On February 8, 2018, Justice Shirley Werner Kornreich of the Commercial Division rejected a disclosure-only class action settlement in City Trading Fund v. Nye, 2018 BL 44689 (Sup. Ct. Feb. 08, 2018).[i] The settlement provided for additional disclosures to shareholders in a proxy statement plus $500,000 in attorneys’ fees and expenses for plaintiffs’ counsel. As discussed below, the Commercial Division’s rejection of this disclosure-only settlement is one of the first applications of the First Department’s new standard for reviewing such settlements of merger challenge litigations.
The lawsuit arose out of a pre-merger suit seeking to enjoin an acquisition by Martin Marietta Materials, Inc. (“MMM”) of Texas Industries, Inc. (“TXI”) on the ground that disclosures made to shareholders regarding the merger were inadequate. In 2014, Justice Kornreich had denied the MMM stockholder’s motion for a preliminary injunction; thereafter, in 2015, Justice Kornreich denied preliminary approval of the settlement.[ii] The First Department reversed the Commercial Division’s denial of the preliminary approval to the settlement, and remanded the case for a fairness hearing to review the settlement terms.[iii]
On remand, Justice Kornreich denied final approval of the settlement, concluding that the supplemental disclosures called for under the settlement were “utterly worthless” and failed to satisfy the “some benefit” to shareholders standard recently adopted by the Appellate Division, First Department.[iv] Justice Kornreich analyzed the settlement standard articulated in the First Department’s 2016 decision in Gordon v. Verizon Commc’ns, Inc. (a decision we covered here).[v] She distinguished the governing standard in New York from the prevailing Delaware standard.
In Delaware, supplemental disclosures must address a “plainly material misrepresentation or omission” and “it should not be a close call that the supplemental information is material[.]”[vi] By contrast, the First Department in Gordon held that courts should apply the classic Colt factors[vii] for reviewing such a settlement: “the likelihood of success, the extent of support from the parties, the judgment of counsel, the presence of bargaining in good faith, and nature of the issues of law and fact” plus “whether the proposed settlement is in the best interests of the putative settlement class as a whole” and “whether the proposed settlement is in the best interest of the corporation.” [viii] As a result, New York requires a “lesser showing” than Delaware: supplemental disclosures that provide “some benefit to shareholders” are sufficient to warrant approval of a settlement.[ix]
Justice Kornreich’s opinion is among the first to apply the Gordon “some benefit” standard, and the Court’s application of this standard shows that the standard is not without teeth. Under the First Department’s test, for a disclosure to have “some benefit” the court “must be able to plausibly conclude that the supplement disclosures would, in fact, aid a reasonable shareholder in deciding whether to vote for the merger.”[x] With regard to the supplemental disclosures that were agreed in City Trading, Justice Kornreich highlighted that although management projections would be of “some benefit” to shareholders, the supplemental disclosures provided for in the City Trading settlement pertained only to independent, third-party projections by analysts and advisors and were of “trivial value.”[xi] The Commercial Division also rejected the sufficiency of disclosures relating to shareholding positions in TXI held by the banks advising on the transaction, all of which owned common shares in the target company, TXI. The Court reasoned that there was no claim of insider trading and it would be illogical for banks holding positions in the company to recommend an unwise merger.[xii]
Among the other specific disclosures rejected by the Court was a supplemental disclosure providing background information about the fact that MMM management had discussed how the merger would affect the company’s forecasts appeared. Justice Kornreich deemed this a “tell me more” disclosure that was not material and would not have provided useful information to shareholders.[xiii] According to the Commercial Division, the focus of a disclosure should be whether “there is good reason to believe the merger price is fair” – an inquiry that the largest shareholders had answered in the affirmative by voting to support the MMM-TXI merger.[xiv] This aspect of the City Trading decision suggests that courts may consider the outcome of the merger vote and behavior of large institutional investors in determining whether a disclosure would have in fact been useful.
After concluding that the agreed-upon disclosures were not material, the Court then proceeded to apply the Gordon factors to review the agreed settlement. In applying the first Gordon factor, i.e., likelihood of success, the Commercial Division concluded that there was “zero doubt” that it would have granted a motion to dismiss the complaint in the case.[xv] The second factor, support of the parties, also weighed against settlement because only the named plaintiff supported the settlement and large institutional shareholders objected to the settlement (and the promised attorneys’ fees). Justice Kornreich noted that there “surely [is] a middle ground between rubber stamping settlements and requiring a [Delaware] Trulia-like heightened showing.”[xvi] Justice Kornreich underscored the “frivolous tactics” and “frivolous nature of this case” in finding that factors three (judgment of counsel), four (bargaining in good faith), and five (issues of law and fact) also weighed against approval.[xvii] Finally, the Court concluded that the proposed settlement was not in the best interests of the settlement class or of the corporation—the supplemental disclosures did not leave the shareholders in a better position and were, in fact, “net losers” and the “only winners are the lawyers.”[xviii]
In rejecting approval of the settlement, Justice Kornreich also distinguished two recent cases applying the Gordon disclosure standard. In Saska v. Metro. Museum of Art, 54 N.Y.S.3d 566, 571-72 (Sup. Ct., N.Y. Co. 2017), another decision by Justice Kornreich, the Commercial Division approved a settlement providing for disclosures to museum patrons about the museum’s admission policy. [xix] Justice Kornreich noted that this case did not have any bearing on merger-related disclosures and that the court approving the new museum signage had concluded that the disclosure would provide a benefit to the public.
The other case was Roth v. Phoenix Cos., 50 N.Y.S.3d 835 (Sup. Ct., N.Y. Cnty. 2017), another Justice Kornreich opinion. In that case, the Commercial Division approved the settlement of a lawsuit challenging a going private transaction. [xx] Justice Kornreich distinguished Roth, citing the Roth court’s analysis that the settlement “lack[ed] the pernicious indicia of a frivolous ‘strike suit’ seeking a ‘merger tax.’”[xxi] She noted that the Roth disclosures were useful and beneficial because they provided financial transparency to bondholders of the company and preserved their rights to disclosures going forward.
If City Trading is any indication, the fears of practitioners that New York is “racing to the bottom” in its scrutiny of class settlements may be misplaced. Justice Kornreich’s analysis hews closely to Delaware law on materiality, even though the Court ultimately applied the First Department’s Gordon factors to evaluate the agreed settlement.
It is also noteworthy that as part of a threshold choice of law question, Justice Kornreich held that where “a New York court is called upon to approve a settlement of a class action concerning claims governed by the internal affairs of a Delaware corporation . . . New York’s settlement approval factors should be applied, while the merits of the underlying claims are governed by Delaware law.” [xxii] In practice, this means that Delaware law, or the law of the state of incorporation will decide the applicable materiality standard, and that the New York settlement approval factors are only applied after the disclosures have been found to be material or immaterial. For this reason, the materiality standard under Delaware and federal law may still be relevant even in cases that are brought, and perhaps settled, in New York courts.