Freezouts and the Treatment of Minority Shareholders

M&C Partners
4 min readOct 1, 2019

Have you ever wondered what happens to minority shareholders in the event of a freezeout or a merger? Well, if this has already happened to you several times before, or if you have a lot of experience when it comes to handling share, you probably already know.

However, if you are still finding your footing in the corporate and stockholders world, you are in the right place. Today, we will discuss a lot about freezeouts and the treatment of minority shareholders.

Freezeouts and the Treatment of Minority Shareholders

Usually, the approval of a majority of the shareholders is needed before a merger can be completed. The most common majority threshold is a 51% margin. Now, when the majority shareholders approve the deal, what happens to the minorities?

The minority shareholders are now required to tender their shares to the controlling shareholder. This remains true even though they may not have voted in favor of the deal, unfortunately. Most of the time, minority shareholders are said to be frozen out of their positions. It is just how mergers and acquisitions work.

Voting Approval

In a previous article, we have discussed voting approval and the process in which shareholders go through voting to close out or approve a deal. The approval of the shareholders is needed in able to close the deal.

Why does this happen and what is the reason behind this? Well, the majority approval is required so holdout problems can be avoided in the future. Usually, holdout problems can occur when a minority attempts to hold up the completion of any transaction unless they receive some type of compensation over and above the acquisition stock price. This happens in a lot of merger deals, so the majority approval was designed to help put a stop to this problem.

However, the majority approval doesn’t mean that the dissenting shareholders don’t have any rights to the deal. Those shareholders who highly believe that their shares are worth a lot more than what the terms of the merger are offering do have the option to go to court.

In court, dissenting shareholders can pursue their shareholder appraisal rights. One must remember that the dissenting shareholders must follow the proper procedures in able to successfully pursue these rights.

The dissenting shareholders are also required to object to the deal within the designated period of time — this is a big deal to these procedures and must be followed. The minority shareholders who pursue their shareholder appraisal rights will then demand a cash settlement for the difference between the fair value of their shares and the compensation they actually received should they choose to do so.

When the dissenting shareholders want to ask a court to judicially determine the value of their shares, they are given 120 days to file suit. In essence, the potential appraisal payments are a post-closing obligation of the buyer. And there are certain hedge funds who have pursued this appraisal process as an investment strategy which is more commonly known as appraisal arbitrage. We will discuss appraisal arbitrage in another article for another time.

As expected, most corporations resist these maneuvers because the payment of cash for the value of shares will raise some problems. Most of the time, the problems are related to the positions of other stockholders. At the end of the day, suits like these are difficult for dissenting shareholders to win.

Dissenting shareholders may also choose to file a suit only if the corporation does not file suit to have a fair value of the shares determined. This is after having been notified of the dissenting shareholders’ objections. In the event that there is a suit, the court may then choose to appoint an appraiser to assist in the determination of the fair value.

Additionally, freezeouts can also occur after tender offers as well as controlling the shareholder closeouts in going-private transactions. Let’s take the 2001 Siliconix decisions for instance. Prior to this decision, all freezeout bids in Delaware were then subject to the demanding “entire fairness” standard governing such transactions.

For those who are confused, allow us to explain further. The Delaware Chancery Court decided that freezeouts in tender offers would not be subject to this standard in Siliconix. Subramanian then analyzed a database of freezeouts in the years immediately following this monumental Siliconix decision. In their analysis, it was revealed that controlling shareholders paid less to minority shareholders in tender offers than they did in mergers. This was discussed in “Post-Siliconix Freeze-outs: Theory, Evidence, and Policy,” Journal of Legal Studies 36, no. 1 (2007): 1–26. By Guhan Subramanian.

Now, following a Merger and Acquisition, it is not uncommon or unusual that there are still shareholders who still have not exchanged their frozen-out shares for compensation months after the deal. This is most common to as much as 10% to 20% of shareholders in a company.

Companies then offer services paid by the shareholders where they locate the shareholders and seek to have them exchange their shares. This is usually done for a fee which is negotiated between shareholders and companies themselves.