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E-MailCharles Korsmo is Assistant Professor of Law at Case Western Reserve University School of Law and Minor Myers is Professor of Law at Brooklyn Law School. This post is based on a recent article by Professors Korsmo and Myers and is part of the Delaware law series; links to other posts in the series are available here.
In a forthcoming article, we critique Delaware’s system for awarding prejudgment interest in stockholder appraisal actions and propose a set of reforms designed to improve upon the existing regime.
The recent rise in appraisal litigation is largely a positive development, as we have argued before and as mounting evidence confirms. Nonetheless, it has sparked a backlash among an influential group of deal advisers and defendants. Citing danger to the deal market, these critics have sought drastic changes in Delaware to curtail the ability of minority shareholders to pursue appraisal.
One unlikely flashpoint in this battle is the statutory interest rate awarded to petitioners in appraisal proceedings. In 2007, the Delaware legislature amended the appraisal statute to establish a presumptive interest rate equal to the prevailing federal funds rate plus 5%. As we show in our paper, this amendment reflected more a codification of existing judicial practice than a sharp change: the Court of Chancery had been awarding at rates along these lines since the 1990s. Nevertheless, critics contend that this statutory interest rate has been a prime driver of the increase in appraisal activity, with sophisticated “appraisal arbitrageurs” parking money in appraisal claims in order to take advantage of an “above-market” interest rate. Delaware recently enacted an amendment designed to moot the interest rate question by allowing an appraisal respondent to prepay an amount of its choosing, thereby avoiding the accrual of interest.
A striking feature of complaints about the interest rates—even when made by otherwise sophisticated observers—is the failure to articulate any general principles for the role of interest in appraisal, or for determining whether the statutory rate is, in fact, too high.
In our article, we develop a set of relevant principles, and we use them to propose reforms that would improve the functioning of Delaware’s appraisal remedy by encouraging accurate, economical resolution of disputes over fair value.
The primary policy goal in designing an interest regime should be to make the parties time-indifferent, with no incentive to either prolong the proceeding or give up value to secure a hasty settlement. Likewise, the interest regime should ideally not distort the incentives of minority stockholders to dissent in the first place. The decision to dissent should be driven by the merits—a divergence between the merger consideration and fair value—not by the interest rate. To these primary goals we add the principle that the interest rate regime should economize on litigation costs and, at the margin, err in the direction of encouraging settlement.
Drawing on these principles, we offer a set of reforms that builds upon Delaware’s recent amendment and improves the interest rate regime. We propose that the respondent should have a unilateral option to prepay an amount of its choosing to the dissenting stockholder within 30 days of the completion of the relevant transaction. The dissenting stockholder would thereafter possess a unilateral option to walk away from the litigation for the amount prepaid. Finally, following trial, either party would be liable to the other for interest on the difference between the amount prepaid and the adjudged fair value, with the interest rate set at the weighted average cost of capital of the target company, a figure that is already required to be calculated in virtually every appraisal proceeding.
Our proposal would force the company and the dissenting stockholders to be reasonable: The company would face an incentive to put its best offer of fair value on the table, and the dissenting stockholder similarly must decide whether fighting for additional value is really worth it. This also would promote settlement, a welcome development for an area of law that has been regularly characterized by the Court of Chancery as pitched battle. By correcting the incentives associated with the passage of time, our reforms to the interest rate regime can promote efficiency-enhancing settlements.
Equally important, strong appraisal claims would be unharmed by our proposal. If anything, the focus of the litigation in such cases would be more squarely on the merits of the claim—the fair value of the cashed-out stock—without any distractions associated with the interest rate. The amount of equity dissenting in the most problematic transactions may increase. Given the salutary effects of appraisal activity we have adduced in other work, this would be a welcome development.
Like the recent Delaware amendment, our proposal addresses precisely the problem that critics say is generated by the current interest rate regime: that the interest rate is an independently attractive feature of participating in an appraisal claim. Under our reforms, it would no longer be even theoretically attractive for a stockholder to dissent in hopes of capturing the statutory interest rate. If a company were confident that the merger price equals the fair value of the stock, it could immediately pay the dissenters the merger price, and never pay a cent in interest. The threat of this outcome would prevent stockholders from pursuing such a path in the first place. Thus, the supposed policy crisis—that the statutory interest rate is deforming the appraisal remedy—would be solved completely.
The complete article is available for download here.
