The beginning of the end of ‘deal tax’ litigation boom?

July 10, 2015

(Reuters) – If it had just been Vice Chancellor Travis Laster of Delaware Chancery Court sounding off about the blight of so-called deal tax M&A suits, the Delaware bar might have been able to chalk up this week’s developments to the judge’s occasional tendency to rile the complacent. But it isn’t just Laster. Something is afoot in Delaware Chancery Court.

On Wednesday, Vice Chancellor Laster refused to approve a settlement of shareholder litigation stemming from Cobham PLC’s $1.5 billion acquisition of the microelectronics company Aeroflex. Laster found the global release of shareholder claims was too broad and plaintiffs’ lawyers didn’t deserve $825,000 for negotiating some additional disclosures and a reduction in the termination fee Aeroflex would have had to pay Cobham if another bidder had emerged. His remarks on deal-tax M&A shareholder suits, delivered from the bench, have implications that The Chancery Daily described as “tectonic” for everyone involved in these cases.

Judge Laster’s hearing in the Aeroflex litigation took place in Wilmington on Wednesday morning. On Wednesday afternoon in Dover, Vice Chancellor John Noble withheld approval of a shareholder settlement stemming from Roche’s $8.3 billion acquisition of the biotech company InterMune. There’s no transcript yet available for the InterMune hearing, but according to plaintiffs’ lawyer Peter Andrews of Andrews & Springer, Vice-Chancellor Noble – like Vice Chancellor Laster in the Aeroflex case – said he was concerned about the scope of the releases the class had granted to defendants in exchange for what seemed to the judge to be not much consideration. Noble said he’d take the InterMune settlement under advisement.

Two Delaware judges in one day refusing to approve settlements featuring what Delaware Supreme Court Chief Justice Leo Strine has called “intergalactic releases”? That seems like more than a coincidence. It seems like a coordinated effort by Delaware Chancery Court to rein in settlements that deliver only marginal benefits to shareholders but offer sweeping relief to defendants.

Laster just about said as much at the Aeroflex hearing, which is a must-read transcript. (I’m indebted to Chancery Daily for passing it along to me.) The lead shareholder lawyer in the case, Robert Weiser of the Weiser Law Firm, opened the hearing with a presentation on how class members benefited from the settlement’s $18 million reduction in the termination fee Aeroflex would have had to pay Cobham had a higher bid come in, calling that and other relief “not a gigantic settlement but  clearly far more valuable than the types of transactional cases that people are screaming about.”

Weiser cited Vice Chancellor Laster’s own 2011 opinion in In re Compellant for the proposition that shareholders are better off when deal protections are loosened, even if a better bid doesn’t emerge. But Vice Chancellor Laster said the class in this case wasn’t really any better off as a result of the slashed termination fee. There was another potential bidder for Aeroflex, he pointed out, and its concern was not the Cobham termination fee but its own non-disclosure agreement with Aeroflex, which the plaintiffs couldn’t persuade Aeroflex to change in negotiations.

Laster said that for the class – the 24 percent of Aeroflex’s shareholders other than the insider holding company that owned a majority stake – the reduced termination fee was of no more use than an oil change and a new air filter in a car with a busted transmission.

“I mean, look, you put time in, and that’s what you did here,” the vice-chancellor said. “You put time in. But what I still have is an undriveable, broken car. You fixed something that didn’t need fixing, and you’re saying that it’s worthy of a release and a fee.” (Weiser said the reduced termination fee “certainly opened the door” for a topping bid even if the potential competing bidder didn’t walk through it.)

Vice Chancellor Laster said that perhaps Weiser and the other plaintiffs’ lawyers should have simply walked away from the case when their investigation failed to uncover evidence that Aeroflex’s board breached its fiduciary duties. “We pick our cases but sometimes we pick wrong, and sometimes we get in there and there’s nothing there,” the vice chancellor said. “And if there’s nothing there, you know, you win some, you lose some.”

Aeroflex counsel Gregory Varallo of Richards Layton & Finger and Cobham lawyer Edward Welch of Skadden Arps Slate Meagher & Flom defended the settlement as a fair trade: The class got real, if small, economic benefit and defendants got global releases.

But that seems to be just what Vice Chancellor Laster intends to stamp out. In a dialogue with Welch, Laster made clear his goal (and the goal, he said, of Chief Justice Strine): “We want to be in the business of seeing good cases litigated, and we don’t want people to file junky cases.”

In his ruling at the end of the hearing, Laster elaborated on that point. Citing a 2015 paper by law professors Jill Fisch of the University of Pennsylvania, Sean Griffith of Fordham and Steven Davidoff Solomon of Berkeley, the judge said it has become clear over the last several years, as reflexive shareholder suits followed every major deal announcement, that disclosure-only settlements deliver no real benefit to class members.

Those settlements may be good for plaintiffs’ lawyers, who are awarded hundreds of thousands of dollars in fees, and for defendants, who can buy releases for a relatively low price. But according to the judge, there’s a real cost to such agreements. Good cases sometimes don’t get litigated because plaintiffs settle too quickly. Boards that have run pristine transactions become cynical. And Delaware’s “credibility as an honest broker in the legal realm” is damaged, Vice Chancellor Laster said, when other state courts, such as New York’s, look at disclosure-only M&A settlements and say, “‘This does not make sense.'”

“What we’ve learned is that routine approval of these settlements carries real consequences, all of them bad,” the judge said.

He offered three options for a new ending to the Aeroflex case: Plaintiffs can dismiss the suit as moot, the two sides can narrow the release so the class gives up only fiduciary breach claims, or defendants can move to toss the case. Under any of those options, Vice Chancellor Laster said, plaintiffs’ lawyers deserve no more than about $250,000. That would be quite a disappointing outcome for the shareholder lawyers, who brought the vice chancellor an unopposed request for more than three times that amount. (Weiser didn’t return my call requesting comment.)

But this tough new stance on releases in M&A class action litigation in Chancery Court has consequences way beyond one plaintiffs’ firm and one deal. If defendants can’t get broad releases, will they be willing to settle M&A shareholder suits in Delaware? Right now, defendants like litigating in Delaware because state law is business-friendly and cases in Chancery Court move fast. But if they can’t get Chancery judges to sign off on quick disclosure-only settlements with global releases, corporations may prefer to litigate elsewhere.

Meanwhile, if defendants aren’t willing to settle quickly, will plaintiffs’ lawyers stop filing suits after every deal announcement? What happens if corporate boards don’t have to worry about shareholders scrutinizing their sale processes?

Delaware judges from Strine down have thought a lot about these questions, and if this week’s developments are a signal, they seem to be pretty sure that reflexive deal tax litigation is bad for corporations, shareholders and Delaware. And it looks like they’re now willing to act on that instinct.

(This post has been corrected. A previous version contained a typographical error in the third-to-last paragraph.)

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