Analysis

Clearwire Ruling Shines Light On Appraisal Arbitrage Risks

By Matt Chiappardi

Law360, Wilmington (July 25, 2017, 8:31 PM EDT) -- The Delaware Chancery Court's recent opinion appraising the fair value of Clearwire Corp. stock at nearly 60 percent below the Sprint Nextel Corp. buyout price delivered a stunning blow to the so-called appraisal arbitrage practice that highlights its enormous risks, but is unlikely to stem the tide of such challenges in a climate that still favors them, experts say.

Vice Chancellor J. Travis Laster's ruling that found the fair value of Clearwire stock at $2.13 per share, despite an actual merger price of $5, was a bruising defeat for Aurelius Capital Management LP, which pushed for a valuation north of $16 per share.

But, adding salt to the wound, Vice Chancellor Laster's determination of fair value was one of the rare rulings that came in below actual deal price — in this case, well below — in part because, by statute, judicial appraisal doesn't take into consideration things like synergies that can add to transactions' worth.

It would seem such a punishing loss would dissuade even the most daring investors seeking to squeeze more value out of a merger they believe is underpriced, and experts say the opinion will force a long, sober look at the risks involved. But experts also agree that just one opinion will not be enough to clamp down on appraisal challenges when litigation winds are still favorable.

"Appraisal is where the money is in Delaware," said Joshua D.N. Hess, a partner with Dechert LLP. "You don't get post-closing damages anymore."

Hess said that the Clearwire opinion and other guidance from the courts over the years has served as a "yellow light" to prevent deal litigation from becoming "all appraisal, all the time," and to slow a train of investors who may expect big paydays as a rule.

"It's a clear signal from the Chancery Court, subconscious or otherwise, to not expect to file an appraisal case and get your stock bump," he said. "This case will be the totem of the consequences you have if you get this wrong."

But there have been cases where the Chancery Court did give investors a big stock bump. Two recent cases now being evaluated by the Delaware Supreme Court, the appraisals of Dell Inc. and DFC Global Corp., gave appraisal petitioners roughly 30 percent and 10 percent respective stock price increases.

Such rulings are not the only such incidents and their fruits have borne a practice known as appraisal arbitrage, a strategy in which investors buy up stock after a deal is announced with plans to seek judicial appraisal and get a premium.

It's unclear when Aurelius actually bought its stake in Clearwire, but the strategy, and any appraisal petition, comes with risks. Those who petition for appraisal can be essentially on the hook for losses if a judicial determination of fair value comes in below the actual deal price, but rulings of that nature have been relatively uncommon.

"The Delaware Court of Chancery has proven time and again that it can and will award significant recoveries in mispriced deals subject to appraisal," said A. Thompson Bayliss, partner with Delaware law firm Abrams & Bayliss LLP. "I don't expect the [Clearwire] outcome to deter sophisticated players from pursuing appraisal in cases where they have confidence in their unfair sale process and valuation arguments."

Bayliss added that the notion appraisal is a "no-risk game" is an "ill-informed theory," and Lawrence Hamermesh, professor of corporate and business law at Widener University Delaware Law School, said that a string of cases that had very few consequences for petitioners might have fueled such suppositions.

Cases that have either yielded big premiums, or at least leaned on deal price as the fair value — in which it could be argued the only real loss is litigation costs — created an environment where there was little downside to "roll the dice" on appraisal, Hamermesh said.

But the professor added that investors should have "never thought of this as an ATM that spits out money," and the "possibility was lurking" of a Chancery Court decision that would hammer investors.

"The mentality that this ought to be a no-risk thing is just wrong," Hamermesh said. "If that discourages appraisal arbitrage, it's unfortunate for some practitioners, but it's not unfortunate for the system."

Appraisal, even arbitrage, acts as a "safety valve" or check on deals where a price is genuinely too low because of an unfair transaction or a conflict of interest, Hamermesh said.

Hess adds that the Delaware Legislature has been "tentative to close the door on arbitrage," perhaps for that very reason.

The Clearwire decision acts as a major warning marker on risks, but the litigation landscape has changed in the Chancery Court over the past two years since the Delaware Supreme Court's now-famous Corwin v. KKR Financial Holdings LLC ruling.

Many plaintiffs attorneys would instead call it infamous, contending that the ruling — which allowed many breach of fiduciary duty claims to be "cleansed" by a fully informed shareholder vote — has made it unreasonably difficult to adjudicate successful shareholder claims.

That pressure has been pushing many shareholders over to appraisal actions, where a petitioner doesn't have the difficult task of proving there was any fiduciary duty breach in order to see a victory and claim a premium, experts say.

Despite a "dramatic outcome," the Clearwire decision still followed straightforward appraisal logic that has been consistent with the judicial canon so far, Hess said.

Investors and attorneys are waiting for a particular shoe to drop — specifically, the Supreme Court's decisions in Dell and DFC, which are expected to delve into the role of deal prices in appraisal evaluations, according to Hamermesh.

The DFC case has already been argued before Delaware's justices and is pending a ruling. Arguments over the Dell case are scheduled for September in Dover, according to court records.

There's also the notion the facts surrounding Sprint's buyout were so unusual, they're unlikely to be repeated.

At first glance, the case appears to have some of the same issues that can crop up in controlling-party takeovers, such as uncertainty about what insiders might know about a target company, said Jeremy D. Anderson, a principal with Fish & Richardson PC's Delaware office.

But it's an unusual instance where the controller was also a strategic buyer, the assets meshed together with synergies valued at upward of $2 billion, and there was a late-stage bidding war with Dish Network Corp. that not only drove the deal price up, but essentially cleansed what Vice Chancellor Laster said was "unfair dealing early in the process."

"This reiterates that appraisal is very fact-specific," Anderson said. "If we count this as a strategic transaction, then it may temper appraisal somewhat for this specific type of transaction ... it is a stark reminder of the risks of appraisal actions. There aren't many cases out there that find fair value is below the deal price."

Alston & Bird LLP partner Kevin Miller also noted the fact-specific nature of the case, contending that Aurelius had an argument that "didn't reflect the objective reality of the case."

"The petitioners were, in a sense, rolling the dice on this," Miller said. "You're wondering why the petitioners pursued appraisal in the first place."

Hamermesh said that a "rethinking of investment strategies is an inevitable consequence" of the ruling.

Appraisal arbitrage "hit a high watermark" when the rulings appeared to be rolling in the petitioners' favor, but there now may have been "a restoration of an appropriate balance," he said.

The cases are ACP Master Ltd. et al. v. Sprint Corp. et al., case number 8508, and ACP Master Ltd. et al. v. Clearwire Corp., case number 9042, both in the Delaware Court of Chancery.

--Editing by Katherine Rautenberg and Kelly Duncan.

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