The Delaware Court of Chancery’s decision in In re Trulia Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016), was hailed as a meaningful step toward curtailing lawsuits alleging that corporate boards were breaching their fiduciary duties in nearly every public company merger transaction. The vast majority of those actions resolved quickly, before a stockholder vote (or closing of a tender offer), for nothing more than additional disclosures to stockholders in already-lengthy proxy or solicitation/recommendation statements. In exchange, corporate defendants received releases of any and all claims relating to the merger, and plaintiff’s counsel received a fee for the “corporate benefit” they provided. That all came to an end in Trulia, following mounting criticism from the corporate community of what many called a deal tax and increasing skepticism by the Delaware courts. [see note 1] Or did it?
Since Trulia, there has been a decline in Delaware in the number of run-of-the-mill challenges to nearly every public company merger transaction. That decline is likely attributable to Delaware’s disfavor of disclosure-only settlements, as expressed in Trulia, coupled with at least two other important developments: (1) the Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015), which held that a fully-informed and uncoerced vote in favor of a merger by a majority of a corporation’s stockholders invokes the business judgment rule standard of review; and (2) an amendment to the Delaware General Corporation Law that permits Delaware corporations to adopt forum selection bylaws to drive lawsuits concerning their internal affairs to Delaware.
But while the volume of merger litigation in Delaware has been on the decline, there has been a noticeable surge in filings in other jurisdictions, particularly federal courts. According to Cornerstone Research’s “Securities Class Action Filings: 2017 Midyear Assessment,” the number of federal filings of class actions involving merger transactions are at record high levels and increased to 95 in the first half of 2017—up from 57 in the second half of 2016 and 28 in the first half of 2016. These federal actions typically assert disclosure claims against the target company (and often its directors) under §14 of the Securities Exchange Act of 1934 (and related regulations promulgated by the Securities and Exchange Commission) with respect to alleged misstatements and omissions in either a proxy statement filed in connection with a stockholder vote or a solicitation/recommendation statement filed in connection with a tender offer. In substance, the disclosure claims alleged under federal law—which, notably, are not subject to forum selection bylaws (because federal courts have exclusive jurisdiction over claims under the Securities Exchange Act)—are virtually identical to the disclosure claims that previously were alleged under Delaware fiduciary duty law.
Federal securities class actions challenging merger transactions pose practical issues to boards of directors similar to those previously presented by Delaware suits: A lawsuit threatening to enjoin or otherwise delay a merger transaction has been filed, and there is some chance (even if small) that a judge will side with the stockholder plaintiff, risking deal certainty. Thus, the same conditions that gave rise to disclosure-only settlements in Delaware (i.e., the desire to eliminate closing risk) also exist in federal courts. But there is a twist in federal court.
The Private Securities Litigation Reform Act, which Congress enacted to abate perceived abuses in securities class actions, includes two procedural mechanisms that impact the resolution of federal securities law claims concerning merger transactions. First, the PSLRA imposes a stay of all discovery during the pendency of any motion to dismiss. While the stay can be lifted under certain circumstances, plaintiffs often bypass the issue altogether and immediately file a preliminary injunction motion (without discovery) on the basis of the alleged proxy statement omissions. Thus, unlike in Delaware—where a preliminary injunction motion is typically preceded by a motion for expedited discovery and proceedings, which provides defendants with an opportunity to thwart a frivolous action before it gains traction (and without risk to the closing of the transaction) by opposing expedition—in federal court, more often than not, a preliminary injunction motion is set for hearing as a matter of course and the first time the parties will appear in front of the judge is at the preliminary injunction hearing. That alone increases the stakes for defendants because, if defendants proceed to a preliminary injunction hearing, there is a risk (however small) that a transaction can be delayed or enjoined. Second, the PSLRA requires the appointment of a lead plaintiff, including a publication notice to other stockholders who may seek to be appointed lead plaintiff, even if they have not filed a complaint. Thus, it is not possible for the parties to enter into a settlement until after a lead plaintiff is appointed, which often will not occur under the statutory schedule until after a merger vote has occurred (and, in many cases, after the merger has already closed).
These practical realities of federal securities litigation have given rise to a practice of “mooting” federal securities law claims in the merger context. In a typical mootness situation, the target company will make supplemental disclosures in response to a complaint—often with input from the plaintiff—in exchange for the plaintiff withdrawing any preliminary injunction motion and voluntarily dismissing the class action complaint with prejudice, as to himself or herself only, and without prejudice to the class. Because there is no class-wide release of claims, this resolution does not require court approval or notice to the putative class under the Federal Rules of Civil Procedure. But, just as in disclosure-only settlements, plaintiff’s counsel will seek a fee for having conferred a “corporate benefit” on the stockholders. [see note 2]
So, after nearly two years, has Trulia been the panacea for the perceived abuses of merger litigation that the corporate community and defense bar had hoped it would be? The evidence suggests perhaps not. While Trulia remains a significant decision in terms of influencing the thinking of state and federal courts around the country about the proliferation of merger litigation, the uptick in federal securities law class actions challenging merger proxy disclosures and the corresponding dynamics that drive mootness resolutions of those cases suggest that Trulia’s impact on merger litigation filings is more limited. Moreover, given the practical ease (and relatively modest cost) of mootness resolutions of federal court actions, merger-related securities class actions are not likely to abate unless Congress acts to curb the practice, just as it did in enacting the PSLRA.
1. In Trulia, the court rejected a proposed “disclosure-only settlement” and adopted a standard for approval of such settlements that requires that (1) the supplemental disclosures supporting a proposed settlement must correct “plainly material” misrepresentations or omissions, and (2) the release defendants obtain in connection with the settlement must be narrowly tailored to the disclosure claims.
2. While disclosure-only settlements, including a release of claims, remain a viable path in federal court and in state courts outside of Delaware, recent decisions suggest the tide may be turning. The Seventh Circuit Court of Appeals, for instance, endorsed and applied Trulia in In re Walgreen Co. Stockholder Litigation, 832 F.3d 718 (7th Cir. 2016) (Posner, J.). In a sharp critique of disclosure-only settlements, the Seventh Circuit stated that “[t]he type of class action illustrated by this case—the class action that yields fees for class counsel and nothing for the class—is no better than a racket. It must end. No class action settlement that yields zero benefits for the class should be approved, and a class action that seeks only worthless benefits for the class should be dismissed out of hand.” Id. at 724. Similarly, a state court in Connecticut recently rejected a disclosure-only settlement based on the rationale articulated in Trulia and Walgreen. See Stein v. UIL Holdings Corp., 2017 WL 1656891 (Conn. Super. Ct. April 10, 2017). In notable contrast to these decisions, however, the New York Supreme Court, Appellate Division declined to follow Trulia’s requirement that supplemental disclosures be “plainly material” to support a settlement, instead adopting a standard that asks whether the disclosures provide “some benefit” to stockholders. See Gordon v. Verizon Commc’ns, 46 N.Y.S. 3d 557 (N.Y. App. Div. 1st Dep’t 2017); see also Roth v. The Phoenix Cos., 50 N.Y.S. 3d 835, 838 n.4 (N.Y. Sup. Ct. 2017) (Gordon “cannot be viewed as anything other than an outright rejection of Trulia”) (citations omitted).
John A. Neuwirth is co-head of the securities litigation practice at Weil, Gotshal & Manges. Joshua S. Amsel is a partner, and Christine T. Di Guglielmo and Evert J. Christensen Jr. are senior associates, in the practice.