Corporate Governance: M&A Legal Fee Awards and Proxy Strike Suits

The prevalence of mergers and acquisitions (M&A) litigation is excessive and many in the defense bar place the blame on the fact that these strike suits can be extremely profitable for plaintiffs’ counsel. See Dias, 2012 WL 4503174, at *5 (“The fact that merger litigation has gone from common to ubiquitous in just a few years suggests that the current balance of incentives is flawed.”). Indeed, according to Daines& Kourmrian, supra, in 2010–11, the median time between the filing of an M&A lawsuit and settlement was 44 days and the median award of attorney fees was between $501,000 and $600,000. Given the large stakes and compressed timeline of the challenged deals, M&A class actions place defendant-companies on the horns of a dilemma. Should they quickly settle these lawsuits by agreeing in most cases to make certain—typically immaterial—supplemental disclosures and pay a relatively modest award of attorney fees to plaintiffs’ counsel, or vigorously defend these lawsuits and risk an injunction, derailment of the merger transaction, and a much larger payment of plaintiff’s counsel fees?

Because most defendant companies are risk-averse, particularly in this setting, the vast majority of strike suits settle quickly and settle on a disclosure-only basis. Daines & Kourmrian, supra, at 9. Is there a way, however, to stem the tide of strike suits and to avoid wasting resources and legal fees when the claims actually lack merit or significance? It does not seem that plaintiffs' counsel will voluntarily agree to reform the system as they often profit from simply filing suit and can receive a handsome fee for just six weeks of litigation work. On the other hand, defendants could more aggressively litigate these actions with the hope of deterring the plaintiffs’ bar from pursuing “bad” cases.

In the end, litigation is inherently risky and expensive. In the M&A context, defendants are most concerned with avoiding delay and successfully completing the proposed transaction. As a result, they are highly incentivized to settle nuisance suits, particularly if the remedy being sought results in only additional disclosures and relatively modest payments. However, not every matter can be settled and there needs to be a solution to the rising tide of M&A litigation.

Vice Chancellor Glasscock in Dias v. Purches recently suggested that “bench judges over many diverse jurisdictions [should] shift fees in a way that discourages overuse or abuse of the class action mechanism while encouraging meritorious suits.” 2012 WL 4503174, at *5. The Chancery Court provides a valuable and sensible road map for judges to follow in awarding attorney fees in M&A cases.

Legal Standard of Awarding Legal Fees in M&A Litigation

Under the American Rule, parties bear their own legal fees and expenses. However, an award of attorney fees and expenses may be warranted under an equitable exception to the American Rule, known as the “substantial benefit” or “corporate benefit” doctrine. Serrano v. Priest, 20 Cal. 3d 25, 34 (1977) (acknowledging the non-statutory exception where a representative plaintiff confers a pecuniary or nonpecuniary “substantial benefit”). In the M&A context, plaintiffs rely on this doctrine to negotiate a fee settlement with the company or to compel the court to shift fees in exchange for the benefits they achieve for the shareholder class, which are, most often, supplemental disclosures concerning the proposed transaction. The decision to award attorney fees, and how much to award, is left to the court’s broad discretion and plaintiffs bear the burden of supplying the court with a reasoned basis to justify a fee award. Ketchum v. Moses, 24 Cal. 4th 1122, 1138 (2001) (recognizing a trial court’s “broad discretion to adjust [a] fee downward or deny an unreasonable fee altogether”); accord Korn v. New Castle Cnty., 2007 WL 2981939, at *2 (Del. Ch. Oct. 3, 2007).

In California, for example, a court assessing the reasonableness of attorney fees starts with a lodestar figure, which is the amount obtained by multiplying the number of hours spent by counsel by counsel’s hourly rate. This figure may then be increased or decreased depending on a number of factors, including (1) the novelty and difficulty of the questions involved, (2) the skill displayed in presenting them, (3) the extent to which the nature of the litigation precluded other employment by the attorneys, and (4) the contingent nature of the fee award. Ketchum, 24 Cal. 4th at 1131–32.

In Delaware, rather than beginning with a lodestar analysis, the courts instead focus on the benefits conferred—the first of the well-settled Sugarland factors (see Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del. 1980)) and the one “generally accorded the greatest weight” (see In re Chips & Techs., Inc. S’holders Litig., 1998 WL 409155, at *2 (Del. Ch. June 24, 1998); see also Seinfeld v. Coker, 847 A.2d 330, 336 (Del. Ch. 2000)). Of course, the benefit conferred is “not the only[] factor . . . considered.” Friedman v. Baxter Travenol Labs., Inc., 1986 WL 2254, at *3 (Del. Ch. Feb. 18, 1986). Indeed, “[a]s a cross-check on whether a fee award is reasonable, [the courts] examine[] the time and effort expended by counsel,” and place particular importance on the latter. See Dias, 2012 WL 4503174, at *5 (recognizing the perverse incentives associated with only emphasizing time).

Therefore, whether in California or Delaware (the two jurisdictions in which most M&A cases are litigated), the time and effort expended by plaintiffs’ counsel is a critical component of the fee-shifting calculus. This critical component was the focus of Vice Chancellor Glasscock’s opinion in Dias v. Purches.

Dias v. Purches and A Twist to Assessing a Plaintiffs' Legal Fees

On December 23, 2011, Perfumania Holdings, Inc. announced an agreement to acquire Parlux Fragrances, Inc. Dias, 2012 WL 4503174, at *1. Under the agreement, Parlux stockholders could, as consideration for their Parlux shares, elect to receive $4.00 in cash per share and 0.20 shares of Perfumania or .53333 shares of Perfumania. The plaintiff filed suit in Delaware on January 30, 2012, seeking to enjoin the transaction based on allegations of inadequate disclosure and breach of fiduciary duty. Shortly thereafter, the plaintiff filed a motion to expedite the litigation, which the court granted. The defendants then filed a motion to stay the action in favor of parallel litigation in Florida, which the court denied.

The parties then briefed a motion for preliminary injunction, which the court heard on March 23, 2012. In support of the injunction, the plaintiff argued that the defendants failed to disclose the free-cash-flow projections that Parlux’s management had provided to its financial advisor. The defendants contended that Parlux’s management did not prepare any free-cash-flow projections, and that any such suggestion in Parlux’s Form S-4 and proxy statement was incorrect. Ultimately, the court “found this inaccuracy material because a stockholder could give extra weight to PJSC’s discounted cash flow analysis if he believed that the analysis was based on management’s own estimates.” As a result, on April 5, 2012, the court ordered a single supplemental disclosure to be made informing shareholders “that the Proxy was inaccurate and that the [financial advisor] had relied on its own future free cash flow estimates rather than management’s estimates.”

Thereafter, the plaintiff moved for $500,000 in attorney fees and expenses, which the defendants opposed. This request resulted in an instructive analysis as the vice chancellor noted that this case raised the recurring issue of “how to apply Sugarland where a plaintiff brings a meritorious claim alongside unproductive, boilerplate claims.”

In analyzing the plaintiff’s motion for fees, the vice chancellor properly began with analyzing the benefit conferred, which, in this case, was the single corrective disclosure regarding free cash flows. Recognizing a going rate in Delaware of “approximately $400,000 to $500,000 for one or two meaningful disclosures, such as previously withheld projections,” the court assessed the benefit provided at the “lower end of the Sauer-Danfoss range.” Again, nothing remarkable. But as a “crosscheck on whether a fee award is reasonable,” the vice chancellor addressed the time and effort of counsel, placing particular emphasis on the latter and asking, “What did the plaintiff do?” Id. (recognizing that “[e]mphasizing only time might invoke perverse incentives”).

Here, unlike many disclosure-only cases, the court noted that the plaintiff actually “put forth a substantial amount of effort to obtain the supplemental disclosure,” including adversarial discovery and successfully litigating a motion to expedite, a motion to stay, and a preliminary injunction hearing. The problem, however, was that he did not provide the court with any account of his counsel’s time spent on various tasks or claims. As a result, the vice chancellor found it “exceedingly difficult to determine the degree to which Plaintiff’s counsel deserve to benefit from their overall litigation effort.” Id. As noted by the court,

[i]n addition to the successful claim, the Complaint listed many weak, even noncolorable claims, as I describe below. Not only did Plaintiff present dozens of meritless claims, but Plaintiff’s counsel has also made it difficult for me to determine how Plaintiff’s counsel divided its time between wheat and chaff. Plaintiff’s counsel asserts that it spent over 617 hours and approximately $35,560 in expenses litigating this action through the preliminary injunction hearing, yet fails to include a detailed account of what time was spent on what particular task. Instead, the Plaintiff has merely presented affidavits with lump sums for expenses and the total hours spent by each individual attorney. I am unable to determine how many of those 617 hours were devoted to providing value to Parlux stockholders, and how many were devoted to claims that amounted to a waste of resources. Stockholders ultimately pay for the defense of meritless expedited litigation, offsetting the benefits received by a stockholder class.

Id.

The vice chancellor could have demanded detailed time sheets from plaintiff’s counsel; something defense counsel encourage all courts to require. Instead, and due to a lack of “guidance from [p]laintiff’s counsel on how its time was spent,” the vice chancellor opted “to compare the number of colorable claims found in the Complaint to the number of uncolorable ones to determine the appropriate adjustment.” In this case, as in most M&A class actions, the plaintiff asserted a meritless Revlon claim along with dozens of fruitless disclosure claims—only one of which was “valid.” Id. at *9 (noting that “Plaintiff alleged a litany of claims that this Court has unambiguously indicated do not support a disclosure claim”). As a result, the Court noted:

By my count, Plaintiff made one good claim and 64 poor claims. Should I assume that Plaintiff’s counsel divided its time equally among the various claims, I would find that they spent approximately 9.5 hours litigating one good claim. As discussed above, I have determined that a fee award of $400,000 is commensurate with the benefit that the supplemental disclosures gave to Parlux stockholders. When divided by 9.5 hours attributable to the successful claim, this results in an effective hourly rate of more than $42,000 an hour, which would be, obviously, an unacceptable windfall to Plaintiff’s counsel.

Id. at *10.

In the end, the vice chancellor effectively assumed that two-thirds of plaintiff’s counsel’s time, as opposed to only 9.5 hours, was reasonable (and devoted to the successful claim), and therefore awarded $266,667 to the plaintiff. This adjustment, the vice chancellor reasoned, “will ensure that the compensation to Plaintiff’s counsel is appropriate, and it should encourage similarly situated attorneys to more carefully consider what claims to include in their complaints.” Let us who have to defend these types of claims hope the court is right.

For defendants, the importance of Vice Chancellor’s Glasscock’s analysis in Dias cannot be understated. The hallmark of any award of attorney fees (whether in Delaware, California, or elsewhere) is reasonableness, and “[p]laintiffs’ attorneys should not get credit for larding a complaint with obviously meritless claims.” Accordingly, courts should discourage plaintiffs’ counsel from pursuing patently frivolous M&A claims, thereby inflating their lodestar, which is then used to justify an excessive award of attorney fees. Courts presiding over M&A shareholder litigation should require detailed time sheets from plaintiffs’ counsel or, at minimum, sufficient detail to determine how much time was spent pursuing meritorious and unmeritorious claims. Whether this will happen remains to be seen. At a minimum, hopefully this recent opinion will be followed in other jurisdictions and provide an analytic road map to assess the reasonableness of requested fees and produce a lasting impediment to frivolous M&A shareholder litigation.

A Brief Background of Proxy Litigation

In 2010 and 2011, the “say-on-pay” provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act spawned a rash of shareholder lawsuits filed against the directors of companies that failed their say-on-pay votes. These lawsuits, filed as derivative actions (i.e., in which a shareholder brings claims on behalf of the company), generally alleged that the board’s decision to adopt the proposed executive-compensation plan, despite a negative say-on-pay shareholder vote, was not a valid exercise of business judgment. The shareholder plaintiffs sought monetary damages and various corporate-governance reforms. A limited number of plaintiffs were able to secure settlements in these cases, including a couple of lucrative attorney-fee awards in excess of $1,000,000. See, e.g., King v. Meyer, No. 1:10-cv-01786-DAP (N.D. Ohio, 2010) ($1.75 million attorney-fee settlement); Woodford v. Mize, No. 1:11-cv-00879-RGA (D. Del. 2011). However, most courts dealing with these cases dismissed them at the motion-to-dismiss stage, finding that the shareholders could not maintain a lawsuit on behalf of the company but, instead, were required to make a demand on the company’s board before filing suit. These consistent rulings effectively shut the door on this first wave of say-on-pay litigation. See, e.g., Teamsters Local 237 Additional Sec. Benefit Fund v. McCarthy, 2011 WL 4836230 (Ga. Super. Ct. Sept. 15, 2011); Plumbers Local No. 173 v. Davis, 2012 WL 104776 (D. Or. Jan 11, 2012); Laborers’ Local v. Intersil, 2012 WL 762319 (N.D. Cal. Mar. 7, 2012); Weinberg v. Gold, 838 F. Supp. 2d 355 (D. Md. 2012); Iron Workers Local No. 25 Pension Fund v. Bogart, 2012 WL 2160436 (N.D. Cal. June 13, 2012); Gordon v. Goodyear, 2012 WL 2885695 (N.D. Ill. July 13, 2012); Swanson v. Weil, 2012 WL 4442795 (D. Colo. Sept. 26, 2012).

The Second Wave of Say-on-Pay

With the prospect of a quick settlement in derivative say-on-pay lawsuits diminishing, plaintiffs’ firms have adopted a new litigation approach: threatening to enjoin a shareholder meeting by challenging the adequacy of a company’s compensation-related disclosures in its proxy statement. In the last year, over 20 class-action lawsuits (most of which have been filed by the plaintiffs’ law firm of Faruqi & Faruqi) have been filed against companies and their directors seeking to enjoin the annual shareholder meeting (i.e., before the say-on-pay vote).

The gravamen of these class action lawsuits is that the proxy statement failed to disclose all material information related to (1) the say-on-pay vote; and/or (2) any other compensation-related proposal, such as amendments to an equity plan. Like the first wave of say-on-pay litigation, these lawsuits allege breaches of fiduciary duty by the company’s directors. However, because they are class actions and not derivative suits, plaintiffs do not first need to make a demand on the company’s board or adequately allege demand futility to proceed with their claims. Therefore, these cases avoid the primary obstacle that impeded the prior wave of say-on-pay litigation.

Given that most of these lawsuits are filed by the same firm, the allegations are very similar across the board and largely derived from the disclosure claims often asserted in M&A litigation. As to the say-on-pay vote, these plaintiffs have usually alleged that the following information is material and should be disclosed in the proxy statement:

• how and why the board or compensation committee retained an independent compensation consultant
• the amount of fees paid to the compensation consultant
• a “fair summary” of the compensation consultant’s analysis
• the reasons why the board or compensation committee opted for a particular mix of salary, cash incentive, and equity-incentive compensation
• details regarding the metrics associated with the peer-group analyses

As to other compensation proposals, such as amendments to an equity plan, plaintiffs have typically alleged that the following information is material and should be disclosed in the proxy statement:

• the projected number of shares to be awarded during the current year (and subsequent years) under the company’s equity-incentive plan
• how the board determined the number of additional shares requested to be authorized
• the dilutive impact that issuing additional shares may have on existing shareholders
• the potential equity value and/or cost of the issuance of additional shares
• a summary of any expert analysis provided to the company’s board in connection with the proposal

As in the M&A strike suits, the plaintiffs (and their lawyers) hope to create enough uncertainty about whether the company can proceed as scheduled with its annual shareholder meeting to encourage the company to settle, make additional disclosures, and pay the plaintiffs' attorney fees. To induce companies to settle quickly, plaintiffs routinely file a motion for preliminary injunction or a temporary restraining order asking the court to postpone the shareholder meeting until additional disclosures are made in the proxy statement. If the plaintiff obtains a preliminary injunction and the court orders the company to make additional disclosures in the proxy, then plaintiff’s counsel will submit an application to the court for an attorney-fee award under the theory that it secured a material benefit for the shareholders. In fact, even if the company voluntarily amends its proxy statement and discloses the allegedly omitted information, thereby mooting the plaintiff’s claims, plaintiff’s counsel still can and likely will submit an application to the court for an award of attorney fees, arguing that the lawsuit caused the company to make the additional disclosures.

Even though most of the companies that have been on the receiving end of these class-action lawsuits are incorporated in Delaware, which means that Delaware law applies, plaintiffs have not been filing these actions in Delaware. Instead, plaintiffs have filed in state courts where the company has its principal place of business. Presumably, plaintiffs believe that, in front of a judge who may not be well versed in Delaware law, there is a greater likelihood of prevailing on a motion for preliminary injunction. One practical effect of plaintiffs’ forum selection may be the impairment of the development of binding Delaware case law regarding the materiality of information and adequacy of disclosures, which would increase the consistency of outcomes, allow companies to better assess the risk of fighting the lawsuits, and help companies to understand the scope of information that is required to be disclosed. Several defendants have removed these actions to federal court, but in nearly each case in which the plaintiff moved for remand, the district court judge granted the motion and sent the action back to state court. Hutt v. Martha Stewart Living Omnimedia Inc., No. 12-cv-03414 (S.D.N.Y. 2012); Rice v. Ultratech, Inc., No. 12-cv-05722-SBA (N.D. Cal. 2012); Boxer v. Accuray, Inc., No. 12-cv-01006 (N.D. Cal. 2012).

These proxy class actions, like their merger-litigation cousins, create a dilemma for the defendant-companies trying to assess the risks and benefits of settlement. Should the company opt for quick resolution by settling the lawsuit, agreeing to provide certain supplemental disclosures, and paying an award of attorney fees to plaintiffs’ counsel? Or should it vigorously defend the lawsuit, risking a possible injunction, postponement of the shareholder meeting, and a potentially larger payment of attorney fees? The risk-benefit analysis is further complicated by the inherent difficulty in predicting how courts will view the merits of these lawsuits, particularly where, as here, only a handful have reached a resolution on a preliminary-injunction motion.

The good news for defendants is that, so far, the results have not been particularly favorable for plaintiffs. Although a number of companies have opted to settle these cases (with an associated range of attorney-fee awards of $125,000 to $450,000), there are only two cases in which the plaintiff has successfully obtained a preliminary injunction. Knee v. Brocade Commc’ns Sys., Inc., No. 1-12-cv-220249 (Cal. Super. Ct. Santa Clara Cnty. filed Mar. 7, 2012); St. Louis Police Ret. Sys. v. Severson, No. 12-cv-5086-YGR (N.D. Cal. filed Oct. 1, 2012). In late 2012, several companies such as AAR Corp., Clorox, Globecomm Systems, and Hain Celestial Group opted to fight these injunctions and successfully opposed the motion. Noble v. AAR Corp., No. 12-c-7973 (N.D. Ill.); Mancuso v. Clorox Co., No. RG12651653 (Cal. Super. Ct. Alameda Cnty.); Wenz v. Globecomm Sys., Inc., No. 031747/2012 (N.Y. Sup. Ct. Suffolk Cnty.); Morrison v. Hain Celestial Group, Inc., No. 602074/2012 (N.Y. Sup. Ct. Nassau Cnty.). In denying the motions, the judges generally followed the same rationale that the say-on-pay vote is advisory and, as a result, neither the plaintiff nor the shareholder class will suffer irreparable harm if the court refuses to enjoin the shareholder meeting.

As companies enter the 2013 proxy season, we expect more of these shareholder class actions to be filed, but it is unclear how many, how often, and whether other plaintiffs’ firms will enter the fray. As a result, most, if not all, public companies face some litigation risk. And although there is no guarantee that amplifying proxy-statement disclosures will prevent one of these suits, companies should, in addition to ensuring that their proxy statements comply with applicable securities laws, consider enhanced disclosures (particularly regarding say-on-pay and stock-plan share-reserve proposals) and consult their legal advisors.

Keywords: litigation, corporate counsel, mergers and acquisitions, Dias v. Purches, attorney fees, proxy litigation, say-on-pay

Koji F. Fukumura is a partner and Peter M. Adams is an associate with Cooley LLP in San Diego, California.