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July 28 — Delaware corporations can take steps to limit their costs in shareholder appraisal litigation when a new law kicks in Aug. 1.
However, while the companies can save money by making early payments to shareholders challenging the deal price in mergers and acquisitions, that also may inadvertently fuel more litigation by unlocking money for shareholder litigants.
Attorneys told Bloomberg BNA that the decision to take advantage of the changes to Delaware's appraisal statute may not be straightforward, and involves both economic and strategic considerations.
“It should be an easy decision, but it's not,” John Landry, a Los Angeles-based special counsel at Sheppard, Mullin, Richter & Hampton LLP, told Bloomberg BNA in an e-mail.
In Delaware, shareholders that choose not to participate in a merger can ask the state's chancery court to assess the value of their shares. Petitioners that file such claims are awarded interest on the court's appraisal determination at 5 percent over the Federal Reserve discount rate, compounded quarterly. The interests on the claims accrue from the effective date of the merger until the judgment is paid.
Starting in August, a new law gives Delaware-incorporated companies the option of making a payment to appraisal claimants to prevent the accrual of interest. The prepayment amount is at the company's discretion.
The law was enacted partly because of concerns that the statutory rate was spurring some appraisal claims, especially those involving a strategy known as “appraisal arbitrage,” where investors acquire a large block of shares in a company shortly after it announces that it is merging with another, with the intent to file an appraisal petition after the deal closes.
To take advantage of the statutory amendment, one hurdle that companies may have to overcome is the psychological barrier against prepaying an appraisal award. “Companies are rational, economic actors, and one would expect them to want to reduce the amount of any appraisal judgment and the amendment provides a mechanism to do just that,” said Landry, who is a member of his firm's Business Trial Practice Group.
However, prepaying a judgment is something companies in litigation aren't used to doing, he added. “It's really a foreign concept.”
Among other strategic considerations, companies should keep in mind that by prepaying, they may be freeing up money for appraisal petitioners that would otherwise be locked up in litigation, said David J. Margules, a Delaware-based partner at Ballard Spahr LLP.
Stockholders that file appraisal petitions might not get a penny for a year and a half to two years if prepayments aren't made, and “that's a real deterrent for a lot of people,” Margules said.
The attorney added that appraisal petitioners have a certain amount of time after a deal closes to withdraw their demands. If a company comes right out and says it's not going to make an early payment, there may be some petitioners that opt to take the merger consideration, he said.
Additionally, it is not clear what impact prepayment will have on appraisal arbitrage.
“While many who buy on the announcement of a merger to pursue appraisal rights believe the fair value is higher than the deal price, those hoping to use the favorable interest rate as leverage for a quick settlement will have to think twice before locking up their capital,” said Margules, who has 30 years' experience litigating a broad range of business disputes.
Prepayments also may affect the settlement process.
Frederick D. Lipman, a partner at Blank Rome LLP, told Bloomberg BNA in an e-mail that for cash mergers, he expects most acquirers to make the early payments to prevent the accrual of interest, assuming the interest environment remains the same.
In the absence of an early cash payment, the appraisal petitioner is encouraged to proceed with the case and not settle because of the potential higher return, said Lipman, who advises a wide range of clients in corporate and securities issues.
However, in stock mergers it would be a “close call” whether to make the prepayment, he said. “The acquirer would have to weigh the cost of the early payment of cash against the benefit of forcing the dissenter to pay their own litigation cost, which could have the effect of inducing a favorable settlement.”
Companies that opt for prepayment also must consider the amount they want to pay.
The figure will depend on an assessment of the appraisal claim, which takes into account the financial valuation considered by the board, the actual deal price, and any market check process undertaken, said William Mills, a New York based-partner at Cadwalader, Wickersham & Taft LLP.
“Depending on that assessment, it may be advisable for a company to make a payment at a value that is at least equal to the company’s view of valuation based on those factors,” said Mills, who chairs his firm's Corporate Group. “Interest would then accrue only for any excess valuation the claimants can prove.”
A company may have concerns that the amount it prepays will be interpreted by the petitioner, or even the court, as some indication of the company’s estimate of fair value, Landry said.
Landry also noted that to take full advantage of the amendment, a company will want to prepay as soon as the appraisal petition is filed, which likely is before it has retained a valuation expert or the expert has completed his work.
Accordingly, the company must consider the chances that the amount prepaid might exceed its own expert’s estimate, and the optics of that, Landry said. “These considerations will likely prompt companies to not utilize the amendment, or to prepay using a low-ball estimate that would fail to take full advantage of the cost-saving opportunity the amendment affords.”
The decision to prepay or not ultimately could be driven by economic factors. Companies must consider their balance sheets and whether they have cash available, attorneys said.
The answer will vary from company to company, Landry said. “Each company will need to determine whether prepaying to reduce the interest component of the appraisal award years down the road is the best use of its current cash,” he said. “It may not be.”
Margules warned that interest rates also factor into the equation. The interest amounts in appraisal cases may have assumed an outsized significance recently because the statutory rate has been so much higher than the market rate, he said.
“I don't know if anybody anticipates that the historic low [market] rates will continue, so whatever we are thinking today, the calculus will change somewhat in a different interest environment,” he said.
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