John C. Coffee Jr. ()
The practice of nominal shareholder plaintiffs challenging virtually every sizable corporate merger with a lawsuit alleging a fiduciary breach has been a scandal for some time. At least when brought by the “bottom fishers” of the plaintiff’s bar, these suits result invariably in a nonmonetary, “disclosure only” settlement that benefits no shareholder, but does justify an award of attorney fees to the plaintiff’s attorney (the only party with an economic interest in the suit).
The near inevitability of M&A litigation is a relatively recent phenomenon, as the rate soared after 2000. One study finds that only 12 percent of M&A transactions attracted litigation in 1999 and 2000, but by 2010, this rate was up to 90 percent, and it peaked at 93 percent in 2012.1 In deals over $500 million, the rate hit 96 percent in 2011 and 2012. What had happened? A group of specialist plaintiff firms had learned that there was no downside, so long as they agreed to a quick and painless settlement. The merging corporations considered them a mere nuisance, not a threat, but their fees were only a small rounding error in multi-billion dollar transactions. For defendants, a settlement was necessary to assure no delay in the transaction’s schedule.
Tawdry as this practice was, it had seemed to be declining and even gradually being brought under control. Important decisions in Delaware and federal court had made very clear that fees would not be awarded for meritless litigation that resulted in only a few immaterial disclosures being made.2 Several New York decisions had also agreed.3 The best law firms in the plaintiff’s bar did not bring such actions (or had at least ceased to bring them). In 2016, the rate of mergers challenged in court actually fell below 90 percent. Maybe, it seemed, reform was working.
That optimism was, however, crushed last month when the Appellate Division, First Department, broadly disagreed with Delaware and the federal courts and reversed a state Supreme Court judge who had sensibly rejected an egregious settlement involving only immaterial disclosures and a token corporate governance reform. On its face, that decision, Gordon v. Verizon Communications,4 slightly tweaks the existing formula for settlement approval in New York,5 but in reality, it establishes that there is now a divine right to settle in New York without meaningful judicial oversight.6 As a result, the decision has set off a debate among corporate practitioners as to what motivated it. Having talked to a number, I find that one side takes the hard-nosed realist’s viewpoint: “This is an attempt to steal Delaware’s lunch; this decision will cause plaintiff’s litigation to migrate from Delaware to New York.” The other side of this debate blames the decision on judicial naiveté and inexperience: “New York judges see relatively few of these cases, and do not understand how tacky they are, while Delaware judges saw them on a weekly basis for years and finally grew sick of them.”
So framed, this debate is between those who see an ulterior motive behind the decision and those that think New York judges are just a little dumber than their Delaware and federal colleagues. Neither position is a clear-cut winner. For example, even if it might make economic sense for New York to seek to attract litigation back from Delaware, a judge is more a bureaucrat than an entrepreneur and has little personal incentive to seek additional business. Logically, a judge who is less than energetic or fully motivated prefers the quiet life to more litigation and more cases to decide. Arguably, New York state courts cannot handle the litigation they already have, and attracting business that has a distinct odor to it is a dubious achievement.
Similarly, the claim that New York judges are naïve, inexperienced, or somewhat dumber (I have heard all these positions asserted, but will name no names), overlooks that New York Supreme Court trial judges had rejected these proposed settlements and were overruled. The Appellate Division thus was staking out a strong position (for whatever reason) and not simply missing the obvious. Possibly, the Appellate Division was motivated by political sympathies and believed it was being tough on corporate misbehavior by favoring the plaintiff’s bar. In fact, however, it has done the reverse, as next explained.
The great irony about “disclosure-only” settlements is that their real impact is to block or discourage serious litigation that might be pursued to a judgment. A serious plaintiff’s law firm might contest an unfair merger, but it would know in advance that it would have to invest heavily in expensive discovery and face a high risk of defeat. This would not make sense if it also had to face the risk that the case could be stolen from it through a collusive settlement. That risk is minimized if “disclosure-only” settlements are banned. Indeed, the evidence on this point seems clear. As Delaware has increasingly discouraged “disclosure-only” settlements, it has allowed other (and better) plaintiff’s firms to carry merger-based litigation to very lucrative settlements. Consider, for example, the following list of judgments and settlements, all involving recent merger and acquisition cases in Delaware:
(1) In re Rural/Metro Corp. Stockholders Litig.7 (2014) (judgment for $91 million);
(2) In re Dole Foods Co. Shareholder Litig.8 (2015) (judgment for $148 million);
(3) In re Jeffries Corp., Inc. Shareholders Litig.9 (2015) (settlement for $70 million);
(4) In re Del Monte Foods Co. Shareholder Litig.10 (2011) ($89 million settlement);
(5) In re Emerging Company, Inc. Shareholders Litig.11 (2004) (damages for $27.80 per share)
Nothing similar has occurred in New York; nor, I predict with confidence, will such recoveries ever result in New York under its current case law. Collusive settlements (and other problems in New York) will preclude any serious M&A litigation from gaining traction in this state.
Thus, a more realistic (and possibly cynical) explanation of Gordon v. Verizon Communications would be that it was designed to preserve New York as a world of cheap, collusive settlements with little risk of major liability. Phrased slightly differently, the decision preserves the status quo and thus the quiet life for judges, by placing nearly insurmountable barriers in the path of serious adversarial litigation. This latter interpretation could co-exist with the view of some that the New York judges are a step or two slower than their federal or Delaware colleagues, but it is not necessary to believe that. Preserving the status quo implies that New York judges will not face complex and time-consuming shareholder litigation.
For the future then, it is at least conceivable that we could see two parallel worlds of M&A litigation. New York would be dominated by the kind of “feigned litigation” that occurs in “disclosure-only” settlements, with no real discovery being conducted, few, if any, depositions taken, and little motion practice. Plaintiff’s attorneys in New York cases would pore over the presentations made by the investment bankers to the board to imagine some additional, if immaterial, disclosures that might have been made in the proxy statement. Conversely, in Delaware, plaintiffs would focus on conflicts of interests and would either proceed to trial or settle for monetary relief.
In reality, however, the foregoing equilibrium is not likely. The problem is that any time a trial grew near in Delaware and the risk of serious liability loomed, defendants could settle the litigation with a cooperative plaintiff’s attorney in New York.
Delaware’s only hope for preventing collusive settlements outside of Delaware lies in the use of “forum selection” clauses that require any action asserting a fiduciary breach to be brought in Delaware. Although most other state courts have upheld the validity of these clauses, they have one fatal weakness: Under the prevailing template for these clauses, the board of the defendant can waive them and permit a suit to be settled elsewhere. Thus, a corporation may adopt such a clause, but decide, if a serious litigation threat surfaces in Delaware, to waive the clause’s application and permit an action to be settled elsewhere for “a peppercorn and an attorney’s fee.”12 To be sure, this is self-interested, and the settlement might be collaterally attacked, but a collateral attack is a very uphill battle.13
The unpleasant truth is that, although Delaware and some federal courts have tried justifiably to restrict “disclosure only” settlements, it takes only one state to lead a race to the bottom. Although public corporations and most of the Bar profess dismay at “disclosure-only” settlements, defense counsel rediscover their virtues once their client is sued in serious litigation. Then, they recall, that a “disclosure only” settlement can contain an extraordinarily broad release protecting all defendants from all claims, known and “unknown.” Delaware, in contrast, has refused to accept releases this broad. Much as the corporate defense bar dislikes “nuisance” litigation and sees “disclosure only” settlements as dubious payoffs to lawyers of marginal competence, their clients want to keep the merger train on schedule, and the “disclosure only” settlement expedites that process. Less obviously, it also blocks more serious litigation, which occasionally results in large recoveries (but only in Delaware and never New York).
Gordon v. Verizon Communications will ensure that the nuisance suit remains alive and well in New York and should bring the worst of the plaintiff’s bar streaming back to New York. Unless the Court of Appeals reverses, New York will become celebrated as the jurisdiction of the judicial rubber stamp. Sadly, New York state courts once prided themselves on following in the footsteps of Cardozo and Fuld. Today, however, they appear to be carrying on a tradition established by another famous New Yorker: Boss Tweed!
1. I summarize a variety of studies charting the growth of M&A litigation in my book, John C. Coffee Jr., “Entrepreneurial Litigation: Its Rise, Fall and Future” (Harvard Univ. Press 2015) at pp 89-91. For more recent data, see Jill E. Fisch, Sean J. Griffith, & Steven Davidoff Solomon, “Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform,” 93 Texas L. Rev. 357 (2015); Matthew D. Cain & Steven Davidoff, “A Great Game: The Dynamics of State Competition and Litigation,” 100 Iowa L. Rev. 465 (2015).
2. The leading case is In re Trulia, Inc. Stockholder Litig., 129 A.3d 884 (Del. Ch. 2016). Judge Richard Posner, writing for the U.S. Court of Appeals for the Seventh Circuit in In re Walgreen Co. Stockholder Litig., 823 F.3d 718 (7th Cir. 2016), has been even more critical of the conduct and ethics of the plaintiff’s attorneys bringing these cases.
3. As of 2016, it looked as if New York courts would follow Delaware on the path to reform. In Matter of Allied Healthcare Shareholder Litig., 2015 N.Y. Misc. LEXIS 3810, 49 Misc.3d 9210, 993 N.Y.S.2d 646 (2015), Judge Charles Ramos rejected a “disclosure only” settlement in tart language, indicating that he refused to serve as a “rubber stamp” and in City Trading Fund v. NYE, 9 N.Y.S.2d 592, 46 Misc.3d 1206 (2015), Judge Shirley Werner Kornreich wrote a lengthy decision that seemed to bring New York law into rough correspondence with Delaware. The decision was, however, reversed by the First Department in 2016 in a very brief, one-page decision. See City Trading Fund v. Nye, 144 A.D.3d 595, 43 N.Y.S.3d 21 (1st Dept. 2016). These decisions, along with that of Judge Melvin Schweitzer in Verizon Communications, show the common perception of sensible trial court judges with their feet on the ground that they were witnessing collusion.
4. 46 N.Y.S. 2d 557 (1st Dept. 2017)
5. See Matter of Colt Indus. Shareholders Litig., 553 N.Y.S.2d 138 (1st Dept. 1990), modified on other grounds, 77 N.Y.2d 185, 566 N.E.2d 1160, 565 N.Y.S.2d 755 (1991).
6. Indeed, the decision is a functional analogue to the Second Circuit’s decision instructing S.D.N.Y. Judge Jed Rakoff that he had to accept settlements negotiated by the SEC and a defendant, no matter how weak they appeared. See SEC v. Citigroup Global Markets, 752 F.3d 285 (2d. Cir. 2014). The difference, of course, is that deference to a federal agency is more justified than deference to a self-interested plaintiff’s firm seeking an easy fee.
7. 102 A.3d 205, 263 (Del. Ch. 2014).
8. 2015 Del. Ch. LEXIS 223 (Del. Ch. 2015).
9. 2015 Del. Ch. LEXIS 158 (Del Ch. 2015).
10. C.A. No. 6027-VCL (Del. Ch. Dec. 1, 2011).
11. 2004 Del. Ch. LEXIS 70 (Del. Ch. 2004).
12. I borrow this well-known phrase from Chancellor William Allen. See Solomon v. Pathe Comunications, 1995 Del. Ch. LEXIS 46 at *4, aff’d 672 A.2d 35. (Del 1996).
13. Delaware, itself, has set a high standard for those bringing collateral attacks. See MCA v. Matsushita Elec. Indus. Co., 785 A.2d 625 (Del. 2011), cert denied, 535 U.S. 1017 (2002).