January 6, 2015 / 9:40 PM / 4 years ago

Hedge fund scores win for appraisal arbitrage strategy

Jan 6 (Reuters) - A Delaware court has ruled in favor of an increasingly popular strategy in which hedge funds buy the stock of a company targeted in a merger and then litigate for a bigger payout on their shares.

In a pair of Monday rulings, Sam Glasscock, a vice chancellor of the Court of Chancery, ruled that Radnor, Pennsylvania-based hedge fund Merion Capital could seek an appraisal of its 1.8 million shares in Ancestry.com and its 7.6 million shares in BMC Software Inc.

The decisions hinged on whether Merion could ask a judge to value the stock even though Merion did not vote against the 2012 buyout of genealogy website Ancestor.com by private equity firm Permira and the 2013 acquisition of software company BMC by Bain Capital and Golden Gate Capital.

Appraisal rights have traditionally allowed shareholders to seek a better price in a deal they oppose. In recent years, hedge funds have bought up blocks of stock in deals they considered undervalued and then pursued appraisals to generate big payouts, a strategy known as “appraisal arbitrage.”

Merion bought its stock in between the record date, which determines who is eligible to vote on the buyout, and the shareholder meeting when the vote is held.

The companies argued that Merion Capital should be required to show that the prior owner of the shares had abstained or voted against the deal. Appraisal is not available to those shareholders who vote in favor of a merger.

Glasscock ruled that it only mattered that Merion had not voted for the deal, had given proper notice it was seeking appraisal, and held the stock.

The cases were closely watched as a ruling against Merion could have made its strategy much more difficult to pursue.

“There was a big open question if Chancery would kill appraisal arbitrage,” said Steven Hecht, an attorney with Lowenstein Sandler who tracks the appraisal cases.

Merion and lawyers for Ancestry.com and BMC did not immediately respond to requests for comment.

Merion, founded by securities class action lawyer Andrew Barroway, has been a leader in bringing appraisal arbitrage cases, which can take years.

Unlike shareholder class action lawsuits, Merion does not have to prove any wrongdoing by the company’s board of directors, just that the deal price was unfair.

The strategy has produced big returns. In 2012, Orchard Enterprises Inc was ordered to pay Merlin Partners and others $4.67 per share for their stake in the company, more than twice the $2.05 per share merger price. (Reporting by Tom Hals in Wilmington, Delaware; Editing by Noeleen Walder and Leslie Adler)

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