Delaware Enacts Appraisal Rights Reform

Two amendments intended to scale back Delaware "appraisal arbitrage" proceedings came into effect on August 1.

What You Need To Know

• Appraisal proceedings now must meet minimum thresholds.
• Corporations can prepay dissenting shareholders in order to limit the accrual of interest on a fair value award.

The amendment to section 262(g) of the Delaware General Corporation Law (DGCL) eliminates de minimis actions. The new law permits appraisal rights proceedings only if more than 1% of the outstanding shares are eligible for appraisal or the value of eligible shares exceeds US $1 million. Proceedings can also go forward for short-form mergers pursuant to sections 253 or 267 of the DGCL. One estimate suggests these new thresholds will reduce the number of appraisal proceedings by as much as 25%.

The second amendment, to DGCL section 262(h), is intended to reduce the amount of interest available on a "fair value" award. Under the DGCL, interest accrues from the effective date of the merger through the payment date of the award at 5% over the Federal Reserve discount rate, compounded quarterly. This interest rate provides a financial incentive for shareholders to exercise appraisal rights, including an incentive to "buy into" a merger merely to exercise appraisal rights. Previously, surviving corporations could make a voluntary payment to shareholders seeking an appraisal remedy in order to prevent interest from accruing on the amount prepaid, but the shareholders were not required to accept the payments. The amendment addresses this by entitling the surviving corporation to make a prepayment, in which case interest will accrue only on the sum of (i) the difference, if any, between the amount paid and the fair value of the shares as determined by the Court of Chancery, and (ii) any interest accrued before the prepayment, unless such interest is paid as part of the prepayment. The new prepayment rule is expected to reduce appraisal arbitrage.

These amendments arrive on the heels of a remarkable appraisal decision in May 2016, In re: Appraisal of Dell Inc., in which the Court of Chancery determined that the fair value of Dell shares was nearly 30% greater than the price paid in connection with a 2013 management buyout. The court did so despite finding that the company's sale process would "sail through" enhanced scrutiny and that the board's special committee did "many praiseworthy things" to maximize value for Dell's shareholders. The interest portion of the trial award was significant.

Critics of the Dell decision have expressed concern that it will further encourage the practice of appraisal arbitrage, which will hurt public shareholders as prospective buyers seek to offset the risk of appraisal awards with lower offers or by remaining on the sidelines altogether. The recent amendments are likely to blunt the impact of the Dell decision.

Canadian Perspective

In Canada, there is less need to address the potential impact of appraisal arbitrage. In some jurisdictions, shareholders cannot "buy into" many M&A transactions to exercise dissent rights since that right is restricted to shareholders who held shares as of the record date for the shareholder meeting.

In addition, interest on the amounts awarded to shareholders exercising dissent rights and seeking fair value is at the discretion of the court and, therefore, interest does not provide the same incentive that it does in Delaware. Finally, while Canadian corporate statutes do not include a de minimis threshold for the exercise of dissent rights, many jurisdictions have a "loser pays" costs rule, which may operate, in effect, as a gatekeeping mechanism to preclude small shareholders from exercising dissent rights.  

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