In recent years, we approached the point where nearly every M&A transaction attracted one or more merger objection lawsuit, which all too often was resolved through a “disclosure only settlement” in which the defendant company agreed to make supplemental deal document disclosures and to pay the plaintiffs’ attorneys fees, in exchange for a comprehensive release for the defendants. However, the courts in Delaware, the state where the majority of these cases were filed, have recently shown – in a series of rulings culminating with the Trulia decision last January — their unwillingness to approve these kinds of disclosure -only settlements where there is no material benefit for the company or its shareholders.
The Trulia decision seemed as if it might mark the end of the merger objection lawsuit phenomenon. And indeed, the early returns seem to suggest that there has indeed been a marked drop-off in the number of merger objection lawsuits filed in Delaware. However, the decline of merger objection lawsuit filings in Delaware doesn’t mean that the merger objection lawsuit problem has gone away; it has simply shifted location.
As my recent analysis of 2016 federal securities class action lawsuit filings found, there were 73 federal court merger objection securities class action lawsuit filed in 2016, representing about 27% of all federal court securities suit filings. This compares with only 14 federal court merger objection securities class action lawsuit filings during the full-year 2015, representing about 7% of all securities suit filings. Clearly, the plaintiffs’ lawyers have decided that if the Delaware state court is a hostile environment, they are better off filing their lawsuits elsewhere, particularly in federal court.
For those who have been watching the merger objection lawsuit phenomenon as it has developed and evolved, the obvious question is – weren’t forum selection bylaws supposed to prevent plaintiffs’ lawyers from shifting lawsuits to the court of other jurisdictions? Readers will recall that as the merger objection lawsuit wave grew, corporate reformers suggested that companies could at least avoid litigating merger objection lawsuits in multiple forums by adopting forum selection bylaws, specifying a designated forum (presumptively, Delaware Chancery Court) for litigating shareholder disputes. The adoption of these kinds of bylaws has been upheld by Delaware’s courts and is now expressly permitted by Delaware statue. Many companies have adopted forum selection bylaws. So, with so many companies having now adopted these kinds of provisions, how are the plaintiffs’ lawyers getting away with filing lawsuits elsewhere?
The first factor undermining the effectiveness of the forum selection provisions, and the reason for the plaintiffs’ lawyers recent pronounced preference for filing federal court lawsuits alleging violations of the federal securities laws (rather than state court lawsuits alleging violations of state law), is that Section 27 of the Securities Exchange of Act of 1934 gives the federal courts exclusive jurisdiction over actions alleging violations of the Act. A company’s forum selection bylaw is ineffective with respect to action subject to the ’34 Act’s exclusive jurisdiction provision. The typical federal court merger objection lawsuit alleges that the company’s proxy materials omitted material information in violation of Section 14 of the Act and Rule 14-a-9 thereunder, and is subject to Section 27’s exclusive jurisdiction provision.
There is a second reason why the forum selection clauses have proven to be less than effective in keeping this kind of litigation in Delaware, and that is that the provisions are not self-executing. In order for the provision to be enforced, somebody has to bring it to the attention of the presiding court.
As Fordham Law School Professor Sean Griffith points out in his January 5, 2017 paper entitled “Private Ordering Post-Trulia: Why No Pay Provisions Can Fix the Deal Tax and Forum Selection Provisions Can’t” (here), defense counsel “must be seen as complicit in the out-of-Delaware dynamic because they have failed to exercise Exclusive Forum bylaws to bring the litigation back to Delaware.”
As Griffith explains, the defendants’ failure to invoke the provision “must be seen as a revealed preference,” one that “demonstrates defendants’ continued interest in retaining the option of a cheap settlement and a broad release in an alternative jurisdiction.” Not only are defendants failing to assert the forum selection clauses, but they are also refraining from bringing the Trulia decision to the court’s attention, even where the law of Delaware is the substantive law applicable to the action.
There have of course been recent cases like the Walgreen stockholder litigation (about which refer here), in which Seventh Circuit Judge Richard Posner expressly applied Trulia and rejected a disclosure-only settlement in a merger objection lawsuit. However, as Griffith pointed out, the reason the Seventh Circuit addressed these issues in the Walgreen case is that an objector to the class action lawsuit settlement had come forward. If there is no objector, or the court disregards the objector, these issues may not even come to the court’s attention.
There is, as Griffith notes, rarely any adversary process in connection with the settlement proceedings in thess case; one source he cites in his article says that the hearings are “pep rallies jointly orchestrated by plaintiffs’ counsel and defense counsel.”
The upshot of all of this is that neither the proliferation of forum selection bylaws nor the Trulia decision have proved to be enough to “cure what ails merger litigation,” because, regardless of what the company may have thought when it adopted the forum selection bylaws, once if finds itself caught up in one of these cases, the company “has a strong incentive to buy the broad, cheap releases that disclosure settlements provide.”
The problem, therefore, according to Griffith, is not that plaintiffs’ lawyers are bringing merger claims outside of Delaware; rather, it is that “defense lawyers advise their clients to pay for nuisance settlements in order to mitigate the risk that they might have done something wrong in the sale process.”
These problems, and the failure of forum selection bylaws to remedy these problems, can be addressed, Griffith suggests, by the adoption of what he calls a “No Pay” provision – that is, a charter or bylaw term barring corporations from reimbursing stockholders for attorneys’ fees and expenses incurred in merger litigation. Griffith summarizes his proposal in a January 20, 2017 Law 360 article entitled “Another Jurisdiction, Another Disclosure Settlement?” (here).
As Griffith points out, “paying for nuisance settlements perpetuates the cycle of litigation.” The best way to “break the cycle” is not to force the litigation into a single jurisdiction, but rather to “pre-commit not to pay.”
A “No Pay” provision, Griffith proposes, could be “crafted to preclude fees for shareholder litigation generally.” It could be written more narrowly, to preclude fees only for class action litigation. Or, even more narrowly, No Pay provisions could be written to preclude fees only for disclosure settlements.
Griffith contends that this type of provision is “likely to be held enforceable,” as it amounts to “shareholders collectively agreeing that because specified claims provide them with no benefit, they will not pay to litigate them.” Griffith adds that this type of provision is consistent with Delaware’s statutory prohibition of fee-shifting bylaws, because the no-pay provision does not impose liability on any stockholder for the fees and expenses of the corporation, it merely forces the stockholder to bear his or her own fees and costs. Griffith adds that an additional advantage of these kinds of provisions over forum-selection provisions is that no pay provision, unlike the forum selection bylaw, should be effective in federal cases as well as in state law cases.
Finally, Griffith points out, the “mere existence of the provision will deter litigation.” If plaintiffs’ lawyers cannot be paid for certain kinds of claims, they will stop bringing them or “abandon them upon concluding that the claims can yield only settlements for which they cannot be paid.” No-pay provisions, Griffith suggests, promise to succeed where Trulia and forum-selection bylaws have failed, by “radically reducing or even eliminating the deal tax.”
I don’t know whether or not Griffith’s suggestion will succeed or fail, but I suspect strongly that we will not have to wait long to find out. I was struck a few years ago how in a very short time the idea of adopting forum selection bylaws went from a proposal, to action, to court decisions affirming companies’ ability to adopt those type of bylaws, to statutory provisions affirmatively allowing companies to adopt bylaws of that type. It would not surprise me to see a wave of corporate action in favor of adoption “no pay” provisions, followed quickly by court consideration of these issues.
The one reason I can see that some companies might hesitate is that they may fear that if they adopt these kind of provisions they will lose the ability in some future dispute of being able to just pay the plaintiffs’ lawyers to go away. I suppose I can see the internal logic of this analysis. To anyone that finds themself being drawn down this road, I would say, isn’t it better to deter the dispute in the first place? If the plaintiffs’ lawyers know for sure they can’t extract a payoff, they will go find something else to do.
Corporate reformers have been working hard to try to find a way to drive a stake into the heart of the merger objection litigation curse. Griffith himself has been at the forefront of these effects, for example, as noted here, by appearing as a shareholder objector at merger objection lawsuit settlement hearings that might otherwise have involved “pep rallies jointly orchestrated by plaintiffs’ counsel and defense counsel.”
So far at least, the plaintiffs’ lawyers have proven both resilient and effective in coming up with ways to overcome the obstacles the reformers have tried to implement – and, as Griffith points out, the plaintiffs’ lawyer success in circumventing the potential obstacle that the forum selection by laws represent may be due in part to the “complicity” of company defendants and their counsel.
Griffith’s latest proposed litigation reform bylaw offers the potential at least to break the cycle in which cheap payoffs provide incentives for plaintiffs’ lawyers to file more lawsuits. It is an idea that certainly seems like it is worth a try. I think there will be quite a few companies that will be willing to adopt the provisions in the hope that keep the plaintiffs’ lawyers away.