Hedge funds lead charge against buyouts

DEPLOYING a rarely used tool for hedge funds, Carl Icahn’s firm and other investors are spearheading proposed class actions that challenge multibillion-dollar buyouts of public firms.

The hedge funds, which also include Glazer Capital and Empyrean Capital Partners, are seeking to fill a role traditionally played by individual shareholders and pension plans that sue after being cashed out by private equity buyers at prices they contend are too low.

Their legal battles are unfolding in Delaware, home of the premier business court in the United States, which overhauled its corporate law last year after Elon Musk’s frustration with a prolonged legal fight over his record pay package spurred him to quit the state and reincorporate Tesla Inc in Texas.

Delaware’s changes aim to entice firms to stay by loosening the standards for deal approval and by making it harder for investors to obtain company records to fight buyouts.

That may be prompting sophisticated firms with more valuation expertise and resources to take the lead in suing over take-private deals they argue are unfair.

“Until relatively recently, hedge funds were generally content to let someone else take the leadership role in a Delaware class action,” says Jonathan Kass, a plaintiffs attorney at Reid Collins & Tsai.

Sophisticated investors are noticing more companies “truly pushing the envelope if not ignoring it altogether”, he adds.

Still, some lawyers argue that hedge funds shouldn’t be permitted to use litigation as a tool to boost their profits.

Since last year, hedge funds have brought or tried to lead proposed class-action lawsuits challenging at least 11 deals, with nine of the 14 cases filed this year, according to a Bloomberg analysis of lawsuits in Delaware Chancery Court. That compares to just one case in 2024.

The proposed class actions typically argue that directors and executives breached their fiduciary duties to shareholders, and if they’re successful, every investor in the public company stands to gain.

The surge of such suits by hedge funds has coincided with a revival of a separate kind of legal challenge known as appraisal – the traditional path those investment firms have taken in an arbitrage bet to contest a deal price.

In appraisal arbitrage, hedge funds snap up shares after a deal announcement and then challenge the price in court.

If a judge appraises the buyout at a higher price, the investors that filed the appraisal case keep the difference and collect accumulated interest – which could be attractive especially given the current higher interest rate environment. 

Some buyouts have been hit with both proposed class actions and appraisal fights. Since last year, at least five deals have faced both types of challenges. 

Hedge funds that buy shares after a deal announcement shouldn’t be permitted to pursue fiduciary claims or appraisal, attorneys for private equity firm Silver Lake has written in a filing defending its US$25bil take-private of Endeavor Group Holdings from a legal attack by Icahn. 

“Neither remedy was intended to serve as a tool of financial engineering for professional investment firms to profit through litigation while hedging their downside exposure,” they write.

For hedge funds, class actions can be more enticing because they get cashed out when a deal closes. That sometimes isn’t the case in appraisal proceedings, where companies can wait to pay for shares until the end of litigation.

And appraisal challenges can backfire on hedge funds if a judge opts to award less than the deal price.

Litigation casino

Silver Lake has put up the biggest fight against hedge funds challenging deals. The firm was hit with an appraisal case filed by dozens of investors fighting the price in Silver Lake’s US$25bil buyout of Endeavour. 

At the same time, Icahn Enterprises, which is known for activist investing, is co-leading a proposed class action objecting to the deal.

The status of lead plaintiff comes with greater control over the legal strategy and sometimes additional compensation.

In September, Silver Lake filed a lawsuit accusing Icahn’s firm, among other things, of colluding with some of the hedge funds behind the appraisal case.

Silver Lake and Endeavour argue that hedge funds shouldn’t be able to buy shares after a buyout is announced, and then challenge those deal terms.

“Facilitating a litigation casino was never the point of the appraisal remedy or the breach of fiduciary duty cause of action,” attorneys wrote for Silver Lake in an October filing. 

An attorney for Icahn’s firm called the collusion allegations baseless and said his client made his investment independently.

In October, Endeavour asked a federal court in New York to force Icahn’s firm and a hedge fund in the appraisal case to hand over any profits they make on their bet.

The firm argued they were bound by a rule that requires company insiders to forfeit proceeds if they buy and sell their shares in six months.

“There was no coordinated scheme and he is not seeking appraisal,” says Jim Woolery of Woolery & Co, co-counsel to the Icahn parties.

“These vacant accusations are an obvious attempt to distract from our clients’ documented claims that Silver Lake and Endeavour’s insiders improperly took billions of dollars in value from Endeavor’s shareholders.” 

Attorneys for the defendants denied those claims in court filings.

Silver Lake said the price it ended up paying came from “arm’s-length negotiations” between it and the company’s special committee, and represented a 57% premium to Endeavor’s trading price before an October 2023 announcement that the business was seeking strategic alternatives.

Hedge funds have also faced criticism from some corporate attorneys over using appraisal litigation – which isn’t covered by the corporate law overhaul – to gather company records with the aim of bringing proposed class-action claims.

Earlier this year, Verition Fund Management was accused of exploiting the appraisal process as it challenged the US$1.4bil take-private of Guess? Inc by Authentic Brands Group.

Attorneys for Guess accused the hedge fund of trying to “make an end-run” around the corporate law overhaul, contending the changes were supposed to ensure more certainty around buyouts.

Law firm Johnson Van Kwawegen, which has built a reputation representing hedge funds in appraisal and class cases, has argued in a filing that “well-established precedent” gives Verition the right to seek appraisal and use that information to bring additional claims. The hedge fund later settled its case. 

Glazer Capital and Empyrean have declined to comment. Verition didn’t respond to requests for comment. A spokesperson for Endeavour and Silver Lake have declined to comment.

Hedge funds have so far had mixed success in competing for lead plaintiff in class-action cases. In August, hedge funds Empyrean, Verition and others lost out in a fight to lead a class-action against 3G Capital’s US$9.4bil buyout of Skechers USA Inc. 

Judge Lori Will handed the role of lead plaintiff to a Fiduciary Management Inc-managed mutual fund, the only contender that held shares before the deal announcement.

Still, she hasn’t been entirely opposed to hedge funds sharing control of these suits.

In the Endeavour case, she made Icahn’s firm co-lead plaintiff after taking comfort that the activist firm had partnered with longer-term shareholder Handelsbanken, a Swedish commercial bank.

The judge has yet to rule on Silver Lake’s request to kick Icahn out of the case. — Bloomberg