As reported by Cornerstone Research, Advisen and others, the frequency and volume of shareholder derivative and class action lawsuits challenging mergers and acquisitions of U.S. public companies have skyrocketed in recent years. In 2007, only 53 percent of all M&As valued at $500 million or more encountered legal challenges by the target’s shareholders in the form of multiple derivative and/or class action lawsuits against the target’s board of directors. By 2011, the rate of M&A objection suits had practically doubled: Nearly all (96 percent) of the larger M&A deals and the vast majority (85 percent) of smaller combinations (valued between $100 million to $500 million) faced an average of four separate shareholder lawsuits per deal, with some transactions attracting more than 15 lawsuits, according to Cornerstone’s “Recent Developments in Shareholder Litigation Involving Mergers and Acquisitions.” In light of this rapid growth, M&A objection suits now represent more than 25 percent of all securities suits filed, up from 8 percent in 2004, according to Advisen’s “Securities Suits Remain Off Recent Highs.”
Given this new reality where no M&A deal, no matter the terms and decision-making process, is immune from M&A objection suits boards of directors of potential M&A targets must be prepared to face an onslaught of shareholder claims. One important tool in the board’s arsenal is the special litigation committee (SLC). As explained in more detail below, when a shareholder makes a written demand on the target’s board to assert claims on behalf of the corporation in the form of a derivative action, the directors can appoint an SLC to fulfill their obligation to investigate and evaluate the claims. So long as the SLC can demonstrate that it acted independently and in good faith, a court will give deference to the SLC’s “business judgment” as to whether or not claims should be brought against the company. While shareholders of Delaware corporations often try to circumvent the demand requirement by alleging demand futility, shareholders of companies incorporated in Pennsylvania do not have this option and must make a written demand on the board to file suit. Therefore, before announcing an M&A deal, the target’s board should be apprised of the SLC process so it can effectively respond to a shareholder demand letter.
