2018/02/delaware-court-chancery-finds-fair-value- appraisal-case-unaffected-market-price/.
44 ACP Master, Ltd v. Sprint Corp, C.A. No. 8508-VCL, 2017 WL 3421142 (Del. Ch. 21 Jul 2017).
45 Id. at *1, *30 and 31.
46 ACP Master, Ltd v. Spring Corp, No. 380, 2017, 2018 WL 1905256 (Del. 23 Apr 2018).
47 See MFW, 88 A.3d at 644 (Del. 2014) ('. . . where the controller irrevocably and publicly disables itself from using its control to dictate the outcome of the negotiations and the shareholder vote, the controlled merger then acquires the shareholder-protective characteristics of third-party, arm's-length mergers.').