Last week, in In re Walgreen Co. Stockholder Litigation, No. 15-3799 (7th Cir. Aug. 10, 2016), the United States Court of Appeals for the Seventh Circuit rejected a disclosure-only settlement of a litigation challenging a merger. The court adopted the standard for approval of such settlements set forth by the Delaware Court of Chancery in In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del Ch. 2016), requiring that the supplemental disclosures supporting a proposed settlement must correct “plainly material” misrepresentations or omissions, and the release defendants obtain in return must be narrowly tailored to the claims relating to the disclosures.

The Seventh Circuit thus joins the Delaware courts and others in recognizing the costs that disclosure- only settlements have imposed on companies and their stockholders by incentivizing a proliferation of non-meritorious litigation. Such settlements will continue to come under greater scrutiny, which may cause plaintiffs’ lawyers to assess the merits of their claims more carefully. This may drive a reduction in the overall number of deal litigation cases filed. But the cases that do get filed may be more difficult to settle and may require greater effort at the pre-closing stages, such as motions for preliminary injunctive relief and expedited discovery.

Background

The litigation arose out of a proposed reorganization of Walgreen Co. following its acquisition of Alliance Boots GmbH. The stockholder class action was filed shortly after Walgreen filed a proxy statement seeking stockholder approval of the transaction. Eighteen days later, the parties agreed to a settlement. Under the terms of the settlement, Walgreen would issue six supplemental disclosures, the plaintiff’s counsel would submit an unopposed request for $370,000 in fees, and defendants would receive a “narrow release of claims.”

Despite expressing misgivings regarding the value of the supplemental disclosures to the stockholders, the District Court judge approved the settlement. She concluded that at least some of the supplemental disclosures “may have mattered to a reasonable investor.”

The Seventh Circuit’s Decision

In a 2-1 decision, a panel of the Seventh Circuit reversed, holding that supplemental disclosures provide a meaningful benefit to class members only if “they would be likely to matter to a reasonable investor.” The court reviewed each of the six disclosures and variably described them as “worthless,” “add[ing] nothing,” and “frosting on the cake.” Thus, because the supplemental disclosures “contained no new information that a reasonable investor would have found significant,” the court concluded that their value to the stockholders was “nil” and could not support a settlement.

The court observed that the “type of class action illustrated by this case—the class action that yields fees for class counsel and nothing for the class—is no better than a racket. It must end. No class action settlement that yields zero benefits for the class should be approved, and a class action that seeks only worthless benefits for the class should be dismissed out of hand.” The court endorsed and applied the standard set forth in Trulia, in which the Court of Chancery expressed its intent to apply greater scrutiny to disclosure-only settlements and to approve them only where the supplemental disclosures correct a “plainly material misrepresentation or omission.”

Finally, the Seventh Circuit expressed concern about the incentives and conduct of class counsel, noting that “class counsel, if one may judge from their performance in this litigation, can’t be trusted to represent the interests of the class.” The court held that class counsel had not adequately represented the class and instructed the district court on remand to consider either appointing new class counsel or dismissing the case.