Is $137.5 mln shareholder dividend new model for derivative suits?

January 15, 2015

On Thursday, the mining and metals company Freeport-McMoRan filed the long-awaited settlement of shareholder claims in Delaware Chancery Court that it overpaid for two affiliates whose 2013 acquisition was tainted by directors’ conflict of interest. Freeport agreed to pay $137.5 million, $115 million of which will come from its insurers. That’s the third-biggest-ever cash payout in a derivative settlement, behind the record-setting $275 million Activision Blizzard deal last November and the $139 million News Corp settlement in 2013.

The Freeport deal is different, though. Apparently for the first time in a derivative settlement, all of the cash (less attorneys’ fees) will be distributed to Freeport shareholders, via a special dividend. Ordinarily, because shareholders bring derivative actions against directors and officers on behalf of the corporation itself, the money they obtain in settlements – usually from D&O insurance policies – goes to the company’s treasury. The structure of the Freeport settlement, by contrast, delivers the proceeds of the litigation to shareholders themselves.

That’s appropriate because it was investors who allegedly lost value when Freeport acquired the affiliates without a shareholder vote, said Scott Zdrazil, the director of corporate governance at Amalgamated Bank, one of the lead plaintiffs in the case. “The dividend structure is a critical tool to return value to shareholders,” said Zdrazil, whose company was also a lead plaintiff in the News Corp derivative case. “That aspect is going to introduce a new opportunity” in future derivative litigation.

I said last week, based on an early Wall Street Journal story anticipating the special dividend structure of the Freeport settlement, that paying shareholders directly – rather than delivering money back to the corporation – sends a strong message of accountability to directors and officers. I got some pushback after that story ran. One plaintiffs’ lawyer told me that the real way to judge the value of a derivative settlement is to see how much of the cash comes from a source other than the company itself; if the money comes from a co-defendant, this lawyer said, shareholders will benefit indirectly from a rise in the share price. Setting up a special dividend, he said, may be less effective than it appears.

It’s true that structuring a derivative settlement as a special dividend to shareholders raises some questions. Does the company ordinarily pay dividends, and, if so, how do shareholders know the corporation won’t use money that would have gone to them anyway to pay the special dividend? Will directors and officers who own stock receive the special dividend? And if so, aren’t there issues of circularity and even conflict of interest because they’re receiving the proceeds of a settlement against themselves?

The Freeport settlement, according to Zdrazil, builds in protections against the first possibility. And plaintiffs’ lawyers in the case anticipated the issue of directors and officers who are also shareholders receiving a dividend. In the Freeport case, he said, they’re not excluded from the special payout to shareholders because they have relatively modest stock holdings and Delaware law frowns on discriminatory dividends.

So, will the settlement-as-dividend become a new model for derivative litigation? It’s certainly an exciting new option, as Zdrazil said, and if the Freeport deal is approved by Vice Chancellor John Noble, who’s holding a hearing on March 6, there’s going to be a lot of buzz about delivering money directly to shareholders through derivative suits, which have boomed in recent years. But Christine Azar of Labaton Sucharow – one of the five plaintiffs’ firms that led the Freeport case – said, this deal’s structure may not work in a lot of other cases.

The Freeport suit, she explained, wasn’t a typical M&A shareholder case because Freeport was the acquirer, not the target company. It’s much more common for shareholders of acquired companies to sue over claims that the sale price was too low. Those cases are usually brought as direct actions, not derivative suits, and a special dividend to the acquirer’s investors wouldn’t make sense. “This was an unusual factual situation for a merger suit,” she said. “I doubt this structure will become that commonplace.”

Nevertheless, the impulse that drove the Freeport deal ought to inspire plaintiffs’ lawyers to push to get derivative settlement money to the victims of alleged director misconduct: the investors. As Azar describes it, the shareholder firms in this case began with the premise that Freeport had taken money from its shareholders by overpaying for the two companies it acquired in 2013. “The thought was, How do we really benefit shareholders?” Azar said.

The other plaintiffs’ firms in the Freeport case were Bernstein Litowitz Berger & Grossmann, Grant & Eisenhofer, Bernstein Liebhard and Chimicles & Tikellis. Azar said that a five-firm leadership structure can be unwieldy but that the firms in the Freeport litigation worked well as a team. They may get to continue their cooperation: The settlement agreement specifies that the plaintiffs intend to bring separate derivative claims against Freeport’s financial advisor Credit Suisse.

Freeport was represented by Wachtell Lipton Rosen & Katz.

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