After Chancery crackdown on M&A settlements, shareholder filings drop off

November 16, 2015

(Reuters) – Class action lawyers can’t stay in business unless they earn contingency fees from settling cases. That’s just a plain economic truth. And based on new data compiled by the indefatigable folks at The Chancery Daily, it has not taken long at all for shareholder lawyers to respond like the rational economic actors they are to the new reality of M&A litigation in Delaware.

The judges of Delaware Chancery Court spent the summer and early fall warning shareholders and defendants that they would no longer approve deal-challenge settlements that benefited everyone but shareholders. One by one, Chancellor Andre Bouchard and the four vice-chancellors said they were sick and tired of being asked to bless broad releases for defendants and hundreds of thousands of dollars in legal fees for plaintiffs’ lawyers in settlements granting investors no more than additional proxy disclosures that, more often than not, had no discernible impact.

The judges’ restlessness culminated on Sept. 18, when Vice-Chancellor Sam Glasscock said in a written decision in In re Riverbed that plaintiffs and defendants should no longer expect Chancery Court to approve disclosure-only settlements. As if to prove Glasscock’s point, on Oct. 9, Vice-Chancellor Travis Laster not only rejected a proposed disclosure-only settlement in In re Aruba Networks but also dismissed the suit, finding that plaintiffs’ lawyers hadn’t done an adequate job of investigating HP’s acquisition of the software company Aruba.

To measure the impact of these decisions – which have prompted geologically cataclysmic metaphors from The Chancery Daily – the newsletter’s staff went back to January 2015 to compile a month-by-month tally of the number of new shareholder class action complaints filed in Chancery Court. In raw numbers, there were fewer new cases, 16, filed in October than any previous month. November seems headed for an even lower total, with only five filings in the first half of the month.

As The Chancery Daily explained in a post accompanying the data, the trend held when the newsletter looked at shareholder class actions as a monthly percentage of all corporate and commercial disputes launched in Delaware. October’s ratio, 23 percent, was the year’s lowest. In the first half of November, shareholder class actions made up only 18 percent of Chancery Court’s corporate docket.

The drop-off in filings, according to The Chancery Daily, is not the result of fewer large M&A transactions being announced in October and November. To control for fluctuations in deal volume, the newsletter counted up announced transactions of more than $100 million in every month since the beginning of the year and calculated a ratio of shareholder class action filings per big deal. Between January and September, the ratio was greater than 1 – meaning there were more class action suits than announced deals, probably because multiple shareholders challenged certain transactions – in every month except May, when it dipped to .83 (24 announced deals of more than $100 million and 20 new shareholder class actions).

In October, by contrast, there were only 16 new suits and 24 new deal announcements – a ratio of .69. That’s notably low, especially because most of the class actions were filed in the first half of the month, before Vice-Chancellor Laster’s blistering ruling from the bench in the Aruba case. In the first half of November, shareholder firms filed only 5 new class actions, despite the announcement of 15 big new deals – a ratio of .33. That’s a pretty dramatic number.

Studies in the past few years by law professor Steven Davidoff Solomon of Berkeley and Matthew Cain of the Securities and Exchange Commission have shown that shareholders bring class actions challenging more than 95 percent of deals involving at least $100 million. Not every case is filed in Delaware, of course. It could be that plaintiffs – with the tacit acquiescence of defendants that understand the value of global releases – are filing deal challenges outside of Chancery Court. And six weeks is not a long enough time period to declare a decisive trend.

But if the numbers continue along the same lines, as they probably will, we’re witnessing the death throes of reflexive M&A litigation. Corporate boards that run robust, unconflicted sales with untainted advisors will soon be able to stop assuming shareholder litigation is a cost of doing business.

These are going to be challenging times for small plaintiffs’ shops whose lawyers have made a nice living in the era of disclosure-only settlements. Delaware judges seem confident that ending incentives for reflexive deal tax litigation will encourage the shareholder bar to devote its time and money to suing over truly flawed deals. That would be an ideal outcome. I fear, however, that when boards stop worrying about suits, they will start getting sloppy. Chancery Court has given the pendulum of deal litigation a big shove. Let’s hope the judges didn’t push too far.

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