“Frivolous” Merger Litigation Settlement Rejected by the Court
In an opinion that could help remedy the problem of baseless merger litigation, a court applying North Carolina law recently refused to approve a class action settlement because the underlying lawsuit was without merit.
The case, City Trading Fund v. Nye, et al., arose out of the acquisition of Texas Industries by Martin Marietta Materials. As happens in almost every public company merger, a shareholder filed litigation challenging the transaction. The lawsuit alleged that Martin Marietta’s disclosures regarding the proposed merger were inadequate, thereby breaching the directors’ fiduciary duty to the shareholders. The lawsuit was filed in New York, but, because Martin Marietta is a North Carolina corporation, the claims were governed by North Carolina law.
To avoid the expense of litigation and any potential delay in closing the deal, the defendants ultimately agreed to a “disclosure only” settlement, which required Martin Marietta to make some minimal additional disclosures in advance of the shareholder vote on the merger. Based on those disclosures, and in connection with their motion to approve the settlement, the shareholders’ lawyers sought an award of substantial attorneys’ fees. Such settlements are common in merger litigation and are generally approved by courts.
In this case, however, the court refused to approve the proposed settlement. The court began by examining each of the ways in which Martin Marietta’s disclosures were allegedly lacking. The court concluded in each instance that the omitted information was not material, and thus the omissions did not violate the directors’ fiduciary duties. Accordingly, the additional disclosures required by the proposed settlement did not create any real value for the shareholders. The court also discussed the shareholder who brought the lawsuit, a small partnership formed for the sole purpose of bringing shareholder lawsuits, and concluded that it was not an adequate representative for other shareholders because it is “essentially a fictitious entity.” More generally, the court lamented the current state of merger litigation, recognizing that it has effectively created a “merger tax.” The court concluded that it should not countenance “frivolous litigation,” and therefore rejected the settlement and ordered the defendants to respond to the complaint—such response presumably being a successful motion to dismiss the lawsuit.
The ruling generated substantial publicity, including an article on the front page of the New York Law Journal, for its thorough excoriation of the shareholder and law firm bringing the lawsuit.
The decision potentially represents another mechanism for minimizing the unnecessary costs imposed on North Carolina companies by merger litigation. In the past couple of years, efforts to control such costs have focused on litigation management provisions in a company’s bylaws or articles of incorporation, particularly provisions limiting shareholder litigation to a single forum. Last year, the North Carolina General Assembly passed SB 648, empowering North Carolina corporations to adopt provisions limiting shareholder litigation to a North Carolina forum, and separately the Delaware Court of Chancery recognized that Delaware corporations headquartered in North Carolina can do the same (see here and here). If courts applying North Carolina law, like the City Trading Fund court, continue to scrutinize settlements closely and refuse to reward meritless claims, shareholders (and the law firms representing them) will have less incentive to bring such litigation in the first place.