Using the Absurdity Principle & Other Strategies Against Appraisal Arbitrage by Hedge Funds

Abstract

This paper focuses on appraisal arbitrage, an investment strategy where an investor acquires an equity position in a cash-out merger with the specific intention of exercising a statutory shareholder appraisal right under the Delaware Code (8 Del. C. § 262).

After buying shares in a company that will merge, the investor can petition for appraisal of those shares, and a Delaware court will grant a judgment of what it determines as the shares’ fair value. This can be 200 percent to 300 percent more than the price of the shares in the merger. Since hedge funds buy shares from shareholders usually at the proposed price in the merger, they can potentially gain — and in fact have gained — millions of dollars from this strategy.

This paper argues that this strategy is an abuse of the Delaware appraisal statute, which has its origin in facilitating mergers by giving dissenting shareholders fair value for their shares to keep such shareholders from blocking the merger. Investing hedge funds, on the other hand, could care less about the merger and are essentially just buying their way into a lawsuit for appraisal, hoping to reap huge gains at the expense of liquidity needed to complete the merger and other stakeholders involved.