The Dallas Court of Appeals’ recent decision in Rocker v. Centex Corp., et al., No. 05-10-00903-CV, 2012 WL 3264023 (Tex. App.--Dallas Aug. 10, 2012, no pet. h.), marks a significant development in class action merger litigation in Texas state courts.
Centex extends the so-called “coupon rule”?which specifies that when any portion of the benefits recovered in a class action consists of noncash common benefits, the attorney's fees awarded must be in cash and noncash amounts in the same proportion as the class recovery?to settlements in merger litigation in which noncash declaratory or injunctive relief is obtained for the class. It also prohibits the inclusion of a broad release of unknown claims in a class action settlement that does not afford class members the opportunity to opt out.
The facts in Centex follow a common template for merger litigation. Following the announcement of a merger agreement between Centex and Pulte Homes Inc., a series of class action cases commenced in state district court alleging that the value to be received by Centex shareholders and the disclosures regarding the proposed transaction were insufficient. Shortly thereafter, Centex and Pulte agreed to disclose additional information about the merger in exchange for plaintiffs’ agreement not to seek to enjoin the shareholder votes on the merger and their agreement to release all claims belonging to any Centex shareholder arising from the merger, subject to confirmatory discovery and the court’s approval. The supplemental disclosures were included in Centex’s final proxy statement, and the shareholders overwhelmingly approved the merger. Following notice to the proposed class, the trial court held a hearing to evaluate the terms of the settlement. The court approved the settlement and awarded a fee to class counsel of $1.1 million, an amount that had been agreed upon by counsel for the class, Centex, and Pulte. The court overruled the objections of Mr. Rocker, the only Centex shareholder who challenged the settlement. The Dallas Court of Appeals reversed, holding that because the only recovery to the class was non-monetary?i.e., additional information provided by Centex in its supplemental disclosures?the trial court erred by awarding to class counsel attorney’s fees in cash. It also held that the trial court erred in approving a settlement that includes a release of unknown claims without granting eligible class members the right to opt out of the class. It remanded the cause for further proceedings.
Due to the paucity of Texas opinions considering settlements in merger cases, Centex will likely leave a big imprint for some time to come:
- Fewer state court merger cases. One of the attractive features of merger litigation for the shareholders’ bar is the prospect of a quick and significant fee in return for a release and some non-monetary “benefit” to the class. While the coupon rule has been a feature of the Texas Rules of Civil Procedure and the Texas Civil Practice & Remedies Code since the legislature’s passage of the 2003 tort reform legislation, Centex resolves any doubt as to whether the rule applies to disclosure-based settlements in the merger context. Only if a class receives monetary benefit will its counsel be eligible for a monetary fee award. If a class receives a pecuniary benefit, such as the amendment of a noncash deal term or additional disclosure with no cash recovery, its counsel cannot recover a fee award in cash. Accordingly, Centex effectively eliminates the incentive to bring cases?at least in state court?where the end game is to settle on a noncash basis. To the extent shareholders’ lawyers believe they have a good case that the merger price is inadequate, Centex may not deter them from filing in Texas state court.
- Federal court as the Texas forum of first resort. We expect Centex to have the perverse result of encouraging class litigants to pursue their claims in the federal courts of Texas, as well as the courts of the corporation’s state of incorporation if incorporated elsewhere. Shareholders generally can bring merger cases in the state where the company is headquartered as well as the state of incorporation. For companies headquartered in Texas but incorporated elsewhere, the state of incorporation often will be viewed as a more favorable forum for shareholders. Shareholders can still challenge mergers in federal court under the federal securities laws once the relevant SEC filings are made, and those cases can continue to be settled with non-cash consideration to the class and cash attorney's fees under the federal securities laws. Of course, shareholders suing under the federal securities laws will be subject to the heightened pleading standards and other provisions of the Private Securities Litigation Reform Act.
- New rules for settling derivative cases.Centex does not directly bear on corporations incorporated in Texas. The fiduciary duties of directors and officers of Texas corporations run only to the company, and not directly to shareholders. Accordingly, it is settled law in Texas that a shareholder of a Texas company complaining of a breach of fiduciary duty must bring the claim derivatively. In those cases, fee awards are governed by the Texas Business Organizations Code and are considered as a function of the “substantial benefit” rendered to the corporation. But Centex may have an impact here as well. Centex includes a discussion of the common fund doctrine, which posits that those receiving benefits of a suit should bear their shares of expenses, and notes that attorney’s fees should not be recovered until the party seeking them proves the pecuniary value of the benefits achieved. While Centex is not dispositive as to fee applications in derivative cases, we anticipate that plaintiffs will likely endeavor to establish the pecuniary benefits of their lawsuit before seeking court approval for an award of fees.
Centex marks the predictable progression of the 2003 tort reform legislation into the merger litigation arena and will likely have the desired policy consequence of fewer filings in state court. But federal court and the courts of other states will remain viable options for shareholder plaintiffs, and shareholders may yet pursue cases in Texas state court where they think they have a viable claim that the merger price is inadequate.