As has been widely reported, almost every large public company merger and acquisition (M&A) transaction attracts at least one shareholder lawsuit. In 2014, lawsuits were filed in 93 percent of all announced public company transactions valued over $100 million, up from 44 percent in 2007.1 Unfortunately for defendant companies and directors, many of these lawsuits are not triggered by failures to properly exercise fiduciary duties, a faulty board process or inadequate disclosures and result in disclosure-only settlement agreements together with plaintiffs’ counsel fee awards that are nothing more than a “transaction tax.”2
Many companies have implemented defensive measures in an attempt to mitigate the frequency and impact of these routine and questionable lawsuits. Forum selection charter and bylaw provisions, which were recently statutorily validated in Delaware,3 have proven popular and effective at reducing the number of jurisdictions where an M&A lawsuit is filed.4However, Delaware stock corporations recently lost one potential mitigating tool when the Delaware legislature enacted a statutory prohibition on the adoption of fee-shifting charter and bylaw provisions related to internal corporate claims.5
However, Delaware entities may take solace in recent developments in the Delaware Chancery Court that indicate that Delaware courts will closely scrutinize M&A litigation settlements and will reject settlements involving a global release for defendants where the court believes that the shareholder benefits obtained by plaintiffs, even if tangible, do not justify such a release. The court’s recent actions may indicate a sea change is beginning that could alter the M&A litigation landscape in the Delaware Chancery Court and potentially elsewhere.
Courts Increasingly Scrutinize Settlements
Although courts in Delaware, New York and Texas have in recent years rejected some “disclosure-only” settlements,6 historically, such settlements have been routinely approved. Two recent Delaware Chancery Court cases illustrate how troubling that court now finds these settlements and its increasing willingness to break with the tradition of routinely approving not only “disclosure-only” settlements, but also settlements that involve changes to deal protections. The Delaware courts appear focused on ensuring that under the facts of each case the relief obtained by plaintiffs in the settlement provides sufficient value to justify a global release and plaintiffs’ counsel fee award.
Acevedo v. Aeroflex Holding Corp.7 After filing a lawsuit over the merger and conducting discovery, the plaintiffs could not find support for their fiduciary duty claims. As a result, the parties negotiated a settlement agreement, which resulted in (i) an approximately 40 percent reduction of the termination fee from $32 million to $18 million, (ii) a one day reduction in the buyer’s matching rights period and (iii) certain supplemental disclosures.
In return, plaintiffs’ counsel would receive a fee award of $825,000 and defendants would receive a global release of all claims relating to the merger.
Despite acknowledging that this type of settlement was routinely approved in the past, Vice Chancellor Laster rejected the settlement because he did not believe that the relief obtained by the plaintiffs justified a global release. The Delaware Chancery Court stated it was unsure what benefit there was in this case to the reduction of the already reasonable termination fee or the shortening of a matching right when the issue preventing a potential competing bidder was a nondisclosure agreement. The court discussed at length that the settlement agreement achieved something that was only cosmetic and provided no real relief because (a) the plaintiffs’ discovery found no conflicted board and (b) the potentially competing bidder was impeded from bidding because of a nondisclosure agreement, and the nondisclosure agreement was not addressed in the settlement agreement.
The court dispelled the notion that plaintiffs’ counsel could come forward with “run-of-the-mill” reductions in deal protections and expect to receive fees in exchange for a global release. Instead, the court expects plaintiffs to show that the relief obtained is worth something in the context of the case. Otherwise, plaintiffs’ counsel merely “put time in” and “fixed something that didn't need fixing.” In those cases, the court suggests that plaintiffs’ counsel needs to recognize that “sometimes when you've got nothing, you've got to acknowledge you've got nothing and just go away.”
When plaintiffs’ counsel questioned the court as to why defendants would settle if the relief obtained was not worth anything, the court bluntly indicated that “[i]t's a testament to the holdup value of a lawsuit.”
The court’s rejection of the settlement illustrates not only a real concern with the current state of M&A litigation and the resulting settlements that “do not provide any identifiable much less quantifiable benefit to shareholders” and allow defendants to buy broad releases at low cost, but also the court’s willingness to act on those concerns. The court bemoaned the “real consequences, all of them bad,” associated with routine approval of these settlements, including:
- “cases that should be litigated actually don't get litigated;”
- “the intergalactic releases extinguishing all claims cover a lot more than anything that the plaintiffs ever have time to or do diligence in the short period between the time of filing and the time when these [settlements] are agreed to” (for example, the releases could extinguish antitrust and federal securities law claims); and
- “worst of all, it undercuts Delaware's credibility as an honest broker in the legal realm.”
The court gave three options to resolve the case:
- reframe the dismissal as being warranted because the claims were rendered moot;
- limit the release to the fiduciary duty and disclosure claims that the plaintiff actually investigated; or
- defendants may move to dismiss.
Despite rejecting the settlement, the court acknowledged that plaintiffs’ counsel would still be entitled to a fee award because the defendants indicated that the relief obtained had some value and caused the claims to be moot. Due to the “low value” of the relief obtained by plaintiffs, the court estimated a greatly reduced fee award of no more than $250,000 (approximately 30 percent of what plaintiffs’ counsel stood to receive if the settlement was approved).
Subsequently, on August 10, 2015, the court granted defendants’ motion to dismiss the complaint with prejudice and retained jurisdiction over plaintiffs’ counsel’s application for an award of attorneys fees.
In re Intermune.8 In connection with an acquisition structured as a front-end tender offer with a back-end reverse triangular merger, plaintiffs filed suit indicating concern about the transaction’s short negotiating window (approximately five weeks between first contact and deal signing) and whether there was sufficient marketability of the target considering that the merger agreement did not include a go-shop provision. Following an initial investigation, plaintiffs’ counsel could not make a case that the pricing was unfair, did not find any conflicted directors or any process issues, and determined it was only a disclosure case. As a result, the parties negotiated a settlement agreement, which resulted in the defendants making certain supplemental disclosures.
In return, plaintiffs’ counsel would receive a fee award of $470,000, and defendants would receive a global release of all claims relating to the transaction.
Vice Chancellor Noble, like Vice Chancellor Laster in Aeroflex, was concerned about the scope of the release in light of the marginal benefit provided to shareholders by the supplemental disclosures. The court wondered “if it's a disclosure case, why shouldn't the release go to what the case was destined to be, which is disclosure?” The court indicated that after long being concerned with these types of settlements, it is ready to act on them by stating“[t]his is something which I have struggled with over many years, and I finally decided this was the one that I wanted to raise the issue in. I apologize to all of you because nobody was anticipating that….I have approved a lot of settlements where the disclosures were no better or no worse than the disclosures here. But this is more of, as I suggested, more of a structural question that I'm struggling with.”
Unlike in Aeroflex, the court did not reject the settlement but indicated that it would further consider whether or not to approve the settlement.
How Will Greater Judicial Scrutiny of Settlements Impact M&A Lawsuits?
As Vice Chancellor Laster noted in Aeroflex, “the trend in which the Court of Chancery looks more carefully at these settlements is a good one.” That view that the judicial scrutiny applied in Aeroflex and Intermune is in fact a trend is further enforced by Vice Chancellor Laster’s comments in a recent scheduling order for a settlement hearing that plaintiff’s counsel should be prepared to address the issues raised in Aeroflex.9
If the Delaware Chancery Court’s recent actions are indeed the beginning of a trend of closer judicial scrutiny of M&A litigation settlements, such scrutiny may serve as the beginning of the end of the reflexive lawsuit following the announcement of every large M&A transaction, or at a minimum, a more targeted proposed return with an accordingly reduced plaintiff fee award. The volume of M&A litigation may recede if plaintiffs’ counsel no longer believes that there is a strong likelihood of obtaining a decent award fee where the relief obtained in a settlement is merely disclosure or could otherwise be deemed insufficient by the court. Moreover, companies may be less likely to settle if their only award is a narrow release, which may further deter plaintiffs’ counsel from filing suits following almost every large M&A transaction.
Although Delaware public companies would welcome greater judicial scrutiny of settlements if the long-term result is an actual reduction in the volume of M&A litigation, greater scrutiny could prove problematic for companies. Plaintiffs may pursue claims more vigorously than when a quick and cheap settlement was a realistic possibility. Companies can also lose the ability to obtain relatively cheap “deal insurance” in the form of a global release without potentially providing more relief to shareholders in the form of cash or greater reductions in deal protections. As Vice Chancellor Noble stated in Intermune, rejecting settlements is “somewhat a punishment” as companies lose the ability to obtain “total peace.” If only a narrow release is available to companies, other potential transaction-related claims will remain unresolved, which could result in protracted litigation involving higher costs and adverse press.
Only time will tell whether the court’s recent actions represent a sustainable trend of closer scrutiny of settlements and the ultimate impact of such scrutiny on the M&A litigation landscape. Although many may expect these actions to benefit companies and directors, as Vice Chancellor Laster noted in Aeroflex, closer judicial scrutiny may not ultimately make “anyone happy.” In the meantime, boards of public companies should continue to exercise their fiduciary duties as they always have in connection with M&A transactions, including avoiding conflicts of interest, running a thorough evaluation process, using sound business judgment, consulting with company counsel and disclosing material information about the transaction to shareholders.