Appraisal rights
A right of shareholders in a merger to demand the payment of a fair price for their shares, as determined independently.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.
Appraisal Right
In mergers and acquisitions, the right of shareholders who object to being acquired to demand a fair price for their shares,
as determined by a court. In theory, this guarantees that shareholders
are adequately compensated for being overridden on the merger or
acquisition. These shareholders may elect to have their shares purchased
by the acquiring corporation at the price set by the court. In the United States, most states grant appraisal rights in their regulatory statutes.
Harry Campbell
The hedge fund Merion Capital might have hit a
roadblock in its multimillion-dollar appraisal proceedings involving
the $1.6 billion buyout of Ancestry.com. And it’s a roadblock that just
might slow the trend toward exercising appraisal rights.
Appraisal rights allow shareholders in an
acquisition to ask a court to assess the value of their shares. The idea
is that if the buyer underpaid for the stock, shareholders have a
remedy — namely going to court and having a judge determine the right
price for the shares.
While appraisal seems like an effective
remedy, shareholders have been reluctant to exercise this right because
the process can take years, shareholders have to pay legal fees and many
state courts, including Delaware’s, can actually award less than the
amount paid in the merger.
Enter the hedge funds. Merion is the largest
of a number of funds that are now exercising appraisal rights as a
business strategy. Merion has reportedly raised more than $1 billion and
to date has exercised appraisal rights in nine different actions,
including takeovers involving Dole Foods, BMC Software and Airvana.
These funds have led to an upsurge in appraisal rights. According to a paper by two law professors,
Minor Myers of Brooklyn Law School and Charles Korsmo of Case Western
Reserve Law School, the value of appraisal claims was $1.5 billion last
year, a tenfold increase from 2004.
In the case of Ancestry.com, which was bought
by an investor group led by the European private equity firm Permira,
Merion bought 1.225 million shares of its stock at the $32 cash buyout
price, worth about $39 million.
Merion is pursuing appraisal rights to obtain
a higher dollar figure. It seems to be a strategy perfect for a hedge
fund that is run by experienced lawyers and is designed to take risks.
However, perfection may have run into reality
in the Ancestry.com proceedings, which are taking place in a Delaware
court. The combination of hedge funds and appraisal rights is new, and
that means that the law governing it is still in flux.
Ancestry is opposing the appraisal rights
petition, arguing that the price paid was fair value. Ordinarily this
would lead to a trial where the court would determine who was correct.
Courts have tended in the past to favor the party seeking appraisal, a
fact that is underpinning Merion’s strategy.
But Ancestry filed a brief two weeks ago on a novel legal point that may wipe out Merion’s case not only in its proceeding but possibly in others as well.
The issue is that in order to exercise appraisal rights in Delaware, a stockholder must not have “voted in favor” of the transaction.
This makes sense, because if you are asking the court to give you more
money in a takeover, then you should at least show you opposed the deal
at the price you think is too low.
It sounds like a simple rule, but it is complicated.
First, there is the issue that most
shareholders don’t hold their shares directly in a company. They are
merely beneficial owners. Actual record ownership of the shares is held
through brokers and then through the share ownership company Cede &
Company. Cede votes its shares as all the shareholders direct, but Cede
votes these shares in the aggregate and does not allocate shares to each
owner. Consequently, it is impossible for a beneficial owner to assert
how their shares were voted and to know whether the appraisal
requirement to not vote for the deal is met.
Second, for each shareholder vote there is a
record date. The record date marks the date when shareholders are
counted as eligible to vote. But shareholders can buy shares after that
date and exercise appraisal rights. However, such a shareholder never
votes on the transaction. Instead, the previous owners who held the
shares on the record date may vote their shares for the deal. In this
case, what happens if the previous owners voted for the transaction or
their votes are unknown?
It is this second problem that Merion faces.
Merion bought all of its shares after the record date for the
shareholder vote on the transaction.
In depositions by Ancestry’s counsel, Samuel
Johnson, a portfolio manager at Merion said that he did not know how
Merion’s shares were voted because they were bought after the record
date.
This would seem to doom Merion’s claim. But not entirely. In the case of Transkaryotic Therapies Inc.,
the court addressed the issue of whether a beneficial holder of shares
who acquired shares after the record date was required to show that the
previous owner did not vote for the transaction. In that case, the
stockholders demanding appraisal had held their shares beneficially with
Cede as the record-holder. The court held that in such a case, only the
record-holder — Cede — had to show that there was not an affirmative
vote. Because Cede had voted sufficient shares as record-holder against
the transaction, the appraisal petition was sufficient.
This case made sense because the Delaware
statute at the time permitted only a record-holder of stock to exercise
appraisal rights. Cede also appears unable to retrace its shares and
show how they were voted for its beneficial shareholders. If the court
in Transkaryotic had required this, many shareholders would effectively
lose their appraisal rights.
Merion will no doubt argue this case applies here because it held its shares beneficially and not as record owners.
In the wake of Transkaryotic, however, the Delaware appraisal statute was amended to allow shareholders who own stock beneficially to exercise appraisal rights.
In the wake of Transkaryotic, however, the Delaware appraisal statute was amended to allow shareholders who own stock beneficially to exercise appraisal rights.
Ancestry’s counsel is now arguing that this
amendment requires that a beneficial owner show it did not vote in favor
of the transaction. In its filing to the Delaware court, Ancestry
stated that a “beneficial owner may now bring an appraisal action in
its own name, without relying on Cede (or some other nominee) to
vindicate its rights indirectly.” The beneficial holder thus now
“assumes the statutory obligation to show that the shares it seeks to
have appraised were not voted in favor of the merger.”
The case is not completely in favor of
Ancestry, though. The section of the appraisal rights statute Ancestry
is citing requires that the beneficial owner exercising appraisal rights
set forth a statement of “the aggregate number of shares not voted in
favor of the merger or consolidation.” But the amended statute does not
state whether these shares are required to have not been voted for the
transaction. Moreover, the statute itself when it refers to a
shareholder defines it as a shareholder of record, meaning that the
basis for Transkaryotic appears to remain despite this amendment.
In its petition seeking appraisal, Merion
said it had not voted in favor of the transaction. When asked at
deposition about this, Mr. Johnson said that it was “boilerplate” and
that Merion did not know how its shares were voted. In other words,
Merion is relying squarely on the Transkaryotic opinion to win.
The question now is whether court views on appraisal rights are changing now that their exercise is more frequent.
Even if Merion wins, it might only be kicking
the can down the road. In the appraisal proceedings for Dole, another
action Merion is participating in, more shares are exercising appraisal
rights than those that voted against the deal or abstained. This means
that there are definitely stockholders exercising appraisal rights who
hold shares that voted yes.
It all means peril not just for hedge funds
but for companies as they wait for the law to catch up and see whether
their business strategies work. It’s a risky strategy, but then again
that is what hedge funds specialize in.
Steven M. Davidoff, a professor at the Michael E. Moritz College of Law at Ohio State University, is the author of “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion.” E-mail: dealprof@nytimes.com | Twitter: @StevenDavidoff
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