The Delaware Chancery Court has put M&A litigants on express notice that disclosure-only settlements accompanied by sweeping releases are much less likely to be approved in the future.
The Delaware Chancery Court has put M&A participants on express notice that disclosure-only settlements accompanied by sweeping releases are much less likely to be approved in the future.
While Vice Chancellor Glasscock did approve such a settlement in In re Riverbed Technology, Inc. Stockholders Litigation, he warned that his September 17, 2015 Memorandum Opinion in that matter – along with the Court’s pronouncements in three other cases argued since July – had “diminished or eliminated” any “reasonable expectation” that the Chancery Court will approve these settlements going forward.
The Riverbed litigation arose from the acquisition of Riverbed Technology, Inc. by affiliates of Thoma Bravo and Ontario Teacher’s Pension Plan. The transaction was announced in December 2014 and shareholder litigation quickly followed, alleging the typical menu of claims: the sales process was tainted by conflicts of interest, Riverbed had been undervalued, and the disclosures in the preliminary proxy were inadequate.
The parties reached a settlement that enhanced the disclosure in Riverbed’s proxy, including the disclosure of an ongoing business relationship between buyers and Riverbed’s financial advisers and additional detail on how Riverbed’s financial advisers opined that the transaction was fair to Riverbed’s shareholders. In exchange, Riverbed received a broad release of all federal and state law claims arising from the transaction. Plaintiffs’ counsel requested $500,000 in attorneys’ fees.
The main objector was a law school professor named Sean J. Griffith, who has been very critical of the class action system for failing to protect the interests of shareholders, and who bought stock in Riverbed for the express purpose of objecting to the settlement. After finding that Griffith had standing to object, Vice Chancellor Glasscock discussed the failure of the agency system inherent in representative class actions, which was at the core of Griffith’s objection.
As explained by the Court, the “proper functioning” of the common-law review of corporate transactions depends on the plaintiffs’ bar “and the risks they take in the prosecution of cases for a contingency fee, on behalf of the stockholders,” whose individual interests are too small to pursue separately. This agency action is critical to flushing out “conduct by fiduciaries inimical to the interests of the stockholders.”1
According to the Court, however, problems arise when both sides have incentives and motivations that keep them from engaging in a robust, adversarial process. Plaintiffs’ lawyers might prefer disclosure-only settlements because they generate high fees for little work, and eliminate the risk of investing significant additional time and expense for no guaranteed financial return. At the same time, defendant boards may be willing to assume the relatively minimal cost (especially in the context of the size of the transaction) of making corrective disclosures and paying attorneys’ fees – in exchange for avoiding meaningful scrutiny of a transaction and obtaining a sweeping release of all claims that could have been asserted (so-called “deal insurance”).2
The Court did not in any way suggest there was wrongful conduct by the litigants in Riverbed, and also found there was at least a small “peppercorn” of value achieved for shareholders through the additional disclosures. Although the Court was openly dismayed at the sweeping, “mustard seed” release which Riverbed received in return, the settlement was approved, albeit with a reduced fee award.
The path to Riverbed
A key equitable consideration underpinned Vice Chancellor Glasscock’s decision to approve the settlement in Riverbed:
[G]iven the past practice of this Court in examining settlements of this type, the parties in good faith negotiated a remedy – additional disclosures – that has been consummated, with the reasonable expectation that the very broad, but hardly unprecedented, release negotiated in return would be approved by the Court.3
The Vice Chancellor made clear, however, that his ruling in Riverbed – and pronouncements by the Chancery Court in Intermune, Susser Holdings, and Aeroflex4 – have now “diminished or eliminated” this equitable consideration in future cases, and there is no longer a “reasonable expectation” that the Delaware Chancery Court will approve disclosure-only settlements accompanied by broad releases.
In Intermune, the Chancery Court heard argument on July 8, 2015 of a disclosure-only, broad release settlement arising out of Roche’s proposed acquisition of Intermune. In this case, Vice Chancellor Noble asked the parties to defend approval of a settlement agreement with a broad release and $470,000 in fees in a case where, to the Court, it would make more sense to design a release to “go to what the case was [always] destined to be, which is disclosure.”5 Vice Chancellor Noble commented that he was “struggling” with the “structural question” of whether the Court should approve broad releases when the only consideration was additional disclosure, and he deferred his decision on the settlement to reflect that issue.6
In Susser Holdings, argued on September 15, Vice Chancellor Glasscock approved a disclosure-only settlement with a broad release. When he issued the Riverbed decision two days later, however, he referred to transcript of that fairness hearing as one of the “decisions of this Court” that signaled its reluctance to approve such settlements in the future.7
And in Aeroflex, argued on the same day as Intermune, the Chancery Court outright rejected the proposed settlement. The case involved a shareholder attempt to enjoin the target’s sale to Cobham, a UK aerospace company, on the grounds that “onerous” deal terms arising from a conflict of interest blocked another bidder from topping Cobham’s allegedly too-low offer. The parties ultimately reached a settlement whereby certain of the deal protections were relaxed and the parties made additional disclosures – in exchange for a broad release for the company, as well as a fee award in excess of $800,000 to plaintiffs’ counsel for what was reported to be three weeks’ work. The Vice Chancellor refused to approve the settlement, finding these proposed remedies were not “sufficient to support an intergalactic release.”8 He compared the situation to that of a car owner who, upon informing his mechanic that the transmission was broken, received only an oil change and a bill for services rendered which did not fix the underlying problem. It provided some very small value, but the transmission was not fixed and the car still did not run.9
The impact of Riverbed on future disclosure-only settlements
It remains to be seen what impact the Riverbed decision – along with pronouncements by Chancery Court in Intermune, Aeroflex and Susser Holdings – will have on M&A litigations and settlements.
If the Court continues to reject or challenge these settlements, we will likely see fewer transactions resulting in litigation, thus reversing a trend of recent decades. Today, approximately 95% of deals valued above $100m are challenged through shareholder class actions, and litigation has become an expected cost of doing business. If Delaware courts require plaintiffs’ lawyers to demonstrate quantifiable shareholder benefit obtained through their efforts, they may become more selective in pursuing cases and more likely to focus on cases with obvious conflicts and bad behavior.
If plaintiff’s lawyers do become more selective, fewer transactions may be challenged but the cost of litigations that do go forward is likely to increase. These cases are more likely to involve significant breaches of fiduciary duties, conflicts, bad actors, and similar concerns, thus increasing the settlement value and the incentives of both sides to engage in a robust adversary process.
We may also continue to see disclosure-only settlements, but without the broad releases that seem to trouble the Delaware Chancery Court. Defendant boards will be less incentivized to enter into these types of settlements, however, because of the ongoing exposure left by a narrower release. As a result, they may be more likely to engage in a forceful defense of meritless claims, which may further dissuade plaintiffs’ lawyers from pursuing certain cases.
Finally, there is some chance that plaintiffs’ firms could engage in more aggressive forum shopping and start filing more lawsuits outside of Delaware. This will be limited to some degree by legislative and governance limitations on this kind of forum-shopping. Unless and until other courts start to adopt the Delaware approach, however, there will certainly be incentives for filing suit in other states.