On The Case

Appraisal litigation after Aruba? It’s still a bad bet for shareholders

(Reuters) - For hedge funds specializing in appraisal litigation – in which shareholders refuse to tender their shares of a target company to the acquirer and instead ask a judge to set a fair value for their stake – there was good news and bad news in Tuesday’s extraordinary opinion from the Delaware Supreme Court in Verition Partners v. Aruba Networks.

The good news is that the Supreme Court outright rejected the notion that a company’s pre-deal share price is the most reliable indicator of its fair value. Last year, you may recall, Vice-Chancellor Travis Laster of Delaware Chancery Court threw plaintiffs’ lawyers into a tizzy when he relied on Aruba’s 30-day average trading price of $17.13 to determine the company’s fair value in the run-up to its 2015 acquisition by HP at $24.67 per share. Since most acquirers pay a premium over the target’s trading price, Laster’s methodology suggested it would be idiotic for shareholders bring appraisal actions: They’d be awarded less for their shares than they’d have gotten by participating in the deal.

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The Delaware Supreme Court said Vice-Chancellor Laster misread its precedent in two 2017 cases, DFC Global v. Muirfield Value Partners and Dell v. Magnetar, and abused his discretion by basing his fair-price valuation on Aruba’s trading price. “The Vice Chancellor seemed to suggest that this court signaled in both cases that trading prices should be treated as exclusive indicators of fair value,” the Supreme Court wrote. “However, Dell and DFC did not imply that the market price of a stock was necessarily the best estimate of the stock’s so-called fundamental value at any particular time … The Vice Chancellor surfaced Aruba’s stock price as an appropriate measure of fair value in a way that is antithetical to the traditional hallmarks of a Court of Chancery appraisal proceeding.”

So trading price is officially off the table as a proxy for fair value. Should we expect a resurgence in appraisal litigation?

I don’t think so – because the bad news in Aruba is that the Delaware Supreme Court now seems to regard the per-share deal price as a ceiling – not a floor – for the fair value of a company acquired by a publicly-traded competitor. Chancery judges, the opinion said, should begin with the assumption that the deal price reflects a fair market value for the target company – and should subtract the value of whatever synergies the acquiring company has factored into its bid. (The calculation is a bit different when the acquirer is not a public company; instead of subtracting the value of synergies, the Supreme Court said, judges should subtract the value of “reduced agency costs” to reflect that a private equity owner can run things more efficiently than diffuse shareholder owners.)

Basically, under Aruba, disgruntled shareholders of a target company shouldn’t expect Chancery judges to place a higher value on their shares than the acquirer has agreed to pay (unless there’s something really hinky about the deal process.) In the heyday of appraisal arbitrage, hedge funds that brought appraisal actions benefited from Delaware’s generous statutory interest rate, but Delaware legislators changed the law a few years back to reduce the interest rate incentive. Now that the Delaware Supreme Court has said that fair value calculations, in deals involving public companies, roll downhill from the deal price, there seems to be little sense in spending the time and money to litigate appraisal actions.

Indeed, the Verition hedge funds that brought the action against Aruba will wind up with $19.10 per share as a result of the Supreme Court’s ruling. The justices reached that figure by starting with the $24.67-per-share deal price and subtracting HP’s estimate of the value of the synergies it would achieve in the deal. Nineteen bucks is more than Vice-Chancellor Laster said Aruba shares were worth based on their pre-deal trading price – but it’s a lot less than the hedge funds would have gotten if they’d sold to HP at the deal price. (Ironically, the Delaware Supreme Court chided Vice-Chancellor Laster for “injecting due process and fairness problems into the proceedings” for basing his valuation on an idea that neither side tested at trial but the justices’ fair value calculation, which came from an HP post-trial brief, also wasn’t subject to cross-examination.)

In case you haven’t already sensed it from the snippets I’ve quoted, the per curiam Supreme Court opinion is stunningly tough on Vice-Chancellor Laster. In addition to reaching the legal conclusion that the trial judge abused his discretion, the opinion criticized Laster, in rather tart terms, for his “surprising” perception of the Supreme Court’s 2017 appraisal cases – one of which, as the Aruba opinion noted, reversed a Laster appraisal decision in the Dell case.

The justices even mentioned the hedge funds’ assertion that Vice-Chancellor Laster meant to provoke the Supreme Court after he was reversed in Dell. “As Verition argued,” the Supreme Court opinion said, “the Vice Chancellor’s desire not to award deal price minus synergies could be seen — in light of his letter to the parties and the overall tone of his opinion and reargument decision — as a results-oriented move to generate an odd result compelled by his personal frustration at being reversed in Dell.”

The vice-chancellor rejected Verition’s assertion when the hedge fund first suggested it in a motion for reargument, writing, “I personally do not believe that I issued the post–trial ruling out of frustration. To the contrary, I personally believe that I engaged in a lengthy, laborious (in both senses), and reasoned effort to implement Delaware Supreme Court precedent.” In Tuesday’s opinion, the justices said they “take (Laster) at his word” – but not before repeating Verition’s theory that Laster had acted out of pique. The Supreme Court said that “the evident plausibility” of the assertion “gives us pause.”

Clearly, the Delaware Supreme Court wrote the Aruba decision to make a point, not just to prospective appraisal plaintiffs but also to Vice-Chancellor Laster.

The Verition funds were represented at the Supreme Court by Christine Mackintosh of Grant & Eisenhofer. Michael Kelly of McCarter & English argued for Aruba. Both lawyers declined to provide a statement on the ruling.