Opinion

Alison Frankel

How plaintiffs’ lawyers are winning the Delaware injunction game

By Alison Frankel
March 7, 2012

Robert Rosenkranz was one hell of a CEO and chairman for Delphi Financial Group. As Vice Chancellor Sam Glasscock details in a 56-page ruling issued late Tuesday, when Rosenkranz took the insurance holding company public in 1990, he created two classes of shares, one for the public and one for him. His shares carried 10 times the voting power of the public shares, which meant, for all intents and purposes, that he controlled the company despite owning only a 13 percent equity stake. Rosenkranz did surrender some rights in Delphi’s charter, though. Upon the sale of the company, his Class B stock would convert to Class A, which, according to Glasscock, was intended to eliminate the possibility that Rosenkranz would receive a control premium for his shares if the company were acquired.

That assumption, however, underestimated the creativity of Robert Rosenkranz. When a company called Tokio Marine Holdings came along with an offer to acquire Delphi, Rosenkranz told Delphi’s board that he wouldn’t agree to any deal that treated him like an ordinary shareholder. As Glasscock put it: “Notwithstanding the charter provision, he would not consent to the sale without a premium paid for his Class B stock.” Rosenkranz argued that the charter precluding such an arrangement could simply be amended to permit it. (Rosenkranz inspired Deal Prof Steven Davidoff to write a column on the hubris of CEOs — and the scrutiny they can now expect to receive in Delaware.) The Delphi board, advised by Cravath, Swaine & Moore, was in a bind. Tokio Marine was offering a huge premium on Delphi’s share price, as much as 75 percent. But its controlling shareholder — and the sole negotiator of the deal — said he would veto the acquisition if he didn’t get his way.

A special committee of independent board members ultimately held its nose and endorsed a $9 per share differential between public shares and Rosenkranz shares in Tokio Marine’s overall $2.7 billion offer. Shareholders, predictably, sued to block the deal, arguing (among other things) that Rosenkranz and the rest of the board breached their fiduciary duty to the Class A shareholders by permitting Rosenkranz to negotiate a control premium for himself. The Delphi shareholders, who had counsel from about half of the M&A class action bar — Grant & Eisenhofer; Bernstein Litowitz Berger & Grossmann; Prickett, Jones & Elliot; Robbins Geller Rudman & Dowd; and Kessler Topaz Meltzer & Check — asked the court to enjoin a shareholder vote on the deal.

Glasscock’s ensuing opinion is less colorful than last week’s ruling by Chancellor Leo Strine in the El Paso case, but the result is the same: Both Delaware judges said the sale processes were tainted and shareholders had shown a likelihood of success on the merits of their claims against the target company’s CEO and possibly other defendants as well. And both refused to enjoin the deals, concluding that shareholders deserved a chance to vote on single-bidder transactions that offered them big premiums.

But if you’re thinking that plaintiffs’ lawyers took a hit when Strine and Glasscock denied their injunction motions, you’re not thinking strategically. In fact, shareholders’ counsel may have emerged from both the El Paso and Delphi rulings in better shape than they’d have been in if the deals had been enjoined.

Both Delphi and El Paso, remember, attracted only one bidder, and that bidder was willing to pay a huge premium for the target’s shares. Strine and Glasscock were afraid that if they barred a shareholder vote, Kinder Morgan (in the El Paso case) and Tokio Marine would simply walk away, costing shareholders billions of dollars and leaving them without viable alternative bidders. Grant & Eisenhofer and its brethren in the securities class action bar represent an array of institutional shareholders. Even thought the lead plaintiffs in the El Paso and Delphi cases supported an injunction motion, other institutional shareholders might have been mighty displeased if judges blocked deals that promised them a nice bump for their shares.

So why go through the kabuki theater of a preliminary injunction process? There are a couple explanations. First, there’s often a jurisdictional fight in these M&A cases, in which different plaintiffs’ firms file suits in different courts. If the Delaware filers don’t seek an injunction and expedited discovery, they risk losing control of the litigation to rivals who persuade judges in other jurisdictions to fast-track the case. But that’s not the only reason to ask for speeded-up discovery and an injunction hearing if you think you’ve got strong facts. Even if you don’t think you’ll succeed in enjoining the deal, you’ll get leverage via rulings that criticize the deal process and discuss money damages as an alternative remedy for shareholders. Glasscock was even more explicit about monetary relief in the Delphi ruling than Strine was in El Paso; he said he could simply order Rosenkranz to disgorge the premium he’s slated to receive, giving Class A and Class B shareholders the same price per share. In both rulings, the judges hint at the additional revelations that may emerge from shareholders’ discovery in a post-deal damages case, as if to encourage settlements.

Thanks to those opinions, plaintiffs’ lawyers are much better situated in settlement negotiations than they would have been without expedited discovery and injunction hearings. For the purposes of eventually requesting fees, it’s also a lot easier to quantify the benefit you’ve earned for shareholders through money damages than through an injunction, especially in a single-bidder scenario.

Chancery Court, meanwhile, keeps plaintiffs’ lawyers coming back for more when it issues rulings like those in El Paso and Delphi, even as the rulings pay service to Delaware’s business judgment rule. As Strine wrote, “the traditional tools of equity may not provide the kind of fine instrument that enables optimal protection of stockholders in this context.” But “singling out the sinners for opprobrium,” as UCLA Law professor Stephen Bainbridge put it in a column on the El Paso ruling, can serve as a blunt instrument to bludgeon defendants into settling.

I asked in my post on the El Paso ruling if that’s really the system we want, in which the law offers no penalty but after-the-fact money damages for deal participants who break the rules and manipulate the process. I’m not crying for shareholder lawyers, but the Delphi ruling only deepens that concern.

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