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Court of Chancery Addresses Interest Awards in Appraisal Proceedings

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In a February 12, 2014 decision, the Court of Chancery held that a petitioner in an appraisal proceeding could not be compelled to accept “prepayment” of an appraisal award in order to stop the accrual of interest on the amount prepaid. The holding is significant because the default statutory interest rate on an appraisal award (5% over the Federal Reserve discount rate) may be viewed as very favorable by stockholders considering whether to bring appraisal claims. Download a copy of the Court’s opinion.

Under Delaware law, appraisal is available in all private company mergers, as well as any public company merger where the consideration is anything other than shares of the surviving company or public company stock. Stockholders seeking appraisal are entitled to a judicial determination of the “fair value” of their shares (without the need to litigate fault) and, once that value is determined, to be paid in cash that fair value plus interest from the effective date of the merger through the date of payment of the judgment at 5% over the Federal Reserve discount rate absent a showing of “good cause” to depart from that rate. The interest component could be quite significant given the rate and the fact that an appraisal case could easily take a year or more.

In Huff Fund Investment Partnership v. CKx, Inc., the respondent company in an appraisal proceeding sought to compel the petitioner to accept a prepayment of an appraisal award equal to what all parties agreed was the minimum “fair value” of the shares being appraised, in order to stop the accrual of interest on that amount. As argued by the respondent, “where market rates of return are low, the opportunity for . . . a near risk-free return five percent above the Federal Discount rate may penalize a respondent corporation, and may create perverse litigation and investment incentives, including encouragement of litigation of cases without significant potential for an award above the merger consideration, and even arbitrage of appraisal claims.”

The Court agreed with respondent that “compared with fault-based litigation, the opportunities for rent-seeking in appraisal actions are comparatively high.” However, the Court exercised caution in deviating from the statutory default rate. The Court stated that, in drafting the appraisal statute, the legislature “made a determination as to the proper balance of the competing interests of appraisal petitioners, who have been cashed out of their preferred investment and denied the ability to invest the merger consideration in the market pending outcome of the case, and respondents, against whom too large an interest award may operate as a penalty.” Comparing a prior version of the appraisal statute, which offered more discretion to the Court of Chancery in awarding interest, to the current version, the Court stated that the “General Assembly . . . made its call” and deferred to that body’s decision.

Although the Court found that a determination as to whether “good cause” existed to depart from the statutory interest rate must await the end of the appraisal proceedings, it observed that, once that end came, it could consider “a wide variety” of circumstances in its determination. Moreover, the Court specifically acknowledged the potential for abuse of the appraisal process in its reference to “opportunities for rent-seeking,” suggesting that such behavior would be among that wide variety of circumstances that would be considered in looking at the good cause question. This is an area of law that awaits further developments.

This Update provides general information and should not be used or taken as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. For a more complete or detailed discussion, please contact any member of Morris Nichols’ Delaware Corporate Law Counseling Group or Corporate & Business Litigation Group.

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