Appraisal rights are a statutory remedy available in many states to stockholders who object to certain extraordinary actions taken by a corporation, such as mergers or certain other change of control transactions. The remedy typically allows dissenting stockholders to require the corporation to buy their stock at a price equal to its fair value excluding the benefits of the transaction.

Appraisal activity has risen sharply in recent years as certain hedge funds dedicated to "appraisal arbitrage" have actively sought target companies in which to invest after the announcement of a merger (see Charles R. Korsmo & Minor Myers, Appraisal Arbitrage and the Future of Public Company M&A, 92 Wash. U. L. Rev. (forthcoming 2015)). These arbitrageurs acquire shares in the merging company for the express purpose of seeking appraisal. The policy implications of this trend and possible responses to it are discussed in Practice Note, Appraisal Rights: Appraisal Arbitrage.

With the rise in appraisal actions, the Delaware Court of Chancery has had several recent opportunities to appraise the fair value of the corporation's shares using alternative methods of valuation. The court traditionally draws on three primary valuation methods:

The DCF method is usually relied on more than the other analyses because it "merits the greatest confidence within the financial community" (Cede & Co. v. JRC Acquisition Corp., , at *2 (Del. Ch. 2004)). In certain circumstances, however, the court may not assign any weight to the DCF method. A key presumption of the DCF approach is that the corporation has management projections that were made in the ordinary course of business (Cede & Co. v. Technicolor, Inc., , at *7 (Del. Ch. 2003)). The court may choose not to accord management's projections the necessary deference if:

See Gearreald v. Just Care, Inc., , at *5 (Del. Ch. Apr. 30, 2012) for the first four factors and Huff Fund Inv. P'ship v. CKx, Inc., , at *10 (Del. Ch. Nov. 1, 2013) for the fifth factor.

The comparable-companies and comparable-transactions analyses, meanwhile, may be disregarded if the comparables are not in the same industry or stage of their growth cycle (Merion Capital, L.P., et al., v. 3M Cogent, Inc., , at *5 (Del. Ch. July 8, 2013)) or if there are simply not enough comparables in the data set (In re John Q. Hammons Inc. S'holder Litig., , at *5 (Del. Ch. Jan. 14, 2011)).

When none of the traditional valuation methods are reliable, the court can find other ways to arrive at the fair value of the corporation's shares. Recent decisions of the Delaware Court of Chancery describe these methods.

As a general matter, the court does not rely on the merger price as evidence of the fair value of the corporation's shares. The Delaware Supreme Court has stated that to "defer" to the merger price would "contravene the language of the statute" (Golden Telecom, Inc. v. Global GT, LP, 11 A.3d 214, 217 (Del. 2010)). However, the Court of Chancery has interpreted that decision to mean only that it cannot favor the factor of merger price over any other, not that it must ignore the merger price when left with no other valuation options (Huff Fund Inv. P'ship, , at *12). If there are shortcomings with all three traditional valuation methodologies and if the merger price was generated at arms' length in an auction process, the court may rely entirely on the merger price as the best and most reliable indicator of the corporation's value.

By contrast, the Court of Chancery explained last week that it will not rely on the merger price, even if the other three methodologies are also unreliable, in a controlling-stockholder transaction where the price was not generated at arms' length after a full market check (Laidler v. Hesco Bastion Envtl., Inc., , at *6 (Del. Ch. May 12, 2014)).

Certain adjustments to the merger price might be necessary to reflect the value of the corporation as a going concern. An example would be the proverbial finding of gold in the backyard some time between signing and closing. The Court of Chancery explained this week that these new findings of value cannot be potential future cash flows that the corporation may generate if it were to stay independent, assuming that the market was already aware of these business opportunities. Rather, they must be asset values that previously were entirely unknown to the parties or the market (Huff Fund Inv. P'ship v. CKx, Inc., , at *4 (Del. Ch. May 19, 2014)).

When neither the three traditional approaches nor the merger price are reliable, the court can employ an analysis similar to DCF called the Direct Capitalization of Cash Flow method (DCCF). The DCCF method is used to overcome shortcomings with the DCF method due to unpredictable cash flows. Both the DCF and the DCCF begin by estimating the corporation's future free cash flows over a set period of time. The DCF then projects the cash flow over a horizon period toward a terminal value and discounts that value to the present. The DCCF, by contrast, determines a normalized figure for annual cash flows in perpetuity and calculates a capitalization rate by which to divide cash flows. See the Laidler decision for more detail on this method.

For a complete description of appraisal rights, including their advantages and disadvantages, the mechanics of perfecting appraisal rights, the types of transactions that trigger appraisal rights and the court's valuation methods, see Practice Note, Appraisal Rights.