Fair Game: For Dell Investors, a Safety Valve

Investors who think that the price is inadequate have surely been disappointed that a higher bid never emerged. One big Dell investor, Southeastern Asset Management, has estimated that the company is worth almost $24 a share.

But many shareholders may not realize that they have an intriguing alternative that could generate more money than Mr. Dell is offering: requesting that a court appraise the company’s long-term value.

Because Dell is incorporated in Delaware, such an appraisal process would go through that state’s Court of Chancery. Upon the case’s conclusion, Delaware law would require Mr. Dell to pay the shareholders bringing the litigation whatever value the court determined was fair.

Going the appraisal route has its risks. One big one is that the court could award shareholders less than the $13.65 a share that Mr. Dell is offering. The cases also take time, during which investors’ stock is tied up.

But in the Dell case, an innovative trust has been set up by an outside group allowing Dell shareholders to pursue appraisal-rights litigation while also allowing them to sell their shares. More on that later.

Shareholders making legal challenges to buyouts typically base them on a supposed breach of duty by company directors overseeing the process. No such breach is required in appraisal litigation. Investors simply agree to disagree on the proposed purchase price and ask a court to assess the company’s value.Nevertheless, because of procedural complexities, appraisal litigation in takeovers is not that common.

Often purchasers limit shareholder participation in appraisals to minimize their financial exposure should a judge rule that a higher price is in order. But Mr. Dell’s offer did not limit how many shareholders could mount an appraisal case.

In the Dell transaction, said Lawrence A. Hamermesh, a professor of corporate and business law at Widener Law School in Wilmington, Del., appraisal litigation could be “a safety valve on doubts about whether a valuation process worked appropriately.”

“No matter how effective you think special committees are, some people genuinely believe the result isn’t fair,” he said. “So this is a way of giving people access to a court to make that determination.”

For appraisal litigation to proceed in the Dell case, a majority of the company’s shareholders — not counting Mr. Dell — must first approve his offer. Only then can investors who chose not to tender their shares bring an appraisal case.

“What makes this an interesting case for appraisal is you rarely see going-private deals of this size,” said Jeffrey Gordon, a professor at Columbia Law School. “If you’re a 3 percent or 5 percent owner, the litigation cost of an appraisal case for Dell is a tiny fraction of the potential upside.”

The outcomes in past appraisal cases suggest that such litigation can pay off handsomely. Some 40 appraisal cases from 1984 through 2004 that culminated in court decisions were cited in an unpublished paper by Charles Korsmo, assistant professor at the Case Western Reserve School of Law, and Minor Myers, associate professor at Brooklyn Law School.

The professors found that in the 40 cases where both the merger premium and the court’s finding were disclosed, appraisal litigation generated a median award of 50.2 percent over the buyout price. Mr. Myers noted in an interview, however, that some of the cases involved small, private companies where a large premium did not amount to all that much in dollars.

Eric M. Andersen, a lawyer specializing in appraisal litigation at the law firm of Mark Andersen in Wilmington, Del., has also studied cases that went to trial. His analysis identified 46 since 1985; among those, the court assigned a lower price in only seven of them. The median premium paid in cases analyzed by Mr. Andersen was approximately 72 percent.

Another benefit to joining an appraisal case, lawyers say, is that Delaware law gives participating shareholders 60 days after a shareholder vote to change their minds and tender their shares. So why haven’t there been more appraisal cases in recent years? Operational hurdles and costs have made it hard for both institutional and individual investors to participate in such litigation.

But some of the main hurdles are being eliminated in the Dell case by the Shareholder Forum, an independent creator of programs devised to provide the kind of information investors need to make astute decisions.