“[L]ike mushrooms follow[ing] the rain” (Dias v. Purches, 2012 WL 4503174, *5 (Del. Ch. Oct. 1, 2012)), within weeks—sometimes days—after a publicly traded company announces a merger or acquisition, one or more shareholders of the target company sue the target’s board of directors for breach of fiduciary duty and threaten to enjoin the proposed transaction. See Robert M. Daines and Olga Kourmrian, Recent Developments in Shareholder Litigation Involving Mergers and Acquisitions: March 2012 Update (Cornerstone Research, 2012) at 5 (reporting that, in 2011, 39 percent of shareholder lawsuits were filed within 7 days after a deal was announced, and approximately two-thirds were filed within 14 days).
Such is the current state of merger and acquisition (M&A) shareholder litigation, which has exploded in recent years and shows no signs of abating. In 2007, the percentage of announced deals, valued at or above $500 million, subject to shareholder litigation was 53 percent. Daines (2012) at 2. By the end of 2009, that incidence had jumped to 92 percent. Id. Since then, shareholders have continued to target almost every public acquisition, often filing multiple lawsuits in multiple jurisdictions. Id. at 2–4; see also Matthew D. Cain and Steven M. Davidoff, “A Great Game: The Dynamics of State Competition and Litigation” (SSRN, April 2012) at 31 (reporting that, in 2010, 46.5 percent of public acquisitions with a transaction value of at least $100 million were filed in more than one state, up from 21.9 percent in 2007 and 8.6 percent in 2005)). In fact, the average number of lawsuits filed per deal has risen continuously for the last five years.(Id. at 2 (increasing from 2.8 in 2007 to 6.2 in 2011 for deals valued at or above $500 million); see also Cain (2012) at 31 (reflecting an increase from 2.2 in 2005 to 4.7 in 2010 for deals valued at or above $100 million).
Few would argue that the quantity of M&A litigation is anything other than excessive 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.”). It is no secret why: these strike suits are extremely profitable for plaintiffs’ counsel. (According to Daines (2012), in 2010–2011, 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. This suggests that the average M&A case pays a plaintiff’s counsel over half a million dollars for about 6 weeks of “work.”) Given the large stakes and often compressed timeline, M&A class actions place defendant-companies on the horns of a dilemma. Should they quickly settle the lawsuit(s), usually by agreeing to provide certain—typically immaterial—supplemental disclosures, and pay a relatively modest award of attorney fees to plaintiffs’ counsel? Or should they vigorously defend the lawsuit(s), risking a possible injunction, delay (or even derailment) of the merger transaction, and a larger payment of fees to plaintiffs’ counsel? Because most defendant companies are risk averse, particularly in this setting, the vast majority of these strike suits settle quickly on a disclosure-only basis. Daines (2012) at 9 (indicating that 66.1 and 68.6 percent of M&A shareholder lawsuits settled); id. at 10 (reporting that 58.2 percent [103/177] of unique settlements related to 2010 and 2011 M&A deals were resolved within 60 days or less of the deal announcement, and 96.0 percent [194/202] settled before the deal closed); id. at 11 (claiming 82.2 percent [166/202] of unique settlements related to 2010 & 2011 M&A deals settled on a disclosure-only basis).
What, then, is the solution? A plaintiffs’ counsel could decide to challenge fewer deals or pursue fewer claims. But why would they? If they file suit (whether meritorious or not), they can, on average, expect to do about six weeks of “work,” then settle on a disclosure-only basis, and get paid half a million dollars. Defendants could more aggressively litigate the less meritorious actions, thereby weeding them out and ultimately deterring plaintiffs’ counsel from pursuing those “bad” cases. But why would they? Litigation is inherently risky and expensive. And 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 a nuisance suit, particularly for some additional disclosures and a relatively modest payment (often by the insurer) of fees to the plaintiffs’ counsel.
The only workable solution, which was recently articulated by Vice Chancellor Sam Glasscock in Dias v. Purches, is for “bench judges over many diverse jurisdictions to shift fees in a way that discourages overuse or abuse of the class action mechanism while encouraging meritorious suits.” Dias, 2012 WL 4503174, at *5 (recognizing that M&A litigation “dynamic obviously creates a risk of excessive merger litigation, where the costs to stockholders exceed the benefits,” because “[r]ather than carefully considering what claims have merit,” plaintiffs typically file “broad and general complaint[s], taking a scattershot approach in the hopes that the case will be expedited,” and then “rely on the Court to winnow their claims, determining which are meritorious and what value they confer upon stockholders”). In our view, this Chancery Court opinion provides a road map for other judges, in any jurisdiction (i.e., whether in a “benefit conferred” or “lodestar” state), to follow in awarding attorney fees in an M&A case.
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 nonstatutory exception where a representative plaintiff confers a pecuniary or nonpecuniary “substantial benefit”); Dias, 2012 WL 4503174 at *5 (“Under the corporate benefit doctrine, plaintiffs may be reimbursed for attorneys’ fees and expenses in corporate litigation.”) (citing United Vanguard Fund, Inc. v. TakeCare, Inc., 693 A.2d 1076, 1079 (Del. 1997)). In the M&A context, plaintiffs rely on this doctrine to shift fees in exchange for the benefits (which are, most often, supplemental disclosures) they achieve for the shareholder class. The decision to award attorney fees, and how much, is left to the court’s broad discretion, and plaintiffs bear the burden of supplying the court with a reasoned basis on which to justify a fee. 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 Cty., 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 worked by the counsel’s hourly rate. This figure may then be increased or decreased depending on a number of factors: (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 v. Moses, 24 Cal. 4th 1122, 1131–32 (2001).
In Delaware, the court does not begin with a lodestar analysis but instead focuses on the benefit conferred—the first of the well-settled Sugarland factors and the one “generally accorded the greatest weight.” In re Chips & Techs., Inc. S’holders Litig., 1998 WL 409155, at *2 (Del. Ch. June 24, 1998); In re Abercrombie & Fitch Co. S’holders Deriv. Litig., 886 A.2d 1271, 1273 (Del. 2005) (summarizing the factors set forth in Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del. 1980), which include: “(1) the results accomplished for the benefit of the shareholders; (2) the efforts of counsel and the time spent in connection with the case; (3) the contingent nature of the fee; (4) the difficulty of the litigation; and (5) the standing and ability of counsel involved.”). Of course, the benefit conferred is “not the only factor to be 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] Court examines the time and effort expended by counsel,” and places 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 (cf. Cain (2012) at 35 (identifying Delaware or California as the jurisdiction for 43 percent [138/322] of deal case settlements)), the time and effort expended by plaintiffs’ counsel is a critical component of the fee-shifting calculus and was the focus of Vice Chancellor Glasscock’s opinion last October in Dias v. Purches.
Dias v. Purches
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 in cash per share and 0.20 shares of Perfumania or .53333 shares of Perfumania. Id. at *8. The plaintiff filed suit in Delaware in January 2012, seeking to enjoin the transaction based on allegations of inadequate disclosure and breach of fiduciary duty. Id. at *1. Shortly thereafter, the plaintiff filed a motion to expedite the litigation, which the court granted. Id. (granting the motion because defendants argued (but had not so moved) to stay the action in favor of parallel litigation in Florida and, in so doing, “implicitly conceded that the plaintiff set forth colorable claims”). Defendants then filed a motion to stay the action in favor of parallel litigation in Florida, which the court denied. Id. at *2. The parties then briefed a motion for preliminary injunction. Id.
In support of the injunction, the plaintiff argued that defendants failed to disclose the free cash flow projections that Parlux’s management had provided to its financial advisor. Id. 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. Id. 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.” Id. As a result, 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.” Id. Thereafter, the plaintiff moved for $500,000 in attorney fees and expenses, which defendants opposed. Up to this point, there is nothing remarkable about this case or the court’s opinion. What is notable, however, is the vice chancellor’s subsequent analysis of plaintiff’s request for attorney fees, which, in his view, raised the recurring issue of “how to apply Sugarland where a plaintiff brings a meritorious claim alongside unproductive, boilerplate claims.” Id. at *6.
In analyzing the plaintiff’s motion for fees, the vice chancellor began with the benefit conferred, which 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 then anchored the value of this case at the “lower end of the Sauer-Danfoss range.” Id. 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. Id. at *7. 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:
In 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.
One solution to this problem would have been for the vice chancellor to demand detailed timesheets from the plaintiff’s counsel, something we would encourage all courts to do. Instead, “lacking guidance from Plaintiff’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, 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.
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 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’s hope he’s 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.” Id. at *7. Accordingly, judges should not permit plaintiffs’ counsel to pursue patently frivolous M&A claims, thereby inflating their lodestar, which is then used to justify an excessive award of attorney fees. It’s time for judges in M&A shareholder litigation to demand detailed timesheets from plaintiffs’ counsel or, at minimum, enough detail to determine how much time was spent pursuing meritorious and unmeritorious claims. Whether this happens remains to be seen. Ideally, this recent opinion (and similar future opinions) will provide an analytic road map for other courts (particularly outside Delaware) to follow in assessing the reasonableness of requested fees and produce a lasting impediment to the lucrative rent-seeking that is M&A shareholder litigation.
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