Appraisal action petitions, used by stockholders seeking relief when they believe shares in a company are more valuable than the price in a merger where they are being forced to sell their shares, have risen in number dramatically in the past two decades, according to a new study.
Petitions increased from 2 to 3 percent of eligible deals in the early 2000s to around 25 percent of deals in the 2010s.
“Petitions increased from 2 to 3 percent of eligible deals in the early 2000s to around 25 percent of deals in the 2010s,” said Randall Thomas of Vanderbilt Law School. “The top hedge funds file petitions accounting for more than 50 percent of the dollar volume, and the top seven law firms representing them are counsel in about 50 percent of the cases.”
Appraisal action petitions are most often generated when stockholders start to believe there might be a conflict of interest within a company that will lead to:
- A going-private deal, where a company wants to buy back all its stock at the low price;
- Minority squeeze-outs, deals in which a controlling shareholder buys out a minority shareholder’s stock to eliminate that shareholder and which often occur at low prices; and
- A merger between a parent company and its substantially owned subsidiary, with either the parent company or the subsidiary surviving the merger.
Buying stock with the intention of filing an appraisal petition is an investment strategy for some hedge funds. The average annualized return on appraisal action petitions is 32.9 percent, according to the study.
In recent years, hedge fund managers have filed 75 percent of appraisal actions, said Thomas, holder of the John S. Beasley II Chair in Law and Business at Vanderbilt Law School and co-author with three other researchers of the paper “Appraisal: Shareholder Remedy or Litigation Arbitrage?” It was published in August in The Journal of Law and Economics.
More than 80 percent of appraisal action claims are settled before they go to trial.
“Our calibration shows that … issuers are always better off paying the appraisal award to the dissenters rather than trying to preempt the petitions by offering a more generous premium in the transaction to all shareholders,” Thomas said.
Two new laws in Delaware
Researchers also looked at two new laws enacted in Delaware in 2016. Delaware is the state where the majority of Fortune 500 corporations base themselves, making it the center of American corporation law.
The laws target perceived abuses of the statutory procedure and provide:
- Appraisal actions can only be filed by petitioners who collectively hold at least $1 million in stock or at least 1 percent of the company; and
- Corporations are permitted to reduce the amount of interest they pay on judgments that are caused by successful appraisal actions by giving some or all of the money to claimants before the case is settled.
The minimum dollar-investment or 1 percent rule would eliminate a quarter of the cases, the study found.
“Our analysis also shows that the same limitation will not affect shareholders’ motives for seeking appraisal, nor would it have any impact on the likelihood of a case going to trial,” Thomas said.
The second new rule, allowing companies facing appraisal actions to tender money to the claimant before the case is settled, would likely “reduce significantly” the financial motives of some hedge funds for seeking appraisal actions.
“Our analysis of both amendments supports the understanding of Delaware’s reforms as a way of discouraging strike suits and interest-rate-driven appraisal cases,” Thomas said.
The co-authors on “Appraisal: Shareholder Remedy or Litigation Arbitrage?, are Wei Jiang, the Arthur F. Burns Professor of Free and Competitive Enterprise at Columbia University; Tao Li, assistant professor of finance at Warwick Business School; and Danqing Mei, a research assistant at Columbia.