For many years, litigation inevitably followed close on the heels of a public company merger announcement. These lawsuits often led to a quick settlement in which the defendant made additional disclosures relating to the merger, the plaintiff released the defendant from all merger-related claims, and the plaintiff’s lawyers received a six-digit attorney fee award.
But recently there has been a backlash against this process. Public companies have begun adopting corporate bylaws designed to manage risks associated with a merger lawsuit. In addition, the Delaware Court of Chancery has started refusing to approve disclosure-only settlements in a number of merger litigation cases. These developments have significantly affected the merger litigation landscape.
Anatomy of a Merger Lawsuit
For some time now, litigation has followed a public company merger announcement as night follows day. The process has been predictable and formulaic.
It begins as soon as a merger is announced, when numerous plaintiff-side class action firms announce that they are investigating potential claims against the board of directors of the target company. Shortly thereafter, multiple lawsuits are filed by shareholders. One recent study showed that 93 percent of merger and acquisition deals valued at over $100 million resulted in litigation and that the first lawsuit was filed on average 14 days after the merger announcement. Cornerstone Research, Shareholder Litigation Involving Acquisitions of Public Companies—Review of 2014 M&A Litigation (2015). Until recently, these lawsuits typically were filed in multiple jurisdictions, including the target company’s state of incorporation (usually Delaware) and the target company’s principal place of business.
The lawsuits commonly allege that the directors of the target company breached their fiduciary duty to the shareholders by following a flawed sales process and by failing to get the best price for the company. Plaintiffs also typically allege that the target company failed to disclose all material information in connection with the upcoming shareholders’ vote on the merger. The acquiring company is sometimes also sued, on the theory that it aided and abetted the breaches of fiduciary duty by the target company’s directors. The plaintiff shareholders then move for a preliminary injunction to enjoin the shareholder vote and seek expedited discovery in connection with their motion.
Because of the business imperative to complete the merger transaction, there is a powerful incentive for defendants to resolve these types of cases quickly—often through settlement. In the standard settlement, the target company agrees to provide additional disclosures in connection with the shareholder vote (but no additional financial consideration), while the plaintiff—on behalf of a class of all shareholders—agrees to a release of all claims relating to the merger. The plaintiff’s attorneys then apply to the court for an award of attorney fees based on the benefit they obtained for the class.
Bylaw Provisions as a Risk Management Tool
The merger litigation dynamic has been widely recognized as a problem, but solutions have been hard to identify. One response that has been growing in popularity is the use of corporate bylaws to control merger litigation risk.
Forum-selection bylaws. The first and most popular such bylaw is the forum-selection bylaw. These bylaws require shareholders to bring claims related to internal corporate affairs exclusively in the courts of a particular state, usually the company’s state of incorporation. Such bylaws are intended to eliminate the problem of merger litigation filed in multiple states and to ensure that the forum in which suits are brought is one convenient to the company and one that has familiarity with the pertinent body of corporate law. The Delaware Court of Chancery upheld the enforceability of forum-selection bylaws in Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), and that holding was later codified into the Delaware General Corporation Law (Del. Code tit. 8, § 115).
Forum-selection bylaws are increasingly being adopted by target companies in connection with a pending merger. Shareholder plaintiffs have challenged this practice, suggesting that a forum-selection bylaw must be adopted on a “clear day” and not in anticipation of specific litigation. But the Delaware Court of Chancery rejected this argument in City of Providence v. First Citizens BancShares, Inc., 99 A.3d 229 (Del. Ch. 2014), holding that, at least under the facts of that case, the fact that the board of directors adopted the bylaw on a “cloudy day”—i.e., at the same time it entered into a merger agreement—rather than on a “clear day” is immaterial. Courts in other states, following First Citizens, have likewise upheld forum-selection bylaws adopted in connection with pending mergers. See, e.g., Roberts v. TriQuint Semiconductor, Inc., 364 P.3d 328, 334 (Or. 2015).
The First Citizens decision also held that a Delaware corporation may designate the state of its principal place of business—rather than Delaware—as the exclusive forum for internal corporate affairs litigation. That holding, however, was overturned by the Delaware legislature (see Del. Code tit. 8, § 115), and now a Delaware corporation may not designate a state other than Delaware as its sole, exclusive forum for purposes of a forum-selection bylaw.
Fee-shifting bylaws. A more powerful—but more controversial—bylaw is the fee-shifting bylaw. These bylaws require a shareholder plaintiff to pay the corporation’s expenses and attorney fees in the event the shareholder’s suit is unsuccessful. Such a bylaw obviously would serve as a significant deterrent to shareholder litigation, whether merger-related or otherwise.
For Delaware corporations, fee-shifting bylaws are not an option. The Delaware Supreme Court initially gave some support to fee-shifting bylaws in the case of ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), which held—in the context of a non-stock corporation—that a fee-shifting bylaw was facially valid. Soon thereafter, however, Delaware adopted legislation stating that a company’s bylaws “may not contain any provision that would impose liability on a stockholder for the attorney fees or expenses of the corporation or any other party in connection with an internal corporate claim” (Del. Code tit. 8, § 109(b)).
For companies incorporated outside Delaware, however, fee-shifting bylaws may remain an option.
Minimum-stake-to-sue bylaws. Yet another attempt to use bylaws as a tool to manage merger litigation risk is the minimum-stake-to-sue bylaw. This type of bylaw prohibits a shareholder from bringing internal affairs litigation without the written consent of a minimum percentage of the company’s shareholders.
Very few public companies appear to have adopted a minimum-stake-to-sue bylaw, and as a result, the validity of such bylaws remains an open question. One such bylaw was described—and challenged—in the Florida case of Rothenberg v. Goldstein, No. 9:15-cv-80505 (S.D. Fla. filed Jan. 16, 2015). But the case was voluntarily dismissed before any ruling on the validity of the bylaw, so it remains to be seen whether such a bylaw will survive a legal challenge.
Refusal by the Delaware Court of Chancery to Approve Settlements
An even more powerful deterrent to baseless merger litigation, however, has come directly from the Delaware Court of Chancery, in the form of the court’s increasing refusal to approve disclosure-only settlements where the disclosure is judged to be “immaterial” and where the release extends beyond the claims that are the subject of the plaintiffs’ specific claims.
This trend started in July 2015 with Vice Chancellor Laster’s opinion in Acevedo v. Aeroflex Holding Corp., No. 7930-VCL (Del. Ch. July 8, 2015) (transcript), in which the court refused to approve a settlement in which the defendants agreed to changes in deal terms and additional disclosures in exchange for a broad release and consent to attorney fees in excess of $800,000. Vice Chancellor Laster bemoaned the “easy money” available to plaintiffs’ lawyers in such cases and stated that the court should not encourage the filing of “junky cases.”
Shortly thereafter, in In re Riverbed Technology, Inc. Stockholders Litigation, No. 10484-VCG (Del. Ch. Sept. 17, 2015), Vice Chancellor Glasscock approved a disclosure-only settlement but, in the course of doing so, was very critical of such settlements insofar as they allow defendants to “purchase, at the bargain price of disclosures of marginal benefit to the class and payment of the plaintiff’s attorney fees, a broad release from liability.” He made clear that his approval of this particular settlement was based in large part on “formerly settled practice in this Court,” but that going forward, the past practice of approving disclosure-only settlements would no longer be a basis for approval.
The following month, Vice Chancellor Laster again refused to approve a merger litigation settlement in In re Aruba Networks, Inc. Stockholder Litigation, No. 10765-VCL (Del. Ch. Oct. 9, 2015) (transcript). In refusing the settlement, he stated: “We have reached a point where we have to acknowledge that settling for disclosure only and giving the type of expansive release that has been given has created a real systemic problem.”
Most recently, Chancellor Bouchard refused to approve a merger litigation settlement in In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. Jan. 22, 2016). The 42-page opinion is a broadside attack on the practices surrounding disclosure-only settlements. Chancellor Bouchard observed that
far too often such litigation serves no useful purpose for shareholders. Instead, it serves only to generate fees for certain lawyers who are regular players in the enterprise of routinely filing hastily drafted complaints on behalf of stockholders on the heels of the public announcement of a deal and settling quickly on terms that yield no monetary compensation to the stockholders they represent.
The court explained its approach going forward:
[P]ractitioners should expect that the Court will continue to be increasingly vigilant in applying its independent judgment to its case-by-case assessment of the reasonableness of the “give” and “get” of such settlements in light of the concerns discussed above. To be more specific, practitioners should expect that disclosure settlements are likely to be met with continued disfavor in the future unless the supplemental disclosures address a plainly material misrepresentation or omission, and the subject matter of the proposed release is narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently.
Id. at 898.
Where Do We Go from Here?
By refusing to approve what had been standard disclosure-only settlements, the Delaware Court of Chancery has created strong disincentives for such litigation to be brought in the first instance—at least in Delaware. And, in fact, statistics suggest that merger lawsuits dropped dramatically in the final quarter of 2015 in light of the developments described above—down to only 21.4 percent of deals valued over $100 million. Matthew D. Cain & Steven Davidoff Solomon, Takeover Litigation in 2015 (Jan. 14, 2016).
But that is not necessarily the end of the story. In response to the Delaware Court of Chancery’s crackdown on disclosure-only settlements, many plaintiffs are simply choosing to file in other states, as suggested by one study. Anthony Rickey & Keola R. Whittaker, “WillTrulia Drive ‘Merger Tax’ Suits Out of Delaware?,” Legal Backgrounder, Apr. 29, 2016. This is sometimes done despite a forum-selection bylaw requiring that such suits be brought in Delaware, in the hope that the defendants will waive the bylaw in order to obtain a disclosure-only settlement (including a broad release) in a different forum. In other cases, plaintiffs are casting their claims as violations of the federal securities laws and filing in federal court, notwithstanding the procedural hurdles of the Private Securities Litigation Reform Act.
It remains to be seen how courts outside Delaware will react to this shift in jurisdictional focus. For example, in our home state of North Carolina, disclosure-only settlements have been approved in certain cases since Trulia. See, e.g., Corwin v. British Am. Tobacco PLC, No. 14-CVS-8130, 2016 NCBC 14 (Super. Ct. Guilford Cty. Feb. 17, 2016) (order approving partial settlement). But at the same time, the court signaled that it is well aware of developments in Delaware and that it will continue to review merger litigation settlements carefully to ensure that they satisfy applicable standards of fairness under North Carolina law.
Furthermore, there are still ample opportunities for merger litigation within the Delaware Court of Chancery. The new line of cases is limited to settlements involving immaterial disclosures or changes to deal terms; settlements in which plaintiffs can obtain material disclosures, increased deal consideration, or other significant relief for shareholders can still expect approval. In addition, as suggested by Chancellor Bouchard in the Trulia opinion, if a target company revises its disclosures voluntarily in response to a shareholder suit, the shareholder can take a voluntary dismissal and then move for fees outside the context of a class-wide settlement.
The model of merger litigation that reigned for many years is dead. It remains to be seen what will rise up in its place.
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