The scenario is a familiar one. Public companies announce a proposed merger and move forward to solicit shareholder approval. Shareholder class actions challenging the merger soon follow. They often allege that the board of directors breached their fiduciary duties by failing to disclose sufficient information or by disseminating false or misleading disclosures about the proposed transaction. Within weeks, the parties reach a proposed settlement requiring the company to make pre-closing supplemental disclosures and pay a six-figure fee award in exchange for a broad release of claims. These “strike” suits, as they are sometimes called, are largely driven by the attorneys’ fees awarded to class counsel and provide little, if any, benefit to shareholders. The resulting settlements – known as “disclosure” or “disclosure-only” settlements because the additional disclosures are the primary or sole consideration to shareholders for the agreement– were routinely approved by courts until recently.
In January, the Delaware Chancery Court issued a landmark decision calling the future viability of these settlements into doubt, at least in Delaware. In In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016), the court did more than reject the parties’ proposed disclosure settlement. It reexamined the court’s historical practice of approving these settlements, and announced increased judicial scrutiny of the reasonableness of the “give” of the shareholders in providing a release of claims and their “get” in the form of supplemental disclosures. Id. at 898, 907. The court also warned 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 capture only the disclosure and fiduciary duty claims relating the sale process. Id. By employing this standard, the court sought to ensure that the additional disclosures provide adequate value to the shareholders.
In August, the Seventh Circuit endorsed Trulia. In its decision in In re: Walgreen Co. Stockholder Litigation, 2016 WL 4207962 at *4 (7th Cir. Aug. 10, 2016), the court adopted the Trulia standard in rejecting the disclosure settlement proposed in a class action challenging the Walgreens/Alliance Boots reorganization. The court expressed skepticism about strike suits and disclosure settlements, noting that these types of class actions are no better than a “racket” yielding fees for class counsel and nothing of value for the shareholders. Id. at *3. However, the Seventh Circuit went further than the Trulia court in applying the standard of disfavoring such settlements unless the additional disclosures address a plainly material misrepresentation or omission. Id. at *4-5. It made clear that the supplemental disclosures must not only “address” the alleged misrepresentations or omissions, “they must correct them.” Id. at *5.
Courts in other jurisdictions may soon follow Trulia and Walgreen in applying a “plainly material” standard to proposed disclosure settlements. Regardless, Trulia appears to be discouraging pre-merger deal challenges in Delaware as the number of these suits filed there since January has declined dramatically as compared to prior years. This trend is expected to continue, along with the recent shut-out of the fee-driven, disclosure settlements these suits often generate.