In connection with a merger transaction, a company’s minority shareholders have a statutory right under U.S. state corporate law to receive a court-supervised determination of the fair value of their shares. Such appraisal rights are available even if the merger has been approved by the majority of the target company’s shareholders. Appraisal rights are intended to protect minority shareholders from being “squeezed out” by the majority shareholders and forced to receive the merger consideration at a valuation they do not deem fair.

Shareholders who abstained or voted against the merger generally are allowed to exercise appraisal rights. The appraisal rights process can drag on for several months or years after the closing of a merger transaction. There is a risk that the court may determine that the fair value of the target company’s shares was less than the negotiated merger price.

In Delaware, under Section 262 of the Delaware General Corporation Law (DGCL), the dissenting shareholders must initially incur all the expenses associated with the appraisal proceedings. However, the court may determine in certain circumstances that the cost of the proceedings should be apportioned between the parties.

Section 262(d) of the DGCL sets forth the mechanics of the appraisal process and relevant deadlines. The dissenting shareholders must deliver a written demand for appraisal to the target company prior to the date that shareholders vote to approve the merger. Once the target company receives the appraisal request, it must within 10 days provide a statement disclosing the aggregate number of shares owned by the dissenting shareholders for which appraisal has been demanded. Additionally, the target company must within 20 days file with the office of the Register in Chancery in Delaware a verified list of dissenting shareholders who have submitted appraisal requests.

Section 262(e) of the DGCL provides dissenting shareholders with 120 days from the effective date of the merger transaction to initiate appraisal proceedings by filing a petition in the Delaware Court of Chancery. The dissenting shareholders must also serve a copy of the petition on the company.

If the acquiring company is concerned that there may be a significant number of dissenting shareholders, the parties may insert a “dissenters right” condition in the merger agreement. This provision will state that the acquiring company is not obligated to close the merger if more than a certain percentage of the target company’s shareholders exercise appraisal rights. This percentage is typically between 5-15%. In the absence of a closing condition in the merger agreement, the parties should carefully evaluate the risk of dissenting shareholders seeking an appraisal award.

The process used by courts to determine the “fair value” of the shares depends substantially on the facts and circumstances. Section 262(h) of the DGCL provides the Delaware Court of Chancery with significant latitude consider all relevant factors in determining the fair value of the shares. The court may review financial analyses, such as a discounted cash flow analysis, and other market indicators in appraising the value of the shares.

As explained by the Delaware Supreme Court in the case DFC Global Corp. v. Muirfeld Value Partners, “the purpose of an appraisal is not to make sure that the petitioners get the highest conceivable value that might have been procured had every domino fallen out of the company’s way; rather it is to make sure that they receive fair compensation for their shares in the sense that it reflects what they deserve to receive based on what would fairly be given to them in an arm’s-length transaction.” Thus, the broad discretion of the court creates uncertainty of the ultimate outcome for the dissenting shareholders seeking an appraisal.