Appraisal Arbitrage: Closing the Floodgates on Hedge Funds and Activist Shareholders

Arbitrage. The words that come to mind when attempting to define “arbitrage” inevitably include terms such as lies, trickery, unfair play, and deception. Intuition calls us to correct the system and level the playing field to eliminate whatever mechanism allows such arbitrageurs their ability to exploit a loophole in the system. Unfortunately, when a party reaps the benefits of system inefficiencies, surrounding organizations bear the burden of an unfair economic advantage. The mechanism enabling such arbitrage requires correction not only to restore marketplace balance but also to remedy the negative impact inflicted on related corporations. A particular form of arbitrage is growing in Delaware appraisal litigation as hedge funds and activist shareholders exploit the leniency of Delaware General Corporation Law (“DGCL”) section 262. When a corporation decides to acquire or merge with another corporation, section 262 provides shareholders that dissent or abstain from a merger “appraisal rights” granting shareholders the ability to challenge the impending merger price through an appraisal action. In the past decade, the Delaware court system has seen a tremendous growth from shareholders fixated on bringing appraisal claims. However, these claims are not being brought by the dissenting minority shareholders that section 262 was designed to protect. The surge of new plaintiffs has primarily been hedge funds and activist shareholders attempting to take advantage of an unjust investment strategy that is now commonly referred to as “appraisal arbitrage.” Appraisal arbitrage occurs when hedge funds and activist