Mergers And Acquisitions; Appraisal Rights
Unless they are a party to the transaction itself, such as in the case of a share-for-share exchange agreement, shareholders of a company in a merger transaction generally have what is referred to as “dissenters” or “appraisal rights.” An appraisal right is the statutory right by shareholders that dissent to a particular transaction, to receive the fair value of their stock ownership. Generally such fair value may be determined in a judicial or court proceeding or by an independent valuation. Appraisal rights and valuations are the subject of extensive litigation in merger and acquisition transactions. As with all corporate law matters, the Delaware legislature and courts lead the way in setting standards and precedence.
Delaware Statutory Appraisal Rights
Although the details and appraisal rights process vary from state to state (often meaningfully), as with other state corporate law matters, Delaware is the leading statutory example and the Delaware Chancery Court is the leader in judicial precedence in this area of law. More than half of U.S. public companies and more than two-thirds of Fortune 500 companies are domiciled in Delaware.
Moreover, as is consistent with all states, the Delaware General Corporation Law (“DGCL”) Section 262 providing for appraisal rights requires both petitioning stockholders and the company to comply with strict procedural requirements. The following is a high-level summary of the detailed procedures and process required by the company and stockholders where appraisal rights are available and where the stockholder desires to avail itself of such rights.
Except in share exchange transactions where all shareholders are a direct party to the transaction and transaction documents, stockholders of a corporation that is being acquired in a merger transaction have a statutory right to a court appraisal of the fair value of their shares. Dissenting stockholders may seek this judicial determination as an alternative to accepting the merger consideration being offered in the transaction negotiated by the company’s board of directors.
Section 262 of the DGCL gives any stockholder of a Delaware corporation who (i) is the record holder of shares of stock on the date of making an appraisal rights demand, (ii) continuously holds such shares through the effective date of the merger, (iii) complies with the procedures set forth in Section 262, and (iv) has neither voted in favor of nor consented in writing to the merger, to seek an appraisal by the Court of Chancery of the fair value of their shares of stock.
Where an action allowing for appraisal rights is to be voted on by stockholders, the corporation must give written notice to its stockholders as of the meeting notice record date, not less than 20 days prior to the meeting. The written notice must include a copy of Section 262 of the DGCL. Each stockholder electing to demand appraisal rights for their shares must (i) deliver a written demand to the company for appraisal prior to the taking of the stockholder vote on the merger (or, in the case of a short-form merger or a merger approved by a written consent of stockholders, within 20 days of the mailing of a notice to stockholders informing them of the approval of the merger), (ii) file a petition with the Delaware Court of Chancery within 120 days after the effective date of the merger, and (iii) serve a copy of such petition on the corporation surviving the merger. Within 10 days of the effective date of the merger, the surviving corporation must give each stockholder that has elected appraisal rights, and not thereafter voted for or consented to the merger, notice of such merger effective date.
Where an action allowing for appraisal rights is approved without a vote by stockholders, within 10 days of the approval the corporation shall notify each of the stockholders who are entitled to appraisal rights of the approval of the merger and that appraisal rights are available. If already completed, the notice shall include the effective date of the merger. The written notice must include a copy of Section 262 of the DGCL. Each stockholder electing to demand appraisal rights for their shares must deliver a written demand to the company for appraisal within 20 days of the mailing of a notice to stockholders informing them of the approval of the merger. Thereafter the same procedures will apply as when approval was by a vote of stockholders.
At the hearing the court will determine the stockholders that have properly complied with the statute and are entitled to appraisal rights. Once it is determined which stockholders are entitled to an appraisal, the court will proceed with the substantive process of determining fair value. The statute requires that in determining such fair value, the court shall take into account all relevant factors (see the discussion below regarding the substantive fair value determinations).
Unless the court has good cause and determines otherwise, interest of 5% above the Federal Reserve discount rate shall accrue on the fair value of the shares from the date of the merger until the date paid. The court also has the statutory right to grant or deny the recovery of attorney’s fees and costs to a petitioning shareholder. From and after the effective date of the merger, stockholders who have demanded appraisal rights are not entitled to vote their shares or to receive any dividends or other distributions (including the merger consideration) on account of these shares unless they properly withdraw their demand for appraisal.
Dependent on the consideration to be received, appraisal rights are not available for (i) shares of the corporation surviving the merger if the merger does not require the approval of the stockholders of such corporation and (ii) shares of any class or series that is listed on any national security exchange or held of record by more than 2,000 holders. In particular, these exceptions do not apply if the holders of such shares are required to accept in the merger any consideration other than (i) shares of stock of the corporation surviving or resulting from the merger or consolidation, (ii) shares of stock of any other corporation that will be listed on a national securities exchange or held of record by more than 2,000 holders, (iii) cash in lieu of fractional shares, or (iv) any combination of the foregoing. In addition, these exceptions do not apply in respect of shares held by minority stockholders that are converted in a short-form parent subsidiary merger.
Section 262 of the DGCL also allows for a corporation to include in its certificate of incorporation the same merger appraisal rights for (i) amendments to the certificate of incorporation and (ii) the sale of all or substantially all of the assets of the corporation.
Determining Fair Value; The Longpath and Merion Capital Cases
On October 21, 2015, in Merion Capital LP v. BMC Software, Inc., the Delaware Court of Chancery rejected a dissenting shareholders effort to receive greater than the set merger price through the appraisal rights process. The Merion opinion is consistent with the June 30, 2015, Delaware Court of Chancery opinion which also rejected a dissenting shareholders effort to receive greater than the set merger price through the appraisal rights process. In Merion Capital and Longpath Capital, LLC v. Ramtron Int’l Corp., the Delaware court continued its recent consistent record of upholding the merger price as the most reliable indicator of fair value where the merger price was reached after a fair and adequate process in an arm’s length transaction. In this case, the merger price followed several rejected bids, an active solicitation of other potential buyers, and a three-month hard bargaining process.
Generally there are four recurring valuation techniques used in an appraisal rights proceeding: (i) the discounted cash flow (DCF) analysis; (ii) a comparable company’s analysis and review; (iii) a comparable transactions analysis and review and (iv) the merger price itself. Merger price is usually reached through the reality of a transaction process, as opposed to the academic and subjective valuation processes used in litigation challenging such price. Courts unanimously give greater, and usually 100%, weight to the merger price where the merger negotiation process was adequate.
Where there is a question as to the process resulting in the final merger price, Delaware courts generally look to the DCF analysis as the next best indicator of fair value. In this case, the court rejected the DCF analysis presented by the parties’ experts in the litigation as based on unreliable management projections. Although a DCF analysis is often used in litigation to challenge the merger price, as with the Longpath case, the Delaware courts will not give much weight to a DCF model based on management-prepared projections where such projections are prepared outside the ordinary course of business such as in response to a hostile takeover bid, other potential transaction or for use in litigation. Moreover, even where management projections are prepared in the ordinary course, the courts will consider the process used, assumptions made and the experience of management in preparing such projections as well as other qualitative and quantitative standards as to their reliability.
In addition to being skeptical regarding the weight to be given a DCF analysis, courts will likewise be skeptical regarding comparable transactions. In reviewing comparable transactions, courts will consider the types of companies involved, multiples used in each industry, and basic business realities.
Prior to the recent slew of cases upholding merger price as the best indication of value, the seminal case on appraisal rights was Weinberger v. UOP, 457 A.2d 701 (Del. 1983), which held that a proper valuation approach “must include proof of value by any techniques or methods which are generally considered acceptable in the financial community and otherwise admissible in court.” The Weinberger court also held that the valuation should include elements of future value that are known or susceptible to proof, excluding only speculative elements. Following Weinberger the DCF model gained in popularity with the Delaware courts. As discussed above, recently the DCF model has been losing ground in favor of the merger price itself where the price is achieved following a fair and adequate process in an arm’s length transaction.
Managing Risks Associated with Appraisal Rights
The best way to manage risks associated with the appraisal process, and all aspects of the merger itself, is to pay meticulous attention to the process. The board of directors should utilize legal and financial advisors and delve into information gathering, analytical and deliberative processes and the manner in which they are documented in order to ensure that a defensible record is produced. See also my blog related to directors’ responsibilities in the merger process and the importance of the process itself, HERE.
Careful attention must be paid to the disclosure documents provided to stockholders related to the transaction. The document should include a thorough description of all relevant facts that support the fairness of the merger consideration. Relevant facts include, among other matters, historical operating results and future prospects, competitive and other risks, levels of liquidity and capital resources, internal and external indicia of value, efforts to explore strategic alternatives and the results thereof, opportunities for interested parties to submit competing acquisition proposals, and fairness opinions obtained from financial advisors and supporting analyses. Of course, as with all anti-fraud considerations, the document cannot misstate or omit material facts and information.
Hedging in Merger Transactions
There has been a recent dramatic increase in appraisal rights actions filed by shareholders that purchase shares after the record date of the relevant transaction. That is, it appears that a group of investors are hedging on merger transactions and utilizing the appraisal process as part of their hedging strategy. An interesting paper and analysis by the The Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “Appraisal Arbitrage – Is There a Delaware Advantage” sets forth a well thought out theory as to why this investment strategy may be profitable to arbitrageurs. Here is a brief summary of the theory and for those interested in learning more about this theory, I encourage reading the entire paper.
First, Delaware allows shareholders to pursue appraisal rights even if they purchase shares after the record date for voting on the transaction. Investors can delay their investment decision until they have a better idea of valuation of the target. Moreover, by delaying the investment decision to as close as possible to the closing date, investors can minimize or even eliminate the risk that the deal will not close.
Second, many courts give preference to the DCF analysis valuation method. However, investment bankers advising on M&A deals tend to be more conservative. The paper points out that in a review of sample deals, nearly two-thirds of the time there was a differential between valuation used by investment bankers in providing fairness opinions to parties in an M&A transaction and fair values determined by the Delaware Courts. Investors have an opportunity to take advantage of this spread.
Third, the Delaware statute requires the court to determine a point estimate rather than a range of fair value. Accordingly, transactions completed at the low end of the DCF value range have a greater chance of a court determining that the fair value is higher, even if only by a few points.
Finally, the Delaware statutory rate for successful petitioner in an appraisal rights action is higher than the current yield on U.S. Treasury Bonds, thus creating a potential economic incentive for arbitrageurs.
The Author
Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. The firm’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the producer and host of LawCast, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington D.C., Denver, Tampa, Detroit and Dallas.
Contact Legal & Compliance LLC. Technical inquiries are always encouraged.
Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.
Download our mobile app at iTunes.
Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.
This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.
© Legal & Compliance, LLC 2015
« The Materiality Standard; NYSE Amends Rules; FASB Proposed Guidance SEC Proposes Amendments Related To Intrastate And Regional Securities Offerings- Part 1 »
OTC Markets Comments on Proposed SEC Rules Regarding Amendments to Regulation D, Form D and Rule 156
On July 10, 2013, the SEC issued proposed rules further amending Regulation D, Form D and Rule 156. On September 23, 2013 the OTC Markets Group published a letter responding to the SEC’s request for comments on the proposed rules. The entire OTC Markets comment letter is available on both the OTC Markets website and the SEC website. The OTC Markets Group, through OTC Link, owns and operates OTC Markets and its quotation platforms including OTCQX, OTCQB and pink sheets.
Summary of Proposed Rule Changes
The proposed amendments will (i) require the filing of a Form D to be made before the Issuer engages in any general solicitation or advertising in a Rule 506(c) offering and require the filing of a closing amendment to the Form D at the termination of the offering; (ii) require that all written general solicitation material used in a Rule 506(c) offering include certain legends and disclosures; (iii) require that all written material used in general solicitation and advertising be submitted to the SEC; (iv) disqualify an Issuer from relying on Rule 506 for one year for future offerings if the Issuer, or any predecessor or affiliate of the Issuer, failed to comply with the Form D filing requirements for a Rule 506 offering in the last five years; (v) amend the Form D to include additional information about offerings; and (vi) amend Rule 156 to extend the antifraud guidance in the rule to include sales literature of private funds (hedge funds). In addition, as part of the proposed rule release, the SEC is seeking comments from the public on the definition of “Accredited Investor.”
On August 20, 2013, I published a blog detailing the proposed rule changes related to Form D and Rule 507, which can be viewed here. On August 27, 2013, I published a blog detailing the remainder of the proposed rule changes including the proposed amendments to general solicitation materials and the temporary requirement that all such materials be submitted to the SEC, which can be viewed here.
OTC Markets Comment Letter
OTC Markets has been vocal about its support of the lifting of the ban on general solicitation and advertising, and it continues to be so in its comment letter. However, OTC Markets is not supportive of the proposed new rules and, in fact, is concerned that the rules “would counteract the positive impact of the new general solicitation and advertising rules, contradict the intent of the JOBS Act, and ultimately harm small capital formation.” The OTC Market’s biggest concern is the proposed advance Form D filing requirement.
OTC Markets Comments Related to the Proposed Advance Form D Requirement
Currently, an Issuer must file a Form 15 within 15 days of the first sale of securities in a Regulation D offering. An Issuer must file an amendment if there is a material change to the information filed in the original Form D. The proposed rule would require the Issuer to file an advance Form D with the SEC at least 15 days prior to using advertising or general solicitation in conjunction with the new 506(c) offering exemption. OTC Markets has many issues with the proposed new filing requirement.
First, OTC Markets is concerned that the advance filing requirement will chill communications between Issuers and potential investors. It is unclear what constitutes general solicitation and advertising or non-confidential information. This lack of clarity will likely result in confusion by Issuers as to when or if an advance Form D is required. Moreover, the lack of clarity could cause Issuers to err on the cautious side and instead of providing more information to the public, maintain such information as confidential. One of the underlying intents of the JOBS Act was to increase the amount of publicly available information about Issuers.
OTC Markets points out that “[F]or many small companies, the fear of violating the Advance Form D requirement will cause them to keep information confidential. Investors, employees, the press and regulators would be deprived of valuable company information, leading to unreliable price discovery, a lack of market efficiency, reduced incentive to participate in private offerings, and less capital raising by small companies.” OTC Markets goes further to conclude that “the Advance Form D requirement may completely frustrate the Congressional intent behind the JOBS Act and make the end of the ban on general solicitation and advertising a non-event for small companies.”
In addition, OTC Markets takes issue with the SEC’s reasoning behind the proposed advance Form D requirement. In particular, the SEC has indicated that the requirement will help it analyze and better understand the market for Rule 506(c) private placements. The SEC does not offer a rationale as to how an advance Form D would provide information not already provided by the current Form D. Moreover, the SEC has access to documents submitted to FINRA by broker dealers acting as placement agent or participating in private placements. The current Form D filing requirement together with FINRA information already provides the SEC with enough data to analyze any market impact of 506(c) offerings without the negative effect of chilling small companies’ communications and capital raising efforts.
In a point very well taken, the OTC Markets states, “[T]he capital formation process would be much better served if the SEC engaged in thoughtful private placement rulemaking 12 months from now after conducting a thorough analysis of the impact of the new general solicitation rules on the private placement market. Implementing the Advance Form D requirement simultaneously with the end of the ban on general solicitation and advertising deprives the markets of the opportunity to properly evaluate the impact of the JOBS Act on small company capital formation.”
OTC Markets Comments – the Benefits of Adequate Current Public Information
OTC Markets advocates full public disclosure by all Issuers, especially those engaging in private placement offerings. The OTC Markets comment letter advocates “mandatory public disclosure of the information required under Securities Act Rule 144 in connection with any Rule 506(c) offering that utilizes general solicitation and advertising.” Rule 144 requires adequate current public information as a prerequisite to the sale of securities under the Rule. For a reporting company, the current public information requirement is met by being current in its reporting requirements with the SEC. For a non-reporting company, the current public information requirement is met by having all the information required by SEC Rule 15c2-11 made publicly available. Generally, this information is uploaded onto the OTC Markets website.
OTC Markets points out that prior to the new Rule 506(c), Regulation D required that information be kept confidential and not publicly available. OTC Markets sees the new rule as an opportunity for the SEC to increase and encourage public information by Issuers.
Although OTC Markets does not address this in its letter, one of the SEC’s reasons behind previously prohibiting public information was to ensure that only qualified investors had access to such information. However, in the proverbial “throw the bath water out with the baby,” the result was an influx of private secondary markets (such as pre-IPO Facebook) where everyone could see the trading of a security but only a qualified few could access information related to the Issuer. The new 506(c) is a tremendous shift whereby everyone can access the public information but only a qualified investor can make the actual investment.
OTC Markets rightfully points out that “[Public] availability of company information builds trust in our capital markets and provides vital protection against fraud.”
OTC Markets Comments on Proposed 506 Ban for Form D Noncompliance
The SEC has proposed a rule whereby Issuers would be banned from Rule 506 offerings for one year if that Issuer has failed to comply with the Form D filing requirements within the past 5 years. OTC Markets points out—and I couldn’t agree more—that the complexity of the Form D filing requirements, especially if the advance Form D is required, will lead to substantial technical noncompliance by well-intentioned Issuers. The one-year penalty is an overly severe punishment, especially in the environment of changing rules and regulations.
The Author
Attorney Laura Anthony
LAnthony@LegalAndCompliance.com
Founding Partner, Legal & Compliance, LLC
Corporate, Securities and Business Transaction Attorneys
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the host of LawCast.com, the securities law network.
Contact Legal & Compliance LLC. Technical inquiries are always encouraged.
Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.
Download our mobile app at iTunes and Google Play.
Legal & Compliance, LLC makes this general information available for educational purposes only. The information is general in nature and does not constitute legal advice. Furthermore, the use of this information, and the sending or receipt of this information, does not create or constitute an attorney-client relationship between us. Therefore, your communication with us via this information in any form will not be considered as privileged or confidential.
This information is not intended to be advertising, and Legal & Compliance, LLC does not desire to represent anyone desiring representation based upon viewing this information in a jurisdiction where this information fails to comply with all laws and ethical rules of that jurisdiction. This information may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.
© Legal & Compliance, LLC 2015
« SEC Has Approved A Two-Year Tick Size Pilot Program For Smaller Public Companies SEC Proposed Executive Compensation Clawback Rules »