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.
