Responding to Appraisal Demands

At a Glance

• Appraisal rights are a critical statutory remedy for stockholders who object to certain extraordinary corporate transactions, such as mergers or other change-of-control events. Under Section 262 of the Delaware General Corporation Law (DGCL), dissenting stockholders may demand the company purchase their shares at “fair value,” determined by the Delaware Court of Chancery. This guide provides a comprehensive overview of appraisal rights, the procedural mechanics for perfecting and responding to appraisal demands, and practical guidance for boards and legal counsel.

Overview of Appraisal Rights

Appraisal rights are governed by Section 262 of the DGCL, which allows dissenting stockholders to seek a judicial determination of “fair value” for their shares if they do not wish to accept the merger consideration. The remedy allows stockholders to require the company to buy their stock for its fair value immediately before the extraordinary transaction.

Appraisal rights can be triggered by mergers, domestications, and other corporate transactions. Recent amendments expanded coverage to include conversions under Section 266 and transfers or continuances to non-US jurisdictions under Section 390.

Transactions Triggering Appraisal Rights

Appraisal rights typically arise in mergers, but they also may be triggered in other change-of-control transactions, depending on the structure and state law.

Common triggers include:

• Long-form mergers requiring stockholder approval.
• Short-form mergers where the parent owns at least 90% of the subsidiary.
• Certain conversions or domestications.

Exceptions:

• Market-Out Exception. No appraisal rights for shares listed on national exchanges, unless stockholders receive only cash.
• De Minimis Exception. Minimum stake required for appraisal in some public corporations.

Mechanics of Appraisal Rights

To perfect appraisal rights under Delaware law, a stockholder must:

• Demand appraisal in writing, before the stockholder vote. Ensure their written demand sufficiently identifies them as the stockholder and clearly communicates their intention to seek appraisal for their shares.
• Not vote in favor of or consent to the transaction.
• Maintain continuous ownership of their shares from the demand date through the effective date of the transaction.
  • Delaware allows beneficial owners to demand appraisal directly, not just record holders, provided ownership is maintained through closing.
• File a petition with the Delaware Chancery Court and serve it on the surviving entity within 120 days of the transaction's effective date.

Since August 2022, beneficial owners (not just record holders) can demand appraisal directly, but those owners must demonstrate continuous ownership through the transaction’s effective date. In addition, a beneficial owner seeking appraisal must (1) identify the record holder of the shares it beneficially owns; (2) accompany the demand with documentary evidence of its beneficial ownership; and (3) include a statement affirming that the documentary evidence is a true and correct copy. The demand must also provide an address at which the beneficial owner consents to receive notices from the surviving, resulting, or converted entity and to be listed on the verified list required by subsection (f) of Section 262.

The Chancery Court is unforgiving of procedural lapses. A stockholder that does not establish its compliance with relevant appraisal rules will have its claim dismissed. But the company is not required to notify stockholders of all deficiencies in their appraisal demands. The company may wait until after the petition is filed to raise all defects in an appraisal demand.

Responding to Appraisal Demands

The corporation must notify stockholders of the availability of appraisal rights at least 20 days before any stockholder meeting called to vote on a transaction, such as a merger or consolidation. For transactions approved without a meeting — such as by written consent or short-form merger — the corporation must provide notice within 10 days after the transaction’s effective date. In addition, the notice:

• Must include either a copy of Section 262 or a link to access it freely online.
• Can be delivered electronically unless the stockholder objects.
• Must include disclosures that are accurate and sufficiently detailed to permit stockholders to decide whether to seek appraisal in lieu of transaction consideration.

A board’s failure to deliver proper notice can result in a claim for breach of fiduciary duty.

Upon receiving appraisal demands, the company must provide a statement of the aggregate number of shares for which appraisal has been demanded (upon request), and then file a verified list of stockholders demanding appraisal with the Register in Chancery within 20 days of being served with the appraisal petition.

What to Keep in Mind About Appraisal Litigation

The Delaware Chancery Court will determine entitlement to appraisal, scrutinizing whether stockholders have properly perfected their rights. When first served with an appraisal demand, the company should immediately assess compliance of each demand.

Both the dissenting stockholders and the company bear the burden of establishing fair value by a preponderance of the evidence. Thus, after receiving the appraisal demand — if not as part of the underlying transaction — the company should gather and organize evidence supportive of the deal price, as well as documents and communications necessary to reach the conclusion that the sale process was fair and unbiased. To meet that burden, both petitioning stockholders and the corporation typically present expert witness testimony and detailed financial analyses, which the Court of Chancery has broad discretion to consider under Section 262(h).

The court may assign significant weight to management projections made in the ordinary course of business and will reject projections or valuation approaches it finds unreliable, speculative, or tainted by conflicts. The court is not bound by the parties’ suggested values and may estimate a value range by blending or independently analyzing multiple approaches. Even if both parties’ evidence is insufficient or unconvincing, the court must still assign a value to the shares, underscoring the importance of thorough, credible expert testimony and financial analysis in the appraisal process.

Negotiating settlements with non-petitioning dissenters can be an effective strategy for corporations facing appraisal demands, especially when the stake held by dissenting stockholders is relatively small compared to the potential costs and risks of litigation. By resolving claims early, companies can reduce uncertainty, avoid protracted litigation, and prevent the accrual of statutory interest, which can be substantial given the length and complexity of appraisal proceedings. Under Section 262(h), a company can prepay any amount to appraisal claimants at any time before judgment, effectively stopping further accrual of pre-judgment statutory interest — which is set at 5% above the Federal Reserve discount rate and compounded quarterly — from the date of the merger until the date of payment. However, companies should know that Delaware does not require dissenting stockholders to refund any overpayment if the prepayment exceeds the fair value ultimately determined by the court. To address this risk, corporations should negotiate an upfront contractual clawback provision for any appraisal prepayments.

Determining Fair Value

To value the corporation as a going concern, excluding speculative merger synergies, the court will consider the following approaches:

• Merger price (deal price minus synergies). Assumes a well-run, robust, arm’s-length, and market-based sale process.
• Unaffected market price (pre-merger trading price). Assumes a deep and efficient public market. This methodology reflects what buyers and sellers in the open market thought the shares were worth, based on all public information, before news of the merger influenced prices.
• Discounted Cash Flow (DCF) analysis. Relies on management projections made in the ordinary course of business. DCF tries to estimate how much money the company will make in the future, then adds up the value of all those future amounts, and then discounts back to today’s dollars.
• Comparable companies and transactions analyses. Considers what other, similar companies are worth, or what buyers have paid for similar companies in other transactions.

Practical Guidance for Management

Before the Transaction

• Conduct a thorough, arm’s-length sale process to maximize deal price reliability in any subsequent appraisal action. Document efforts to solicit multiple bidders, reject low offers, and run a competitive auction.
• Assess the likelihood of appraisal demands by considering the shareholder base and any deal features or process flaws that might attract dissent.
• Decide whether to include maximum-dissent closing conditions in merger agreements. These conditions may permit the buyer to withdraw if more than a certain percentage of stockholders (or shares) seek appraisal before closing.

During the Transaction

• Ensure compliance with all statutory notice and disclosure requirements. Failure to comply can undermine the company’s defense in later litigation.
• Maintain accurate records of communications and demands.
• Develop certainty with valuations and consider engaging an expert to ensure that the support for the valuation is documented during the transaction process.

After Receiving an Appraisal Demand

• Confirm whether each demand complies with statutory requirements.
• File required lists and respond timely to court and stockholder requests.
• Evaluate whether to prepay appraisal amounts to mitigate interest exposure.
• Use the waiting period before the petition is filed to negotiate and potentially resolve appraisal demands.