We have some high-level explanation and comment about appraisal rights.

 

Here, we set forth the basics on how they work, identify some recent developments, and highlight the generally positive financial results from demanding appraisals. Others have written much better and more extensively than we could, so we provide some references and links to the best sources.

 

How Appraisal Rights Work

If an investor in a Delaware corporation does not like the price that an acquirer pays for a portfolio company, then he or she can appeal to the Delaware courts for an independent appraisal. Other states provide for similar appraisal rights, but as with so many other matters, Delaware law (Section 262) merits the most attention.

 

This seems like a great idea. Yet, the court can decide that the buyer paid too much, rather than too little. So, the investor bears some risk that they will receive less than the price paid to other shareholders.

 

Investors need to mind some other elements:

 

❖ an investor can seek appraisal only for cash deals (or for  deals in which the buyers pays with non-public shares), so (for example) the proposed Valeant-Allergan deal would not qualify since Valeant has offered its own shares

❖ appraisal applies to full sale or mergers only, not asset sales, sale of a division, etc.

 

Investors also need to:

 

❖ demand appraisal before the vote on the deal

❖ vote against the deal and refuse the consideration, so you can’t vote for the deal, take the cash, then demand appraisal

❖ pay all his or her own legal fees, so appraisal actions differ from shareholder class-action matters.

 

The entire proceeding can take years, with intricate, mind-numbing procedure.

 

Recent Developments

Of course, appraisal rights apply only to transactions that actually close, so only a small number of deals even qualify in a given year. A recent comprehensive research effort notes that in 2013, investors demanded appraisal on 28 deals, or about 17% of eligible deals in the year. That paper also has much more about the legal and financial underpinnings of appraisal rights cases, and is worth a close read.

 

Much of the current attention on appraisal rights stems from the Dell privatization in 2013. Then, investors (including Carl Icahn and Southeastern Asset Management) challenged the price Michael Dell and private equity investors paid to take Dell private. The Shareholder Forum provides a thorough account of that saga, with numerous useful legal and media references.

 

Finally, appraisal rights have led to a sort of new asset class - appraisal arbitrage. Similar to merger arbitrage, some asset managers have begun to acquire stakes in companies subject to appraisal demands, looking for that higher share price. Investors can do that because they may demand an appraisal even if they acquire shares after the record date for voting on the merger. As long as the seller of those shares votes against the merger and refuses the deal consideration, the acquirer can use those shares to demand an appraisal.

 

The research paper noted earlier highlights seven funds that have undertaken multiple appraisal arbitrage trades. One fund, Merion Capital, raised capital for these trades, has invested in seven such deals since 2010, and may have also tripped up on a legal technicality analyzed in a New York Times article.

 

Results From Demanding Appraisals

Appraisal demands generally deliver decent returns. The cited research paper estimates that on average, the Delaware courts increased the purchase price by about 50% relative to what investors would have received.

 

In another analysis of nine more recent deals, Fried Frank estimates that on average, buyers received 45% more from sellers after appraisal. This, too, is a superb legal memo exploring the nuances of appraisal rights.

 

For certain deals, then, appraisal rights provide another way for investors to influence corporate leadership, and is worth investigating.