A new decision makes clear that parties should no longer expect the Delaware Court of Chancery to approve broad settlements of M&A class actions based on supplemental proxy disclosures. Chancellor Andre Bouchard issued a 42-page opinion on Friday that rejected a proposed class settlement in which defendants obtained releases in exchange for supplemental disclosures, decried the “dynamics that have led to the proliferation of disclosure settlements,” and admonished that such settlements will be met with “continued disfavor” and are not likely to be approved except in exceptional circumstances. The decision is certain to affect both the number of future cases and the manner in which they are litigated.
The case at issue, In re Trulia, Inc. Stockholder Litigation, C.A. No. 10020-CB, followed a typical path: class actions were filed shortly after announcement of the $3.5 billion merger of Zillow, Inc. and Trulia, Inc.; plaintiffs obtained expedited discovery and filed a preliminary injunction motion; and, with that motion pending, the parties agreed to a settlement providing for supplemental disclosures to be made in exchange for a broad release of claims. While such settlements (usually accompanied by six-figure fee awards to plaintiffs’ counsel) have been routinely approved over the past several decades, they have been viewed with increasing skepticism by the Court of Chancery in recent months. The proposed Trulia settlement was rejected because the Court concluded that the agreed-upon supplemental disclosures—providing additional details underlying the analysis of Trulia’s financial advisor—were neither “material” nor “even helpful” to shareholders, and thus were inadequate to justify a release of claims. In reaching that result, and explaining why “the Court’s historical predisposition toward approving disclosure settlements needs to be reexamined,” Chancellor Bouchard noted the following:
Ubiquity of M&A litigation. Over the past decade, M&A litigation has “explode[d]… beyond the realm of reason.” By 2014, nearly 95% of deals valued at $100 million or more resulted in shareholder suits. Although that percentage declined a bit in 2015, it is still true that “virtually every transaction involving the acquisition of a public corporation provokes a flurry of class action lawsuits…”
Incentives for defendants to settle. Because plaintiffs “leverage the threat of an injunction to prevent a transaction from closing[,]… defendants are incentivized to settle.” Moreover, the fact that plaintiffs have generally not been held to a rigorous standard when moving for expedited discovery means that one possible “gating mechanism” for screening frivolous cases is often bypassed.
Lack of benefits to shareholders. “[F]ar too often [M&A] litigation serves no useful purpose for stockholders,” especially because the agreed-upon supplemental disclosures are not material. Of particular note, the Court has routinely been asked to approve settlements where (as in Trulia) plaintiffs do little more than “identify and obtain supplemental disclosure of a laundry list of minutiae in a financial advisor’s board presentation.”
Lack of an adversarial process. In light of the “potent” incentives for defendants to settle without incurring the time and expense of opposing expedited discovery or preliminary injunction motions, the Court is forced to examine the merits of alleged claims and proposed settlements without the benefit of vigorous give-and-take between the parties.
The Trulia decision concludes that, going forward, disclosure settlements will not be approved unless: (i) the supplemental disclosures “address a plainly material misrepresentation or omission”; (ii) the release is “narrowly circumscribed” to cover only disclosure claims and fiduciary duty claims relating to the sale process; and (iii) the record demonstrates that the released claims have been “investigated sufficiently (e.g., through discovery). On the first point, Chancellor Bouchard stressed that the “plainly material” standard means that “it should be not be a close call” whether the supplemental information was material. In other words, a settlement would only be available in instances where (among other things) a company effectively admits that it failed to provide necessary information to its stockholders.
However, Trulia endorses another mechanism for resolving such cases: a “mootness dismissal.” Under this “preferred scenario,” the parties can agree that supplemental disclosures—even non-material disclosures—moot plaintiffs’ claims. Plaintiffs are free to apply for a “mootness fee,” which defendants could contest. This enables the Court to assess the value of specific disclosures with the benefit of adversarial proceedings—a process that will, in the ordinary case, presumably result in fees substantially lower than those previously approved in connection with disclosure settlements. Defendants would not obtain a class-wide release, but in most cases it is unlikely that other stockholders would commence litigation after a mootness dismissal.
So what should companies expect going forward? A few takeaways seem clear:
- Fewer cases. Trulia fundamentally alters the business model employed by the plaintiffs’ bar, by increasing the risks and expenses of M&A litigation (from the perspective of plaintiffs) while reducing the expected benefits. Consequently, the recent decline in case filings should accelerate, and plaintiffs will be more selective in the claims they bring.
- Greater chance of contested litigation in those cases that are filed. As plaintiffs become more selective, they will presumably be willing (at least in the short run) to devote resources to those cases that “make the cut.” This means not only seeking to enjoin proposed transactions, but also pursuing damage claims after a deal closes.
- More fights over expedited discovery. In the past, plaintiffs have often been able to obtain expedited discovery too easily. As Trulia notes, contested motions for expedited discovery afford the Court an opportunity to prevent meritless claims from imposing undue burdens on defendants.
- Greater use of forum selection bylaws. Plaintiffs will look for opportunities to bring class actions in jurisdictions other than Delaware, hoping to find judges more hospitable to traditional disclosure settlements. As a result, Delaware corporations that have not already adopted bylaws establishing the Court of Chancery as the mandatory forum for such suits should do so.
- Less emphasis on financial advisors’ analyses. The supplemental disclosures at issue in Trulia—i.e., specific data used by a financial advisor regarding anticipated synergies, multiples for comparable companies and transactions, and components of a discounted cash flow analysis— are the sorts of allegedly “omitted” information on which plaintiffs frequently base fiduciary duty claims. The Court’s explanation of why such information was immaterial in Trulia, and its reiteration that Delaware law merely requires a “fair summary” of a financial advisor’s work, should force plaintiffs to rethink their approach.
- More mootness fees. With disclosure settlements no longer an option (except in the rare situation in which a company is willing to acknowledge that its proxy fails to include “plainly material” information), the “preferred scenario” described in Trulia provides the only realistic option for a negotiated resolution of class claims.