It's a familiar story in M&A transactions. A merger is announced and, within days, the plaintiffs' bar scrambles to file suits on behalf of the selling company's stockholders, alleging that the seller's board agreed to an inadequate price and made misleading disclosures about the deal. After going through "the motions"—the plaintiffs file a motion for preliminary injunction and the defendants produce certain agreed-upon documents—a settlement is reached whereby the plaintiffs give defendants a broad release in exchange for (often immaterial and unhelpful) supplemental disclosures and the defendants' agreement to pay (and not to oppose court approval of) a "six-figure" fee award to plaintiffs' counsel. According to the Trulia Court, the result is tantamount to a deal "tax" on M&A transactions.
For these reasons, the Chancery Court has been reviewing (and cutting plaintiff's attorneys' fees associated with or rejecting) disclosure-only settlements with increasing vigor, and perhaps unsurprisingly, deal litigation recently has dropped significantly. For instance, in In re Riverbed Technology, Inc. Stockholders Litigation, C.A. No. 10484-VCG, 2015 WL 5458041 (Del. Ch. Sept. 17, 2015), discussed here, the Court approved a disclosure-only settlement but warned that such settlements (and attorneys' fee awards associated with them) will no longer be approved as a matter of course, particularly where the additional information disclosed is "insignificant." Indeed, in 2014, 94.9% of completed takeovers were challenged in court, compared to just 21.4% in the fourth quarter of 2015. See Matthew D. Cain, et al., Takeover Litigation in 2015 (Jan. 14, 2016), available here. Riverbed and other decisions from late 2015—such as In re Susser Holdings Corp. Shareholder Litigation, C.A. No. 9613-VCG (Del. Ch. Sept. 15, 2015) (TRANSCRIPT); Acevedo v. Aeroflex Holding Corp., C.A. No. 9730-VCL (Del. Ch. July 8, 2015) (TRANSCRIPT); and In re Intermune, Inc. Shareholder Litigation, C.A. No. 10086-VCN (Del. Ch. July 8, 2015) (TRANSCRIPT)—likely are in no small part responsible for this decline. Each of these decisions, in questioning the value provided to a seller's shareholders from disclosure-only settlements, reflects the Court's increasingly vocal antipathy for the status quo.
Chancellor Bouchard's January 22 decision in In re Trulia, Inc. Stockholder Litigation, C.A. No. 10020-CB (Del. Ch. Jan. 22, 2015), wherein he denied approval of a disclosure-only settlement, is the latest decision expressing the Court's "disfavor" of disclosure-only settlements. Indeed, Trulia may be the knock-out blow to this type of resolution other than in rare situations where supplemental disclosure is deemed truly material. Importantly, such an outcome is not necessarily limited to instances where supplemental disclosure is the lone non-monetary consideration from defendants. The Court stated that its analysis is equally applicable to settlements where supplemental disclosures were the predominant, but not the sole consideration, for example where, in addition to supplemental disclosures the settlement included an "insubstantial component of other non-monetary consideration, such as a minor modification to a deal protection measure."
On July 28, 2014, Trulia and Zillow announced that they had agreed to a stock-for-stock merger whereby Zillow would acquire Trulia for $3.5 billion. Trulia's stockholders would own 33% of the combined company and Zillow's would own 67%. Shortly after the merger was announced, plaintiffs filed suit, claiming that Trulia's directors breached their fiduciary duties by agreeing to inadequate consideration and that Zillow and Trulia aided and abetted those breaches.
The parties agreed to an expedited schedule, the defendants produced "core documents" (i.e., board books and bankers' presentations) and the plaintiffs deposed a director of Trulia and a member of its financial advisor team from J.P. Morgan. The plaintiffs then filed a motion for preliminary injunction in which they focused on alleged inadequacies in the companies' joint proxy statement. The defendants swiftly filed a supplemental proxy statement and, two days later, the parties memorialized their agreement to settle the litigation in exchange for the supplemental disclosures that had been made, subject to confirmatory discovery. The plaintiffs took confirmatory discovery (one additional deposition of a Trulia director), the Trulia stockholders voted overwhelmingly in support of the transaction, and the deal closed. The parties then executed a settlement agreement, which provided for a $375,000 fee award to plaintiffs' counsel and the release of all claims, including "unknown claims," related to the transaction.
On January 22, Chancellor Bouchard rejected the settlement and, in doing so, issued an opinion that cast serious doubt on the continuing viability of resolving M&A litigation by means of disclosure-only settlements. Indeed, he lamented 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 plaintiff's counsel," warned future litigants that the Court "will be increasingly vigilant in scrutinizing the 'give' and the 'get' of such settlements," and encouraged courts in other states to do the same.
In setting the stage for his decision, the Chancellor offered several telling comments regarding these types of resolutions:
- "On occasion, although it is relatively infrequent, such litigation has generated meaningful economic benefits for stockholders when, for example, the integrity of a sale process has been corrupted by conflicts of interest on the part of corporate fiduciaries or their advisors. But far too often such litigation serves no useful purpose for stockholders. 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."
- "Given the Court's historical practice of approving disclosure settlements when the additional information is not material, and indeed may be of only minor value to the stockholders, providing supplemental disclosures is a particularly easy 'give' for the defendants to make in exchange for a release."
- "Scholars have criticized disclosure settlements, arguing that non-material supplemental disclosures provide no benefit to stockholders and amount to little more than deal 'rents' or 'taxes,' while the liability releases that accompany settlements threaten the loss of potentially valuable claims related to the transaction in question or other matters falling with in the literal scope of overly broad releases."
- The Court also acknowledged that its practice of approving disclosure-only settlements has contributed to causing "deal litigation to explode in the United States beyond the realm of reason."
Going forward, disclosure-only settlements will likely be rejected unless the supplemental disclosures cure an obviously material misrepresentation or omission, and the release is narrowly crafted to encompass only disclosure claims and fiduciary claims concerning the sale process that have been adequately investigated.
Chancellor Bouchard cautioned that disclosure-only 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 the disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently." He further added that, by "plainly material," he meant "it should not be a close call that the supplemental information is material as that term is defined under Delaware law," i.e., there is a "substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available." The Court added that "[w]here the supplemental information is not plainly material, it may be appropriate for the Court to appoint an amicus curiae to assist the Court in its evaluation of the alleged benefits of the supplemental disclosures, given the challenges posed by the non-adversarial nature of the typical disclosure settlement hearing."
Extremely broad releases of any and all claims, including unknown claims, regardless of whether they relate to the alleged flaws at issue in the transaction, are likely to be rejected.
The Court cited, as a cautionary example, Rural/Metro, where Vice Chancellor Laster "initially considered it a 'very close call' to reject a disclosure settlement that would have released claims which subsequently yielded stockholders over $100 million." Chancellor Bouchard expressed serious concern over the risk that stockholders would release "potentially valuable claims that have not been investigated with rigor" in exchange for supplemental disclosures of immaterial and unhelpful information that "empirical studies suggest . . . make[s] no difference in stockholder voting." The Court's skepticism of the breadth of releases in disclosure-only settlements suggests that counsel will need to carefully consider whether settlement releases should cover only claims relating to the disclosures and the price/procedure inadequacies that are alleged in the complaint and thoroughly investigated. Even a relatively narrow release may be subject to increased scrutiny, as Chancellor Bouchard found that the release in Trulia was still too broad even after "the parties commendably agreed to narrow the release to exclude 'Unknown claims,' foreign claims, and claims arising under state or federal antitrust law," because "the revised release was not limited to disclosure claims and fiduciary duty claims concerning the decision to enter into the merger."
Rather than adjudicating claims challenging a merger in the context of a proposed settlement, the Court stated: "Based on these considerations, this opinion offers the Court's perspective that disclosure claims arising in deal litigation optimally should be adjudicated outside of the context of a proposed settlement so that the Court's considerations of the merits of the disclosure claims can occur in an adversarial process without the defendants' desire to obtain an often overly broad release hanging in the balance."
The Court identified a number of problems with resolving such merger-related claims in the context of a settlement. According to the Court, often there has been "little or no motion practice" and the "discovery record is sparse," and the "lack of an adversarial process often requires that the Court become essentially a forensic examiner of proxy materials so that it can play devil's advocate in probing the value of the 'get' for stockholders in a proposed disclosure settlement." In an adversarial process, on the other hand, "defendants, armed with the help of their financial advisors, would be quick to contextualize the omissions and point out why the missing details are immaterial (and may even be unhelpful) given the summary of the advisor's analysis already disclosed in the proxy. In the settlement context, however, it falls to law-trained judges to attempt to perform this function, however crudely, as best they can."
Moreover, in characterizing the confirmatory discovery typically taken in connection with these settlements (i.e., discovery conducted after an agreement-in-principle is reached), the Court stated that in "reality, given that plaintiffs' counsel already have resigned themselves to settle on certain terms, confirmatory discovery rarely leads to a renunciation of the proposed settlement and, instead, engenders activity more reflective of 'going through the motions.'"
The Court suggested two alternative avenues: adjudicating the claim in the context of a preliminary injunction hearing or filing stipulations in which the plaintiffs voluntarily dismiss their claims without prejudice after the defendant has made supplemental disclosures that render the disclosure claims moot. The Court characterized this latter approach as a "preferred scenario" that "appears to be catching on."
Chancellor Bouchard noted that, "[f]rom the Court's perspective, this [mootness dismissal] arrangement provides a logical and sensible framework for concluding the litigation. After being afforded some discovery to probe the merits of a fiduciary challenge to the substance of the board's decision to approve the transaction in question, plaintiffs can exit the litigation without needing to expend additional resources . . . on dismissal motion practice after the transaction has closed." In this scenario, "the parties also have the option to resolve the fee application privately without obtaining Court approval," subject to stockholders' receiving notice of the fee application. Chancellor Bouchard reiterated that private resolution of fee applications by plaintiffs' counsel would be appropriate as long as stockholders received advance notice.
Adding additional details to a financial advisor's analysis, such as individual comparable company deal multiples, likely will not be deemed "material" or helpful to stockholders where the analysis has already been fairly summarized in the proxy statement. In addition, courts will carefully scrutinize the stated purpose of the supplemental disclosures to determine whether the additional information truly is material. The Court added, however, that "one important qualification bears mention. Although management projections and internal forecasts are not per se necessary for a fair summary, this Court has placed special importance on this information because it may contain unique insights into the value of the company that cannot be obtained elsewhere."
The supplemental disclosures provided by Trulia added, among other things: (i) that J.P. Morgan had assumed $175 million in synergies in performing its intrinsic value calculation; (ii) all of the available EBITDA multiplies for the companies J.P. Morgan analyzed in its precedent transactions analysis; and (iii) the revenue and EBITDA multiples for each of the companies used by J.P. Morgan in its comparable companies analysis. Chancellor Bouchard found that none of this supplemental information was "material or even helpful to Trulia's stockholders."
Chancellor Bouchard emphasized that Trulia's original proxy provided a "fair summary" of J.P. Morgan's work, which was all that was required. The proxy "need not contain all information underlying the financial advisor's opinion," nor does it "need to provide sufficient data to allow the stockholders to perform their own independent valuation." According to Chancellor Bouchard, Trulia's supplemental disclosures constituted minutiae and provided extraneous details that were not of value to stockholders.
With respect to the synergy assumption, Chancellor Bouchard observed that the $175 million figure was not new information, but rather had been previously disclosed in a table of management-estimated synergies in the original proxy. The Court also rejected the plaintiffs' argument that the specific number used in the intrinsic value calculation mattered because it was substantially higher than the number J.P. Morgan used to calculate synergies using a market-based approach. Chancellor Bouchard explained that it was logical to use different synergy figures for the two different approaches in calculating implied equity value, and, in any event, the difference was overstated because "a fair reading of the proxy indicates that the market-based approach analysis was less important."
As for the EBITDA multiples in the precedent transactions analysis, plaintiffs argued that this information was material because it showed that multiples could not be calculated for 16 of the 32 companies included in the analysis. Chancellor Bouchard held that this information was immaterial because there was no argument that the multiples information that was available (i.e., the multiples information for the other 16 companies) was insufficient. Chancellor Bouchard also rejected the plaintiffs' argument that individual revenue and EBITDA multiples for each of the 16 companies in the comparable companies analysis were material in light of the discussion in the proxy of "the median multiples for three different categories of companies that J.P. Morgan considered in its judgment to be similar to Trulia."
There is a potential downside for defendants in the limited ability going forward to resolve cases through disclosure-only settlements.
The Court itself acknowledged that, to date, "economically rational" defendants saw a value in a disclosure-only settlement once a suit was filed. Quoting former Chancellor Allen, the Court stated that "'[i]t is a fact evident to all of those who are familiar with shareholder litigation that suriving a motion to dismiss means, as a practical matter, that economical[ly] rational defendants . . . will settle such claims, often for a peppercorn and a fee.'" Now that this avenue of resolution is, if not foreclosed, seriously narrowed, the question that arises is whether defendants will, at least at times, be required to endure a lengthier and more costly litigation, and possibly more expensive settlement, in those cases where plaintiffs are not deterred from suing by decisions such as Trulia.