Interest in Appraisal
Posted by Charles Korsmo, Case Western
Reserve University and Minor Myers, Brooklyn Law School, on Monday,
August 8, 2016
|
Editor’s Note:
Charles Korsmo is Assistant Professor of Law at Case Western
Reserve University School of Law and Minor
Myers is Professor of Law at Brooklyn Law School. This post is
based on a recent
article by Professors Korsmo and Myers and is part of the
Delaware law series; links to other posts in the series are
available
here. |
In a forthcoming
article, we critique Delaware’s system for awarding prejudgment
interest in stockholder appraisal actions and propose a set of reforms
designed to improve upon the existing regime.
The recent
rise in appraisal litigation is largely a positive development, as we
have argued before and as mounting evidence confirms. Nonetheless, it
has sparked a backlash among an influential group of deal advisers and
defendants. Citing danger to the deal market, these critics have
sought drastic changes in Delaware to curtail the ability of minority
shareholders to pursue appraisal.
One unlikely
flashpoint in this battle is the statutory interest rate awarded to
petitioners in appraisal proceedings. In 2007, the Delaware
legislature amended the appraisal statute to establish a presumptive
interest rate equal to the prevailing federal funds rate plus 5%. As
we show in our paper, this amendment reflected more a codification of
existing judicial practice than a sharp change: the Court of Chancery
had been awarding at rates along these lines since the 1990s.
Nevertheless, critics contend that this statutory interest rate has
been a prime driver of the increase in appraisal activity, with
sophisticated “appraisal arbitrageurs” parking money in appraisal
claims in order to take advantage of an “above-market” interest rate.
Delaware recently enacted an amendment designed to moot the interest
rate question by allowing an appraisal respondent to prepay an amount
of its choosing, thereby avoiding the accrual of interest.
A striking
feature of complaints about the interest rates—even when made by
otherwise sophisticated observers—is the failure to articulate any
general principles for the role of interest in appraisal, or for
determining whether the statutory rate is, in fact, too high.
In our
article, we develop a set of relevant principles, and we use them
to propose reforms that would improve the functioning of Delaware’s
appraisal remedy by encouraging accurate, economical resolution of
disputes over fair value.
The primary
policy goal in designing an interest regime should be to make the
parties time-indifferent, with no incentive to either prolong the
proceeding or give up value to secure a hasty settlement. Likewise,
the interest regime should ideally not distort the incentives of
minority stockholders to dissent in the first place. The decision to
dissent should be driven by the merits—a divergence between the merger
consideration and fair value—not by the interest rate. To these
primary goals we add the principle that the interest rate regime
should economize on litigation costs and, at the margin, err in the
direction of encouraging settlement.
Drawing on
these principles, we offer a set of reforms that builds upon
Delaware’s recent amendment and improves the interest rate regime. We
propose that the respondent should have a unilateral option to prepay
an amount of its choosing to the dissenting stockholder within 30 days
of the completion of the relevant transaction. The dissenting
stockholder would thereafter possess a unilateral option to walk away
from the litigation for the amount prepaid. Finally, following trial,
either party would be liable to the other for interest on the
difference between the amount prepaid and the adjudged fair value,
with the interest rate set at the weighted average cost of capital of
the target company, a figure that is already required to be calculated
in virtually every appraisal proceeding.
Our proposal
would force the company and the dissenting stockholders to be
reasonable: The company would face an incentive to put its best offer
of fair value on the table, and the dissenting stockholder similarly
must decide whether fighting for additional value is really worth it.
This also would promote settlement, a welcome development for an area
of law that has been regularly characterized by the Court of Chancery
as pitched battle. By correcting the incentives associated with the
passage of time, our reforms to the interest rate regime can promote
efficiency-enhancing settlements.
Equally
important, strong appraisal claims would be unharmed by our proposal.
If anything, the focus of the litigation in such cases would be more
squarely on the merits of the claim—the fair value of the cashed-out
stock—without any distractions associated with the interest rate. The
amount of equity dissenting in the most problematic transactions may
increase. Given the salutary effects of appraisal activity we have
adduced in other work, this would be a welcome development.
Like the
recent Delaware amendment, our proposal addresses precisely the
problem that critics say is generated by the current interest rate
regime: that the interest rate is an independently attractive feature
of participating in an appraisal claim. Under our reforms, it would no
longer be even theoretically attractive for a stockholder to dissent
in hopes of capturing the statutory interest rate. If a company were
confident that the merger price equals the fair value of the stock, it
could immediately pay the dissenters the merger price, and never pay a
cent in interest. The threat of this outcome would prevent
stockholders from pursuing such a path in the first place. Thus, the
supposed policy crisis—that the statutory interest rate is deforming
the appraisal remedy—would be solved completely.
The complete
article is available for download
here.
|
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