Applebaum v. Avaya, Inc.
2002 WL 31647809, 2002 Del. LEXIS 699, 812 A.2d 880 (2002)
Rule of Law:
Delaware General Corporation Law (DGCL) Section 155 permits a corporation to effect a reverse/forward stock split that selectively disposes of fractional interests held by stockholders who no longer possess whole shares, provided there is a rational business purpose, and allows compensation at "fair value" based on the actively traded market price of the stock, distinguishing it from an appraisal-like "going concern" valuation, particularly when no controlling stockholder benefits.
Facts:
- Avaya, Inc. is a Delaware corporation that designs and manages communications networks, having been spun off from Lucent Technologies, which itself was a spin-off of AT&T.
- Avaya's capital structure is a product of two spin-off transactions, resulting in over 3.3 million common stockholders each owning fewer than 90 shares, making its stock one of the most widely-held on the New York Stock Exchange.
- Avaya incurs approximately $4 million annually in administrative expenses to maintain these numerous small stockholder accounts, regardless of the number of shares held.
- To reduce administrative costs, Avaya's board of directors proposed one of three alternative reverse/forward stock splits (e.g., 1-for-30 reverse followed immediately by a 30-for-1 forward split).
- The Proposed Transaction was designed to cash out stockholders owning shares below the chosen minimum number, while those with sufficient shares would retain their fractional interests, which would then be reconverted into whole shares during the forward split.
- Avaya planned to compensate cashed-out stockholders by either combining their fractional interests and selling them as whole shares on the open market, or by paying them cash based on the stock's average trading price over a ten-day period preceding the Reverse Split.
- At Avaya's annual meeting, 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, would be cashed out under any of the proposed alternatives because he held less than the minimum number of shares required to survive the initial reverse split.
Procedural Posture:
- Applebaum filed an action in the Delaware Court of Chancery to enjoin the Proposed Transaction.
- Applebaum alleged that Avaya's treatment of fractional interests would not comply with Section 155 and that the proposed cash-out methods were non-compliant 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.
- Applebaum appealed the final judgment entered for the defendants to the Supreme Court of Delaware.
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Issue:
Does Delaware General Corporation Law Section 155 permit a corporation to (1) implement a reverse/forward stock split that selectively cashes out fractional interests of only those stockholders who would no longer hold whole shares, and (2) compensate cashed-out stockholders based on the average market trading price of the stock rather than an appraisal-like "going concern" valuation?
Opinions:
Majority - VEASEY, Chief Justice
Yes, Delaware General Corporation Law Section 155 permits a corporation to implement a reverse/forward stock split that selectively cashes out fractional interests of only those stockholders who would no longer hold whole shares, and to compensate cashed-out stockholders based on the average market trading price of the stock. The Court held that Section 155 does not prohibit the disparate treatment of stockholders by selectively disposing of some fractional interests but not others, so long as the corporation follows the statute's procedures. The Reverse/Forward Split is an integrated transaction where fractional interests are created but fractional shares are not necessarily issued; instead, interests are either cashed out or reconverted. This disparate treatment, which serves the rational business purpose of saving transaction costs, is permissible under Delaware law, which does not mandate absolute equality among stockholders. Regarding compensation, the Court affirmed that Section 155(1) allows Avaya to aggregate fractional interests and sell them on behalf of cashed-out stockholders, as the corporation's duty to "arrange for the disposition" naturally includes aggregation to create marketable shares and prevent dissipation of value. Furthermore, an amount based on the average trading price of actively-traded, widely-held stock constitutes "fair value" under Section 155(2). The Court explicitly distinguished this from the "going concern" valuation required under Section 262 (the appraisal statute), noting that Section 155's reference to fair value predates Section 262's definition and serves a different statutory purpose. Market price valuation is appropriate here because Avaya is not a controlling stockholder benefiting from a "freeze-out" transaction, and cashed-out stockholders can easily reinvest in the company. To apply a going concern valuation in this context would grant an unwarranted windfall to these stockholders. The Court also affirmed that nominees are properly instructed to effect the split for beneficial holders.
Analysis:
This case significantly clarifies the interpretation of DGCL Section 155, affirming corporate flexibility in managing capital structure, particularly for widely-held companies seeking to reduce administrative costs. It establishes that "fair value" under Section 155(2) is distinct from Section 262's appraisal valuation, allowing reliance on active market prices for liquid, widely-traded stock. This distinction is crucial for transactions not involving a controlling stockholder's "freeze-out," providing a clear pathway for corporations to streamline their stockholder base without triggering burdensome appraisal-like valuations. Future cases will likely refer to this precedent for reverse stock splits and cash-outs of small fractional interests, especially concerning the appropriate valuation methodology and the permissible scope of disparate stockholder treatment for rational business purposes.
