Combating Shareholder Derivative Actions
As day follows night, the filing of a shareholder derivative action follows a press release or securities filing announcing that two public companies will combine in a sale or merger. A potential class of minority shareholders from the target or selling company sues to block the transaction, and typically claims that the price per share is not high enough because the companys board of directors and advisers undervalued the transaction, or suffered from conflicts of interest and a lack of overall independence. Additional allegations almost always focus on whether the selling company accurately disclosed to its minority shareholders all material information about the sale.
For corporate lawyers and their public clients who are thinking about buying or selling, Pennsylvania law provides a particularly powerful tool to defend against these types of routine shareholder derivative lawsuits. In Cuker v. Mikalauskas (1997), the Pennsylvania Supreme Court approved a framework and procedure that allows the seller to decide for itself whether there is any merit to the claims filed by the minority shareholders.
Cuker starts with the basic proposition that, in the first instance, a decision by a company to file a lawsuit, including a decision by minority shareholders to file a suit on behalf of the company itself, is no different than any other business decision or financial decision that falls within the purview of the companys board of directors and, as such, deserves the protection of the business judgment rule. Carefully following Cuker may give sellers and their buyers the upper hand over derivative claims.
Effective Use of Special Litigation Committees
Under the procedure approved by Cuker, once a companys minority shareholders file a derivative action, the board of directors is authorized to make an independent assessment of the actions merits. To begin this evaluation process, the board of directors should typically (and most effectively) form a Special Litigation Committee to perform this assessment.
Above all, Cuker requires that the directors analyzing the allegations by minority shareholders be capable of objective judgment in the circumstances. Thus, the committee should include two or more directors who are independent and otherwise insulated from the wrongful activity complained of by the minority shareholders. If the existing board of directors does not have a sufficient number of members who are independent, then it should elect one or more new members who qualify.
After its creation, the Special Litigation Committee should retain counsel of its ownchoosing to underscore its independenceand its determinations should be based upon a careful review and evaluation of the material facts and documents, including interviews with the selling companys board of directors, senior management, financial advisers, and lawyers. If it ultimately decides to ask a court to dismiss the claims filed by the minority shareholders, then the committee should present its findings by means of a written report setting forth its conclusions in sufficient detail so that a court will be in a position to judge the comprehensive nature of the investigation and analysis.
In many instances, following these steps will provide a sufficient basis for the selling company to ask a court to dismiss the derivative claims as contrary to the companys best interests. If the court agrees and finds that the work of the Special Litigation Committee satisfies the business judgment rule, then it will dismiss the minority shareholders derivative claims. Thus, if properly deployed and implemented as Cuker envisioned, a Special Litigation Committee equips selling companies (and their new owners) with a decisive procedure to address derivative actions filed by minority shareholders and, ultimately, position them for dismissal.
While Special Litigation Committees are generally effective and seemingly bulletproof, minority shareholders still attack the work they perform, on the basis of their independence or the legitimacy of their findings. For this reason, as well as the usual desire for certainty that the transaction will actually close on time, it is often advisable for buyers and sellers to try to settle these actions.
Many shareholder derivative actions settle on the basis of what is commonly referred to as a disclosures-only settlement, with no increase in the sale price. Instead, minority shareholders negotiate for additional disclosures to the class in a securities filing and for payment of their attorneys fees and costs. For buyers and sellers, a disclosures-only settlement can be a relatively inexpensive way to eliminate any perceived risk to the transaction. For minority shareholders, these types of settlement offer the potential class a better than nothing result, and, at least in theory, less of a battle over their attorneys fees and costs.
The Uncertain Future of Disclosure Only Settlements
Although Pennsylvania case law is far from abundant, in Exum, et al. v. White, et al. (2011) and Balanced Beta Fund v. Southworth, et al. (2011), two trial courts in Pennsylvania approved settlements that did not provide the class of minority shareholders with any money, but did provide for supplemental disclosures and attorneys fees. Similarly, in In re James River Group, Inc. Shareholders Litigation (2007), the Delaware Court of Chancery approved a settlement that consisted only of additional proxy disclosures.
Another example is In re National City Corporation Shareholders Litigation (2009), in which the Delaware Court of Chancery approved a disclosures-only settlement after determining that the disclosures obtained, though minor, conferred a reasonable benefit upon the class. These types of settlements are by no means limited to these jurisdictions, and can be found in courts across the nation.
The continued viability of these settlements, however, may be moving into a gray area, which could cause corporate litigants to rethink the early strategies employed in shareholder actions. A recent opinion by Judge R. Stanton Wettick Jr. (Court of Common Pleas of Allegheny County, Pennsylvania) accentuates the issues that often arise when analyzing disclosures-only settlements, and raises serious questions about whether courts will continue to approve these types of settlements in routine fashion.
The case, Curnow v. Pfischner (2012), involved a challenge to a merger between Parkvale Financial Corporation and F.N.B. Corporation in a stock-for-stock transaction. Parkvales shareholders were to receive 2.178 shares of F.N.B. common stock for each share of Parkvale stock under the mergers terms. Two Parkvale shareholders filed a lawsuit, both on behalf of all other shareholders and derivatively on behalf of Parkvale itself, primarily alleging that the purchase price for Parkvale shares was inadequate, but also claiming that the disclosures to shareholders in Parkvales securities filings were deficient and materially misleading.
After just three weeks of litigation, during which time Parkvale (as the seller) initiated the procedure set forth in Cuker to evaluate the derivative claims, the plaintiffs and defendants entered into a memorandum of understanding outlining the basic terms of a settlement. The terms did not provide for any more money to Parkvales shareholders, but instead only amounted to additional disclosures about the sale in Parkvales securities filings.
When the parties presented him with their settlement, Judge Wettick rejected it, stating that the settlement was not within the range of possible approval. Judge Wettick observed that the settlement only benefitted the corporate defendants (Parkvale and F.N.B.) and plaintiffs counsel, all to the detriment of the Parkvale shareholders.
Judge Wettick held that the settlement disproportionately released all claims brought by the minority shareholders, even though the relief secured for the shareholders only related to the claims about adequate disclosures in Parkvales securities filings. Judge Wettick also underscored the extremely short amount of time between the filing of the complaint and the negotiation of the settlement (19 days), and questioned whether a full and fair evaluation of the plaintiffs claim for money damages could have been accomplished in that time period.
Potential buyers and sellers would be wise to take note of the significance of Judge Wetticks opinion. His refusal to approve the Curnow settlement may signal a shift in the willingness of courts to give their blessing to settlements that only provide minority shareholders with enhanced disclosures, and plaintiffs counsel with their fees and costs.
Case in point: In In re Sauer-Danfoss Inc. Shareholders Litigation (2011), after a careful analysis of the qualitative importance of the disclosures secured in a disclosures-only settlement, the Delaware Court of Chancery trimmed the award of counsel fees to just $75,000, instead of the $750,000 that had been requested. Sauer-Danfoss emphasized the absence of effort and the insubstantial additional disclosures in finding that the case [did] not merit a significant award.
Buyers and Sellers Beware
While hardly perfect, disclosures-only settlements provide buyers and sellers with a way to settle derivative actions, eliminate or reduce risk, and ensure that the deal will close on time. However, while corporations have typically proceeded in lawsuits with these types of settlements as an appealing prospective option for early case resolution, the winds of change are blowing. Any shift in judicial philosophy against these types of settlements will reduce the likelihood of early settlements, and will compel buyers and sellers to take a closer look at Cuker and consider a Special Litigation Committee as an effective tool to counter shareholder derivative actions.
Scott Vernick, a partner at Fox Rothschild, has a national litigation practice focused on technology, health care, data security, privacy, intellectual property, and other complex commercial matters for Fortune 1000 clients. He can be reached at email@example.com. Matthew Olesh is an associate in the firms litigation department, representing clients in state and federal court as well as in arbitration forums, concentrating on shareholder derivative actions and other complex commercial litigation matters. He can be reached at firstname.lastname@example.org.