June 15, 2016

From Aeroflex to Trulia: A Seismic Shift

A discussion of the Delaware Chancery Court's recent jurisprudence on disclosure-only settlements in deal litigation

Peter Adams, Jeffrey Kaban, and Jeffrey Walker

On January 22, 2016, Chancellor Bouchard rejected a proposed disclosure-only settlement in In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016), marking the culmination of what has been a seismic shift over the past several months in the Delaware Chancery Court’s treatment of disclosure-only settlements in lawsuits challenging mergers. While the Chancery Court had expressed increasing skepticism of the value of disclosure-only settlements with broad, “intergalactic” releases over the past couple years, the recent change in the court’s jurisprudence on this issue gained critical momentum on July 8, 2015, after Vice Chancellor Laster rejected the proposed disclosure-only settlement in Acevedo v. Aeroflex Holding Corp. Since Aeroflex, the pressure for change within the Delaware Chancery Court has only increased as the other members of the court signaled their desire to reconsider how the court treats disclosure-only settlements going forward. And Chancellor Bouchard’s Trulia opinionat the beginning of this year appears to confirm that the likelihood of approval for most disclosure-only settlements in the future is bleak. We briefly discuss the Delaware Chancery Court’s recent shift in jurisprudence on disclosure-only settlements and what this might mean for deal litigation in the future.

Increased Scrutiny for “Disclosure-Only” Settlements with Broad Releases in Aeroflex
In Aeroflex, Vice Chancellor Laster began the “seismic” shift in the Chancery Court’s jurisprudence by expressly rejecting the parties’ stipulated settlement of a class action challenging the 2014 acquisition of Aeroflex by Cobham PLC for about $1.5 billion. The proposed settlement included additional disclosures to Aeroflex’s shareholders plus two modifications to the deal protections: (1) a 40 percent reduction in the termination fee and (2) a reduction in the matching rights period from four days to three days. The settlement also included a broad release of class claims against the defendants. The defendants agreed not to oppose the plaintiffs’ request for an award of attorney fees of up to $825,000.

During the settlement hearing, Vice Chancellor Laster began by acknowledging “that this is the type of settlement which courts have long approved on a relatively routine basis.” Transcript of the Court’s Rulings at 62, Acevedo v. Aeroflex Holding Corp., No. 7930-VCL (Del. Ch. July 8, 2015). The court held, however, that the “relief” obtained by the plaintiffs—i.e., the supplemental “disclosures plus two tweaks to the merger agreement”—was not “sufficient to support an intergalactic release.” Id. at 63, 73. He found the supplemental disclosures to be “precisely the type of nonsubstantive disclosures that routinely show up in these types of settlements.” Id. at 73. And he considered the reductions in the termination fee and matching right period to be merely “cosmetic.” Id. at 22. Ultimately, the court concluded:

I don’t think this relief is sufficient to support an intergalactic release. I don’t know what’s covered by an intergalactic release and I don’t think the plaintiffs know either. I think what they know is that there was essentially, once they got in there, no merit to their Delaware breach of fiduciary duty claims. I don’t think we know anything else beyond that.

Id. at 73.

In rejecting the settlement, the court identified three options going forward: (1) the parties could reframe the settlement as a mootness settlement; (2) the parties could seek approval of the settlement in exchange for a release limited to only those claims that the plaintiffs actually investigated; or (3) the defendants could move to dismiss, given the plaintiffs’ concession that the merger was approved by a fully informed vote. The parties chose the third option, opting to file a joint motion to dismiss, and the court granted their motion on August 10, 2015.

Aftershocks from Aeroflex
The impact of Vice Chancellor Laster’s Aeroflex opinion was evident in the Chancery Court’s other decisions issued throughout the remainder of 2015. See, e.g., Transcript of Settlement Hearing and Rulings of the Court at 65, In re Aruba Networks, Inc. S’holder Litig., No. 10765-VCL (Del. Ch. Oct. 9, 2015) (Laster, V.C.) (rejecting proposed disclosure-only settlement and stating that “we have reached a point where we have to acknowledge that settling for disclosure only and giving the type of expansive release that has been given has created a real systemic problem”); Letter from Settling Parties in In re Conversant, Inc. Stockholder Litig., No. 10174-VCL (consol.) (Del. Ch. Aug. 25, 2015) (Laster, V.C.) (settling parties requested the court vacate the currently scheduled settlement hearing and permit withdrawal of the parties’ previously submitted stipulated settlement in light of Aeroflex). For example, on July 27, 2015, Vice Chancellor Glasscock heard argument in In re Riverbed Technology, Inc. Stockholders Litigation concerning the approval of a settlement in which a class of shareholders challenging a private party’s $3.6 billion acquisition of the company granted broad litigation releases in exchange for supplemental disclosures that an objector argued were “worthless.” Transcript of Hearing at 65, In re Riverbed Tech., Inc. Stockholders Litig., No. 10484-VCG (Del. Ch. July 27, 2015). On the day of the hearing, the vice chancellor advised the parties that “[t]ypically, my practice is to resolve settlement motions from the bench” but that he would take the current motion under consideration because “at least certain members of the Court have been thinking in some depth about what the value of disclosure-only settlements is.” Id. at 93. While Vice Chancellor Glasscock subsequently issued a memorandum opinion on September 17, 2015, approving the proposed settlement, he emphasized that he did so because in “the past practice of this Court in examining settlements of this type, the parties in good faith negotiated a remedy—additional disclosures—that has been consummated, with reasonable expectation that the very broad, but hardly unprecedented, release negotiated in return would be approved by this Court.” In re Riverbed Tech., Inc. Stockholders Litig., No. 10484-VCG, slip op. at 14 (Del. Ch. Sept. 17, 2015). However, he warned the parties that “this factor, while it bears some equitable weight here, will be diminished or eliminated going forward in light of this Memorandum Opinion and other decisions of this Court.” Id.

Similarly, the other members of the Chancery Court who approved disclosure-only settlements with broad releases in the second half of 2015 warned that disclosure-only settlements entered into after July 2015 would receive greater scrutiny. See, e.g., Transcript at 26, In re CareFusion Corp. Stockholders Litig., No. 10214-VCN (Del. Ch. Sept. 17, 2015) (Noble, V.C.) (“[W]e need to be careful about imposing a whole new set of rules on folks who don’t have advance knowledge or notice. . . .” But “[t]he times they are a-changing.”); Transcript at 54–55, In re Silicon Image, Inc. Stockholder Litig., No. 10601-VCG (Del. Ch. Dec. 9, 2015) (Glasscock, V.C.) (“This is, I think, something of a dying breed of cases. And it’s a dying breed of cases because the bench in the Court of Chancery and other courts around the country have expressed concern at broad releases given up for disclosure-only settlements. . . . If this were a post-July case, I suspect strongly my decision here would be different.”); Transcript of Settlement Hearing and Rulings of the Court at 38, 40, Assad v. World Energy Sols., Inc., No. 10324-CB (Del. Ch. Aug. 20, 2015) (Bouchard, C.) (“[I]t should be pretty clear from some of the questions that I’m asking and some of the recent hearings . . . that there is a lot of concern in this court about nonmonetary settlements” and “there is going to be more scrutiny on some of the give and the get of these things. . . .”).

Chancellor Bouchard Confirms in Trulia That It Is No Longer Business as Usual for Disclosure-Only Settlements
On January 22, 2016, Chancellor Bouchard rejected a proposed “disclosure-only” settlement of a shareholder suit challenging a merger in which Zillow acquired Trulia for about $3.5 billion in stock. In re Trulia Stockholder Litig., 129 A.3d 884 (Del. Ch. Jan. 22, 2016). Under the proposed settlement, Trulia agreed to provide supplemental disclosures in its proxy materials, the plaintiffs agreed to drop their motion to preliminarily enjoin the merger and to provide a broad release of claims on behalf of a proposed class of Trulia’s shareholders, and Trulia later agreed to pay the plaintiffs’ counsel $325,000 in attorney fees. At the fairness hearing in September 2015, Chancellor Bouchard took the proposed “disclosure-only” settlement under advisement and asked the parties to provide additional briefing about (1) what standard applied when determining the value of supplemental disclosures and (2) “why does it make sense that the Court would be endorsing releases with unknown claims included in them?” Transcript at 43–44, In re Trulia Stockholder Litig., No. 10020-CB (Del. Ch. Sept. 16, 2015). Following the supplemental briefing, the chancellor issued a memorandum opinion in which he rejected the proposed settlement. In the opinion, the chancellor explained:

Given the rapid proliferation and current ubiquity of deal litigation, the mounting evidence that supplemental disclosures rarely yield genuine benefits for stockholders, the risk of stockholders losing potentially valuable claims that have not been investigated with rigor, and the challenges of assessing disclosure claims in a non-adversarial settlement process, the Court’s historical predisposition toward approving disclosure settlements needs to be reexamined.

In re Trulia Stockholder Litig., 129 A.3d at 896.

The chancellor went on to clarify that

the optimal means by which disclosure claims in deal litigation should be adjudicated is outside the context of a proposed settlement so that the Court’s consideration of the merits of the disclosure claims can occur in an adversarial process where the defendants’ desire to obtain a release does not hang in the balance.

Id.

The court identified two alternative ways for courts to assess disclosure claims outside the settlement context: (1) as part of a preliminary injunction motion and (2) as part of the adjudication of “mootness” fee applications. Id. at 896–97. Under the second scenario, plaintiffs can apply for a fee award after “defendants voluntarily supplement . . . their proxy materials by making one or more of the disclosures sought by plaintiffs, thereby mooting some or all of [plaintiff’s] claims.” Id. In this situation, because there is no release, “defendants are incentivized to oppose fee requests they view as excessive.” Id. at 897.

Chancellor Bouchard further warned that

practitioners should expect that disclosure settlements are likely to be met with continued disfavor in the future unless the supplemental disclosures address a plainly material misrepresentation or omission, and the subject matter of the proposed release is narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently.

Id. at 898.

The court clarified that for a misrepresentation or omission to be “plainly material,” “it should not be a close call that the information is material as that term is defined under Delaware law.” Id. In applying these standards, the court found that “none of plaintiffs’ Supplemental Disclosures were material or even helpful to Trulia’s stockholders” and the scope of the release was too broad to support a fair and reasonable settlement because it “was not limited to disclosure claims and fiduciary duty claims concerning the decision to enter the merger.” Id. at 907 n.89. Ultimately, “it is the Court’s opinion, based on its extensive experience in adjudicating cases of this nature, that the historical predisposition that has been shown towards approving disclosure settlements must evolve for the reasons explained above.” Id. at 899.

What Does This Mean for Deal Litigation Going Forward?
In lawsuits challenging mergers, litigants should no longer expect quick and easy settlements featuring only supplemental disclosures and broad releases. What is less clear, however, is what impact this shift will have on future deal litigation in the long term. There are several potential results going forward.

Fewer deal cases being filed.The end of routine “disclosure-only” settlements could result in plaintiffs challenging fewer deals. A recent review by the Wall Street Journal found that this may be happening. Liz Hoffman, “The Judge Who Shoots Down Merger Lawsuits,” [log-in required] Wall. St. J., Jan. 10, 2016. While 78 percent of Delaware companies that sold themselves during the first nine months of 2015 faced at least one lawsuit in Delaware, only 34 percent of mergers have been challenged since October 1, 2015. Id. Another recent study found that the lawsuit rate for the fourth quarter of 2015 dropped even lower, to 21.4 percent. Matthew D. Cain & Steven Davidoff Solomon, Takeover Litigation in 2015, at 1 (Jan. 14, 2016). This same study also found that dismissals—voluntary or otherwise—are up from 32 percent in 2014 to 46 percent in 2015. Id. at 5. While these numbers suggest a downward trend in deal litigation being filed and litigated in Delaware, it is still too early to know for sure if this trend will continue in the long term.

Companies should be prepared for more discovery and motion practice. While fewer deals may be challenged, those that are challenged may be more expensive to litigate.With no quick and easy settlement route, plaintiffs may seek more discovery before the transaction closes and companies may need to more aggressively fight plaintiffs’ applications for expedited proceedings and motions for preliminary injunction.

Uptick in post-close litigation. Plaintiffs may also more aggressively pursue damage claims, which would result in plaintiffs opting to litigate more merger cases post-close. There is little data to date on whether any trends have developed on this front. However, should this trend develop, it may be most prudent for defendants to provide supplemental disclosures, thereby mooting any disclosure claim and potentially invoking the business judgment rule. See Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304, 308 (Del. 2015) (holding that business judgment standard of review applies when a merger, not subject to entire fairness, has been approved by fully informed, uncoerced majority of disinterested stockholders).

Increased adjudication of “mootness” fee awards or disclosure-only settlements with limited releases. To the extent parties still seek to negotiate a pre-close resolution, such resolutions will likely involve voluntary supplemental disclosures by defendants with either no release and plaintiffs’ application for a mootness fee award, or a much more limited release, provided that plaintiffs can show a “plainly material” disclosure and that they have adequately investigated the released claims.

More suits against Delaware corporations in other jurisdictions. As Chancellor Bouchard highlighted, “some have expressed concern that enhanced judicial scrutiny of disclosure settlements could lead plaintiffs to sue fiduciaries of Delaware corporations in other jurisdictions in the hope of finding a forum more hospitable to signing off on settlements of no genuine value.” In re Trulia Stockholder Litig., 129 A.3d at 899. However, Delaware corporations can mitigate this concern by adopting a forum selection provision requiring that fiduciary duty cases be litigated exclusively in Delaware. Indeed, since the Chancery Court’s decision in Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934, 955 (Del. Ch. 2013) (upholding the validity of an exclusive forum bylaw provision), hundreds of Delaware corporations have adopted such a provision.

Keywords: litigation, securities, Delaware Chancery Court, disclosure-only settlement