Delaware Governor Jack Markell (D) last month signed into law amendments that some hope will curb appraisal arbitrage—a type of litigation in the state dominated by hedge funds.
Under Delaware law, shareholders that choose not to participate in a merger can ask the state’s chancery court to assess the value of their shares. There are concerns—voiced by prominent law firms and other commentators—that appraisal litigation has been seized on by a large group of hedge funds trying to capitalize either on interest accrual on their shares or a higher valuation from the court. Basically, the funds acquire a large block of shares in a company shortly after it announces that it is merging with another, with the express intent of asking the Delaware Chancery Court to evaluate the value of their stock after the deal closes.
When the Delaware Legislature was considering virtually identical amendments in 2015, seven law firms—Cravath, Swaine & Moore LLP, Davis Polk & Wardwell LLP, Latham & Watkins LLP, Skadden, Arps, Slate, Meagher & Flom LLP, Simpson Thacher & Bartlett LLP, Sullivan & Cromwell LLP and Wachtell, Lipton, Rosen & Katz—asked for even more stringent measures. The firms described the hedge fund activity as “claims-buying that is rampant and serves no legitimate equitable or other purpose.” They also argued that hedge fund appraisal arbitrage “threatens to undermine transactional certainty and reduce” shareholder value.
According to a recent joint study by professors from Columbia Business School, Warwick Business School and Vanderbilt Law School, about 20 appraisal petitions are filed annually. The study, utilizing Bloomberg Law data, found that hedge funds account for about three-quarters of the dollar volume of the petitions, and the top seven funds account for over 50 percent of the dollar volume.
The Delaware appraisal amendments are effective for merger agreements entered into on or after Aug. 1. The amendments restrict appraisals to shareholders that hold more than $1 million or 1 percent of the company’s shares, and allow companies to make payments to claimants to prevent the accrual of interest.
The study suggests that the amendments will substantially reduce appraisal litigation. The $1 million/1 percent cutoff itself could decrease the lawsuits by about one-quarter, it said.
It remains to be seen whether that will actually happen. Some observers, including University of California, Berkeley, law professor Steven Davidoff Solomon, suggest that the amendments may have the opposite effect. In a recent oped in the New York Times, Solomon said the amendments may increase appraisal litigation by paying the hedge funds sooner, putting money in their pockets for the next appraisal challenge.
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