The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

Litigation related to M&A activity continued at an “extremely high rate” in 2012, according to the latest research update from Ohio State law professor Steven Davidoff and Notre Dame business professor Matthew Cain. According to the professors’ analysis, presented in their February 1, 2013 paper entitled “Takeover Litigation in 2012” (here), 91.7% of all merger transactions that met the professors’ criteria attracted at least one lawsuit, compared to 91.4% in 2011.

The professors’ paper is the latest update on their research originally presented in their January 2012 article entitled “A Great Game: The Dynamics of State Competition and Litigation” (here), which I reviewed here. Following the original article’s publication, the professors updated their research with additional litigation data regarding M&A transactions that took place in 2011. Their latest paper updates their research with regard to 2012 transactions.

The professors have limited their analysis to merger transactions over $100 million involving publicly traded target companies with an offering price of at least $5 per share. The 2012 update includes only transactions there were completed as of January 2013. The professors intend to update their 2012 data in six months to incorporate information relating to the in process transactions.

It is probably worth noting that there were fewer deals that met the professors’ sorting criteria in 2012. There were only 84 deals with the defined characteristics in 2012, compared to 128 in 2011 (representing a year over year drop of 34%). But the percentage of deals attracting at least one lawsuit remained virtually unchanged, with 91.7% of deals attracting at least one suit, compared to 91.4%. The professors believe based on anecdotal evidence, that when they update their 2012 “the ultimate litigation rate will match or exceed the 91.7% figure.” Though the litigation rate is virtually unchanged from 2011, the 2012 rate is “almost 2.5% that of 2005,” when the litigation rate was only 39.3%.

The number of complaints brought per transaction remained at about 5.0 lawsuits per transaction, the same rate as in 2011 but more than double the mean number of lawsuits in 2005, when the figure was 2.2/ Multi-jurisdiction litigation “remained similar in 2012 with 50.6% of transactions with litigation experiencing litigation in multiple states,” compared to 53% in 2011.

87.5% of all 2012 cases that had settled involved “disclosure only” settlements, compared to 79.5% in 2011. The average attorneys’ fees were down substantially in 2012, but that may be driven by a few larger settlements in 2011. The median attorneys’ fee award was about the same both years -- $580,000 in 2011, $595,000 in 2012.

Delaware attracted a slightly reduced share of M&A litigation in 2012. The state attracted 46.7% of all litigation that could have been filed in there in 2012, compared with 52.8% in 2011. Delaware “also appears to be dismissing fewer cases, thus allowing more cases to be settled” – 76.9% of Delaware cases settled in 2012, compared with 61.5% in 2008. The authors note, referencing their original paper, that “when Delaware loses cases to other jurisdictions it historically has dismissed fewer cases and allowed more to settle, consistent with conduct designed to reattract litigation.”

Discussion

Because of the authors’ sorting criteria, their analysis and conclusion are most relevant to the larger transactions. However, based on my own observations, the authors’ conclusions are consistent even with respect to the smaller deals that do not meet their sorting criteria. The explosion of M&A-related litigation in recent years has not been limited just to the larger companies and transactions.

The surge in M&A related litigation in recent years has been one of the principal justifications the D&O insurance carriers have given as an explanation for their efforts to try to increase the insurance rates, particularly with respect to the rates for primary D&O insurance. In addition, the upsurge in M&A-related litigation has also affected the terms and conditions that the carriers are willing to offer. In particular, some carriers have been insisting on adding a separate, larger retention for M&A-related claims. The professors’ updated M&A-related litigation date seems to suggest that the carriers will try to continue to push rate and to try to include separate M&A-related claim retentions.

As I detailed in a prior post (here), the defense expenses and settlement amounts associated with M&A-related litigation represent a serious problem, for the companies involved and for their insurers. The prevalence of the multi-jurisdiction litigation is a particularly vexing problem, as the proliferating lawsuits are expensive to defend and difficult to resolve.  Unfortunately, based on the professor’s updated research, all signs are that these phenomena will remain a significant part of the corporate and securities litigation landscape for the foreseeable future.

Special thanks to Professor Davidoff for providing me with a copy of his latest paper.

Chinese Reverse Merger Cases: Is There a “China Discount”?: During 2010 and 2011, and to a lesser extent during 2012, the plaintiffs’ securities lawyers rushed to file securities class action lawsuits against Chinese companies that had obtained a U.S. listing through a reverse merger. But while these cases flooded the courts, they have not proven to be a huge bonanza for the plaintiffs’ lawyers or their clients. As I noted in a prior post, the settlement so far have been rather modest.

Michael Goldhaber’s February 12, 2012 Am Law Litigation Daily article entitle “Whither Chinese Reverse Merger Litigation?” (here) suggests that there may be a “China discount” in the Chinese reverse merger cases. The article quotes a defense attorney with the Sherman & Sterling law firm as saying that there is now a “critical mass of settlements between $2 million and $3 million” and that these lower settlements “may exert a gravitational pull on other settlements down the road.” The article notes that “the remarkable uniformity of the settlements suggests that $5 million D&O insurance policies are standard for this niche,” adding that a policy of that amount allows enough for defense fees and a settlement compromise with in the policy limit.

The two arguable exceptions to these generalizations both involve proceedings outside the U.S. The first is the $77.5 million Hong Kong arbitration award that C.V. Starr obtained against the founding shareholders of China MediaExpress Holdings (about which refer here) and E&Y’s $118 million December 2012 settlement of a Canadian class action arising out of its audit of Sino-Forest Corporation (refer here). Though these two exceptions each have their own distinct characteristics, these developments may hearten the claimants in the other cases and give them the incentive to continue to try to press on. The evidence so far, however, suggests the greater likelihood of the more modest settlements that have tended to become the norm.

A particularly interesting feature of the Am Law Litigation Daily article is a link to Sherman & Sterling document provided a comprehensive status summary of more than 75 disputes in U.S. forums relating to allegations of securities violations by Chinese parties, including more than 50 reverse merger companies. The summary document can be found here.

• Print
• Comments
• Trackbacks
• Share Link

According to news reports, on June 1, 2011, Alpha Natural Resources completed its $7.1 billion acquisition of Massey Energy Company. The deal went forward despite last minute efforts by groups of Massey shareholders proceeding in West Virginia and Delaware courts to try to enjoin the transaction on the grounds that the merger did not properly value the pending derivative claims against the company’s board, resulting in Alpha being able to acquire Massey without taking into account the fair economic value of the derivative claims.

The courts in both West Virginia and Delaware rejected the preliminary injunction motions. Delaware Vice Chancellor Leo E. Strine Jr.’s  81-page May 31, 2011 opinion (here) refusing to enjoin the merger makes for some extraordinarily interesting reading, as Susan Beck notes in her June 1, 2011 Am Law Litigation Daily article about the decision (here).

All of these events relate back to the April 5, 2010 disaster in Massey’s Upper Big Branch Mine in Montcoal, West Virginia, in which 29 miners were killed. In the wake of the disaster, the company’s share price declined, and the company struggled to deal with the fallout and scrutiny from the tragedy. These events set up a lengthy process that resulted in Alpha’s agreement to acquire Massey. During this process, Massey forced out its long-standing CEO, Don Blankenship.

Another thing that happened in the wake of the disaster (“inevitably,” Vice Chancellor Strine noted) is that Massey shareholders filed derivative suits seeking to ensure that to the extent Massey was harmed by the obligation to pay fines, judgments to the deceased miners’ families and lost cash flow from the damaged mine, the companies directors and officers should be held responsible for failing to make sure that Massey complied with mine safety regulations.

In addition to damages, the derivative plaintiffs sought a preliminary injunction against the merger, arguing among other things that the merger was an attempt by the board to evade its responsibilities for the harm to the company by means of a sale to Alpha.

In his May 31 opinion, Vice Chancellor Strine denied the plaintiffs’ motion for a preliminary injunction, holding that it is “highly doubtful” that the shareholders would be able to show that Massey’s board had sought to sell the company “solely, or even in a material way” to escape liability for the shareholder claims. He also said that to delay the deal would “threaten more harm to Massey shareholders than its potential benefits to them,” reasoning that Massey’s shareholders ought to be able to vote for against the merger on their own.

There are a host of interesting things about Vice Chancellor Strine’s highly readable 81-page opinion. Among them, in no particular order, are the following.

First, Vice Chancellor notes that it is “undisputed” “regrettable” “concerning” and “might even be characterized as a breach of the duty of care” that in connection with its consideration of the proposed Alpha merger the Massey board “failed to address the value” of the derivative claims, as the duties of a board in negotiating the sale of company are to consider and get full consideration for “all of the corporation’s material assets.” However, he added, that “does not much help the plaintiffs obtain an injunction,” as the record “does not support the inference that the Derivative Claims are material in comparison to the overall value of Massey as an entity.”

Second, as part of reaching the preceding conclusion, Vice Chancellor Strine noted that “the record does not persuade me that the Merger would, after trial, likely prove to be economically unfair to the Massey shareholders,” citing a number of considerations. In particular, with respect to the question whether or not the failure to separately negotiate value for the derivative claims harmed Massey shareholders, Strine noted numerous difficulties the claims face,  including the difficulty of showing that the defendants “acted with a wrongful state of mind, particularly given the exculpatory provision in Massey’s charter”; the possibility that “insurance proceeds may not be available to pay any judgment”; the questionable ability of even the wealthy board members to satisfy any judgment; and the fact that most of the individual defendants are independent directors whose “motivation to tolerate unsafe practices for the sake of profits would be tempered.” The value of the derivative claims might represent at most an opportunity for the company to recoup some of the costs for the disaster – and for that reason “it is unlikely that Alpha viewed these Claims as an asset at all, but merely as having some potential to reduce the gravity of the Disaster Fall-Out Alpha was inheriting.”

Third, though the Massey board itself might have been unclear on what the merger’s completion would mean for the derivative claims, Stine himself is very clear that the claims survive the merger (given his determination that the merger was not motivated primarily to avert the derivative suit liability). But with the merger’s completion, Alpha, as Massey’s successor in interest, controls the claims, putting the derivative plaintiffs in the position of having to prove demand excusal, and thus “receive leave to proceed in a double derivative action on behalf of Alpha” – an outcome Strine says “is not one an objective mind ought to consider probable” given that Alpha’s board has no exposure to the claims but “myriad of rational business reasons why Alpha may later decide that prosecuting these Claims does or does not make sense for Alpha.”

Nevertheless, Strine also notes that it is not a foregone conclusion that Alpha would not itself decide to pursue claims against the former fiduciaries of Massey. The fact is, as Strine notes, “Alpha will have to make a difficult business calculation about the extent to which it goes after Massey’s former management,” and its board will have to answer to Alpha’s own shareholders on their decision whether or not to pursue such claims. As Strine notes, “it is not clear why Alpha would not seek to offset the costs to itself of those violations by suing previous management if by doing so it had a realistic chance of obtaining some meaningful recovery.” That does not necessarily mean that Alpha will be able to effect a recovery commensurate with this costs (See the “second” item above and the “seventh” item below).

Fourth, Strine has some choice words to say about the Cravath law firm, which is not only acting as the board’s counsel in the derivative lawsuit, but also counseled the board on how it ought to consider the derivative suit in connection with the proposed merger. Strine characterized the law firm as being an “awkward source for advice” on this issue, and given the Cravath firm’s recommendation that the board not consider the existence of the derivative claims at all, “one cannot conclude that the Massey Board was presented with a reasoned analysis of the 'value' of the Derivative Claims." Strine also faulted Cravath for insufficiently explaining to the board what a survival of derivative claims means in the context of a merger. (Susan Beck’s Am Law Litigation Daily article linked above has more on this particular topic.)

Fifth, using language that is both noteworthy and striking, Strine went out of his way to excoriate former Massey CEO Don Blankenship, quoting descriptions of him as “autocratic” and describing him as having an “adversarial relationship” with the UAW and a “combative approach” to the federal mining regulator. He noted that Massey’s managers and employees understood that “if you wished to stay or get ahead at Massey under Blankenship, then the priority of profits over safety is one not to be questioned.” He also noted that in 2009, after President Obama’s election and a change in leadership at the mining regulator, and after Massey had sustained a number of losses in legal proceedings, Blankenship’s attitude toward regulators “deteriorated very sharply.”

Sixth, Strine makes it clear that he believes the real victims here are the deceased coal miners and their families – and in that regard, Strine is not prepared to let the shareholders off the hook. As he points out in a biting 1,071-word footnote (number 185), Massey’s shareholders not only had an annual opportunity to elect directors, but they “continued to invest in a company they say was well known to treat its workers and the environment poorly.” Indeed, “to the extent Massey kept costs lower and exposed miners to excess dangers, Massey’s stockholders enjoyed the short-term benefits in the form of higher profits.” The very practices of which the plaintiff shareholders now complain might rationally have been expected to act as a “goad” to shareholders to “give more weight to legal compliance and risk management in making investment decisions.” In the end, Strine notes, the “most sympathetic victims here were not shareholders, they were Massey’s workers and the families” and other constituencies who suffered while the company prospered and shareholders benefitted.

Seventh, readers of this blog will be interested in some parenthetical comments Strine has to make about D&O insurance. In noting the difficulties Alpha would have in collecting on any judgment entered in the derivative case, he notes that even if the derivative claims were to settle for the full amount of the D&O insurance, the total amount of coverage available is $95 million – not a “trifle,” but also not material in the context a merger valued over $ 7 billion. Also, Strine notes, showing that he has a keen appreciation for the D&O insurance market’s dark reality, “anyone who has dealt with coverage questions and insurance carriers would also tell you that a scenario in which the D&O insurers in the ‘tower’ would easily pay out anywhere near the full amount of the policy in a quick and low-cost way to Alpha is more the stuff of dreams than of real life.”

Eighth , it may not be entirely relevant to Vice Chancellor Strine’s decision or to the fact that the Alpha acquisition went forward as planned, but it is probably worth noting that among Massey’s former independent directors is another individual whose name has been in the news for entirely different reasons this week – that is, among the independent Massey directors named as defendants in the derivative litigation is Ohio State University President E. Gordon Gee. According to Wikipedia, Gee served on Massey’s board from 2000 until 2009 (that is, he resigned before the Big Branch Mines disaster, but during many of the prior safety and environmental problems the company faced.)

Now that the merger has been completed, the ball shifts to Alpha’s board to consider whether or not to pursue direct claims against the former Massey directors and officers. While Alpha might as Strine notes have substantial business reasons for wanting to close the book on the past and moving forward, the fact is that Alpha also inherited the wrongful death and regulatory claims that were pending against Massey. As much as Alpha might want to move on for business reasons, that may not be an available option.

To the extent Alpha must pay settlements, fines, and judgments, it will have to consider whether or not to pursue claims against the former Massey fiduciaries to try to recoup these costs. And in making that determination, the Alpha board will also have to consider its fiduciary duties to its own shareholders (some of whom now are former Massey shareholders.) I don’t know where any of this ultimately will lead, but the insurers in that $95 million insurance tower (whoever they may be, I have no idea) may find it prudent to wait a while before deciding whether or not to take down their reserves on this particular claim.

Special thanks to a loyal reader for providing me with a copy of Judge Strine’s opinion.

Yeah, I Really Hate it When the Guy in Front of Me Reclines His Seat Back, Too: On a May 29, 2011 United Airlines flight from Washington Dulles Airport to Ghana, one of the passengers decided to lower his seat back – which set in process a sequence of events that started with a scuffle on the plane and ended with Air Force F-16 fighter jets being scrambled. Because no one could make this up, you really have to read the Washington Post story (here) for yourself.

Just something to think about next time before reclining your seat back, O.K.?

• Print
• Comments (1)
• Trackbacks
• Share Link