Under Delaware law and most Canadian corporate statutes, a shareholder who votes against a fundamental transaction—such as a going-private transaction or a sale of all or substantially all of the corporation's assets—is entitled to object to the consideration offered and in turn require payment of the "fair value" of his, her or its shares as appraised by court. Where an investor concludes that there is a significant gap between the price of a M&A transaction and the fair value of the shares, the threat of the exercise of such appraisal rights can be used as leverage for improvement in the deal terms. In certain instances, specialist funds have even begun to engage in a form of so-called appraisal arbitrage, whereby they will buy into a company on the brink of a sale just for the purpose of appraisal litigation.
Long one of the more esoteric remedies afforded shareholders, the exercise of such appraisal rights has been on a significant upswing in the U.S. in recent years. A record 33 public company appraisal cases were filed in Delaware in 2014, and that number is set to increase again this year, with 20 cases filed in the first quarter of 2015 alone. Indeed, a number of hedge funds have even been established that are devoted exclusively to appraisal actions as independent investment opportunities.
To date however, there have been only limited instances of appraisal litigation in Canada and it remains here as obscure as it used to be in the United States. Is it possible that will change any time soon?
To some degree, it's hard to say. Particularly for an investor that is specifically investing for purposes of appraisal litigation, the strategy is not without its risks. Not only is there the legal risk inherent in the appraisal claim itself, but the party pursuing the claim also ties up its funds for the (often very lengthy) duration of the litigation, and without the benefit of any security on the assets of a successor company that is likely to have been leveraged up to finance the deal.
In the United States, these risks have been dampened and in some ways outweighed by procedural rules and case law.
Under Delaware law—where famously more than half of all U.S. publicly traded companies are incorporated—shareholders may receive statutory compound interest on the appraised award at the federal discount rate plus 5% from the transaction closing date until the award is made. That amount, set at a time when interest rates were much higher (and not as they are today at essentially the zero lower bound) is especially attractive given current market alternatives. Moreover, defendants in such cases are not entitled to pay down even the uncontested portion of the deal consideration while the litigation was ongoing, meaning that interest has to accrue on the full amount.
A loophole in Delaware law—confirmed recently in the Ancestry.com and BMC Software Inc. appraisal proceedings—also permits investors seeking appraisals to buy shares after the record date for voting on a transaction, and right up until the date of the shareholder meeting. In addition, one does not necessarily even need to show that the shares that one is seeking have appraised were voted against a particular transaction. Where a subject company's shares are held by beneficial owners through a global nominee (such as DTC's Cede & Co.), it becomes a practical impossibility to know whether particular shares were voted for or against a transaction. Accordingly, in such circumstances, a beneficial holder seeking appraisal need only hold less than the total amount of shares voted against the transaction in order to be eligible for appraisal. Needless to say, this allows such holders to act with the benefit of the greatest amount of information, a huge benefit when record dates almost always precede the distribution of proxy materials providing disclosure regarding the sale process as well as the valuation metrics and assumptions underlying the fairness opinion.
One further likely reason for the uptick in appraisal actions is simple: those who have pursued them have generally experienced success. Academic work in the area (for more, see here) has shown that courts have awarded "fair value" in excess of the actual deal price in the substantial majority of decided cases. Moreover, much of that success—in cases involving companies such as Dell, Dole and 3M Cogent—has been very prominent.
In Canada, the rules—naturally—are different and many of the structural elements that tend to favour parties seeking appraisal in the U.S. are simply not present. Notably, a party seeking appraisal under most Canadian corporate statutes may only be entitled to a "reasonable rate" of interest in most jurisdictions. Typically, this has meant the interest rates set by provincial courts for pre- and post-judgement interest, which are quite closely tied to market rates and are therefore much less lucrative than in Delaware (in Ontario, for instance, the current rate is 2%). In addition, civil litigation in Canada has long operated on the principle that the loser pays for its opponents legal costs, a sharp contrast from the general U.S. approach where—in shareholder litigation at least—the parties bear their own costs.
That said, whether Canada could see greater action in appraisal litigation remains very much on the table. Some provincial corporate statutes, notably Alberta's, permit investors the key favourable right to exercise dissent rights following a record date, just as in Delaware. Similarly, there is case law in Alberta and Ontario to the effect that a dissenting shareholder is permitted to "buy into" the appraisal remedy if they so choose. Perhaps just as significant however could be the continuing sea change in shareholders' assertiveness and tactical approach. Certainly in the U.S., the increase in appraisal actions has coincided with an explosion in shareholder litigation generally. To the extent that this is no coincidence, and is a product of the change in culture and approach more generally, it seems likely that increasing levels of shareholder activism in Canada may signal the beginning of an upswing in Canadian appraisal litigation as well.
Norton Rose Fulbright Canada LLP
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