Drag along rights and an accompanying waiver by a minority stockholder of appraisal rights in connection with a change in control transaction approved by the majority stockholder are common features in stockholders agreements among majority stockholders and minority stockholders. The recent case of Michael C. Halpin, Et. Al. v. Riverstone National, Inc., No. 9796–VCG (Del. Ch. Feb. 26, 2015) highlighted the following issues that are important for M&A practitioners:
1. The court called into question, while refusing to answer, whether common stockholders can contractually commit to waive in advance their appraisal rights associated with a change in control transaction; and
2. Failure by a majority stockholder to strictly follow the notice procedure and timing requirements of a drag along right will prohibit the majority stockholder from exercising that drag along right.
Michael C. Halpin, Et. Al. v. Riverstone National, Inc. involved plaintiff minority stockholders bringing an action to seek appraisal of their common stock of Riverstone National, Inc. (“Riverstone”), a Delaware corporation, in connection with the June 2, 2014 acquisition of Riverstone by statutory merger.
In response, Riverstone contended that the minority stockholders had no appraisal rights because they had contractually waived them pursuant to the terms of the drag along provision in their stockholders agreement, which required the minority stockholders to vote in favor of the merger. Such a favorable vote would make the minority stockholders ineligible for appraisal rights since voting in favor of a transaction disqualifies a stockholder from seeking appraisal rights by statute.
Contractual waiver in advance by common stockholders of appraisal rights
First, the court addressed the issue of whether common stockholders can contractually commit to waive in advance their appraisal rights. The court noted that this was a question that had not yet been answered by Delaware courts.
In support of its argument, Riverstone pointed to Delaware cases in which Delaware courts held that preferred stockholders could contractually commit to waive in advance their appraisal rights. The court, however, pointed out an important distinction between preferred stock and common stock. Namely, the court noted that the rights of preferred stockholders are largely contractual (i.e., from the certificate of incorporation), whereas the rights of common stockholders are largely derived from Delaware statutory law and the common law of fiduciary relationships.
The court declined to further address this question since it was able to dispose of the case on other grounds, as discussed below.
Effectiveness of exercise of drag along right
Second, the minority stockholders argued that, even if a common stockholder could contractually waive its appraisal rights in advance, Riverstone’s attempt to exercise the drag along right was ineffective. Specifically, the minority stockholders argued that the drag along right, by its explicit language, required that the minority stockholders be provided with “written notice…at least ten days in advance of the date of the transaction…” in order to exercise the drag along right (emphasis added).
To understand the court’s decision regarding the effectiveness of the majority stockholders’ exercise of the drag along right, it is important to understand the timeline of the approval of the merger. The merger was approved by Riverstone’s 91% majority stockholder by written consent on May 29, 2014, and the merger agreement was signed the following day on May 30, 2014. It was not until June 9, 2014, seven days after the June 2, 2014 effective date of the merger, that Riverstone notified its minority stockholders of the merger.
The court held that the “written notice…at least ten days in advance” language in the stockholders agreement was unambiguous and meant that drag along rights could only be exercised following advance notice to the minority stockholders. That is, the court held that the literal language of the drag along right did not include the power to require the minority stockholders to consent to a transaction that had already taken place.
The court also rejected Riverstone’s argument that the implied covenant of good faith and fair dealing should come to Riverstone’s aid by setting aside the advance notice requirement of the drag along provision or otherwise permitting Riverstone to exercise the drag along provision after the merger had been effected. The court noted that the gap-filling function of the implied covenant of good faith and fair dealing is only available when there are developments that could not have been foreseen by the parties at the time they entered into the contract. Here, the court said, there was no gap to fill because the advance notice requirement was unambiguously set forth in the drag along provision.
Accordingly, the court held that the minority stockholders had not waived their appraisal rights and were therefore entitled to an appraisal of their Riverstone common stock.
1. Majority stockholders should carefully review and follow the mechanics of their drag along provisions, including any notice provisions, to preserve the availability of their drag along rights.
2. Stockholders agreements should be revised to eliminate advance notice requirements for drag along rights, and instead provide that notice of a transaction may be prospective or retrospective in connection with the exercise of drag along rights.
3. Experienced investors and M&A practitioners have taken for granted that appraisal rights are contractually forfeited by minority common stockholders pursuant to a drag along right. If a court rules otherwise, it could hinder M&A activity by vesting disproportionate power in minority stockholders who could use the threat of asserting appraisal rights to hold up a transaction. I would anticipate that the Delaware legislature would find such a ruling abhorrent and would revise the DGCL to permit such a waiver of appraisal rights pursuant to a drag along right.