Quasi-Appraisal: The Unexplored Frontier of Stockholder Litigation?

The following post comes to us from Robert B. Schumer, chair of the Corporate Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP, and is based on an article published in the M&A Journal by Mr. Schumer, Stephen P. Lamb, Justin G. Hamill, and Joseph L. Christensen; the article, including footnotes, is available here.

For buyers of public companies, an obscure but increasingly evident judicial remedy known as “quasi-appraisal” is fast becoming a source of concern. Quasi-appraisal – as its name suggests – is not quite what parties expect from M&A litigation and has the capacity to upset the familiar process accompanying the sale of a public company.

There are three primary types of M&A litigation: Pre-closing disclosure litigation, post-closing loyalty litigation and appraisal. Not every litigation fits neatly into one of these categories, but most do. Pre-closing disclosure litigation often culminates in the plaintiffs, the target company and the buyer agreeing to additional disclosures (and occasionally revisions in the transaction terms) in exchange for a class-wide release and a court-approved award of plaintiffs’ fees. In the absence of a pre-closing disclosure settlement, the second type of litigation may arise which is post-closing, class-action litigation alleging breaches of fiduciary duties (other than disclosure). Most often, such post-closing actions relate to transactions subject to entire fairness review, as, for example, when a controlling stockholder is involved. And finally, in cash-out mergers, stockholders can pursue a post-closing appraisal claim, a remedy that requires each individual stockholder wishing to pursue appraisal to dissent from the merger vote, refrain from accepting the merger consideration, and bear litigation costs. In an appraisal, dissenting stockholders also bear the risk that the court will appraise the stockholder’s shares at a lower value than the merger consideration.

These litigation alternatives are well-known to all involved in public company acquisitions, with the result that buyers and targets can, with some confidence, balance the costs and benefits of pre-closing settlement against the likelihood that plaintiffs will pursue post-closing claims with the attendant possibility of a significant damages award. “Quasi-appraisal” is not well-known and its reasons for existing and processes remain uncharted and incompletely justified. Generally, quasi-appraisal has been recognized in cases in which a corporation fails to make disclosures that directly affect the stockholders’ decision whether or not to seek appraisal. But substantial uncertainty has arisen because quasi-appraisal has followed a sharply meandering course and has not, as yet, settled into a predictable doctrine. That uncertainty can make it more difficult to evaluate M&A litigation. Beyond uncertainty, quasi-appraisal may provide plaintiffs an attractive post-closing, class-wide litigation alternative without counterbalancing tradeoffs.

When it is available, quasi-appraisal gives plaintiffs an opportunity to pursue post-closing appraisal litigation in a novel way. Such litigation is conducted in an opt-out class-action format based solely on alleged disclosure violations and without any requirement to vote against the merger and forego merger consideration by seeking appraisal. As such, plaintiffs can use merger consideration to fund class-wide appraisal litigation without any apparent risk that they may have to return merger consideration if the appraised value is less than the merger consideration. In at least one recent case discussed below, plaintiffs appeared to lie in wait during the customary pre-closing litigation process and then threatened a class-wide quasi-appraisal claim after closing. While the development of quasi-appraisal as an equitable remedy in Delaware continues, its unusual history, as described below, shows that the remedy has become unmoored from its origins and that it should be available only in a limited universe of cases to avoid tipping the balance of the law too heavily in favor of post-transaction price litigation in situations involving third-party acquisitions.

The Development of Quasi-Appraisal

The Delaware courts first recognized quasi-appraisal as a remedy in Weinberger v. UOP, Inc., where it was meant simply to open a window, temporarily, for additional appraisal actions in light of Weinberger’s radical alteration of Delaware valuation law. Weinberger was an entire fairness case involving a going private transaction. Accordingly, the court evaluated whether the directors established the fair dealing and fair price of the transaction. With respect to fair price, the Court noted that in the future it would accept various methods of valuation in “appraisal and other stock valuation proceedings.” The Weinberger remedy technically was not a statutory appraisal because the plaintiff had not proceeded under DGCL § 262 (possibly because the restriction on admissible valuation methods in an appraisal proceeding made appraisal an unattractive remedy at that time) nor was it the rescissory relief sought by the plaintiff. Instead, using its equitable power to grant appropriate relief, the court fashioned the remedy that would have been available to the plaintiffs in an appraisal action, had the newly-recognized liberal stock valuation methods (including elements of rescissory damages) been admissible. Thus, because it was unlike appraisal as recognized to that point and gave the plaintiffs another chance to seek appraisal beyond the expired appraisal deadlines, the court called the remedy “quasi-appraisal.”

The Weinberger court did not attempt to create a new remedy apart from statutory appraisal in future cases, rather, its exclusive purpose was to liberalize the appraisal remedy to include “all relevant factors” and to grant the plaintiffs in that particular case, and others similarly situated, the retroactive benefit of such liberalization. The Weinberger court made this as clear as possible. It expressly limited the remedy to that case, other pending cases and mergers with an effective date on or before February 1, 1983 or where notice would be mailed to stockholders on or before February 23, 1983, and held that “we return to the well-established principles of Stauffer v. Standard Brands, Inc., … and David J. Greene & Co. v. Schenley Industries, Inc., … mandating a stockholder’s recourse to the basic remedy of an appraisal.”

For a short period, the limitations set forth in Weinberger on the scope of the quasi-appraisal remedy were observed. A number of cases after Weinberger, however, interpreted and applied the remedy in wider, varying circumstances not contemplated by Weinberger, with the result that outcomes became less predictable.

Two of the post-Weinberger cases addressed themes that have been resuscitated in recent opinions. In both Steiner and Ocean Drilling, the court was given approximately twenty-four hours to decide whether or not to enjoin, on the basis of deficient disclosure, a merger that had been approved by a majority stockholder. Each merger was a fait accompli from the perspective of the stockholder vote. Thus, there was both little practical value in a disclosure-based injunction and too little time to make the close call of whether the marginal disclosure claims presented justified an injunction. Weighing the respective harms, the court held in both cases that an injunction would not issue. As a consolation to the plaintiffs and further justification for denying the injunctions, the court noted in each case that plaintiffs could seek a quasi-appraisal. As discussed below, these circumstances were unique and do not provide a sufficient basis to expand the doctrine of quasi-appraisal.

Other post-Weinberger cases have applied quasi-appraisal in very different circumstances. Nebel v. Southwest Bancorp, Inc. is a notable example of the Court of Chancery employing the quasi-appraisal remedy to address a then-novel, but recurrent problem. In Nebel, minority stockholders who had not elected appraisal challenged a short-form merger. The court held that the company’s failure to include an accurate version of the appraisal statute was a per se disclosure violation because the appraisal statute mandates that corporations attach the operative statute to the merger notice. The court then held that the proper remedy for this violation was to permit the plaintiffs to maintain a class-wide quasi-appraisal to determine “the plaintiffs’ proportionate share of the statutory fair value” of the company.

The Court of Chancery again addressed quasi-appraisal in Gilliland v. Motorola, Inc., allowing an action for quasi-appraisal to proceed where a company had provided no financial information in the notice sent to stockholders advising them of the completion of a short-form merger. While the statute did not expressly require such disclosure (as had been the case in Nebel) the requirement for the dissemination of some measure of financial information was well-established by caselaw. Nevertheless, the Court of Chancery noted that the short form merger at issue had immediately followed a hotly contested hostile tender offer in which the stockholders had been flooded with up-to-date financial information about the company.  Thus, it was most unlikely that stockholders were actually deprived of the financial information needed to make an appraisal election. This factual scenario caused the court to reject the plaintiffs request for certification of an opt-out class composed of all minority holders. Drawing on the court’s inherent power to fashion an appropriate remedy, the court looked to the appraisal statute—for which the quasi-appraisal remedy originally was intended to be a rough substitute—and held that the remedy would be available to stockholders who opted into the class proceeding and who escrowed a portion of the merger proceeds they had received. These features were designed to replicate the important features of an appraisal proceeding.

After Gilliland, however, the Delaware Supreme Court weighed in on the proper scope of a quasi-appraisal remedy in Berger v. Pubco, holding that it did not require in every case replication of the features of the appraisal statute. The disclosure violations in Berger were that the defendants failed to disclose how the merger price was set in the short-form merger at issue and attached the wrong appraisal statute. The Delaware Supreme Court held that an opt-out procedure was more appropriate in that case than an opt-in procedure because opting-out was both “potentially more burdensome” to plaintiffs and would impose “no burden on the corporation.”  Further, the court held that it would not require stockholders to escrow any portion of the merger consideration pending the outcome of the case because there was no authority on point and because such a requirement would, the court held, be incongruous when compared with the remedies available in a long-form merger.

Nebel, Gilliland, and Berger all involved omissions in squeeze-out mergers and, thus, at least belong to the same category of cases as Weinberger. More recently, the quasi-appraisal remedy has been discussed in the Court of Chancery in a variety of different settings. In Krieger v. Wesco Financial Corp., the Court of Chancery denied a preliminary injunction in part because, it observed, any harm could be remedied by a later quasi-appraisal. The court did not expressly avert to Steiner and Ocean Drilling but the themes are similar, albeit under very different factual circumstances. In Krieger, the plaintiffs claimed that a cash election merger triggered appraisal rights and the company had not so informed the stockholders. The proxy materials took the position that no appraisal rights were available. Rather than decide whether appraisal was available on a preliminary injunction record, the court held that if appraisal rights really were available, the harm could be cured by the remedy of later quasi-appraisal, thus obviating the need for a preliminary injunction. In a later decision in the case, the court expressly held that appraisal was not available, removing the threat of a post-closing class-wide, appraisal type remedy.

In other recent cases, the Court of Chancery has expressed a more expansive view of when quasi-appraisal could be available. In Kahn v. Chell, the Court of Chancery remarked that “[i]f folks are deprived of their ability to make a valid appraisal election because of a lack of material information” then quasi-appraisal would be available under Berger v. Pubco Corp. Unlike Berger, Kahn did not involve a short-form merger. Rather, a majority stockholder had consented to the third-party transaction immediately following board approval, a so-called “sign-and-consent deal.” Although the disclosures did not directly concern the availability of appraisal, the court maintained a tie to earlier quasi-appraisal cases by connecting its holding to the fundamental question of whether stockholders’ appraisal rights had been harmed, not to a more general concern about the adequacy of disclosures affecting pre-closing remedies.

Most recently, that final connection to the core quasi-appraisal cases may have been severed, leaving quasi-appraisal as a post-closing remedy available generally for disclosure violations. In a hearing in Parcell v. Southwall Technologies, Inc., the court went further still. It noted that the situation did not call for expedition because “if [plaintiffs] have any disclosure claims, [plaintiffs will] get a quasi appraisal case as contemplated by Berger versus Pubco.” The court expressed the view that quasi-appraisal actions were unattractive to “plaintiffs’ lawyers who represent small holders and bring actions on a class-wide basis” because “[i]t gives them less ability to extract disclosure-only settlements that result in them being awarded a fee.” It seems at least as true that the remedy of quasi-appraisal is unattractive to defendants and their counsel, a fact demonstrated by the Rock-Tenn litigation discussed below. Moreover, plaintiffs thrive on uncertainty and in that respect quasi-appraisal is fertile ground. For precisely the same reason, it is unsettling to companies considering litigation risk in connection with M&A activity. Why that is so can be demonstrated by recent developments in a case that has not yet produced a judicial opinion, but has engendered a great deal of opinions among the bar.

The Latest in Quasi-Appraisal

The ongoing litigation in connection with Rock-Tenn Company’s acquisition of Smurfit- Stone Container Corp. illustrates the potential for quasi-appraisal to upset expectations around stockholder litigation and undermine existing litigation strategies. Until closing, the litigation proceeded as expected. The defendants announced the transaction on January 23, 2011. Three days later, the complaints began rolling in. Actions were filed in Delaware and Illinois and eventually proceeded in Delaware. The defendants made additional disclosures and the plaintiffs failed to achieve a preliminary injunction on their remaining non-disclosure claims (their better disclosure claims had been mooted by the additional disclosures). The transaction was approved and closed on May 27, 2011.

After closing, the acquiror received a letter from Ivory Hill Investments LLC, a purported former stockholder of Smurfit-Stone. According to a letter later filed with the Court of Chancery, Ivory Hill pointed out that the appraisal statute attached to the proxy was outdated and threatened a class-wide quasi-appraisal action. Thus, the defendants were faced with additional, unexpected liability exposure based simply on the inclusion of an outdated version of the appraisal statute, without any showing that there were material changes in the revised statute. Rather than paying Ivory Hill the “substantial return” allegedly demanded, the acquiror sent a letter to the Court of Chancery explaining the situation and sued Ivory Hill seeking a declaratory judgment that Ivory Hill’s claims did not give rise to a quasi-appraisal remedy.

The parties recently agreed to settle, but defendants have not escaped unscathed. They did not agree to the pure, class-wide, opt-out quasi-appraisal remedy as formulated by Berger and sought by Ivory Hill but, instead, to a remedy akin to that ordered in the earlier Gilliland case: all stockholders (including those who voted in favor of the merger) would be permitted the opportunity to opt into a quasi-appraisal class that would replicate, in part, the economic considerations of a traditional appraisal remedy. Stockholders who voted for the merger and who wanted to be part of the quasi-appraisal action would be required to return the merger consideration they received. Stockholders who did not vote in favor, but had not sought appraisal would be required to escrow a portion of the cash.” Stockholders who did not vote in favor and had already exercised their appraisal rights would not be affected in any way. These features dampen the potential harm to Rock-Tenn caused by the inclusion of the wrong appraisal statute in the merger proxy material, although it will remain subject to the possibility of a much broader class of appraisal claimants. As of writing, the settlement has not yet been approved by the court.

The defendants in the Smurfit-Stone litigation appear to have made the best of the situation that was sprung on them, but it was clearly a suboptimal outcome as compared to the expected course of merger litigation. Ivory Hill was a uniquely unsympathetic plaintiff because of the way it appears to have intentionally ambushed the defendants after closing. But situations may arise in which the plaintiffs, through no fault of their own, only discover disclosure failures after closing and after the appraisal period has run. In such a scenario, the plaintiffs may be entitled to a pure Berger-style quasi-appraisal which would enable them to bring a claim on behalf of the entire class of stockholders without the need to escrow any merger consideration.

The Future of Quasi-Appraisal

In the stockholder litigation that has become routine in any sale of a public company, the litigants generally pursue a pre-closing remedy. The incentives for the defendants are clear: they want to eliminate the risk of an injunction and stanch the ongoing legal expenses. The incentives for plaintiffs, however, are less organic and have been shaped by the Delaware courts. The courts have traditionally admonished plaintiffs that the time to bring disclosure claims is prior to the shareholder vote. As such, the plaintiffs are typically incentivized to maximize the threat of an injunction in order to extract concessions.

The quasi-appraisal remedy, however, is triggered in an odd variety of situations when the disclosures either fail to meet the statutory requirements or for some other reason were inadequate to permit stockholders to decide whether appraisal should be sought. As such, the possible availability of a quasi-appraisal remedy changes plaintiffs attorneys’ incentives because it leaves them an avenue to attack a merger post-closing on the basis of inadequate disclosures in unpredictable ways. In addition, because the remedy is available to the entire class of stockholders, the attorneys fees for any recovery could be far greater than in a comparable appraisal action. If quasi-appraisal becomes available as a matter of course to address disclosure claims after closing, litigation costs could increase dramatically with no reason to believe that there would be any accompanying benefit to stockholders in general. This would be an unfortunate outcome at odds with a long tradition of incentivizing plaintiffs to bring their disclosure claims when it can benefit the stockholders—before the stockholder vote.

In light of these developments, it is absolutely essential that the stockholder communications provide adequate information to allow stockholders to choose whether or not to seek appraisal. One risk is easily eliminated. If an appraisal notice is required ensure (and re-ensure) that the correct copy of the appraisal statute is attached and that its provisions are accurately described. This is true even in private company and short-form mergers where disclosure tends to be less expansive.

Perhaps more importantly, buyers may need to reconsider whether the class-wide stockholder release that is customary for pre-closing settlements has become an imperative and that it cover potential post-closing quasi-appraisal actions. When a transaction involves a third-party buyer, the price is likely to equal or exceed the going concern value sought in appraisal (as often recognized by the Court of Chancery). In such a case, the risk should be low that a quasi-appraisal remedy will result in a significant damages recovery for the plaintiff class. Nevertheless, some risk exists, and, especially in a large transaction, even a few cents per share may represent a substantial amount when paid on a class-wide basis. Moreover, the acquirer certainly will incur substantial legal fees in defending the litigation to final resolution. Thus, in calculating the costs and benefits of a pre-closing settlement, the possibility of quasi-appraisal will likely weigh on the side of making peace and securing the protection of a release to guard against later litigation surprises.

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