Among business practices that investors don’t like, one of the most reviled is when companies in their portfolios provide scanty information about planned M&A deals.
Shareholders’ antipathy for the practice is so great that in 2017, they initiated class-action litigation in response to 73% of public companies’ announced deals valued at more than $100 million, according to a new report from Cornerstone Research.
However, taken out of context that figure is misleading, as shareholders’ appetite for such lawsuits has actually waned markedly over the past two years. Between 2009 and 2015, investors challenged more than 90% of such M&A deals, Cornerstone reports.
The average number of lawsuits per deal fell from 4.1 in 2015 to 2.8 in both 2016 and 2017. And the percentage of cases voluntarily dismissed by plaintiffs climbed from an average of 26% from 2013 through 2016 to 52% in 2017, according to Cornerstone.
The shift is traceable to a January 2016 decision by the Delaware Court of Chancery to severely limit its approvals of “disclosure-only” settlements in such cases. (A majority of large, publicly held U.S. companies are domiciled in the state.)
For several years before 2016, deal litigation typically was settled quickly, with defendants — usually the merging companies and their executives — agreeing to provide supplemental disclosures about the challenged deal and pay plaintiffs’ attorney fees.
In exchange, plaintiffs agreed to release the defendants from other disclosure-related and breach-of-fiduciary-duty claims that shareholders may have had against them.
The proportion of litigated M&A deals shot up from just 40% in 2005 to a high of 94% in 2013 “due in large part to courts’ willingness to approve [disclosure-only] settlements,” according to a news alert by law firm BakerHostetler. “But in 2014, Delaware courts began to criticize this practice as an ‘epidemic’ that was short-selling investors and over-insuring companies.”
The tension came to a head in In re Trulia Inc. Shareholder Litigation, where the Delaware Chancery Court re-examined the merits of these settlements.
The result, BakerHostetler notes, “was a new test that limited the viability of disclosure-only settlements to very narrow circumstances and virtually foreclosed the practice of including unreasonably broad litigation releases to defendants.”
Among the cases still being filed, plaintiffs’ attorneys are trying out some new tactics.
For one, they’re bringing lawsuits in federal courts rather than state courts. According to Cornerstone, while the number of M&A deal lawsuits in Delaware plummeted to just seven in 2017, the number of cases brought in the federal Third Circuit, which includes Delaware, more than doubled, from 15 to 33. Nationwide, the number of cases filed in federal courts rose from 97 to 135.
How effective that tactic will ultimately be is still unclear. However, in a late-2016 decision in Hays v. Walgreen, the Seventh Circuit Court of Appeals endorsed Delaware’s Trulia decision and rebuked disclosure-only settlements.
Also, instead of requesting injunctive relief before M&A deals are closed and quickly settling, some plaintiffs’ attorneys “have focused on post-closing monetary damages and have increased their use of statutory relief, such as books-and-records and appraisal actions, to challenge transactions,” according to a November 2017 note by law firm Skadden, Arps, Slate, Meagher, and Flom.
The rate of case resolution before deal closing declined steadily from 78% in 2012 to a 10-year low of 43% in 2017, the Cornerstone report shows.
Further, in the Delaware Court of Chancery there’s been a spike in M&A-related “appraisal litigation,” where shareholders submit their shares for valuation by the court rather than accepting the deal price. Compared to a low of 17 such cases brought in 2009, there were 85 in 2016 and 62 in 2017.
The lower 2017 number likely reflects a series of Delaware Court of Chancery rulings that “appear[ed] to question how to determine fair value in appraisals,” Cornerstone says.