Interest in appraisal.

Author:Korsmo, Charles K.
 
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  1. INTRODUCTION II. THE LOGIC AND HISTORY OF INTEREST IN THE DELAWARE APPRAISAL STATUTE A. The Emergence of Prejudgment Interest in Appraisal B. What Rate? C. The 2007 Amendment to Simplify Interest in Appraisal D. The 2016 Amendment III. CRITICISMS OF THE EXISTING STATUTORY RATE A. The Failure to Provide Guiding Principles B. The Misleading Comparison of Appraisal Claims to Bonds IV. PRINCIPLES FOR INTEREST RATE REFORM A. The Policy Goals of Interest in Appraisal B. Primary Principles C. Secondary Principles V. A SUPERIOR INTEREST RATE REGIME IN DELAWARE APPRAISAL A. An "Optimal" Interest Rate Regime is Impractical A Second-Best Interest Rate Regime 1. An Option to Prepay to Stop the Running of Interest 2. The Prepayment Does Not Constitute an Undisputed Amount 3. The Dissenter Can Walk Away with the Prepayment 4. The Prepayment Option is Time-Limited 5. The Appropriate Interest Rate is the WACC of the Target Company 6. The Policy Merits of This Interest Rate Regime VI. CONCLUSION I. INTRODUCTION

    Over the past five years, Delaware has experienced a substantial rise in the exercise of appraisal rights. (1) This longstanding statutory remedy allows minority stockholders to dissent from a merger transaction, reject the proffered merger consideration, and instead institute a proceeding in the Delaware Court of Chancery to determine the fair value of the stockholder's shares. (2) While we have argued that this rise in appraisal litigation is a positive development, it has sparked a backlash among an influential group of deal advisers and defendants. Citing danger to the deal market, these critics of appraisal have sought drastic changes in Delaware designed to curtail the ability of minority shareholders to pursue the appraisal remedy.

    One unlikely flashpoint in the battle over appraisal 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 5% plus the prevailing federal funds rate. Critics contend that this 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 what critics contend is an above-market interest rate. The supposed exorbitance of the interest rate has loomed especially large in the minds of journalists, (3) law school students, (4) and transactional lawyers. (5) Responding to these complaints, the Council of Delaware State Bar Association's Section on Corporation

    Law proposed an amendment to the appraisal statute designed to moot the interest rate question by allowing the company to prepay an amount of its choosing, thereby avoiding the accrual of interest on that amount. This reform languished through one legislative session but was ultimately passed into law in 2016.

    A striking feature of complaints about the interest rates 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 or low. This failing has attracted judicial attention, with Vice Chancellor Laster recently observing that he has "never understood how people could blithely say that the appraisal interest rate is purely an above-market rate, as if it were a risk-free federal funds obligation." (6)

    In this Article, we identify a set of relevant principles and use them to propose reforms that would improve the functioning of Delaware's appraisal remedy by encouraging accurate and economical resolution of disputes over fair value. We argue that the primary policy goal in designing an interest regime should be to make the parties indifferent to the passage of time. This policy goal has deep roots in Delaware's pre-2007 jurisprudence, where the overriding focus in setting the interest rate was on two twin ambitions: to compensate the dissenter for the lost use of the fair value of the stock and to force the surviving company to pay for the use. Chancellor Chandler captured this insight in Gonsalves v. Straight Arrow Publishers, where he wrote that "[i]n essence, an interest award is the Court's attempt to put both parties in the position most closely approximating their respective positions had the fair value of the dissenting shareholder's stock been paid on the date of the merger." (7) If an interest regime is successful in accomplishing this, the parties will be time-indifferent, with no incentive to either prolong the proceeding or to give up value to secure a hasty settlement. (8) To this principle of time-indifference, we add the equally important condition that 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, not by the interest rate.

    Of course, the design of any dispute resolution system involves a trade-off between the accuracy of the system and its cost. The policy challenge in fashioning the appropriate interest rate in appraisal is this precise question writ small. For a generation, Delaware appraisal proceedings involved expensive battles over the appropriate rate of interest to award, (9) a situation we have no desire to replicate. From this we derive the secondary principle that the interest rate regime should economize on litigation costs and, at the margin, encourage settlement.

    Using these principles, we are in a position to both critique the current interest rate regime and also to propose a new set of reforms that improves on it. under our proposal, the respondent would have a unilateral option to prepay an amount of its choosing to the dissenting stockholder within 30 days of the effective date of the relevant transaction. The dissenting stockholder would thereafter possess the option to walk away from the litigation for the amount prepaid. The amount so paid would not prevent the respondent from arguing for a lower fair value at trial. 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. These reforms would--without creating any new issues for litigation--give the company an incentive to put its best estimate of fair value on the table at the outset, reducing the salience of the interest rate while promoting time-indifference for both parties.

    This Article proceeds in five Parts. Part II introduces the Delaware appraisal statute and the historical logic and use of interest in Delaware appraisal proceedings, including the recent amendment adopted by Delaware. Part III introduces and evaluates recent criticisms of Delaware's interest rate regime, concluding that these criticisms fail to identify valid criteria by which the regime may be evaluated. Part IV derives and explains a set of principles for designing an interest rate regime. Part V employs these principles to design a new interest rate regime for appraisal litigation.

  2. THE LOGIC AND HISTORY OF INTEREST IN THE DELAWARE APPRAISAL STATUTE

    The sophistication of Delaware's approach to awarding interest in appraisal has grown with experience. Delaware's appraisal remedy is a statutory creation, and the major leaps forward in the scheme of awarding interest have come from legislative amendments. At the same time, the Court of Chancery has labored mightily to fashion rules in equity that generate sensible incentives.

    1. The Emergence of Prejudgment Interest in Appraisal

      Delaware first adopted an appraisal statute in 1899, but that original version did not provide for interest. The Delaware Supreme Court observed that the early version of the appraisal statute "[made] no mention of interest," (10) and courts concluded they thus had no authority to award prejudgment interest. (11) As then-Vice Chancellor Seitz reasoned:

      I fully appreciate the policy argument in favor of providing interest for a dissenter in order that he may receive just compensation for his shares. Apparently the legislatures in New York and Maryland have ... seen fit to change their statutes in order to provide for interest. Since, however, I have concluded that the right to interest must be found in the statute, and since I have found that the [Delaware] appraisal statute not only does not authorize its payment but impliedly denies it, I am unable to award interest here on the basis of a so-called 'enlightened view'. I reluctantly conclude that enlightenment must come from the legislature. (12) Enlightenment arrived in 1949, when an amendment first introduced language about interest in the appraisal statute. (13) The revised statute provided that the court may "determine the amount of interest, if any, to be paid upon the value of the stock of the stockholders entitled thereto." (14)

      This mid-century version of the statute provided no guidance in choosing an appropriate interest rate, and indeed it vested the most basic discretion in the trial court: whether to award prejudgment interest at all. The Court of Chancery began to exercise its newfound discretion, (15) and it soon had developed a default rule in favor of awarding prejudgment interest. (16) The reasoning was that the interest award was necessary to compensate the petitioner for loss of use of the petitioner's resources, which remained in the unconstrained hands of the defendant during the pendency of the appraisal petition. (17)

      This is not to suggest that the basic decision to award interest was free of controversy. In Felder v. Anderson, Clayton & Co., for example, the respondent argued that the court should exercise discretion not to award interest where the "delay in payment is largely attributable to the stockholders' excessive estimate of the fair value of their stock which they persisted in demanding." (18) The respondent had offered to settle...

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