In this appeal, we affirm the judgment of the Court of Chancery holding that a corporation could validly initiate a reverse stock split and selectively dispose of the fractional interests held by stockholders who no longer hold whole shares. The Vice Chancellor interpreted Section 155 of the Delaware General Corporation Law to permit the corporation, as part of a reverse/forward stock split, to treat its stockholders unequally by cashing out the stockholders who own only fractional interests while opting not to dispose of fractional interests of stockholders who will end up holding whole shares of stock as well as fractional interests. In the latter instance the fractional shares would be reconverted to whole shares in an accompanying forward stock split.
We hold that neither the language of Section 155 nor the principles guiding our interpretation of statutes dictate a prohibition
A further issue we address is whether, as an alternative method of compensation, the corporation may satisfy the "fair price" requirement of Section 155(2) by paying the stockholders an amount based on the average trading price of the corporation's stock. Here, the Vice Chancellor properly held that the trading price of actively-traded stock of a corporation, the stock of which is widely-held, will provide an adequate measure of fair value for the stockholders' fractional interests for purposes of a reverse stock split under Section 155.
Avaya, Inc. is a Delaware corporation that designs and manages communications networks for business organizations and large non-profit agencies. The enterprise is a descendant of the industry standard-bearer, AT & T. Avaya was established as an independent company in October of 2000 when it was spun off from Lucent Technologies. Lucent itself is a spin-off of AT & T. Because its capital structure is the product of two spin-off transactions, the outstanding stock of Avaya is one of the most widely-held on the New York Stock Exchange. Over 3.3 million common stockholders own fewer than 90 shares of Avaya stock each.
Although a large number of stockholders hold a small stake in the corporation, Avaya incurs heavy expenses to maintain their accounts. Avaya spends almost $4 million per year to print and mail proxy statements and annual reports to each stockholder as well as to pay transfer agents and other miscellaneous fees. Stockholders who own their stock in street names cost Avaya an additional $3.4 million in similar administrative fees.
Since the cost of maintaining a stockholder's account is the same regardless of the number of shares held, Avaya could reduce its administrative burden, and thereby save money for its stockholders, by decreasing its stockholder base. In February of 2001, at the corporation's annual meeting, the Avaya board of directors presented the stockholders with a transaction designed to accomplish this result. The Avaya board asked the stockholders to grant the directors authorization to engage in one of three alternative transactions:
We refer in this opinion to all three of these alternative transactions as the "Proposed Transaction" or the "Reverse/Forward Split." Regardless of the particular ratio the board chooses, at some future date the Reverse Split will occur at 6:00 p.m., followed by a Forward Split one minute later. Once selected, the effective date of the Split will be posted on Avaya's website.
The transaction will cash out stockholders who own stock below the minimum number ultimately selected by the directors for the Reverse/Forward Split pursuant to those three alternative options.
Avaya will compensate the cashed-out stockholders through one of two possible methods. Avaya may combine the fractional interests and sell them as whole shares on the open market. In the alternative, the corporation will pay the stockholders the value of their fractional interests based on the trading price of the stock averaged over a ten-day period preceding the Reverse Split. Stockholders who hold their Avaya stock in street names have been advised to contact their nominees to see that they receive the same consideration as stockholders who have their interests registered in their own names.
To illustrate the Proposed Transaction through a hypothetical, assume Stockholder A owns fifteen shares of stock and Stockholder B owns forty-five shares of stock. If Avaya chooses to initiate a Reverse 1-for-30 Stock Split, Stockholder A will possess a fractional interest equivalent to one-half a share of stock. Stockholder B will hold one whole share of Avaya stock and a fractional interest equivalent to one-half a share. Using the provisions of Section 155(1) or (2) of the Delaware General Corporation Law,
At the annual meeting, Avaya stockholders voted to authorize the board to proceed with any one of the three alternative transactions. Applebaum, a holder of twenty-seven shares of Avaya stock, filed an action in the Court of Chancery to enjoin the Reverse/Forward Split. Under any one of the three alternatives Applebaum would be cashed out because he holds less than thirty shares.
Proceedings in the Court of Chancery
Applebaum asked the Court of Chancery to enjoin the Proposed Transaction, alleging that Avaya's treatment of fractional interests will not comport with the requirements set forward in Title 8, Section 155 of the Delaware Code. Applebaum argued that Section 155 does not permit Avaya to issue fractional shares to some stockholders but not to others in the same transaction. Even if Avaya could issue fractional shares selectively, Applebaum contended that the methods by which Avaya plans to cash-out the smaller stockholders do not comply with subsections (1) and (2) of Section 155.
After considering cross-motions for summary judgment, the Court of Chancery denied Applebaum's request for an injunction and held that the Reverse/Forward Split would comply with Section 155 and dispose of the cashed-out stockholders' interests in a fair and efficient manner.
Issues on Appeal
Applebaum claims the Court of Chancery erred by: (1) holding that Title 8, Section 155 permits Avaya to issue fractional shares to the surviving stockholders but not issue fractional shares to the cashed-out stockholders; (2) holding that Avaya can combine the fractional interests and sell them on the open market; (3) holding that Avaya can instruct nominees to participate in the Split even if a particular nominee holds a sufficient amount of stock on behalf of all of its beneficial holders to survive the Split; (4) granting summary judgment and holding that the payment of cash for fractional interests based on a ten-day average of the trading price of Avaya stock constitutes "fair value" under Section 155; and (5) holding that the meaning of "fair value" in Sections 155(2) is different from Section 262 and thus failing to value the fractional shares as proportionate interests in a going concern.
Section 155 Does Not Prevent Avaya From Disposing of Fractional Interests Selectively
Applebaum questions the board's authority to treat stockholders differently by disposing of the fractional interests of some stockholders but not others. Applebaum contends that Avaya will issue fractional shares in violation of Section 155. According to this view of the transaction, during the one minute interval between the two stock splits the corporation will not issue fractional shares to stockholders who possess holdings below the minimum amount. Those stockholders will be cashed out. Stockholders who hold stock above the minimum amount, by contrast, will be issued fractional shares that will be reconverted in the Forward Split into the same number of whole shares owned by those stockholders before the Reverse Split.
Applebaum argues that Section 155 prevents Avaya from achieving this disparate result by providing that:
Applebaum reads Section 155 to mean that Avaya can employ the cash-out methods provided in Section 155 only if the corporation "does not issue fractions of a share."
This Court reviews de novo the Court of Chancery's decision to grant Avaya's motion for summary judgment.
Applebaum correctly notes that Avaya stockholders are not treated equally in the Proposed Transaction. The disparate treatment, however, does not arise by issuing fractional shares selectively. It occurs through the selective disposition of some fractional interests but not others. The provisions of Section 155 do not forbid this disparate treatment. While principles of equity permit this Court to intervene when technical compliance with a statute produces an unfair result,
Our jurisprudence does not prevent Avaya from properly using Section 155 in a creative fashion that is designed to meet its needs as an on-going enterprise.
Avaya May Proceed with Any of Its Alternative Plans to Dispose of the Fractional Interests
The balance of Applebaum's appeal challenges the alternative methods by which Avaya proposes to dispose of the fractional interests. The Court of Chancery concluded that Avaya could proceed under Section 155(1) by aggregating the fractional interests and selling them on behalf of the cashed-out stockholders. The Court also held that Avaya could employ Section 155(2), which requires payment of the "fair value" of the fractional interests, by paying the cashed-out stockholders an amount based on the average trading price of Avaya stock. We agree with the decision of the Court of Chancery and address separately the issues based on each subsection of the statute.
Section 155(1) Permits Avaya to Sell the Factional Interest on Behalf of the Stockholders
The stockholders have authorized Avaya to compensate the cashed-out stockholders by combining their fractional interests into whole shares and then selling them on the stockholders' behalf. Section 155(1) permits Avaya to "arrange for the disposition of fractional interests by those entitled thereto."
Applebaum claims that Avaya cannot use Section 155(1) because the corporation will sell whole shares rather than "fractional interests." According to this rendition of the transaction, the fractional interests held by the targeted stockholders must be reconverted into whole shares in the Forward Split. Otherwise, their fractional interests will be diluted.
Applebaum's argument incorrectly assumes that Avaya must issue fractions of a share in the Proposed Transaction. After the Reverse Split takes place, the stockholders holding shares below the minimum amount will be cashed out. The fractional interests will not be represented as shares and are therefore not involved in the Forward Split. Avaya will then aggregate the fractional interests and repackage them as whole shares which the corporation will sell on the open market. The statute does not mandate any set procedure by which the fractional interests must be disposed of so long as those interests are sold in a manner that secures the proportionate value of the cashed-out holdings.
Applebaum also contends that Avaya cannot sell the fractional interests on behalf of the cashed-out stockholders. If Avaya sells the interests for the stockholders, Applebaum argues that the corporation will not comply with Section 155(1) because the interests are not disposed of by "those entitled thereto." As the Vice Chancellor noted, Applebaum presents a strained reading of Section 155(1).
Applebaum's interpretation also ignores the corporation's responsibility under Section 155(1) to "arrange" for the disposition of fractional interests. Since fractional shares cannot be listed on the major stock exchanges,
The general practice requires the corporation to act as an intermediary to package the fractional interests into marketable shares. If the corporation were not permitted to do so, the fractional interests of the cashed-out stockholders would be dissipated through the transaction costs of finding other fractional holders with whom to combine and sell fractional interests in the market.
Avaya May Instruct Nominees to Execute the Proposed Transaction on Behalf of the Beneficial Owners
To execute the Reverse/Forward Split, Avaya stated in its proxy statement that "Nominees will be instructed to effect the Reverse/Forward Split for their beneficial holders." Applebaum argues that nominees cannot be forced to elect to receive cash in exchange for the fractional interests held by their beneficial holders if the nominee's combined holdings for all of its beneficial holders exceeds the minimum
Applebaum misstates the responsibility of a corporation to stockholders who hold their interests through nominees and brokers. Nominees, as agents of the beneficial owners,
Applebaum also raises a disclosure issue related to the instructions for beneficial owners. The proxy statement informs stockholders that nominees "will be instructed to effect" the transaction. Applebaum argues that this statement is misleading because, as explained above, he contends that a nominee has the option either to effect the split or refrain from doing so if the aggregate amount of the beneficial holders' stock is sufficient to survive the Reverse Split. The proxy statement places the beneficial owners on notice that they must make arrangements with their nominees to receive payment from the transaction.
The Ten-Day Trading Average by which Avaya Proposes to Compensate the Cashed-Out Stockholders Constitutes "Fair Value" under Section 155(2)
As an alternative to selling the fractional interests on behalf of the stockholders, Avaya may opt to pay the stockholders cash in an amount based on the trading price of Avaya stock averaged over a ten-day period preceding the Proposed Transaction. To do so, Avaya relies on Section 155(2), which provides that a corporation may "pay in cash the fair value of fractions of a share as of the time when those entitled to receive such fractions are determined."
The corporation owes its cashed-out stockholders payment representing the "fair value" of their fractional interests. The cashed-out stockholders will receive fair value if Avaya compensates them with payment based on the price of Avaya stock averaged over a ten-day period preceding the Proposed Transaction. While market price is not employed in all valuation contexts,
Applebaum relies on two instances where the Court of Chancery intimated that a Section 155(2) valuation may be similar to a going concern valuation employed in an appraisal proceeding. In Chalfin v. Hart Holdings Co.,
The court cannot defer to market price as a measure of fair value if the stock has not been traded actively in a liquid market.
Avaya stock, by contrast, is actively traded on the NYSE. The concerns noted in Chalfin are not pertinent to the Proposed Transaction because the market continues to digest information currently known about the company. The value of Avaya's stock is tested daily through the purchase and sale of the stock on the open market.
In a related argument, Applebaum contends that the trading price cannot represent fair value because the stock price is volatile, trading at a range of prices from $13.70 per share to $1.12 per share over
Applebaum also misunderstands the appropriate context for which a going-concern valuation may be necessary under Section 155(2). In both Chalfin and Aramark, the Court of Chancery recognized that a transaction employing Section 155 may warrant a searching inquiry of fair value if a controlling stockholder initiates the transaction.
The Reverse/Forward Split merely forces the stockholders to choose affirmatively to remain in the corporation. Avaya will succeed in saving administrative costs only if the board has assumed correctly that the stockholders who received a small interest in the corporation through the Lucent spin off would prefer to receive payment, free of transaction costs, rather than continue with the corporation. The Transaction is not structured to prevent the cashed-out stockholders from maintaining their stakes in the company. A payment based on market price is appropriate because it will permit the stockholders to reinvest in Avaya, should they wish to do so.
The Meaning of "Fair Value" under Section 155(2) is not Identical to the Concept of "Fair Value" in Section 262
The Court of Chancery correctly interpreted "fair value" in Section 155 to have a meaning independent of the definition of "fair value" in Section 262 of the Delaware General Corporation Law.
The Delaware General Assembly could not have intended Section 155(2) to have the same meaning as the fair value concept employed in Section 262.
As this Court noted in Alabama By-Products v. Cede & Co., the right to an appraisal is a narrow statutory right that seeks to redress the loss of the stockholder's ability under the common law to stop a merger.
The valuation of a stockholder's interest as a "going concern" is necessary only when the board's proposal will alter the nature of the corporation through a merger. When a corporation merges with another corporation, the dissenting stockholder is entitled to the value of the company as a going concern because the nature of the corporation's future "concern" will be vastly different.
The judgment of the Court of Chancery is affirmed.