Free Ride Ending for Disclosure-Only Settlements in Delaware

Disclosure-Only Settlements: A Fast Resolution to Shareholder Suits

Until recently, the process through which these lawsuits are filed and then quickly settled generally have followed a familiar pattern. The process begins when the corporation announces a planned transaction. Immediately following the announcement, shareholder lawsuits are filed alleging that the directors breached their fiduciary duties. Plaintiffs use the threat of injunctive relief jeopardizing the scheduled shareholder vote to coerce supplemental disclosures by the corporation. In exchange for the supplemental disclosures, plaintiffs agree to a settlement binding all shareholders, including broad releases effectively guaranteeing that the proposed deal will move forward. Finally, the court approves a sizable fee to the plaintiffs’ attorney, and the transaction proceeds to a shareholder vote without further litigation obstacles.

These suits became so popular that corporations began to expect them as a matter of course. Corporations viewed the shareholder lawsuits as a form of deal tax. Although the deal tax extracted an additional layer of expense for corporations, with court approval of disclosure-only settlements and the accompanying broad release from shareholders, it was a tax many corporations were ultimately willing to pay.

This pattern of lawsuit-disclosure-settlement-fee proved so lucrative that, in the past 10 years, the percentage of transactions over $100 million that triggered shareholder disclosure litigation in the United States more than doubled, from 39.3 percent in 2005 to 94.9 percent in 2014. Matthew D. Cain & Steven Davidoff Solomon, Takeover Litigation in 2015 (Jan. 14, 2016).

Delaware Courts: “Not So Fast”

After a decade of proliferating disclosure lawsuits, however, Delaware courts are now viewing disclosure-only settlements with a healthy dose of skepticism, if not outright hostility. As far back as 2011, in In re Sauer-Danfoss, Inc. Shareholders Litigation, 65 A.3d 1116 (Del. Ch. Ct. 2011), the Delaware Chancery Court highlighted the difficulties that surround postsettlement fee awards when the fee petition is uncontested and the record is sparse or nonexistent. The court noted that it “strives to avoid conferring unhealthy windfalls on plaintiffs’ counsel” and that by “granting minimal fees when deal litigation confers minimal benefits, this Court seeks to align counsel’s interests with those of their clients and encourage entrepreneurial plaintiffs’ lawyers to identify and litigate real claims.” Id. at 1141.

The trend of Delaware courts closely scrutinizing these settlements began to build in the years following In re Sauer-Danfoss. In 2014 and 2015, for example, the Delaware Chancery Court rejected disclosure-only settlements at least five times, finding that the benefit to shareholders from the additional disclosures did not support the broad release of claims at the heart of the settlement.

In particular, two cases in 2015 reinforced the idea that the courts’ role in evaluating these settlements was to protect the interests of the absent class members. In Acevedo v. Aeroflex Holding Corp., C.A. No. 7930-VCL (Del. Ch. July 8, 2015), Vice Chancellor Laster rejected a proposed settlement in a disclosure case because the additional disclosures were of no value to the shareholders. During the settlement hearing, Vice Chancellor Laster repeatedly pressed plaintiffs’ counsel to identify the value that the disclosures provided to the shareholders and ultimately refused to approve the settlement.

On the same day, Vice Chancellor Noble rejected a proposed settlement associated with the purchase of biotech firm InterMune. Vice Chancellor Noble noted that the additional disclosures offered as consideration for the settlement were insufficient to justify the broad release that the defendant would receive in exchange. In re InterMune, Inc., Shareholder Litigation, C.A. No. 10086-VCN (Del. Ch. Ct. July 8, 2015). The courts’ decisions in Aeroflex and Intermune signaled the beginning of the end for disclosure-only settlements in Delaware.

In re Trulia Drops the Hammer
And then earlier this year, in an opinion by Vice Chancellor Bouchard—In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. Ct. 2016)—the trend of Delaware courts’ increasing skepticism of disclosure-only settlements came to a head. In In re Trulia, Chancellor Bouchard made it clear that Delaware had had enough of disclosure-only settlements and would not tolerate them going forward unless they provided real benefits to shareholders.

In re Trulia involved the proposed settlement of a shareholder class action. Shortly after Zillow, Inc., announced that it would acquire Trulia, Inc., in a stock-for-stock merger, four Trulia shareholders filed suit claiming that the directors had breached their fiduciary duties by approving the merger at an unfair price. After a few months of limited discovery and the corporation’s issuance of supplemental disclosures, the parties agreed on a release and a no-objection attorney fee for the plaintiffs’ attorney and sought approval from the court.

Joining Vice Chancellors Laster and Noble, Vice Chancellor Bouchard rejected the settlement outright as being unfair to the shareholders. As a threshold matter, Vice Chancellor Bouchard determined that none of the supplemental disclosures released by the corporation were material to the shareholders’ voting process and thus provided them with little if any benefit. Lamenting that the practice of disclosure-only settlements and broad releases had become all too common, the court explained that this kind of litigation had evolved into a mechanical process through which the corporation and plaintiffs’ counsel reap the benefits while the class of shareholders allegedly harmed by the corporate action receives little in return. Vice Chancellor Bouchard cited a recent study suggesting that supplemental disclosures like those commonly provided as consideration for disclosure-only settlements often make no difference in stockholder voting trends. See Jill E. Fisch, Sean J. Griffith & Steven Davidoff Solomon, Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform, 93 Tex. L. Rev. 557 (2015).

Vice Chancellor Bouchard further noted how difficult it is, as a practical matter, for courts to evaluate the fairness of disclosure-only settlements. Because such settlements are jointly presented to the court, it is more difficult for the court to evaluate opposing viewpoints and to determine whether the settlement adequately protects the rights and interests of shareholders. The fact that most of the time these settlements are presented to the court without the benefit of discovery further complicates the court’s position. Therefore, the court must often contend with a record that is sparse at best and often may rely only on the information publicly disclosed by the corporation when deciding whether to approve the settlement.

In re Trulia’s impact

The In re Trulia decision has been described as sounding the death knell for disclosure-only settlements in Delaware. At a minimum, In re Trulia signals that, in Delaware at least, courts will closely scrutinize future settlements to make sure that the disclosures provided by the corporation are material to the shareholders’ voting process and justify the release and attorney fees award requested in exchange. The Delaware courts’ past “willingness . . . to approve disclosure settlements of marginal value and to routinely grant broad releases to defendants and six-figure fees to plaintiffs’ counsel in the process” is at an end. In re Trulia, 129 A.3d at 16.

In re Trulia’s influence is not limited to the Delaware courts. Recently, the U.S. Court of Appeals for the Seventh Circuit in In re Walgreen Co. Stockholder Litigation, 832 F.3d 718 (7th Cir. 2016), an opinion by Judge Posner, reversed the district court’s approval of a disclosure-only settlement. Judge Posner adopted Vice Chancellor Bouchard’s test that supplemental disclosures must correct a misrepresentation or omission that is “plainly material” in order to support a settlement. In short, parties settling this kind of litigation going forward would be well served to make sure that the “give” in a disclosure-only settlement provides an adequate “get” for the shareholders who originally brought the claim.

Conclusion

It remains to be seen how courts’ clamping down on disclosure-only settlements will affect the prevalence of shareholder lawsuits following the announcement of a corporate transaction. Plaintiffs’ lawyers may be more reluctant to bring these lawsuits given the courts’ increasing scrutiny of the well-worn path to a quick settlement (and fee award). Meanwhile, corporations and directors may be more incentivized to fight these lawsuits through aggressive motion practice rather than attempting to resolve them with supplemental disclosures.

Keywords: professional services liability litigation, Delaware Chancery Court, disclosure-only settlements, shareholders, In re Trulia

_{Dylan C. Black is a partner with Bradley Arant Boult Cummings LLP in Birmingham, Alabama, and is a cochair of the Professional Services Liability Litgation Committee. T. Brooks Proctor is an associate with the firm.}

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