What Are Section 262 Appraisal Rights in Delaware?

Appraisal rights protect minority shareholders of Delaware corporations during significant corporate changes like mergers. These rights allow a shareholder to dissent from the approved action and petition a court to determine the “fair value” of their shares. This judicial valuation process offers an alternative to accepting the consideration offered in the transaction, which the shareholder may believe undervalues their ownership stake. The process is designed to ensure that shareholders who are forced to give up their shares receive a just price determined through a formal legal proceeding.

Triggering Events for Appraisal Rights

The most common corporate actions that give rise to appraisal rights are mergers and consolidations, but they can also be triggered by corporate conversions, transfers, and domestications. When a company is acquired, shareholders are often forced to exchange their shares for cash or other consideration. It is in this context that appraisal rights become available, particularly when shareholders receive cash for their shares as part of the merger.

A limitation known as the “market-out” exception typically denies appraisal rights to shareholders of a publicly traded company if their shares are listed on a national securities exchange or held by more than 2,000 stockholders. The logic is that a liquid public market already provides a reliable indicator of the stock’s value. However, appraisal rights can be restored if shareholders are required to accept anything other than stock in another publicly traded company as consideration.

Requirements to Perfect Appraisal Rights

To successfully exercise appraisal rights, a shareholder must follow several procedural steps. The first is continuous ownership, meaning a shareholder must own the shares on the date they make a formal demand and continue to hold them without interruption through the effective date of the merger. Selling the shares during this period forfeits any claim to an appraisal.

A shareholder must deliver a formal written demand for appraisal to the corporation before the shareholder vote on the proposed merger. The letter must state the shareholder’s intention to demand appraisal and include their name, address, and the number and class of shares for which appraisal is sought. This document serves as the official notification to the company that the shareholder will not be accepting the merger consideration.

The shareholder’s voting behavior is strictly prescribed. To preserve appraisal rights, the shareholder must not vote in favor of the merger or consolidation. A vote for the transaction is considered an acceptance of its terms and disqualifies the shareholder from seeking appraisal. The shareholder may either vote against the transaction or abstain from voting altogether.

The Appraisal Proceeding

Once the merger is finalized, the process moves to the judicial phase. A petition for appraisal must be filed with the Delaware Court of Chancery within 120 days of the merger’s effective date. Missing this deadline is an absolute bar to proceeding. However, a shareholder can withdraw the demand and accept the original merger terms, as long as they do so within 60 days of the merger’s effective date and have not yet filed a court petition.

The petition to initiate the appraisal proceeding can be filed by either the dissenting shareholder or the corporation. If multiple shareholders have perfected their rights, the court will typically consolidate all petitions into a single proceeding. After a petition is filed, the court issues notices to all other shareholders who have properly demanded appraisal, informing them of the proceeding and their right to participate.

Within ten days of the merger’s effective date, the surviving company must send a notice to every shareholder who submitted a valid appraisal demand. This notice informs the dissenting shareholders that the merger has been completed and starts the 120-day period for filing the court petition.

Determining Fair Value

The central issue in an appraisal proceeding is the determination of “fair value.” Under Delaware law, this is defined as the shareholder’s proportionate interest in the company as a “going concern” at the moment just before the merger takes effect. This valuation explicitly excludes any increase or decrease in value that may arise from the merger itself, such as anticipated synergies. The court’s goal is to value the company as if it were continuing its normal business operations.

To arrive at a fair value figure, the Delaware Court of Chancery considers all relevant factors and is not bound by a single valuation method. Commonly used methods include Discounted Cash Flow (DCF) analysis, analyzing comparable public companies, and examining prices from similar transactions. Courts have also given weight to the deal price itself, especially if a robust and conflict-free sales process occurred.

After the court determines the fair value per share, it will also calculate interest to be paid on that amount. The statutory interest rate is typically 5% over the Federal Reserve discount rate, compounded quarterly, and it accrues from the merger’s effective date until the judgment is paid. To reduce this liability, a corporation can prepay any amount to dissenting shareholders, which stops the accrual of interest on the prepaid sum. The court can also assess the costs of the proceeding, including attorney and expert witness fees, against the parties.