In an age when overburdened courts with reduced budgets often approve class action settlements without significant oversight, Delaware courts have frequently bucked that trend in the merger litigation context: rejecting certain disclosure-based settlements or significantly reducing the claimed attorneys' fees (where the supplemental disclosures provided little value to shareholders). See In re SS& T Techs., Inc. S'holders Litig.,2008 WL 3271242 (Del. Ch. 2008) (rejecting disclosure based settlement); Scully v. Nighthawk Radiology Holdings, Inc., C.A. No. 5890–VCL (Report of Special Counsel) (Mar. 11, 2011) (reducing attorneys' fees). As a result of this scrutiny, shareholder plaintiff firms have resorted to filing lawsuits in jurisdictions other than Delaware that have historically provided little oversight to settlements. See Strine, Leo E. Jr. et. al., Putting Stockholders First, Not the First-Filed Complaint, 69 Bus. Law. 1 (2013) (noting the "anywhere but Delaware" effect and citing Mirvis, T., Anywhere But Chancery: Ted Mirvis Sounds an Alarm and Suggests Some Solutions, 7 M & A J 17 (2007)). A recent New York decision that included scathing criticism of certain merger litigation may signal a shift in that regard, however. The lesson: be careful pursuing a disclosure-only settlement because it may not be the smooth sailing you might expect outside of Delaware.
In January 2014, Martin Marietta Materials, Inc. ("MMM") and Texas Industries, Inc. ("TXI") announced that they had entered a merger agreement for MMM to acquire all of TXI's outstanding stock in a transaction valued at approximately $2.7 billion. After MMM filed its definitive proxy statement detailing the terms of the merger with the Securities and Exchange Commission, plaintiffs – who owned just ten shares of MMM stock – filed a putative class action lawsuit against MMM, TXI, and certain of MMM's officers and directors in New York state court challenging the sufficiency of the MMM's disclosures in the proxy statement. Just ten days prior to the scheduled vote on the merger, on the day the court intended to deny the plaintiffs' motion for preliminary injunction "so all uncertainty surrounding the [m]erger could be expeditiously eliminated," the parties informed the court that the matter had been settled. The court was "disturbed by the settlement," which consisted of MMM's agreement to make certain supplemental disclosures to its shareholders and pay $500,000 to the plaintiffs' counsel. The court refused to approve the settlement and explained its reasoning in an opinion addressing each of the allegedly inadequate disclosures in the proxy statement and finding that each category of allegedly omitted information was immaterial. The court also noted that the four supplemental disclosures that resulted from the settlement were "grossly immaterial" and did "not warrant an award of attorneys' fees," thereby eliminating the basis for the settlement.
The court then summarized the current state of merger litigation as follows: "when a public company announces a merger, lawsuits follow." The court acknowledged that "[t]here is nothing inherently wrong with this phenomenon" and in certain instances, "a lawsuit is very much the proper way to redress" matters such as a "woefully unjustifiable" merger price or truly inadequate disclosures. However, such lawsuits – known as a "merger tax" – are viewed with "a certain degree of skepticism" in light of the pressure on defendants to settle such suits in order to keep a merger on track.
The court noted that "notwithstanding the current climate of merger litigation, this case still stands out … for its downright frivolity." Specifically, the court criticized the plaintiff, essentially a brokerage account masquerading as a general partnership, and the plaintiffs' counsel, whose "modus operandi" is to "purchase nominal amounts of shares in publicly traded companies" to enable them to "file a merger tax lawsuit" upon the announcement of a merger. The court labeled this practice – and the attendant litigation brought by "fictitious entities with no purpose for existing and no economic interests apart from the generation of attorneys' fees" – as "pernicious," and noted that the Delaware courts had previously sanctioned this plaintiffs' counsel for abuses committed in connection with similar suits.
In addition, the court criticized two additional "atypical" features of the lawsuit. First, as shareholders of theacquiring company rather than the target, plaintiffs ordinarily would have to assert claims for breach of fiduciary duty with respect to the merger terms via a derivative suit rather than as a direct claim. Derivative claims entail "extra procedural hurdles making them relatively more difficult to maintain" than direct claims. These plaintiffs sidestepped those hurdles, however, by challenging only the sufficiency of MMM's disclosures about the transaction (which may be attacked by a direct claim) and not the merger price or terms. Second, and of greater concern to the court, the plaintiffs waited until MMM had filed the definitive proxy to commence their lawsuit, rather than filing promptly after the issuance of the substantively-identical preliminary proxy. If the plaintiffs had brought suit after the preliminary proxy, MMM's shareholders and the court would have had "an extra two months to consider the disclosures," and "the risk that the lawsuit would impact the [m]erger" would have been "drastically reduced."
The court went on to observe that "had [the] plaintiffs alleged material omissions or settled for materialsupplemental disclosures, the court would have approved the settlement," but in this case "[a]pproving the settlement … would both undermine the public interest and the interest of MMM's shareholders." Moreover, "[i]t would incentivize plaintiffs to file frivolous disclosure lawsuits shortly before a merger, knowing they will always procure a settlement and attorneys' fees under conditions of duress" and that would be a "perverse result."
This case may signal a turning of the tide with respect to settlements of M&A litigation outside Delaware on a disclosure-only basis. Among other things, it may suggest that courts outside Delaware will view certain merger litigation with a skeptical eye and take seriously their role as "gatekeeper" for class settlements before approving them. While it is too early to tell if such a trend will reduce the number of "merger tax" suits filed, it may result in fewer disclosure-only settlements, as defendants may be more emboldened to fight frivolous disclosure-based claims and plaintiffs may be less willing to submit questionable disclosure-only settlements for approval.
The case is City Trading Fund v. Nye, case number 651668/2014 (N.Y. Sup. Ct.). A copy of the decision can be found here.