Death Knell for the Merger Tax on Disclosure-Only Settlements in Delaware?
As discussed in our prior alert,1 virtually all large public company merger and acquisition (“M&A”) transactions result in at least one stockholder lawsuit. Until recently, Delaware courts regularly approved settlements where the defendants agreed to make supplemental disclosures concerning the M&A transaction and to pay the plaintiffs’ attorneys’ fees and, in exchange, the defendants received a global release of claims relating to the M&A transaction but paid no monetary compensation to the plaintiffs. These types of settlements have been referred to as a “merger tax” or “deal tax.” This practice has been harshly criticized by Delaware courts in cases where the courts believe that the supplemental disclosures provide little value to the stockholder plaintiffs.
On October 9, 2015, Vice Chancellor Laster of the Delaware Court of Chancery refused to approve such a settlement in connection with a lawsuit stemming from the $2.7 billion acquisition of Aruba Networks, finding that he did not “think the case was meritorious when filed” and instead was a “harvesting-of-a-fee opportunity” for the law firm representing the plaintiffs.2 Further expressing his concerns about the proposed settlement and similar settlements not providing tailored releases by the plaintiffs or monetary consideration or meaningful disclosures to the plaintiffs, the court noted that such settlements have created a “cases-as-inventory phenomenon,” a “real systemic problem” and a “misshapen legal regime.”
Several additional recent Delaware court decisions make clear that Delaware courts are drawing a line in the sand, and the historical practice of approving disclosure-only settlements providing little value to the stockholder plaintiffs in exchange for a release which is overly broad and payment of plaintiffs’ attorneys’ fees will be no longer be followed.
As noted in our prior release,3 Vice Chancellor Laster rejected the proposed disclosure-only settlement of litigation filed in connection with Cobham PLC’s $1.5 billion acquisition of the microelectronics company Aeroflex. In addition, at the roughly same time, Vice Chancellor John Noble withheld his approval of a stockholder settlement in a merger objection lawsuit arising from Roche’s $8.3 billion acquisition of InterMune. On September 17, 2015, Vice Chancellor Sam Glasscock III reluctantly approved the settlement in the lawsuit filed in connection with Riverbed Technology’s $3.6 billion acquisition by Thoma Bravo and noted that his court’s prior practice of approving such settlements bore some equitable weight in the Riverbed Technology case, but that factor “will be diminished or eliminated going forward.” Because the courts in the Riverbed Technology and Aruba Networks cases undoubtedly will impact future M&A transaction litigation, each is discussed in turn below.
In re Aruba Networks, Inc.4
In connection with the acquisition of Aruba Networks via merger, plaintiffs filed suit indicating concern about the price to be received by Aruba’s stockholders, which represented a 34 percent premium. Following expedited discovery and a few depositions, plaintiffs’ counsel could not make a case that the price should have been higher. The parties then negotiated a settlement agreement, which resulted in the defendants making certain supplemental disclosures in a Form 8-K. In return, plaintiffs’ counsel would receive a fee award and defendants would receive a global release of all claims relating to the merger.
Vice Chancellor Laster rejected the settlement and outright dismissed the case as to the named plaintiffs for three main reasons. First, he did not believe that the case “was meritorious when filed” based on a variety of factors. As he noted, “[p]rice alone isn’t a claim. You have to have something that suggests a lack of reasonableness, some type of conflict.” He did, however, note that plaintiffs’ counsel uncovered during discovery direct evidence that the proxy statement was materially inaccurate and misleading in some instances, which discovery “was a get” that could support “meaningful relief” beyond the “ephemeral benefits of information.”
Second, Vice Chancellor Laster found the discovery record of the plaintiffs’ counsel “really weak” and not “reassuring.” He also chastised plaintiff’s counsel throughout the settlement hearing for various misstatements in filings with the court about the extent of the work performed and the number of financial experts retained, going so far as to note that the plaintiffs’ bar “needs to recognize…you actually have to be accurate in your papers.”
Finally, Vice Chancellor Laster expressed concern about the scope of the release by noting that he did not understand why plaintiffs “get to release for nothing” the non-disclosure claims. Instead of pursuing those claims, plaintiffs’ counsel “just dealt with [it] through the disclosure and the fee.” In addressing any potential reliance that the parties may have had on the past practice of the court routinely approving broad releases in exchange for inadequate consideration, he noted that “[f]or better or for worse, I don't think you had that reliance interest from me. I've been giving these a hard look for a while now.”
Plaintiffs’ counsel initially argued that the release was different than the broad release at issue in Aeroflex and other cases previously before the court. Under repeated questioning from Vice Chancellor Laster, plaintiffs’ counsel admitted that the release being proposed was not narrower than other broad releases historically before the court and was not specifically tailored to the relief obtained in this case. However, plaintiffs’ counsel felt the release was “somewhat different in terms of the scope of the claims release [from the release in Aeroflex]” because “what ends up ultimately being released here is really what we investigated and prosecuted and litigated.” Unlike the immaterial disclosures at issue in Aeroflex, plaintiffs’ counsel felt the disclosures obtained in this case were “injunction worthy” and were corrective, rather than supplemental, disclosures.
Ultimately, Vice Chancellor Laster did not feel that there was “an adequate get for the give.” Moreover, he was unwilling to simply take plaintiffs’ counsel on their word that they looked at the released claims because he knows “it’s the path to [their] payday” and “[o]ne thing we know is when people have a path to getting paid, behavior starts to reflect how one gets paid.”
As a result, the court found that the settlement “falls outside the range of reasonableness” and raises “a question about adequacy of representation.” On that basis, he rejected the settlement, refused to certify the class, dismissed the case as to the named plaintiffs and denied any mootness fee. In his opinion, the case looked “like it was set up as a harvest case, because there wasn't a basis to file in the first place.”
In re Riverbed Tech., Inc.5
In re Riverbed Tech., Inc. related to Thoma Bravo, LLC’s $3.6 billion acquisition of Riverbed Technology, Inc. Plaintiffs filed suit to enjoin the merger at issue, alleging that the sales process was tainted by conflicts of interest, the target was undervalued and the proxy statement contained inadequate disclosures. Some of the disclosure claims were mooted by disclosures subsequently made by the target in the definitive proxy statement. The parties negotiated a settlement pursuant to which the target made supplemental disclosures in a Form 8-K filed with the SEC prior to the stockholder vote. The settlement agreement proposed that plaintiffs’ counsel would receive $500,000 in attorneys’ fees, and defendants would receive a global release of all claims relating to the merger.
In arguing for approval of the settlement, plaintiffs’ counsel noted that its breach of fiduciary claims were “robust,” but that its expert could not opine that the merger price was unfair, meaning that the claims, if pursued, could not have resulted in a benefit to the plaintiff class. Moreover, despite examining potential breach of federal securities laws claims, none appeared viable. As a result, the plaintiffs argued that the “give” from the plaintiff class was “basically nil” in connection with the release.
The court noted that 99.48% of the target’s stockholders voted in favor of the merger despite the supplemental disclosures obtained by plaintiffs’ counsel, which demonstrated to the court that these disclosures were not of great importance and achieved for the class a “peppercorn, a positive result of small therapeutic value to the Class which can support, in my view, a settlement, but only where what is given up is of minimal value.”
Noting that the supplemental disclosures had a “minor but tangible” value, the court approved the settlement subject to a reduced fee award of $300,000 plus costs. Although the outcome of the case appears consistent with the Delaware Chancery Court’s historical practice of routinely approving these types of settlements, Vice Chancellor Glasscock indicated that this case marks a turning point in how his court will handle these types of settlements in the future.
Despite finding that the specific circumstances of the case merited approval of the settlement because it resulted from good faith negotiation between the parties with the reasonable expectation that the court would approve the broad release, Vice Chancellor Glasscock indicated that the scope of the release was “troubling.” He further noted that “[i]f it were not for the reasonable reliance of the parties on formerly settled practice in this Court…the interests of the Class might merit rejection of a settlement encompassing a release that goes far beyond the claims asserted and the results achieved.” As noted above, in a warning shot to litigants, Vice Chancellor Glasscock noted that reliance on the court’s historical practice of routinely approving these types of settlements “will be diminished or eliminated going forward in light of this Memorandum Opinion and other decisions of this Court.”6
Riverbed and Aruba Networks are not the first decisions to warn about the future viability of disclosure-only settlements, to raise concerns about broad releases or to reject settlements. However, they illustrate that the Delaware Chancery Court understands that, as Vice Chancellor Laster starkly noted in Aruba Networks, the “sue-on-every-deal phenomenon” and “settling for disclosure only and giving the type of expansive release that has been given” has created a “real systemic problem” and that the court will take action to attempt to address that problem.
The plaintiffs and defense bars are now on notice that M&A litigation settlements will be heavily scrutinized in Delaware. One can no longer rely on the historical practices of the court to expect approval of settlements featuring immaterial supplemental disclosures or deal protection changes and a release that covers claims beyond those actually investigated and litigated by plaintiffs. In Aruba Networks, Vice Chancellor Laster indicated that both plaintiffs’ and defense counsel were aware that they no longer had a reliance interest from him because he hears them “complaining about it” and he sees “responsive behavior” by plaintiffs’ counsel who dismiss the M&A litigation cases assigned to him so they can settle in other jurisdictions where there may not be as much scrutiny of the settlement. He seemed to approve of this behavior as he prefers to dedicate judicial resources to “real litigation, not pseudo-litigation.”
To avoid the type of forum shopping by plaintiffs’ counsel addressed by Vice Chancellor Laster, Delaware corporations that have not already done so should consider whether to adopt a forum selection bylaw. Before proceeding, boards should give careful consideration to whether a forum selection bylaw is in the corporation’s best interest, the timing of adoption to ensure it would occur on a “clear day” and the current voting policies or positions of institutional investors and proxy advisory firms with respect to forum selection bylaws.
Riverbed, Aruba Networks and other recent actions of the Delaware Chancery Court do not mean the end of disclosure-only settlements or reflexive M&A lawsuits, but rather indicate that any future settlements should expect reduced fee awards and narrower releases tailored to the claims actually investigated and litigated and the consideration obtained for stockholders. However, these reduced expectations could, over time, reduce the amount of meritless M&A litigation.
The downside for companies of this sea change is that they lose the ability to obtain relatively cheap “deal insurance” and potentially face drawn out litigation if they are unable or unwilling to settle with only a narrow release or, if they do settle, face continued exposure for the claims not covered by the release. In the meantime, plaintiffs’ and defense counsel must develop new settlement structures that attempt to address the issues raised in recent decisions, including Aeroflex.
1. Please see our client alert dated September 10, 2015, Delaware Courts Scrutinize Recent Proposed Settlement Agreements – A Harbinger of Fewer M&A “Transaction Tax” Lawsuits?
2. In re Aruba Networks, Inc. S’holder Litig., No. 10765-VCL (Del. Ch. Oct. 9, 2015) (Transcript).
3. See note 1, supra.
4. See note 2, supra.
5. In re Riverbed Tech., Inc. S’holder Litig., No. 10484-VCG, 2015 WL 5458041 (Del. Ch. Sept. 17, 2015), available at http://courts.delaware.gov/opinions/download.aspx?ID=229930.
6. Citing the Aeroflex and Intermune decisions discussed in our client alert dated September 10, 2015 and In re Susser Holdings Corp. S’holder Litig., No. 9613-VCG (Del. Ch. Sept. 15, 2015) (Transcript).