A friend (who uses my casebook, which gets him extra points) sent along this email:
I assume it is possible for a corporation to contract around appraisal in some meaningful way, but I'm having trouble finding a supporting citation. Any suggestions?
For those joining us late, I explain in my book Mergers and Acquisitions
Mergers and sales of all or substantially all corporate assets can be likened to a form of private eminent domain. If the requisite statutory number of shares approves the transaction, dissenting shareholders have no statutory basis for preventing the merger. Granted, some of the minority shareholders may believe that the merger that is being forced upon them is unfair. They may want to retain their investment in the target or they may believe that the price is unfair.
Corporate statutes give hold-out shareholders no remedy where they simply want to keep their target shares—the statutes permit majority shareholders to effect a freeze-out merger to eliminate the minority. All the statute gives disgruntled shareholders is a right to complain about the fairness of the price being paid for their shares; namely, the appraisal remedy.
In theory, appraisal rights are quite straightforward. Briefly, they give shareholders who dissent from a merger the right to have the fair value of their shares determined and paid to them in cash, provided the shareholders comply with the convoluted statutory procedures.
Obviously, appraisal crops up in purchase agreements. Practical Law tells us that buyers sometimes "demand appraisal-rights closing conditions in their merger agreements. An appraisal-rights closing condition places a maximum limit on the percentage of common stock that can demand appraisal before the buyer can refuse to close." In addition, sellers sometimes offer a representation that appraisal rights are not available in connection with the transaction.
Also, of course, appraisal statutes commonly provide a "market" out that eliminates appraisal rights in certain transactions. Again, we turn to Practical Law:
Delaware, along with several other states (such as California, New Jersey, Texas, and Pennsylvania), maintains an exception to a stockholders' right to an appraisal. This exception, commonly known as the "market-out" exception, is based on whether a stockholder owns shares of a public company or stock that is held by a significant number of stockholders.
The market-out exception presumes that stockholders do not need appraisal rights when they are not being cashed out in the merger and there is a public and liquid market for their stock. If they disagree with a transaction, stockholders can sell their stock in the open market for the fair market value rather than involve the courts.
In Delaware, the market-out exception is only available if stockholders hold stock that is either:
- Listed on a national securities exchange.
- Held of record by more than 2,000 holders. (8 Del. C. § 262(b)(1).)
As of August 1, 2018, the market-out exception applies equally to two-step mergers conducted as front-end tender offers under Section 251(h) of the DGCL. ...
In Delaware, a stockholder owning public company shares listed on a national securities exchange regains the right to a statutory appraisal if the stockholder has to accept anything in the transaction other than:
- Stock of the surviving corporation.
- Stock of any other corporation that is or will be listed on a national securities exchange or held by more than 2,000 stockholders.
- Cash in lieu of fractional shares.
- Any combination of the above. (8 Del. C. § 262(b)(2)(a)-(d).)
None of this, however, speaks to the query. The question was whether you can get out of appraisal by contract. Before we can answer that query, however, we need to further refine it. Could the corporation include a provision in the articles of incorporation eliminating or limiting appraisal rights? Could the shareholders enter into a shareholder agreement that limited or eliminated appraisal rights? Does it matter whether we are talking about a public or a closely held corporation?
I start by looking at DGCL § 262, the appraisal statute. I don't see anything therein that provides a contractual out.
I then turned to the Model Business Corporation Act, which devotes an entire chapter (13) to what it calls dissenter rights. Section 13.02(c) provides a limited option to limit or eliminate appraisal rights:
... the articles of incorporation as originally filed or any amendment to the articles of incorporation may limit or eliminate appraisal rights for any class or series of preferred shares, except that (i) no such limitation or elimination shall be effective if the class or series does not have the right to vote separately as a voting group (alone or as part of a group) on the action or if the action is a conversion under section 9.30, or a merger having a similar effect as a conversion in which the converted entity is an eligible entity, and (ii) any such limitation or elimination contained in an amendment to the articles of incorporation that limits or eliminates appraisal rights for any of such shares that are outstanding immediately before the effective date of such amendment or that the corporation is or may be required to issue or sell thereafter pursuant to any conversion, exchange or other right existing immediately before the effective date of such amendment shall not apply to any corporate action that becomes effective within one year after the effective date of such amendment if such action would otherwise afford appraisal rights.
If you think of the articles as a contract (as I do), we have here a limited contract out. But it's very limited. In particular, it doesn't apply to common stock.
So I then turned to MBCA § 7.32, which governs shareholder agreements. It effectively only applies to close corporations, since it requires unanimity among the shareholders.
Nothing in § 7.32 expressly authorizes contracting out of appraisal, but there is a fairly broad catchall:
(a) An agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation even though it is inconsistent with one or more other provisions of this Act in that it: ...
(8) otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among the shareholders, the directors and the corporation, or among any of them, and is not contrary to public policy.
The commentary explains that:
Although the limits of section 7.32(a)(8) are left uncertain, there are provisions of the Act that may not be overridden if they reflect core principles of public policy with respect to corporate affairs. For example, a provision of a shareholder agreement that purports to eliminate all of the standards of conduct established under section 8.30 might be viewed as contrary to public policy and thus not validated under section 7.32(a)(8). Similarly, a provision that exculpates directors from liability more broadly than permitted by section 2.02(b)(4), or indemnifies them more broadly than permitted by section 2.02(b)(5), might not be validated under section 7.32 because of strong public policy reasons for the statutory limitations on the right to exculpate directors from liability and to indemnify them. The validity of some provisions may depend upon the circumstances. For example, a provision of a shareholder agreement that limited inspection rights under section 16.02 or the right to financial statements under section 16.20 might, as a general matter, be valid, but that provision might not be given effect if it prevented shareholders from obtaining information necessary to determine whether directors of the corporation have satisfied the standards of conduct under section 8.30. The foregoing are examples and are not intended to be exclusive.
Do dissenter rights "reflect core principles of public policy with respect to corporate affairs," such that they would fall within the non-exclusive list of provisions that may not be modified by contract? I was unable to find anything in the MBCA text or commentary that spoke to that issue.
Interestingly, however, Florida's version of § 7.32 formerly provided that:
For purposes of this paragraph, agreements contrary to public policy include, but are not limited to, agreements that reduce the duties of care and loyalty to the corporation as required by ss. 607.0830 and 607.0832, exculpate directors from liability that may be imposed under § 607.0831, adversely affect shareholders' rights to bring derivative actions under s. 607.07401, or abrogate dissenters' rights under §§ 607.1301-607.1320.30
Since Florida is an MBCA state, that sent me back to the history of § 7.32. The statutory comparison included in the MBCA Annotated says that Florida's version of § 7.32(a)(8) was unique.
A Westlaw search for the phrase "public policy" /s "dissent! right!" turned up noting pertinent except for a few references to the Florida statute. A search for the phrase "public policy" /s "appraisal! right!" kicked up one case claiming that courts have "have found a de facto merger or a continuation of the enterprise [where they] have involved public policy considerations which favor compensating tort victims or appraisal rights to minority shareholders." Atlas Tool Co., Inc. v. C. I. R., 614 F.2d 860, 871 (3d Cir. 1980). But the court cited only one case, Knapp v. N. Am. Rockwell Corp., 506 F.2d 361, 367 (3d Cir. 1974), which was a tort case not an appraisal case. A few courts have quoted Atlas, but without useful elaboration.
A Westlaw search for (contract! /5 (around out)) /s "appraisal! right!" found only two results. The first was an article by Ian Ayres from 1991, in which he asserted that:
In the corporate context, for example, most states allow shareholders to contract around the default of preemption rights in the corporation's articles of incorporation, but minority appraisal rights are an immutable part of any corporate form of business. See Black, Is Corporate Law Trivial?: A Political and Economic Analysis, 84 NW. U.L. Rev. 542 (1990); see generally Bebchuk, The Debate on Contractual Freedom in Corporate Law, 89 Colum. L. Rev. 1395 (1989) (discussing mandatory and enabling aspects of corporate law).
Ian Ayres, Back to Basics: Regulating How Corporations Speak to the Market, 77 Va. L. Rev. 945, 999 (1991). As far as I could find, however, neither the Black nor the Bebchuk article speaks to contracting out of appraisal.
The other reference was a 1999 article by John Coates, in which he wrote that:
Some commentators have noted an alternative method for corporations in many jurisdictions to effectively avoid appraisal rights through the choice of transaction structure. See, e.g., Roberta Romano, Answering the Wrong Question: The Tenuous Case for Mandatory Corporate Laws, 89 Colum. L. Rev. 1599, 1600 (1989) (noting that the ability to choose transaction structure makes the rule that shareholders must vote on mergers “completely optional”). For example, the sale of substantially all of a Delaware corporation's assets does not trigger appraisal rights, while a merger does. Compared to “fair price” charter provisions, buy/sell agreements, and redeemable common stock (“discount contracts”), transaction choice is a blunt weapon. Discount contracts vary from traditional corporate structures only by specifying how the “fair value” will be determined. In addition, transaction choice only permits contracting around appraisal rights.
John C. Coates IV, "Fair Value" As an Avoidable Rule of Corporate Law: Minority Discounts in Conflict Transactions, 147 U. Pa. L. Rev. 1251, 1353 n.130 (1999). But this is not the sort of contracting out with which we are concerned. Instead, it's a transactional engineering out by opting for a transaction structure for which the law does not grant appraisal rights.
Turning back to Delaware law, it turns out that there are cases holding that preferred stockholders can waive appraisal rights. In Matter of Appraisal of Ford Holdings, Inc. Preferred Stock, 698 A.2d 973, 977 (Del. Ch. 1997), the certificate of designation governing the rights of the preferred stock in question purportedly limited appraisal rights by contractually specifying the price to be paid the preferred in the event a cash-out merger. Famed Delaware Chancellor William Allen began his analysis by noting that "preferred stock is a very special case." He went on to explain that:
All of the characteristics of the preferred are open for negotiation; that is the nature of the security. There is no utility in defining as forbidden any term thought advantageous to informed parties, unless that term violates substantive law. ...
It is my judgment ... that the terms of the Designations of the Cumulative Preferred clearly describe an agreement between the shareholders and the company regarding the consideration to be received by the shareholders in the event of a cash-out merger. There is no ambiguity ... regarding the value to be paid to shareholders if they are forced to give up their shares in a cash-out merger. The shareholders can not now come to this court seeking additional consideration in the merger through the appraisal process. Their security had a stated value in a merger which they have received.
See also In re Appraisal of Metromedia Intern. Group, Inc., 971 A.2d 893, 900 (Del. Ch. 2009) ("Given the contractual nature of preferred stock, a clear contractual provision that establishes the value of preferred stock in the event of a cash-out merger is not inconsistent with the language or the policy of § 262.").
But what about common shareholders?
At this point, I heard from a couple of friends who are experienced M&A practitioners. One pointed me to Manti Holdings, LLC v. Authentix Acq. Co., Inc., CV 2017-0887-SG, 2019 WL 3814453 (Del. Ch. Aug. 14, 2019). The shareholders of Authentix, Inc., a Delaware corporation, negotiated a merger with The Carlyle Group (a private equity fund manager). Under the terms of the deal, the former Authentix shareholders would remain shareholders of the post-merger entity, but with Carlyle now as a majority shareholder. The former Authentic shareholders, with the advice of counsel, unanimously entered into a shareholder agreement (SA) that waived any appraisal rights the shareholders might have in connection with the merger. In an unpublished opinion, Vice Chancellor Glasscock explained that:
The SA was not a contract of adhesion. As provided in the supplemental Joint Stipulation of Fact, the Petitioners—who were, I find, sophisticated parties—were represented by counsel, who exchanged drafts of the proposed SA before agreeing to a final contract. In other words, the sole owners of Authentix, Inc., with the help of counsel, negotiated the terms of the SA, as part of the 2008 merger with the Carlyle entity, Authentix, which merger was, I presume, valuable to the Petitioners. One of the provisions in that negotiated contract was, as I have found, a waiver of appraisal rights at issue here. The SA also rigorously limits the Petitioners' rights to sell their shares: the Carlyle majority must approve any sale, and the buyer must consent in writing to be bound by the SA's terms, including the waiver of appraisal rights. Presumably, the Petitioners have enjoyed the benefit of their bargain, through the time of the sale of Authentix.
The Vice Chancellor went on to hold that:
The SA is a clear, unambiguous contract, created as part of a merger, that was entered into by sophisticated parties, including the Petitioners here, who owned the entire interest in the entity to be merged. Modification of a statutory right to appraisal “must be express or at least very clearly implied.” This reasoning—that waiver of a party's rights is permitted, but must be clear—is found elsewhere in our law.
Here, Authentix Inc. was a private company (as is Authentix), and the Petitioners were its sole stockholders. There is no record evidence that the Petitioners were not fully informed; to the contrary, there is evidence that the Petitioners are sophisticated investors who were fully informed and represented by counsel when they signed the SA, under which they obtained some rights and relinquished others, and then accepted the benefits of that contract for seven years. The SA clearly and unambiguously waives appraisal rights; therefore, it should be enforced. I need not decide whether a waiver of appraisal would be upheld in other circumstances.
Notice the emphasis on four points: (1) this was a privately held company; (2) there was unanimity among the shareholders; (3) the parties were sophisticated investors represented by counsel; and (4) the terms are clear. To the extent Manti stands for the proposition that you can contract out of appraisal, it provides a very limited contractual out.
My other friend sent along this detailed note:
... venture capital investors routinely waive appraisal rights. The standard National Venture Capital Association form of Voting Agreement provides, in pertinent part, that the investor agrees "to refrain from (i) exercising any dissenters’ rights or rights of appraisal under applicable law at any time with respect to such Sale of the Company, (ii) asserting any claim or commencing any suit (x) challenging the Sale of the Company or this Agreement, or alleging a breach of any fiduciary duty of the Requisite Parties or any affiliate or associate thereof (including, without limitation, aiding and abetting breach of fiduciary duty) in connection with the evaluation, negotiation or entry into the Sale of the Company, or the consummation of the transactions contemplated thereby...."
So it looks like you can ex ante waive appraisal via a unanimous shareholder agreement in a closely held corporation (possibly excepting Florida corporations), and at least limit appraisal rights of preferred stock in the certificate of designation. As for common shareholders of public corporations, however, it seems doubtful.
In closing, I feel constrained to ask: What other casebook author gives you this sort of service?
Update: A friend sent along a link to an article by Jill Fisch:
A judicial determination of fair value in a private company can be a difficult and imprecise process. This difficulty coupled with variations in way mergers are negotiated and structured and the potential for conflicts of interest lend uncertainty to appraisal proceedings. As a result, corporate participants have powerful reasons to seek to limit the uncertainty associated with an appraisal proceeding ex ante. The response has been the growing use of shareholder agreements that limit appraisal rights.
Appraisal waivers also offer a potentially attractive solution to a somewhat different concern, the growth of appraisal litigation in publicly traded companies. As with private companies, public companies face the problem that appraisal proceedings involve substantial cost and uncertainty. Although courts and commentators have grappled with how best to calculate fair value and the impact of that methodology on the incentives of participants in the merger process, they have failed to reach consensus. Appraisal waivers provide an alternative approach - a market-based mechanism to determine the efficient level of merger litigation.
Public companies have not followed the lead of private companies, however, in using appraisal waivers. As this Article explains, the likely reason is the impracticality of using shareholder agreements in public companies and a concern that appraisal waivers in a charter or bylaw would be invalid.
This Article considers both the normative and legal case for appraisal waivers. It argues that, with appropriate procedural protections – specifically the requirement that such waivers take the form of charter provisions -- appraisal waivers are normatively desirable. It then questions whether distinguishing between the use of appraisal waivers in private and public companies is appropriate and argues that it is not. The source of this distinction is a potential difference in the scope of private ordering available through shareholder agreements as opposed to the charter or bylaws, a difference that this Article critiques.
The Article concludes that, under current law, the legal status of appraisal waivers is unclear. Given the potential value that such waivers provide, and the particular value that market discipline would bring to the scope and structure of such waivers, the Article argues for legislation validating a corporation’s authority to limit or eliminate appraisal rights in its charter.
Fisch, Jill E., Appraisal Waivers (August 2, 2020). U of Penn, Inst for Law & Econ Research Paper No. 20-47, European Corporate Governance Institute - Law Working Paper No. 537/2020, Available at SSRN: https://ssrn.com/abstract=3667058 or http://dx.doi.org/10.2139/ssrn.3667058
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