Perverse. Frivolous. Collusive. Wasteful. Pointless. Stinky. Excessive. Worthless. Horse hockey.
No, we’re not talking about the U.S. presidential election. These are judges and commentators characterizing disclosure-only settlements of M&A litigation, which, in no small part due to the efforts of an intrepid Fordham law professor, are under siege.
These controversial settlements are the “path of least resistance,” as one court put it, for public companies seeking to disappear the strike suits – shareholder and derivative actions – that nip at the heels of virtually every M&A deal. The scenario is so familiar it is a cliché. A public merger is announced, and in a nanosecond the suits are filed and settled. (Quick-to-honk New York cabbies have nothing on quick-to-file Delaware plaintiffs’ lawyers.) So inevitable are these suits that they have come to be seen as a tax on public mergers. It is a tax, however, paid not to government revenuers but to a cast of plaintiffs’ lawyers more than happy to take home a six-figure corporate check for the cost of a thimble of Wite-Out and a cartridge of black-and-white toner. Chancellor Andre Bouchard of the Delaware Court of Chancery, ground zero for disclosure settlements, puts it this way:
“It is beyond doubt that . . . the Court’s willingness in the past to approve disclosure settlements of marginal value and to routinely grant broad releases to defendants and six-figure fees to plaintiffs’ counsel in the process have caused deal litigation to explode in the United States beyond the realm of reason.”
How far beyond? According to Cornerstone Research, the percentage of M&A deals challenged by shareholders topped ninety in 2010. The high-water mark was 2013 when a staggering 98 percent of deals over $100 million were challenged in court, with each deal targeted in an average of seven suits. According to William Savitt, a litigation partner with Wachtell, Lipton, Rosen & Katz, an astonishing 80 percent of these actions settled for disclosures alone.
Then last year the number of suits started to plunge – from 9 in 10 deals valued at more than $100 million to 6 in 10. In Delaware, plaintiffs challenged more than 60 percent of deals in the first three quarters of 2015, but over the next three quarters, through June 2016, that number fell to 26 percent.
It seems the Delaware Court of Chancery got tired of holding its collective nose and signing off on “stinky” settlements. In a National Law Journal article, Savitt pointed to a series of unpublished rulings through which the court
“signaled that it was growing weary and skeptical of disclosure-only settlements,” warning litigants to expect heightened scrutiny. Around the same time, Fordham law professor Sean Griffith, a former Wachtell associate, joined by fellow law professors Jill E. Fisch of the University of Pennsylvania Law School and Steven Davidoff Solomon of UC Berkeley School of Law, published an influential article in the Texas Law Review, “Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform.” Among those acknowledged by the authors for their help are none other than former Skadden litigator Leo Strine, Chief Judge of the Delaware Supreme Court (and former Chancellor of the Delaware Court of Chancery), and Vice Chancellor
J. Travis Laster, along with a small army of well-known practitioners and academics who have been buzzing around the topic. The law profs put it this way:
“It is implausible to think that 60% of all mergers (or 80% in the last several years) with public company targets and a transaction value of more than $100 million, deals that are staffed by top quality lawyers and investment bankers, involve materially deficient disclosures,” they wrote. “It is far more likely that merger lawsuits are not filed to correct disclosure problems. The structure of disclosure-only settlements is likely about something else – justification of a fee award to plaintiffs’ counsel.”
The authors set out to supply empirical ammunition to judges in Delaware and elsewhere. They started with a simple hypothesis: the value of nonpecuniary relief in merger settlements should have a demonstrative impact on shareholder voting. They tested this against 453 deals, focusing on various forms of relief, including disclosure-only settlements. They found . . . horse hockey.
“If disclosure settlements do not affect shareholder voting,” they concluded, “it is difficult to argue that they benefit shareholders. Accordingly, the basis upon which courts are awarding fees to plaintiffs’ counsel disappears.” In light of their findings, they called for a “reconsideration” of Delaware merger law.
The media have taken note of the hubbub. Vice Chancellor Laster earned a Wall Street Journal headline as “The Judge Who Shoots Down Merger
Lawsuits” with his rejection of a spate of settlements, which he blasted as “pseudo-litigation.” Seth Rigrodsky, a Wilmington plaintiffs’ lawyer active in shareholder litigation, is depicted in the piece as running away from Laster’s court with his tail between his legs. “The heyday of ‘file a case, make $500,000’
is clearly over,” he is quoted as saying.
Griffith upped the ante by putting his money where his mouth is. He bought some shares and jumped into the fray, which caught the attention of Thomson Reuters’ On the Case blog. They pointed to Riverbed Technologies, where Griffith-the-shareholder objected, and though he failed to kill the deal, he earned an encouragingly skeptical opinion.
The watershed case arose from the proposed combination of real estate websites Trulia and Zillow. In a now oft-cited opinion, the Delaware court’s leader, Chancellor Bouchard, rejected a proposed settlement, opining along the way on the “ubiquity of deal litigation,” the proliferation of disclosure settlements” and the need to rethink Delaware’s “historical predisposition” toward signing off. Bouchard said that disclosures should be vetted in a true adversarial setting, and approval withheld absent a “plainly material misrepresentation or omission,” we well as a far narrower release than the “intergalactic” sort that have become the custom.
The federal courts are poised to follow. In August, Judge Richard Posner of the Seventh Circuit rejected a disclosure-only settlement arising from Walgreen’s purchase of Alliance Boots, adopting the Trulia approach with some choice words for disclosure settlements as a “racket” that “should be dismissed out of hand.” By then New York already had clamored onto the anti-disclosure bandwagon.
All of which has Griffith concerned – not by the results in Delaware, but by what may be in store elsewhere. Testing the waters, he got a good result in New Jersey, where a local judge killed a disclosure settlement. Other states, however, have been less welcoming. For example, a North Carolina court recently dissed Delaware precedent in a case arising from Reynolds’ acquisition of Lorillard. While it’s still early in the game, Cornerstone’s research suggests a diminished docket of M&A cases are finding their way to other states since Trulia, with Delaware now tied, through Q2, with California with10 litigated deals (last year, Delaware had 91 and California 22), followed by New Jersey (4) and Michigan, North Carolina and Pennsylvania (tied at 3).
So what’s next? In Trulia, Bouchard lays out a few paths for evaluating the merits of disclosures – the give – in an adversarial setting that isn’t distorted by defendants’ lust for sweeping releases – the get. He suggests preliminary injunctions and attorney fee requests in conjunction with voluntary proxy supplements that moot plaintiffs’ claims. He also raised the possibility of appointing amici curiae to help courts evaluate disclosures.
Others have been lobbying for companies to adopt forum selection bylaws, but Griffith is dubious of the approach. “Defendants are in the market for the kind of closure and release the settlement gets you but voluntary dismissal doesn’t,” he told MCC in an interview.
Instead, he proposes that companies consider adopting “no-pay” provisions. “It’s akin to fee-shifting,” he said. “They commit to not paying attorneys fees for a corporate benefit settlement.”
Griffith believes this might prevent companies from being sued in the first place. “Plaintiffs would test it to see if it’s valid,” he said, adding that the defendant would not get a blanket release, which could be a problem.
“From the corporate counsel perspective, you’d rather get the release,” he said. “You need a firm commitment on the part of defendants not to pay at all.”
Published October 5, 2016.