Empirical scholars of corporate law are uncovering a rapidly changing and depressing pattern in M&A litigation. This new research dates from a series of articles in 2012 by professors John Armour, Bernard Black and Brian Cheffins, which announced that Delaware was "losing" its cases, as plaintiff’s attorneys migrated to other jurisdictions where they could expect lower dismissal rates and/or higher fee awards.1 This year, a newer study by professors Matthew Cain and Steven Davidoff covers 1,117 merger transactions between 2005 and 2011 and reports more surprising and complex findings.2 But the key question has not been faced by these empiricists: What policy response is appropriate?
Most of the recent studies have hypothesized an assumed competition among jurisdictions for M&A litigation.3 This assumes what is to be proved, because (with the notable exception of Delaware) most jurisdictions do not have a clear incentive to seek more corporate litigation at a time when their courts already perceive themselves as overburdened. Further, this competitive model cannot easily explain the rapidity of recent change. To cite one statistic, in 2005, 39.5 percent of corporate merger transactions with a value over $100 million attracted litigation, but in 2010 and 2011, this rate rose to 87.3 percent and 92.1 percent, respectively.4 That a merger transaction will be attacked in court is now the new norm, not the exception.
Moreover, how it will be attacked has also changed dramatically. In 2005, when a merger attracted litigation, an average of 2.2 complaints were filed, and multi-forum litigation (i.e., actions in multiple jurisdictions) accounted for only 8.3 percent of all merger transactions that attracted litigation.5 But by 2011, an average of five lawsuits were filed if the merger attracted litigation, and multi-forum litigation occurred in 53 percent of all transactions with litigation.6 Almost all this litigation is brought in state court, and professors Cain and Davidoff report that "less than 2% of transactions file exclusively in federal courts."7
The final distinctive factor about the "new" M&A litigation is that it produces little, if any, discernible benefit for the shareholder class. In the Cain and Davidoff study, 71.6 percent of the cases settled, while 28.4 percent were dismissed.8 But these settlements rarely involve monetary relief (under 5 percent in both the Cain and Davidoff study and a similar Cornerstone Research study).9 Instead, the vast majority of these cases settle on a "disclosure only" basis, with some additional disclosures about the transaction being made to the shareholders. Despite the plaintiff’s attorneys make out like bandits, receiving a mean fee award in the Cain and Davidoff study of $1.413 million.10 Because the median time in their study between the lawsuit’s filing and settlement was only 44 days, this seems a very lucrative return on a brief investment of time. Thus, if nearly 70 percent of all merger cases settle and the fees are this high, we can realistically expect more and more attorneys to enter this field, attracted by this combination of low risk and relatively high return.
The net result is both a "deal tax" that reduces shareholder wealth and a waste of judicial resources. Such litigation is not only duplicative, but, as a Delaware Vice Chancellor has aptly phrased it, it is "feigned litigation" because no serious effort is made to conduct discovery, take depositions or pursue a preliminary injunction.11 Still, there may be limits. Possibly the most surprising recent development was the decision last month of Delaware Chancellor Leo Strine to reject a negotiated settlement in a "disclosure only" merger class action because it provided no discernible value or benefit to shareholders.12 Commendable as this decision is, it may only fuel the migration out of Delaware by the lawyers filing the weakest actions. Often in cases settled outside of Delaware, the factor most leading defendants to settle is the uncertainty about what an inexperienced judge might do, who has seen few other merger cases and is approached often at the last minute for a preliminary injunction. Because any delay might seriously disrupt the merging companies’ plans, even a small risk of delay may justify the payment of plaintiff’s attorneys fees, which are, after all, only a "rounding error" in terms of the transaction’s overall scale and cost.
The bottom line answer appears then to be that migration out of Delaware better enables plaintiff’s attorneys to hold the corporation hostage—but for the attorneys’ benefit, not the benefit of shareholders. In addition, the migration phenomenon may compel Delaware to award higher fees in response, but this is less certain. Plaintiff’s attorneys discovered the attractiveness of non-Delaware forums over the last decade and are finding merger cases a welcome substitute for harder-to-win securities class actions (where they must have an institutional client to even play).
Academics surveying this evidence have tended to leap quickly to the theoretical level to present it as a form of market competition.13 Professors Armour, Black and Cheffins originally suggested that Delaware was "losing" this competition, and Cain and Davidoff identify the current winners in this competition as California, Texas, Florida, New Jersey, Nevada and Tennessee.14 But it is far from clear that any jurisdiction is truly attempting on an organized basis to compete with Delaware. Inherently, most states have an advantage over Delaware that naturally attracts plaintiff’s attorneys: They do not have a Chancery Court and thus offer jury trials (which defendants fear). Some jurisdictions may also have a lower dismissal rate at the pretrial stage than does Delaware. But these are preexisting, built-in advantages, and there is no evidence that any jurisdiction has modified its rules or practices to attract merger litigation.15 Indeed, even if such a step were desired by the local plaintiff’s bar (or even the entire state bar), it is not clear that the judiciary in any of these "competing" jurisdictions would accommodate such a desire because overworked judges generally do not want to lengthen their dockets or increase their workloads. Professors Cain and Davidoff suggest (and many others have speculated) that Delaware may have recently liberalized its fee award standards (which were already generous) in order to offset the impact of its higher dismissal rate,16 but they also recognize that over the duration of their study, there is "no empirical evidence that…Delaware adjusts its fee awards in response to attorney forum shopping."17 In short, although the theory of a market for litigation is plausible, the evidence supporting it is thin.
But even if jurisdictions are not competing for merger litigation, this does not make the current problem any less intractable. Teams of plaintiff’s attorneys clearly are competing, some trying to avoid Delaware at all costs, others seeking a home court advantage by filing in the jurisdiction of the company’s principal place of business. All are, however, waiting for the defendant to open settlement discussions. This leads to the critical point that my academic colleagues seem to have missed: Multi-forum litigation is inherently dysfunctional. The simple economic truth is that once parallel litigation begins in two or more forums, each team of plaintiff’s attorneys has a reduced incentive to invest in the action (by conducting discovery or taking dispositions) because it lacks any property right in the action and will be left out in the cold if defendants settle with others. In fact, the more a plaintiff’s team seeks to actively litigate the case, the more defendants may rationally seek to find another team to settle with (because the latter team, having expended less in time and money, can afford to settle cheaper).
Given this predicament, what policy prescriptions make sense? Chancellor Strine has been urging other state courts to apply the doctrine of forum non conveniens and stay their actions in favor of Delaware’s.18 Although that would resolve the multi-forum problem, New York state courts have been resisting for some time.19 This does not mean that he is wrong, but the solution seems unpromising at present.
Three other general approaches may work, but two would require either federal or state legislation. First, the one answer that does not require legislation is the forum selection clause. Either a shareholder-adopted bylaw or an amendment to the corporation’s certificate of incorporation could provide that Delaware is the exclusive forum for the resolution of any action asserting a breach of fiduciary duties, or other wrongdoing, by the merging corporation’s officers or directors. One recent decision, Galaviz v. Berg,20 made it uncertain whether a board-adopted bylaw can be enforced, because such action can be regarded as a form of self-dealing by directors seeking insulation. However, any shadow that that case cast over forum selection clauses has been substantially alleviated by a decision in February by U.S. District Judge Robert W. Sweet in In re Facebook IPO Securities and Derivative Litigation.21
Before going public, Facebook’s pre-IPO shareholders amended its Certificate of Incorporation in April 2012 to add a new Article IX that set forth a forum selection provision requiring any fiduciary litigation to be brought only in the Delaware Chancery Court. This was elaborately disclosed in Facebook’s registration statement. Curiously, the certificate amendment was not filed with the Delaware Secretary of State until May 22, 2012—four days after Facebook’s IPO and the sale of shares that plaintiffs attacked as a fiduciary breach. Finding that Delaware General Corporation Law §242(b) made the amendment effective only on its filing, Sweet declined to enforce Facebook’s forum selection clause with respect to pre-filing conduct. Despite Facebook’s blunder, Sweet’s decision adopted a four part test that would seemingly normally make an earlier filed forum selection provision presumptively enforceable, at least if the provision was approved by shareholders.22
Although he expressly declined to address the desirability of such a provision,23 Sweet held that those seeking to challenge a validly adopted provision "bear the heavy burden of making a ‘strong showing’ in order to overcome the presumption of validity."24 Still, because his decision would deny retroactive effect to such a provision, the decision would appear to preclude the inclusion of such a certificate or bylaw amendment in the same proxy statement that asked shareholders to approve the merger, as the company needs to have the provision in place (i.e., filed with the Secretary of State) at the time of the merger. Conceivably, the charter amendment could be filed before the merger closed, but this is playing very close to the line.
Of course, even if a forum selection provision is enforceable, this does not imply that shareholders will approve them. Here, the de facto veto power held by Institutional Shareholder Services (ISS) complicates matters, as to date ISS has taken a skeptical, case-by-case approach to forum selection clauses. Possibly if the merger were at a high premium, ISS might be more favorably disposed. Facebook’s novel strategy was to ask its pre-IPO shareholders to approve the provision before ISS gained its usual influence.
If shareholder approval is uncertain, an alternative approach might be adopted through legislation. The most logical answer to the chaos of multi-forum litigation would be to empower the U.S. Judicial Panel on Multi-District Litigation to coordinate state, as well as federal, litigation—at least if certain tests in terms of the size and significance of the transaction were met. The panel would not move state cases to federal court, but could, for example, consolidate merger cases pending in multiple courts at the request of the subject corporation before one state judge for discovery and other pretrial purposes. Because merger cases are seldom tried, such pretrial consolidation should be sufficient, and this legislation seems clearly constitutional given the impact of such litigation on interstate commerce. This approach has the advantage of not requiring shareholder action, and it need not necessarily give a preference to Delaware (although a preference for the jurisdiction of incorporation could be specified in a list of criteria to guide the panel in the authorizing legislation).
A third approach might be Delaware legislation that would establish more expedited procedures for merger litigation. Multi-forum litigation always poses the prospect of a race to settlement among the contending teams, but this is a race that the Delaware team should usually win (if it is properly motivated), because other jurisdictions have substantially slower procedures. Of course, defendants may not want to grant expedited discovery to plaintiffs in merger actions; alternatively, plaintiff’s attorneys may prefer to wait for an eventual settlement offer without expending time or money on discovery. But if Delaware—by legislation or court rule—were to set a rapid pace in merger litigation, it could win the race to settlement because other jurisdictions probably lack the incentive to compete for the few cases that they might win. Only for Delaware does merger litigation present a high stakes competition.
A possible rejoinder here might pose a factual setting in which either (1) no case is filed in Delaware, even though the acquired corporation was incorporated there, or (2) the Delaware case simply cannot be settled within the relevant time frame. These cases will be rare, as Delaware has no shortage of plaintiff’s attorneys used to litigating in that forum. But if it were to become a problem, Delaware could consider a truly unorthodox possibility: a new declaratory judgment action under which the merging corporation could, itself, seek a declaration that the merger terms were fair and that its directors complied with their fiduciary duties. All plaintiffs in other out-of-state actions could be served or otherwise invited to appear, and in-state shareholders could supply personal jurisdiction. The point of this procedure would be that it could be litigated to a resolution on the merits and thereby bind all shareholders (whereas the dismissal of a case on procedural or standing grounds generally would not). Assuming that due process safeguards are observed, such a declaratory judgment should be entitled to the protection of the Full Faith and Credit Clause of the U.S. Constitution.25
Finally, even without legislation or other reform, there is always the comity option of informal judicial consultation and cooperation by judges across state lines.26 Judges in Delaware and some other jurisdiction could establish common discovery and deposition schedules, which would spare the defendants the duplicative expense of multi-forum litigation. The judges should also discuss the possibility of a joint settlement. Some Delaware cases appear to have been resolved in this fashion, but on other occasions the process has broken down. That should not be surprising. Even if all the courts have the best of intentions, the deeper problem is that in order for actions in multiple forums to be resolved together, the plaintiff’s attorneys will either have to share the fee award or convince the court approving the settlement to pay them all attorney fees. This is costly for defendants, and particularly unjustified in a "disclosure only" settlement. Moreover, once courts begin to pay attorneys in two forums for settling the same action, actions may be filed in three or more forums in the next case.
For those skeptics who are convinced that the American legal system puts the interests of lawyers first, the current state of merger litigation constitutes Exhibit A to their Complaint. If over 90 percent of all mergers produce litigation, but no case ever results in a plaintiff’s verdict, and if the vast majority of these cases settle on a non-pecuniary basis for purely cosmetic reforms and disclosure, this surpasses even the ability of a Charles Dickens in Bleak House to make lawyers and the judicial system look entirely self-regarding. Sadly, this state of affairs seems likely to persist.
John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.
1. See John Armour, Bernard S. Black and Brian R. Cheffins, "Delaware Corporate Litigation and the Fragmentation of the Plaintiff’s Bar," 2012 Colum. Bus. L. Rev. 427 (2012); John Armour, Bernard S. Black and Brian R. Cheffins, "Is Delaware Losing Its Cases?," 9 J. of Empirical Legal Studies 605 (2012); John Armour, Bernard S. Black and Brian R. Cheffins, "Delaware’s Balancing Act," 87 Indiana L. J. 1345 (2012).
2. See Matthew D. Cain and Steven Davidoff, "A Great Game: The Dynamic of State Competition and Litigation," available at http://ssrn.com/abstract=1984758 (January 16, 2013).
3. See Sean J. Griffith and Alexandra D. LaHav, "The Market for Preclusion in Merger Litigation," available at http://ssrn.com/abstract=2155809 (2012); Cain and Davidoff, supra note 2; Armour, Black and Cheffins, "Is Delaware Losing Its Cases?," supra note 1.
4. See Cain and Davidoff, supra note 2, at 14.
5. Id. at 15.
7. Id. One reason for the paucity of federal cases may be higher pleading standards (even though no federal cause of action is pleaded). Or diversity may be harder to establish. But a final possibility is that plaintiffs may want an inexperienced state law judge.
8. Id. at 16.
9. Id. at 17. (only 4.8 percent of settlements in their sample provided a monetary benefit); see also Cornerstone Research, "Recent Developments in Shareholder Litigation Involving Mergers and Acquisitions," at 10 (2012) (finding that only 9 of 190 settlements sampled resulted in monetary relief to shareholders, while 82 percent resulted in disclosure-only settlements).
10. Cain and Davidoff, supra note 2, at 37 (Table 2, Panel B). However, in "disclosure only" cases, the mean fee award falls to $749,000.
11. See Scully v. Nighthawk Radiology Holdings, No. 5890-VCL (Del. Ch., Dec. 17, 2010).
12. See In re Transatlantic Holdings Shareholder Litigation, Case no. 6574CS (Feb. 28, 2013).
13. In this regard, see in particular, Griffith and LaHav, supra note 3. Cain and Davidoff, supra note 2, are more qualified in their conclusion, recognizing that they do not know what motivates other jurisdictions, but they also see interstate competition as underlying the process of cases migrating out of Delaware.
14. Cain and Davidoff, supra note 2, at 5. On a head to head basis, they find that New Jersey is beating Delaware by a 84.6 percent to 15.4 percent ratio, and California (with far more cases) is winning against Delaware by a 71.9 percent to 28.1 percent ratio. Id. at Table 9.
15. Id. at 5.
16. Id. at 6. (noting that they "find evidence that Delaware engages in this practice" of offering "greater fees to compensate attorneys for higher dismissal rates"). See also In re Southern Peru Copper Shareholders Derivative Litigation, 30 A.3d 60 (Del. Ch. July 15, 2011), aff’d 51 A.3d 1213 (Del. 2012) (awarding $300 million fee award in derivative action).
17. Id. at 5. In other words, Delaware may have long given higher fees to successful plaintiffs, and has not recently changed its practice. Still, the authors do speculate that the $300 million fee award in the Southern Peru case may have been the result of the migration of cases out of Delaware. Id. at 2.
18. See Leo E. Strine Jr., Lawrence Hamermesh, Matthew Jennejohn, "Putting Stockholders First, Not the First-Filed Complaint," available at http://ssrn.com/abstract=2200499 (Jan. 10, 2013).
19. For a description of the recent battles between New York and Delaware, see Griffith and LaHav, supra note, 3 at 18-19 (discussing In re Topps Company Shareholders Litig., 924 A.2d 951 (Del. Ch. 2007), and In re Topps Shareholder Litig., 859 N.Y.S. 2d 907 (N.Y. Sup. 2007). Similar parallel actions are currently pending in New York and Delaware, which I will not here discuss.
20. See Galaviz v. Berg, 763 F. Supp. 2d 1170 (N.D. Cal. 2011). In this case, the board of a public corporation adopted a bylaw containing a Delaware forum selection provision after the time of the challenged conduct. The court rejected this as a form of self-dealing, but indicated that it might decide differently in the case of the shareholder approved provision.
21. 2013 U.S. Dist. LEXIS 19631 (S.D.N.Y Feb. 12, 2013).
22. Sweet principally replied upon the Second Circuit’s decision in Phillips v. Audio Active, 494 F.3d 378, 383 (2d Cir. 2007).
23. 2013 U.S. Dist. LEXIS 19631 at **42-43 n.16.
24. Id. at *33 (citing Eslwordwide.com v. Interland, 2006 U.S. Dist. LEXIS 41935 at *2 (S.D.N.Y. June 21, 2006).
25. See U.S. Constitution, art IV, §1; see also Matsushita Elec. Indus. v. Epstein, 518 U.S. 367, 369 (1996) (holding that a Delaware settlement was entitled to full faith and credit). Matsushita does require that the settlement meet due process standards, but that is hardly an insurmountable hurdle.
26. This option is extensively discussed by Griffith and LaHav, supra note 3. I fear, however, that they fail to recognize the costliness of paying attorney’s fees to attorneys in multiple jurisdictions to resolve the same litigation. Much like putting a saucer of milk outside your door for a stray cat, you soon find that you have a dozen cats dependent on you.