There days, virtually every M&A transaction attracts litigation, usually involving multiple lawsuits. These cases have proven attractive to plaintiffs’ lawyers because the pressure to close the deal affords claimants leverage to extract a quick settlement, often involving an agreement to publish additional disclosures and to pay the plaintiffs’ attorneys’ fees.
As Doug Clark of the Wilson Sonsini law firm notes in his June 6, 2013 article, “Why Merger Cases Settle” (here), there is a “general perception” -- which he describes as “accurate” -- that “the lawsuits are just opportunistic strike suits that amount to tax on sound transactions.” Clark asks, given this general perception that these cases “have no merit,“ why do they usually settle? Why are the parties willing to pay off the plaintiffs’ lawyers and increase the transaction costs of the deal for lawsuits they perceive to be meritless?
Clark suggests two reasons the cases settle. The first is that the litigation is time=consuming and expensive. Most targets of this type of litigation just “want someone to make it go away,” and the settlement allows the defendants to avoid the irksome and expensive litigation activity. Based on these considerations, the decision for most defendants in this type of litigation is “pretty clear” because “settling makes a lot of sense.”
But, according to Clark, there is a second reason these cases settle. Clark’s observations about this additional reason is the more interesting part of Clark’s analysis. According to Clark, another reason the cases settle is that post-merger litigation can drag on interminably because it can be difficult to resolve. The difficulty of resolving the litigation post-close provides another incentive for the defendants to try to resolve the case prior to the transaction closing.
As Clark points out, if the plaintiffs fail as an initial matter to enjoin the transaction and the deal closes, the case isn’t over – the litigation often continues. (Indeed, as Clark’s partner at Wilson Sonsini, Boris Feldman, noted in a November 9, 2012 blog post on the Harvard Law School Forum on Corporate Governance and Financial Reform, here, at least some plaintiffs’ lawyers have “refined their business model” and now they aim to “keep the litigation alive post-close.”)
There are a number of reasons why the post-close case can be difficult to resolve. The first is that the post-merger case is neither time-sensitive nor interesting. There is no longer any sense of urgency. The defendants may begin to feel “disconnected” from the case, which is “unsurprising as the company at issue and the board seats of the defendant directors no longer exist.”
Another reason that it is harder to settle the case post-close is that the acquiring company and its officers and directors are in charge of the case after the merger. The acquiring company’s directors are not defendants and so the dynamics change.
A third reason the post-merger cases are “very difficult, if not impossible, to settle” is that the easy settlement options available prior to the merger (like agreeing to some additional disclosures in the proxy) are no longer available. The most “obvious way” to settle the case post-close is to increase the amount that the acquiring company pays for the target, with the additional amounts to be distributed to the shareholders of the acquiring company. The problem with this option is that increased deal consideration will not be insured under the acquired company’s D&O policy – though the ongoing defense fees will be.
Because the defense fees are covered, the continuing case is not a burden on the acquiring company, but if the acquiring company were to increase the deal consideration post-close in order to try to resolve the case, it would be to “the detriment of their balance sheet, share prices and stockholders.” At the same time, however, there is a risk to the directors of the acquired company if the case does not settle and if it were to go to trial; there could be liability determination that would preclude the directors’ indemnification and insurance.
As Clark puts it, given “the difficulty of settling cases post-close, and the risk of a judgment that is neither insurable nor indemnifiable, one understands why merger cases settle before the deal closes.”
Clark proposes a number of ways to try to address this situation. He suggests amendment to the Delaware appraisal statute, to encompass post-merger claims. This remedy would entail a post-merger appraisal of the shares as the exclusive remedy for post-merger claims. In order to be a member of the post-merger appraisal class, the claimant would be required to vote “no” on the merger or to decline to tender shares in response to a tender offer.
As an alternative to this appraisal remedy, Clark suggests changing Delaware law to limit the classes of persons who can pursue post-merger claims to those who voted “no” on a merger or who did not tender their shares. This would “limit theoretical damages” and reduce the plaintiffs can extract from the mere continued existence of the claim.
Clark suggests another option, which is to make the class a post-merger claim an “opt-in” class (as opposed to the current procedural model where classes are organized on an “opt-out” basis) This would require prospective class members to affirmatively choose to be a part of the class.
Another suggestion is to “take a harder look at the plaintiffs in these cases to see if they are proper representatives” and that they are “bona fide plaintiffs,” as “the merger litigation landscape is littered with “bad plaintiffs” who may be small holders with no real financial interest in the case or repeat “professional” plaintiffs who serve as “nothing but a figurehead for plaintiffs’ counsel.”
Finally, Clark suggests that Delaware should (as California and other states already do) make the post-merger consideration cases derivative cases so that post-merger the plaintiffs would lose their derivative plaintiff standing, as they are no longer shareholders.
Clark’s observations about the difficult of settling cases post-merger and the incentives these difficulties provide the defendants to try to settle the cases prior to the merger are interesting. His description of the post-close dynamics and the difficulties they create to try to settle the cases are quite sobering. It is hard to read this description without reaching the conclusion that something has to change.
Clark’s proposed solutions are also quite interesting, even creative. However, they also represent significant legal or procedural changes. The magnitude of the change required could be a barrier, as legislatures might draw back from changes to remedies or established procedures. However, even if the Delaware legislature were willing to go along, the changes would only prove beneficial when the post-merger litigation goes forward in Delaware. Plaintiffs’ lawyers, eager to circumvent these kinds of restrictions, would have every incentive to press their litigation elsewhere.
One of the great curses of the current wave of M&A-related litigation is that competing groups of plaintiffs are already pursuing litigation in multiple jurisdictions. If Delaware’s legislature were to make its courts less amenable to post-merger cases, the various plaintiffs would have even greater incentives to press their claims outside Delaware.
Just the same, there is still good reason to consider trying to implement reforms. Perhaps if Delaware were to take the lead, others states might follow. Of course, even that optimistic outcome would take considerable time, and meanwhile the curse of post-merger litigation would continue.
For now, many litigants caught up in post-merger lawsuits may conclude they have only one practical alternative to costly capitulation – and that is to fight these cases. Indeed, that is the suggestion raised by Clark’s law partner, Boris Feldman, in his earlier blog post cited above. Feldman suggests that defendants may want to push for summary judgment; he suggests that more courts may be willing to grant summary judgment in post-close cases. Feldman argues that owing to the general weakness of these cases and the scope of the exculpatory provisions in the Delaware Corporations Code, even if the plaintiffs keep their cases alive post-merger, they will have difficulty figuring out “a way to monetize them that survives judicial scrutiny.”
Though there are legislative reforms that might help and though fighting the cases might be successful, the likelier outcome for now is that defendant companies caught up in these kinds of cases will, as the plaintiffs’ undoubtedly hope, tire of the cases and seek some type of compromise -- which increases the likelihood that the plaintiffs will continue to file these cases and continue to pursue them, even post-merger.
We can only hope that eventually a consensus will emerge in legislatures or the courts to make this racket less rewarding for the plaintiffs’ lawyers.
D&O Insurance for U.S.-Listed Chinese Companies: As readers of this blog well know, securities class action lawsuits against U.S.-listed Chinese companies surged in 2011 and even continued into 2012. As a result of this flood of litigation and of the nature of the accounting violations raised in many of the cases, “the cost of insurance to cover directors and officers of Chinese companies against lawsuits has skyrocketed,” according to a June 17, 2013 Bloomberg article entitled “Directors Refuse to Go Naked for Chinese IPOs” (here).
The article details the way that the insurance marketplace reacted to the surge in litigation involving Chinese companies. The article further describes how, as the insurers cranked up the rates and restricted coverage, some Chinese companies reacted by scaling back their coverage, by acquiring insurance with lower limits of liability. However, the article quotes several non-Chinese members of Chinese company corporate boards as saying that they would refuse to serve if their companies did not carry D&O insurance (that is, if their companies went “naked”).
These questions about the cost and availability of coverage for U.S. companies have taken on a renewed relevance as Chinese companies now return to the U.S. for listings on the U.S. exchanges. According to the article, there has already been one U.S. IPO of a Chinese company in 2013, and apparently there are more in the pipeline. Even though the wave of scandals involving U.S.-listed Chinese companies appears to have played itself out, these new IPO companies continue to have to pay “about two-to-three times more than what a comparable U.S.-domiciled company would pay.” Just the same, according to commentators quoted in the article, some carriers “are going back in” to the marketplace for U.S.-listed Chinese companies.
From my perspective, the article’s general observation about the D&O insurance market for U.S.-listed Chinese companies is more or less accurate. Insurers continue to perceive Chinese companies as a tough class of business. The article is also accurate when it says that some Chinese companies reacted to the price rises by cutting back. Indeed, in some instances, the companies simply declined to purchase the insurance because they found it so costly. However, companies that take that step will have difficulty attracting and retaining the most highly qualified non-Chinese directors, who, like several individuals quoted in the article, will refuse to serve if the company “goes naked” and discontinues its D&O insurance.