An increasingly popular legal strategy that allows hedge funds to make potentially lucrative bets on takeover deals, and get a return even if they lose, may be about to become much less attractive.

The strategy usually involves buying stock in a Delaware-incorporated company that is being acquired and then filing a claim that gets a judge to determine the fair price for the shares in a process known as appraisal. The fund will argue in court that the deal value was unfairly low and it should be paid a higher price.

Since an annual interest rate of 5.75 percent currently accrues while a case is pending, and a final judgment can take years, the strategy generates a solid return even when the court rules the deal price was fair.

But now the top corporate lawyers in Delaware, where about two-thirds of Fortune 500 companies are chartered, are proposing an amendment to the law aimed at removing the interest incentive if a case is lost. The lawyers' proposals have traditionally been approved with little opposition by Delaware's state legislature.

That hasn't stopped the appraisal lawsuits from piling up. And there are signs that given the low-return environment in financial markets, more hedge funds and other investors may be filing appraisal suits.

Between 2004 and 2010 only about 5 percent of the deals in which Delaware chartered companies were eligible for such claims were the subject of appraisal rights cases. By 2013 this had increased to 17 percent, according to the law firm Fried Frank.

Largest Ever

In recent days, funds affiliated with Third Point Reinsurance, Farallon Capital Management and Muirfield Capital, among others, have filed appraisal actions over the sale of pet products retailer PetSmart Inc, which closed on March 11.

In all, the funds concerned hold about 10.5 million shares of PetSmart, worth about $870 million, likely making it the largest appraisal action ever, according to Minor Myers, a professor at Brooklyn Law School.

Even if the court eventually determines that the $83 per share that a consortium led by European private equity firm BC Partners paid for PetSmart stock was fair, interest will accrue at more than $50 million per year while that decision is awaited, and will increase as time goes on because the interest is compounded quarterly. In addition, the court could determine the fair price should be much higher, giving the funds a big potential payout.

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