In a 2-1 decision, the Seventh Circuit has joined the Delaware Court of Chancery’s call for enhanced scrutiny of “disclosure-only” M&A settlements that involve no monetary benefits to shareholders. As previously discussed here, M&A litigation, typically alleging breach of fiduciary duty by directors and insufficient disclosures, often ends in settlement, with defendants agreeing to provide supplemental disclosures in exchange for broad releases of claims, while plaintiffs’ counsel “earns” large attorneys’ fees for providing the class with the “benefit” of the agreed-upon disclosures. In In re Walgreen Company Stockholder Litigation (“In re Walgreen Co.”), the Seventh Circuit rejected such a settlement, endorsing the standard for approval of disclosure-only settlements articulated by the Delaware Court of Chancery in In re Trulia, Inc. Shareholder Litigation (“In re Trulia”). In In re Trulia, the Court of Chancery held that disclosure-only settlements in M&A litigation will meet with disfavor unless they involve supplemental disclosures that address a “plainly material misrepresentation or omission” and any proposed release of claims accompanying the settlement encompasses only disclosure claims and/or fiduciary duty claims regarding the sale process.
As previously discussed here, in 2015, the Delaware Court of Chancery issued a number of decisions calling for enhanced scrutiny of “disclosure-only” M&A settlements that involve no monetary benefits to a shareholder class. For example, the recent decision in In re Riverbed Technology, Inc. Stockholders Litigation expressly eliminated the “reasonable expectation” that a merger case can be settled by exchanging insignificant supplemental disclosures (and nothing more) for a broad release of claims. In In re Trulia, Inc. Stockholder Litigation, the Chancery Court demonstrated that its “increase[ed] vigilance” in this area is genuine, rejecting a disclosure-only M&A settlement and finding that the supplemental disclosures did not warrant the broad release of claims.
Disclosure-only settlements have been popular in the past – last year, about 80% of settlements in M&A-related lawsuits were for disclosures only, according to Cornerstone Research – but lately they have come under scrutiny. The Delaware Court of Chancery has issued opinions refusing disclosure-only settlement agreements before, noting that at times in these cases “there is simply little to commend the process of weighing the merits of a ‘settlement’ of litigation where the only continuing interest is that of the plaintiffs’ counsel in recovering a fee.” The incentives of attorneys on both sides can be such that “the potential claims belonging to the class [are not] adequately or diligently investigated or pursued.”
The past decade has seen an incredible rise in M&A litigation. According to Cornerstone, in 2014, a whopping 93% of announced mergers valued over $100 million were subject to litigation, up from 44% in 2007. As Delaware Supreme Court Chief Justice Leo Strine explained several years ago, “the reality is that every merger involving Delaware public companies draws shareholder litigation within days of its announcement.” These lawyer-driven class action suits, which typically allege breaches of fiduciary duty by directors and insufficient disclosures, overwhelmingly end in settlement, with corporate defendants agreeing to provide additional disclosures in exchange for a broad release, and plaintiffs’ counsel walking away with attorneys’ fees for the theoretical “benefit” they conferred upon the class.
ATP Tour: The Little Case That Could
On May 8, 2014 the Delaware Supreme Court upheld a “loser pays” fee-shifting bylaw for a Delaware non-stock corporation in ATP Tour, Inc. v. Deutscher Tennis Bund. While the decision was released with little heralding, if ATP Tour’s “loser pays” provisions are widely adopted by public corporations and held also to be valid, the decisionmay create a significant impediment to the ubiquitous lawsuits alleging that directors have breached their fiduciary duties of loyalty and care to the corporation.
The board of ATP Tour, a membership organization that operates men’s professional tennis competitions, enacted a fee-shifting bylaw which provides that a “Claiming Party,” i.e. a member organization, would be liable for the corporation’s attorneys’ fees and other litigation expenses if it loses in an intra-corporation claim against the company. The fee-shifting bylaw obligates any Claiming Party to reimburse the League and any member or owner of ATP Tour that the Claiming Party also sued. READ MORE
Last Friday, Judge Kleinberg of the California Superior Court, County of Santa Clara, dismissed two shareholder class actions against the former directors of Actel Corporation and Applied Signal Technology, Inc. for breach of fiduciary duties arising out of the sales of Actel and Applied Signal to third-party buyers. In doing so, Judge Kleinberg stated that, under California law, damages claims brought by shareholders of California corporations against directors for breach of fiduciary duties in connection with the approval of a merger are derivative, not direct. Thus, because a plaintiff in a shareholder’s derivative suit must maintain continuous stock ownership throughout the pendency of the litigation, and the plaintiffs ceased to be stockholders of Actel and Applied Signal by reason of a merger, Judge Kleinberg held that they lacked standing to continue the litigation.
In holding that post-merger claims against directors of California acquired corporations are derivative, Judge Kleinberg relied on the pre-Tooley rationale (which is no longer controlling in Delaware and has been questioned in California) that a harm suffered equally by all shareholders in proportion to their pro rata ownership of the company is a derivative harm. Judge Kleinberg rejected the plaintiffs’ argument that Delaware’s Tooley standard for determining whether a claim was direct or derivative was adopted by the California Court of Appeal in Bader v. Andersen, 179 Cal. App. 4th 775 (2009). According to Judge Kleinberg, in stating that California and Delaware law were “not inconsistent,” the Bader court was merely observing that the results of applying California versus Delaware law in that case were not inconsistent; it was not saying that California and Delaware law are the same on the direct versus derivative issue.
Judge Kleinberg’s holding is a victory for the defense bar, as it means that merger litigation involving California incorporated targets will be susceptible to dismissal by demurrer or summary judgment following the preliminary injunction stage.
On April 25, 2012, Cornerstone Research released an interesting report entitled “Recent Developments in Shareholder Litigation Involving Mergers and Acquisitions—March 2012 Update.” The report notes that the incidence of litigation in connection with mergers valued at $500 million or greater rose from 57% in 2007 to 96% in 2011. This observation has already caught the attention of the Delaware Chancery Court where Vice Chancellor Laster commented in a teleconferenced ruling, “I don’t think for a moment that 90%—or based on recent numbers—95% of deals are the result of a breach of fiduciary duty. I think there are market imbalances here and externalities that are being exploited. What this means is that the Court needs to think carefully about balancing.”
The report also shows that the number of lawsuits per litigated deal increased from an average of 2.8 in 2007 to 6.2 in 2011. The absolute count of lawsuits involving deals with values of $500 million or greater also nearly doubled from 289 in 2007 to 502 in 2011. The report also noted that as of March 2012, 67 lawsuits have already been reported for 13 out of 17 deals announced during January and February.