In Re Appraisal of
(Del. Ch. Jan. 5, 2015)
Merion Capital LP v. BMC Software, Inc.
(Del. Ch. Jan. 5, 2015)
As a refresher, “appraisal arbitrage” is a trading strategy pursuant to which an investor purchases stock in an acquisition target following public announcement of the deal but prior to closing, with the specific intention of seeking appraisal rights in order to capitalize on potentially undervalued deals. This arbitrage opportunity gained traction in 2007, when the Chancery Court’s opinion in In re Appraisal of Transkaryotic Therapies, Inc. clarified that any beneficial holder of a company’s stock could seek appraisal rights regardless of when the shares were acquired, provided that the total number of dissenting shares was less than the total number of shares not voted or voted against the deal by the record holder of such shares. Notably, the Delaware legislature amended the appraisal statute in 2007 to allow the beneficial holder of shares to seek appraisal rights directly. Previously, only the record holder of shares, large depositaries such as Cede & Co., could seek appraisal rights at the direction of beneficial holders. The court’s two recent opinions clarify that the 2007 amendments did not impose a “share-tracing” requirement to shares acquired after the record date for determining stockholders entitled to vote on a transaction.
In Ancestry.com, hedge fund Merion Capital initiated appraisal action, through Cede & Co. acting on its behalf as nominee record holder, forstock purchased after the record date for the related cash acquisition. argued that Merion Capital, as mere beneficial owner of the stock, should only be permitted appraisal rights if it could prove that the specific prior owners of its shares had not voted to approve the merger. Arguing a “share-tracing” requirement as a necessary corollary to the 2007 Delaware appraisal statute amendments, contended that Merion (as beneficial owner of the shares, rather than Cede & Co as nominee) should be required to prove that it did not vote its shares in favor of the acquisition. In addition, because the shares were acquired after the record date, argued that Merion Capital should also prove that the prior beneficial owners of the shares did not vote in favor of the acquisition. The Court rejected both arguments, holding that the party seeking appraisal (whether record or beneficial owner) is only required to show that the record owner of the shares beneficially owned would have available sufficient shares not voted in favor of the transaction.
In BMC Software, Merion Capital sought appraisal, through its broker, with respect to shares of BMC purchased after the record date of a going-private transaction. In this case, the broker refused to initiate an appraisal action and Merion Capital transferred record ownership of the shares into its own name and made a direct appraisal demand. BMC agreed that Merion Capital’s standing for appraisal depended on a showing that its shares had not been previously voted in favor of the deal by any prior share owners. The Court disagreed with BMC’s position and ruled that the Delaware appraisal statute only required Merion Capital to show that the record holder (here, Merion Capital) had not voted in favor of the deal.
These decisions, and the technical operation of the Delaware appraisal statute, further support the increasing practice (and publicity) of “appraisal arbitrage.” Since 2007, the number of appraisal actions in the Delaware courts has grown every year and this practice is now a multi-billion dollar business with numerous investors and hedge funds exclusively focusing on this strategy for return. We anticipate, based on the recent recommendation of the Delaware Corporation Law Council, that the Delaware legislature will review this as an area for potential reform in the near future—specifically with respect to (i) a required minimum share ownership percentage held by any dissenting party and (ii) limitations on potential interest payable for pre-judgment settlements (see the proposed amendments here). In the interim, M&A practitioners should be aware that all acquisitions (public and private) potentially risk a time consuming and potentially expensive appraisal process and/or settlement. As a result, we may also see requests for appraisal related closing conditions in certain smaller public deals.