Recent Developments in U.S. Merger Litigation
Pierluigi Matera, Ferruccio M. Sbarbaro
In un modello basato sulla c.d. regulation-by-litigation, come quello della corporate law statunitense, legislatore e giurisprudenza sono chiamati a confrontarsi periodicamente con l’eccesso di contenzioso; un eccesso che comporta costi per il sistema e in specie per le operazioni straordinarie senza determinare, simmetricamente, benefici sostanziali per le società o per i loro azionisti. Il fenomeno della overlitigation nel settore delle M&A ha raggiunto un picco nel 2015, quando oltre il 96% di siffatte operazioni è stato oggetto di un procedimento giudiziale intrapreso da azionisti.
Le specifiche ragioni di questo dato allarmante sono da rinvenirsi nel diffuso impiego di una peculiare strategia: il c.d. disclosure-only settlement, che fa leva sull’attitudine delle corti statunitensi ad approvare ogni accordo tra le parti che definisca transattivamente il giudizio, a prescindere da qualsivoglia evidenza sui benefici di tale accordo per la società e per i suoi azionisti. In particolare, attraverso i disclosure-only settlement, gli azionisti ottengono esclusivamente la disclosure di informazioni di dubbia utilità sull’operazione contestata, mentre ai legali degli attori viene garantita la liquidazione di compensi legali in misura significativa e agli amministratori convenuti un’ampia liberatoria anche in relazione a possibili future azioni – oltre a “portare in salvo” l’operazione oggetto del giudizio.
Agli inizi del 2016, con la decisione In re Trulia, la Delaware Court of Chancery ha mutato orientamento e introdotto degli stringenti requisiti per l’approvazione dei disclosure-only settlement, richiedendo da un lato che la disclosure integrativa oggetto dell’accordo comporti un “plainly material benefit” per gli azionisti e dall’altro che qualsivoglia liberatoria in favore degli amministratori sia “narrowly circumscribed”. Il nuovo standard giudiziale rende non praticabile la descritta strategia, id est meno vantaggioso per le parti che intendano ricavare i predetti benefici iniziare un giudizio senza i necessari presupposti; di guisa che non può di certo considerarsi casuale la riduzione della litigation che ne è conseguita. Le corti federali si sono rapidamente conformate a Trulia con In Re Walgreen, mentre alcune giurisdizioni statali sono state lente e talvolta riluttanti a farlo.
Nondimeno, a fronte della reazione delle corti rispetto alla strategia collusiva illustrata, le law firm specializzate nell’assistere gli attori in questi giudizi hanno prontamente ideato una contro-reazione mettendo in campo un nuovo schema elusivo delle maglie processuali: il c.d. mootness dismissal con il pagamento dei compensi legali collegati. Da qui un nuovo incremento della litigation. Il nuovo stratagemma consiste in una rinuncia all’azione da parte dell’attore, combinata con il versamento di un compenso ai plaintiffs’attorney da parte del convenuto e a carico della società – sulla scorta della c.d. common benefit doctrine. A differenza del disclosure-only settlement, il mootness dismissal non pregiudica alcun diritto né azione dei soci non costituiti, giacché il defendant non ottiene alcuna liberatoria in relazione a future contestazioni. Inoltre, in media le mootness fee sono meno ‘generose’ di quelle connesse ai classici disclosure-only settlement.
Il meccanismo in parola rischia però di generare un nuovo abuso dello strumento giudiziale, con costi non bilanciati da benefici, giacché non corrispondenti a funzioni di deterrenza o di correzione. Peraltro, dinanzi alle corti federali la strategia in questione sfugge al controllo giudiziale, atteso che le Federal Rules of Civil Procedure non subordinano il pagamento delle mootness fee a una approvazione da parte della corte. Si spiega, così, perché nel 2017 l’87% delle azioni è stata portata dinanzi a corti federali e solo il 10% in Delaware, con un trend ancora più marcato nei mesi a seguire.
Nel giugno del 2019, allora, con il caso House v. Akorn, la U.S. District Court dell’Illinois ha esteso il principio di Trulia-Walgreen al mootness fee scheme, condannando i plaintiffs’attorney a restituire i compensi alla defendant corporation. L’appello è tuttora pendente dinanzi al 7th Circuit, ma è verosimile attendersi che la corte confermi la sentenza di primo grado.
Non v’è dubbio che gli standard adottati dalle corti in Trulia e Akorn debbano essere perfezionati e che non possano costituire l’unico freno alla overlitigation. Parte della dottrina addirittura sostiene che la overlitigation sottenda una crisi del sistema, che assume contorni particolarmente preoccupanti ogni qual volta il giudizio assume i caratteri di un processo non contenzioso ma tendente alla collusione tra le parti. E ciò sarebbe dovuto, almeno in parte, a un’inefficace gestione, da parte delle corti e finanche del legislatore, di alcuni conflitti di interessi e degli incentivi su cui il sistema della regulation-by-litigation si regge.
Nondimeno, è anche vero che una serie coordinata di interventi legislativi e di pronunce sembra dimostrare una certa reattività del sistema e la correzione di quanto segnalato: le decisioni C&J Energy, Corwin e Karp v. SI Financial Group ne costituiscono la prova. Altri correttivi sono presumibilmente in arrivo, con lo scopo di ristabilire un equilibrio tra efficacia del controllo e costi ragionevoli per lo stesso. Per contro, qualora tale obiettivo non fosse conseguito, potrebbe realmente entrare in crisi l’intero regulation-by-litigation model; e potrebbe altresì giustificarsi un mutamento più radicale in direzione di un regulatory approach, quale quello adottato nel Regno Unito o in Irlanda, basato su un code e su di un panel per il controllo.
In a regulation-by-litigation system, such as the model adopted in U.S. corporate law, courts and legislatures periodically address overlitigation, which entails significant costs and does not bring material benefits for corporations and their shareholders. Overlitigation in M&A field dramatically peaked in 2015, when over 96% of publicly announced mergers were challenged in a shareholder lawsuit.
A certain scheme was primarily responsible for this spike: the disclosure-only settlement. This relied on the courts’ routine practice of approving any settlement, even when the benefit for corporations and shareholders was evident. Through such form of settlement, the shareholders obtained some modest supplemental disclosures, the plaintiff’s attorneys received significant fee awards from the defendant directors, and the defendant directors secured some blanket class releases from future claims, in addition to settling the case.
In early 2016, with In re Trulia the Delaware Court of Chancery imposed a doctrinal shift for disclosure-only settlements, requiring that supplemental disclosures deliver a “plainly material benefit” to stockholders and that any releases from liability be “narrowly circumscribed.”. In light of this, the new standard made collusive disclosure-only settlements far more difficult and resulted in a decrease of merger litigation. Federal courts have quickly applied Trulia with In Re Walgreen, while some state jurisdictions have been slower and sometimes reluctant to do so.
In the face of this reaction, plaintiffs’ law firms swiftly devised a new scheme and exploited another procedural gap: the mootness dismissal with the payment of the associated fees. This resulted in a new increase of litigation. The new stratagem consists in a voluntary dismissal coupled with the payment of mootness fees to plaintiffs’ attorneys by the defendant, based on the common benefit doctrine. Unlike the disclosure-only settlement, the mootness dismissal is without prejudice for the class since the defendant obtains no release from future claims. Mootness fees are also on average much lower than the attorneys’ fees granted in a typical disclosure-only settlement. Yet, the pattern may result in a new abuse of litigation, since it carries costs without benefit and fails to serve any deterrence or redress function. Moreover, in federal courts the mootness scheme can bypass any judicial scrutiny, since the Federal Rules of Civil Procedure do not explicitly allow a court to review mootness fees. This explains why 87% of claims in 2017 were brought in a federal court and only 10% in Delaware, with the trend becoming more marked in the following months.
In June 2019, in House v. Akorn, a U.S. District Court in Illinois extended the Trulia-Walgreen standard to the mootness fee scheme, thereby ordering the plaintiffs’ attorney to return the fees to the corporation. An appeal is pending before the 7th Circuit, though it is likely that the appellate court will affirm the district court’s decision.
Certainly, the standard adopted in Trulia and Akorn needs to be perfected and is not the only solution to overlitigation. Some commentators contend that overlitigation epitomises a crisis of the litigation system that becomes particularly acute when it evolves into a non-adversarial process. This is partly due to ineffective management – by legislatures and courts – of some conflicts of interest and of some incentives. However, courts and legislature have coordinated a series of decisions and legislative intervention for this purpose: C&J Energy, Corwin and Karp v. SI Financial Group are an example. More adjustments are underway in order to strike a balance which results in an effective control without unreasonable costs. Failure to do so could call into question the regulation-by-litigation model and might motivate a radical departure towards a regulatory approach, such as the Anglo-Irish code and panel-based model.
1. Introduction - 2. Disclosure-only settlements - 2.1.2. The New Standard and Its Rationale - 2.2. The Effectiveness of the New Standard: Limitations, In Re Walgreen and the Jurisdictional Disunity - 3. Voluntary Dismissal and Mootness Fees - 3.2. The Response to Mootness Fee Practice: House v. Akorn - 4. Prospective Developments and Adaptive Responses after Akorn - 4.1.2. Effectiveness of the Other Safeguards: The PSLRA, Assad v. DigitalGlobe and Bushansky v. Remy - 4.2. Unsustainability of the Trulia and Xoom Standard for Mootness Fees and Alternatives - 5. Conclusion - NOTE
In the U.S. no regulatory body fully oversees mergers, acquisitions and other control transactions, and regulation is deliberately not detailed. Rather, courts “regulate” deals, also by policing both potential conflicts and disclosures. In this model, the litigation is serving as regulation, hence private enforcement and judicial decisions are notably essential. Specifically, shareholders can enforce disclosure violations under federal law or claim breach of directors’ fiduciary duties under the state of incorporation law –mostly Delaware. Through the enforcement of shareholders’ rights, Delaware law (which all other states follow) also provides for judicial scrutiny of the sufficiency of the information disclosed by the directors in connection with M&A transactions. This cause of action is a corollary to shareholders’ statutory right to vote on the transaction and of the resulting duty of directors to disclose all material information – since effectively the failure to disclose material information may affect shareholders’ right to make an informed decision. Therefore, while federal courts oversee that the disclosures produced for the merger comply with federal securities law, state courts serve both the principal “regulatory” functions of policing conflicts of interest in the transaction process and ensuring the adequacy of corporate disclosures. [] This jurisdictional overlap means [continua ..]
2. Disclosure-only settlements
2.1. In Re Trulia and the materiality standard 2.1.1. The Scheme of Disclosure-only Settlements The ruling In re Trulia is the most important reaction by the courts to overlitigation in the context of mergers and acquisitions in recent years. It was delivered at the beginning of 2016 by the Delaware Court of Chancery and marked a doctrinal shift in the standard of judicial review for disclosure-only settlements. [] Other decisions of Delaware courts can also be considered as part of a (presumably synchronized) response to overlitigation: C&J Energy Services [] and Corwin [] were both issued in less than 14 months and intended to curb M&A overlitigation. But at this juncture, Trulia serves two functions. [] Firstly, it is the brightest illustration of the perverse mechanism generated by the routine course of proceedings in merger objection lawsuits. [] Secondly, it is the most definitive statement of courts’ firm intentions to carefully scrutinise any settlement that does not include a monetary recovery (or other kind of plainly material benefit) for the class. [] Indeed, this decision addressed the root cause of a disturbing practice that underpinned the distortion and indicated the frivolous and vexatious nature of many (if not most) of those lawsuits. [] As noted earlier, a disclosure-only [continua ..]
2.1.2. The New Standard and Its Rationale
Prior to Trulia, in C&J Energy Services, the Delaware Supreme Court had made it more difficult to award plaintiffs with an injunction to enjoin the transaction, thereby reducing the threat of a delay in the completion of the deal. [] In the following months, the Delaware Court of Chancery intensified its criticism of disclosure-only settlements, showing scepticism in Acevedo and Riverbed Technology and almost anticipating a corrective action. [] The most logical form that this correction could take was an action to make the judicial oversight of this kind of settlement effective. In Trulia the court proclaimed its intention to validate disclosure-based settlements only after a careful scrutiny on actual shareholders’ benefits and held that only supplemental disclosures that deliver a “plainly material benefit” to stockholders can be an adequate consideration for settlement. [] Disclosure is material if “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.” [] That is to say, conversely, that the omission “would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” [] According to the court in Trulia, the benefit must not only be material but must [continua ..]
2.2. The Effectiveness of the New Standard: Limitations, In Re Walgreen and the Jurisdictional Disunity
Under the enhanced standard of judicial review set by Trulia, the “case-by-case assessment of the reasonableness of the ‘give’ and ‘get’ of such settlements” has become remarkably stricter. [] Disclosure-only settlements are now somewhat disfavored, and filing a merger objection lawsuit in Delaware has become less desirable for plaintiffs’ attorneys. Since the new standard discourages the collusive dynamics we mentioned earlier, Trulia might appear as a decision that should be immediately agreed with. Yet, a closer look casts doubt on the legal grounds for the new standard and also on its effectiveness in deterring nuisance litigation. Some commentators argue that directors have a pre-existing duty to disclose all material information, to which shareholders have a right. Hence, any supplemental disclosure, even if material, cannot provide the necessary consideration for a settlement, because it is not “fresh” consideration. [] Nevertheless, it could also be argued that, at that stage of the case, the omission or misstatement is just one party’s allegation. In the “aliquid datum, aliquid retentum” structure of a settlement, the concession on the defendant’s side is exactly the additional information the plaintiff alleges is missing. Instead, what is uncontroversial is that the requirement to disclose material [continua ..]
3. Voluntary Dismissal and Mootness Fees
3.1. The Rise of a New Strategy We noted earlier that, in this litigation-centric model, plaintiffs’ attorneys devise adaptive responses to the attempts of legislatures and courts to halt the exploitation of corporations through litigation–and vice versa. M&A litigation is an instance, and its frequency follows the trend of these adaptive responses. As anticipated, after Trulia, merger litigation declined to 76% of the relevant [] transactions in 2016. Yet, in 2017 the number of litigated deals rose again, reaching 83% of the mergers. [] Notably, only 10% of these claims were brought in Delaware, while 87% were before a federal court. [] The shift away from Delaware courts continued in 2018, when merely 5% of these cases were filed in a Delaware court, compared to 92% in a federal court. [] Not only did the litigation experience a migration but also the pattern changed: a few of these lawsuits were settled; most cases (63%) were voluntarily dismissed, and plaintiffs’ attorneys received a mootness fee. [] In other words, the new increase in M&A litigation was associated with a migration to federal jurisdiction and with a mutation of its pattern: plaintiffs’ attorneys started to repackage state-law fiduciary-duty claims into federal suits for disclosure violations, brought under Section 14(a) of the Securities Exchange Act of 1934 – and its implementing [continua ..]
3.2. The Response to Mootness Fee Practice: House v. Akorn
In an opinion issued on June 24, 2019 (House v. Akorn), a U.S. District Court in Illinois scrutinized an out-of-court agreement to pay mootness fees to plaintiffs’ counsel after supplemental disclosures and a voluntary dismissal. [] Although the claims were filed as prospective class actions, [] they were then dismissed by individual shareholders and not settled on behalf of all the shareholders. Accordingly, no class-action settlement was filed that would have required court approval covered under the Trulia-Walgreen standard. [] When an Akorn shareholder [] challenged the scheme and moved to enjoin the payment of the mootness fees, the judge denied the motion to intervene in the case [] but seized the opportunity to scrutinise the additional disclosures and the fees. He found the disclosures not plainly material and “worthless to the shareholders,” [] since it provided “nothing of value” for shareholders and “instead caused the company in which they hold an interest to lose money.” [] The judge also emphasized that “plaintiffs’attorneys were rewarded for suggesting immaterial changes to the proxy statement,” so that “Akorn paid plaintiffs’ attorney’s fees to avoid the nuisance of ultimately frivolous lawsuits disrupting the [continua ..]
4. Prospective Developments and Adaptive Responses after Akorn
4.1. The Mootness Fee Scheme in Federal Courts After Akorn 4.1.1. The Requirement of Reporting to the Court Any Payment of Mootness Fees By itself, confirming Akorn may not be enough to block overlitigation. Although in principle it discourages plaintiffs’ attorneys from starting a meritless lawsuit in order to extract mootness fees, a precondition is that a court effectively holds a hearing to determine if the payments are justified under the materiality standard. Indeed, even if the 7th Circuit were to affirm the district court’s decision in Akorn, the mootness fee scheme might still persist since the power to review those fees and triggering an assessment are wholly distinct. For, if the parties are not required either to give notice of the agreement on mootness fees to other shareholders, or to apply for a judicial approval of those fees (when the lawsuit is voluntarily dismissed prior to class certification), the court might have no way of becoming aware of such payment – unless an objection is raised. This is true regardless of the existence of a court’s inherent authority to review mootness fees when a case is not pending before it – as held in Akorn – since knowledge of the payment is a pre-condition. [] This might partly explain the shift from Delaware courts to federal courts, since in Delaware notice is required. [] Some commentators have proposed the [continua ..]
4.1.2. Effectiveness of the Other Safeguards: The PSLRA, Assad v. DigitalGlobe and Bushansky v. Remy
If the procedural gap of mootness fees is bridged by the decision in the Akorn appeal and the courts manage to scrutinise those payments, repackaging a state-law fiduciary-duty action into a federal disclosure violation case will no longer be convenient for plaintiffs’ attorneys. [] In order to bring a claim under Section 14(a) of the Securities Exchange Act of 1934 and Rule 14a-9, a plaintiff must establish that: (1) a proxy statement contained a material misrepresentation or omission; (2) the defendants were at least negligent in drafting the proxy statement; (3) the misrepresentation or omission caused the plaintiff injury; and (4) the proxy solicitation was an essential link in accomplishing the transaction. [] In other words, in addition to the materiality of the misrepresentation or omission, a plaintiff must demonstrate an “actual economic harm” [] – the “injury” requirement and the “essential link” element will require the plaintiff to show causation. [] In order to curb potential abuses of federal litigation, the federal legislature also enacted the Private Securities Litigation Reform Act (the “PSLRA”), [] strictly applied by courts to Section 14 claims. This added some filters to enhance the screening of unmeritorious proceedings, such as a heightened “particularity” requirement for plaintiff’s [continua ..]
4.2. Unsustainability of the Trulia and Xoom Standard for Mootness Fees and Alternatives
The affirmation of the district court’s decision in Akorn would leave unresolved another issue in Delaware: the standard for scrutinizing the mootness fees. As we noted earlier, Trulia and Xoom only require “some benefit to stockholder” in order to justify a mootness fee. [] Some commentators argued that such standard is both low and judicially unmanageable: “it rewards plaintiffs for filing complaints in cases in which there is no violation of the law – because section 14(a) imposes liability only for ‘material’ disclosure violations.” [] These commentators outlined that this standard is contrary to the long precedent on disclosure and materiality as set forth in TSC Industries v. Northway. [] It is also illogical because – as stated in Nye [] – if a fact is not material for the decision and the vote that stockholders have to make, there is no duty for directors to disclose it. The conclusion – from this viewpoint – is that “information that is not legally required should not be the basis of a fee award.” [] Regardless of the difference in the scenarios between a federal claim and a state fiduciary claim, prima facie the remark sounds reasonable. In large transactions, information is reasonably omitted when it is not relevant; and an overflow of information would make the [continua ..]
Trulia, Walgreen, Akorn, SI Financial, Scott and a series of other decisions recently issued exemplify the regulation-by-litigation response to M&A overlitigation. This excessive litigation generated costs for the corporation and only benefited the parties’ attorneys by extracting fees without protecting shareholders’ rights. This was the result of the failure of the adversarial system due to the collusion between plaintiffs’ attorneys and defendant directors. The courts have been slow in reacting and, the recent rulings are an attempt to rescue the model from a point of no return. Yet, these decisions need to be confirmed, implemented and supplemented. In Akorn, the district court offered a path for all federal courts to apply the Walgreen standard to mootness fees. We argue that the appellate court should affirm the district court’s decision and confirm this approach. We support both the existence of an inherent authority of a federal judge to scrutinise a mootness fee and the legal grounds for applying the Walgreen standard in such scrutiny – a standard also applied in Scott on the same grounds. In addition, the introduction of a provision to explicitly mandate either a notice to other shareholders or the application for federal court approval (when merger lawsuits are voluntarily dismissed prior to class certification) would clear up any ambiguity. In this way, the process would become [continua ..]