So now what happens to Delaware M&A cases? Chancellor offers answers!

January 25, 2016

(Reuters) – It has only been a few months since Delaware Chancery Court launched its disruption of M&A shareholder litigation but the data already show the class action bar has responded. As Securities and Exchange economist Matthew Cain and Berkeley law professor Steven Davidoff Solomon demonstrated in their latest analysis of shareholder class actions filed in the wake of big merger announcements, new suits fell off a cliff in the last quarter of 2015, after Delaware judges informed plaintiffs and defendants that they’d no longer routinely approve disclosure-only settlements.

We can all agree there’s no social utility in paying plaintiffs’ lawyers hundreds of thousands of dollars to accomplish nothing of value to shareholders while simultaneously requiring those shareholders to waive future rights to sue. But some M&A suits have actually uncovered material problems, in particular, conflicted financial advisers. And as Vice-Chancellor Travis Laster has said, it is not always obvious which transactions may have cheated shareholders.

So the unintended consequence of Chancery Court’s crackdown on settlements that don’t benefit shareholders could be an increased likelihood of flawed deals, assuming that the near-certainty of shareholder litigation in recent years had at least some deterrent effect. As we’ve already seen, without the incentive of fees to reward investigations that don’t turn up wrongdoing, plaintiffs’ lawyers won’t investigate.

Vice-Chancellor Laster said at one of the hearings that signaled Chancery’s new skepticism toward disclosure-only settlements that the prospect of a big payoff when shareholder lawyers discover real flaws in the deal process ought to be incentive enough. In a contingency fee system, he said, those are the breaks: When you have a good case, you win big; when you have no case, you go home empty-handed.

There may, however, be some gray in that black-and-white schematic of the new era of M&A litigation in Delaware. In a landmark opinion Friday, Chancellor Andre Bouchard confirmed that if plaintiffs’ lawyers and defendants continue to attempt to submit disclosure-only settlements to Chancery judges, “they can expect that the court will be increasingly vigilant in scrutinizing the ‘give’ and the ‘get’ of such settlements to ensure that they are genuinely fair and reasonable to the absent class members.” But he also discussed a way that plaintiffs’ lawyers may still be able to obtain fees for cases that fail to identify litigable deal problems.

The chancellor, as my colleague Tom Hals reported, rejected a proposed disclosure-only settlement of shareholder claims stemming from the real estate site Zillow’s February 2015 acquisition of a smaller rival, Trulia. Lawyers had tried to salvage the settlement by restricting the litigation releases Zillow would get from shareholders after Bouchard questioned those releases at a fairness hearing, but the chancellor wasn’t satisfied. Nor will his colleagues be satisfied with similar settlements in the future, Bouchard said.

Fordham professor Sean Griffith, who has been in the vanguard of disclosure-only settlement detractors and submitted an amicus brief urging the chancellor to reject the Zillow agreement, said it’s significant that Bouchard laid out Chancery’s new expectations in an opinion refusing to approve a proposed settlement. (As you may recall, Vice-Chancellor Sam Glasscock warned the Delaware bar in his Sept. 17 opinion in In re Riverbed Technology that the court would frown on disclosure-only deals going forward, but his discussion was dicta because he approved the Riverbed settlement, albeit reluctantly.) I learned from Bouchard’s opinion that plaintiffs’ lawyers have been receiving fee awards from disclosure-only settlements since at least 1996, so the Zillow decision marks the end of a 20-year trend.

The opinion outlined two ways in which plaintiffs’ lawyers can still ask Chancery Court to judge disclosures that supposedly benefit the class – just not in the context of settlements. The first is in a contested preliminary injunction hearing. Until the new crackdown, Bouchard explained, too many plaintiffs’ lawyers used the threat of injunction hearings to push defendants into quick disclosure-only settlements. (You can discern the chancellor’s recent experience as a practitioner in his understanding of such tactics; he cites a soon-to-be-published paper by his former law partner Joel Friedlander that details how second-tier law firms gamed the system to settle quickly and cheaply.) Bouchard said plaintiffs’ lawyers who forced defendants to beef up disclosures in adversarial injunction proceedings could have a shot at persuading the court that the disclosure matters to shareholders. It won’t be easy, though: The chancellor’s opinion, according to Fordham professor Griffith, sets a high bar for materiality.

More intriguing, in my mind, is Chancellor Bouchard’s discussion of mootness fees. Class action lawyers who file a case and then agree to drop it can ask Chancery Court to nevertheless award them fees. Bouchard said that since he and his colleagues have begun scrutinizing disclosure-only settlements, he has seen a rise in a new kind of M&A litigation resolution: After defendants voluntarily add to disclosures in their proxy materials, plaintiffs’ lawyers dismiss class actions and request mootness fees. The big difference between these resolutions and disclosure-only settlements, of course, is releases: Because the class hasn’t settled, class members haven’t released their claims.

Bouchard said court-supervised mootness fees are “a logical and sensible framework for concluding the litigation. After being afforded some discovery to probe the merits of a fiduciary challenge to the substance of the board’s decision to approve the transaction in question, plaintiffs can exit the litigation without needing to expend additional resources,” he said. “Although defendants will not have obtained a formal release, the filing of a stipulation of dismissal likely represents the end of fiduciary challenges over the transaction as a practical matter.”

Plaintiffs’ lawyers can also work out private mootness fee deals with defendants, in which a corporate board authorizes a payment in exchange for the dismissal of a class action suit. That kind of arrangement, which bypasses the court, seems to leave a lot of room for mischief, but Chancellor Bouchard has anticipated such an eventuality. He pointed out that in his 2015 opinion in In re Zalicus, he insisted that shareholders in the putative class be notified of a private mootness fee deal to protect against the risk of defendants “buying off” plaintiffs’ lawyers. “Notice to stockholders is designed to guard against potential abuses in the private resolution of fee demands for mooted representative actions,” he said in the Zillow opinion.

The chancellor strongly implied that Chancery Court isn’t going to award a whole lot of money in mootness fees tied to defendants’ voluntary disclosures, and Griffith said defendants may not even agree to these deals because they don’t include broad releases.

But maybe these scaled-down fees will give the class action bar just enough reason to invest in sniffing out bad deals.

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