Shareholder Litigation That Works
By Charles Korsmo — The New York Times
A battle is brewing in Delaware over what was, until recently, a quiet corner of corporate law: stockholder appraisal rights, which allow shareholders to go to court to contest the price paid in a corporate buyout.
We have studied appraisal litigation extensively, and our research indicates that it plays a strongly beneficial role in mergers and acquisitions. Although shareholder litigation is often a pestilential bog of nuisance suits, appraisal cases stand out as something unusually valuable — a form of shareholder suit where the merits actually matter.
The exercise of appraisal rights has increased substantially in recent years, prompting serious hand-wringing in certain quarters.
Opponents lump appraisal litigation with other, more dubious forms of shareholder suits, and then decry them all as nuisance litigation. Our research, however, shows that appraisal suits are different. They are targeted litigation driven not by plaintiffs’ lawyers but instead by sophisticated investors who often acquire stock specifically to bring an appraisal suit. Because these appraisal specialists put their own money on the line, they pick their battles carefully.
Other shareholder suits are brought virtually indiscriminately, but in our academic work, we have shown that appraisal litigation is significantly associated with buyouts with an unusually low deal price and where insiders are part of the acquiring group. These are precisely the deals where something is most likely to have gone wrong: Insiders may have favored themselves over the shareholders, or the board through negligence or favoritism may have failed to adequately shop the company.
Take the 2013 buyout of the Dole Food Company by the company’s chief executive, David H. Murdock, for $13.50 a share, or about $1.6 billion. The deal has generated one of Delaware’s largest appraisal cases.
Before the transaction, Mr. Murdock held 40 percent of the company’s stock and made it abundantly clear that he would not support a deal with anyone else. As a result, the board approved his bid without conducting an auction to maximize the price received by Dole’s stockholders.
Was the price fair in the Dole deal? Many shareholders didn’t think so and asked a Delaware court for an answer. However the case comes out, this is precisely the sort of deal that ought to get a hard look, which is exactly what appraisal litigation provides.
One of the most common — and most misguided — knocks on appraisal suits is that specialists have emerged to bring them to court, often buying shares after a merger is announced with the intention to exercise appraisal rights.
The existence of specialists should be reassuring, not shocking. Their emergence is about as alarming as the fact that farmers don’t mill their wheat into flour themselves. Just as a farmer is not an expert in milling, the typical diversified shareholder is not an expert in identifying or pursuing legal claims in court. When they sell to people who are, that’s evidence of beneficial specialization, which redounds to the benefit of the buyer and seller alike.
The pernicious claim that appraisal litigation benefits only the specialists who pursue it should also be put to rest. Just as the existence of specialist millers benefits wheat farmers, the existence of appraisal specialists benefits other shareholders. Most directly, appraisal specialists must buy their stock from existing shareholders, and sometimes must pay a premium above the deal price to do so.
Even in today’s nascent market for appraisal claims, shareholders may do better selling to appraisal specialists than to the acquiring company. In one case that recently went to trial, an appraisal petitioner paid former stockholders more than 11 percent more than the acquirer was offering.
Shareholders also benefit indirectly from the genuine deterrence provided by appraisal litigation. An appraisal filing is not like lightning, striking unsuspecting companies indiscriminately. Appraisal specialists predominately take aim at suspicious deals, providing genuine deterrence against lowball buyouts by insiders.
Critics have tried to portray this virtue as a vice by grousing that appraisal rights must be curbed because it deters transactions. But the evidence suggests that appraisal litigation deters transactions that ought to be deterred.
Dole and its allies are pushing Delaware to sharply curtail appraisal rights and, at the very least, limit them to shareholders who happen to own stock on an arbitrary date set by the company.
So far, the experts in Delaware have refused to bite. Last month, the council of lawyers charged with drafting amendments to Delaware’s globally influential corporate code recommended sensible changes. These proposals recognize and affirm the beneficial role of appraisal rights, while reducing potentially perverse incentives for appraisal specialists. The council considered the opponents’ proposals, examined the evidence, and rejected them for what they are: bad policy.
Don’t drop the balloons and confetti yet, however. What Dole and its allies could not accomplish by reason may yet be accomplished through political lobbying, as they continue to press to overturn the council’s recommendations.
With luck, this effort to use political leverage to deform the rules of appraisal litigation will go nowhere. One of reasons that tiny Delaware has such outsize influence is that it shapes its corporate law in the crucible of sound argument and evidence, not back-room pressure. The state has a hard-earned reputation of putting investors’ interests ahead of the parochial interests of any one company. Critics of appraisal litigation appear intent on putting that reputation to the test, playing to all of the worst caricatures of Delaware as a place where corporate defendants get whatever they want.
We are optimistic that Delaware will live up to its reputation of doing right by shareholders. The bar should resist calls to gut the only form of shareholder litigation that appears to be working well, and the legislature should pass only the sensible reforms proposed by the council. When that happens, shareholders can finally break out the Champagne.