Every public company evaluating a potential acquisition analyzes a multitude of variables to see if the transaction makes business sense. One variable they sometimes miss, however, is the cost of stockholder litigation, and unfortunately it’s becoming routine for significant merger transactions to be targeted with class action lawsuits by plaintiffs’ attorneys.
Common sense might lead one to believe class action M&A lawsuits would be filed only in cases of a significant dispute over value, where the plaintiffs might hope-to develop additional information on valuation of the target, seek to negotiate a higher deal price and obtain additional consideration for selling stockholders, with the plaintiffs’ lawyers receiving their share of fees as a just reward for generating a higher price for the target stockholders.
In reality, however, a majority of the “successful” stockholder lawsuits filed in Delaware in 2010 and 2011 resulted in no increase in the deal price and no additional money being paid to the selling stockholders. Instead, these lawsuits resulted only in such indirect benefits as additional disclosure about the transaction, its background or details about the financial advisor’s opinion, or the modification of deal terms that might encourage, but do not necessarily result in, other bidders. See When Merger Suits Enrich Only Lawyers, Bloomberg. That’s right; in the majority of these “successful” stockholder lawsuits, not one cent of additional money was paid to target stockholders.
What can a public company evaluating a potential acquisition do to respond to the specter of this type of stockholder litigation?
First, acquirers should consider the likelihood of lawsuits and factor the costs of defending and settling them into their transaction costs. Active acquirers often have an established process for determining the “litigation budget” for a potential acquisition. Less active acquirers should work with their legal counsel to gain an understanding of the potential for deal-related litigation.
Second, bidders should spend some time and effort to ensure that the target (or, perhaps, a special committee of its board of directors) is adequately managing their sale process. While retracing the target’s steps or second-guessing its disclosure decisions might be costly and not necessarily fruitful, a thorough review of the target’s proposed disclosure, particularly its description (or the joint description) of the background of the transaction and the summary of the analyses employed by its financial advisor in arriving at its fairness opinion would be advisable.
Third, bidders should consider the ultimate benefit of hard-line negotiations. For example, consider whether pro-buyer provisions in a merger agreement that theoretically are protective of the buyer’s deal, yet from a practical standpoint not likely to yield a benefit, may end up being more trouble than they are worth if they create wedges for a plaintiffs’ attorney to make a claim for their removal, resulting only in a net increase of legal fees for the deal and, frankly, no appreciable value for target stockholders.
In the M&A world, it is difficult to have a public company acquisition without the propensity for stockholder litigation. Nevertheless, a well-prepared acquirer should be mindful of the chance of stockholder litigation and its potential costs, and look for opportunities for both acquirer and target to tilt the field away from the M&A plaintiffs’ bar.