So far this year, deal parties are approaching M&A with cautious optimism. This series of Cooley M&A blog posts include some brief observations that offer some M&A highlights over the past year and our thoughts for the year to come.
Delaware Confronts M&A Litigation
M&A deal litigation continues to plague most public M&A deals. However, the Court of Chancery’s Trulia decision (in January 2016) has significantly altered the landscape. In Trulia, the Court rejected a disclosure-only settlement and made clear that it would no longer approve such settlements (i.e., where plaintiffs give broad releases of liability in exchange for an award of attorneys’ fees and minimal disclosures in the proxy or recommendation statement) unless the supplemental disclosures were “plainly material.”
As a result, the overall incidence of M&A litigation has declined, particularly in Delaware. In the first half of 2016, plaintiffs filed suit in only 64% of public deals valued over $100 million, down from 84% in 2015 and over 90% from 2009 to 2014. Among suits involving a target company incorporated in Delaware (where the vast majority of public companies are incorporated), only 36% of litigated deals in the first half of 2016 were filed in Delaware, down from 74% in 2015. This exodus from Delaware has spawned a dramatic uptick in M&A filings in federal court, which jumped from 17 cases in 2015 to 80 cases in 2016 (a 371% increase). Whether the federal courts adopt Trulia’s heightened scrutiny of disclosure-only settlements remains to be seen, but there is reason for optimism. In late 2016, the Seventh Circuit (in In re Walgreen Co. Stockholder Litigation) was highly critical of disclosure-only settlements and endorsed the “plainly material” standard applied in Trulia.
In another welcome development, the Delaware Supreme Court, in Corwin v. KKR Financial Holdings (Del. 2015), held that, where a transaction not subject to entire fairness has been approved by a fully-informed, non-coerced vote of the disinterested stockholders, the business judgment will apply. In those circumstances, any challenge to the transaction will be dismissed unless the plaintiffs can show that the directors committed waste, which will be difficult to prove since the stockholders voted in favor of the deal. Last week, the Delaware Supreme Court upheld the Chancery Court’s decision in In re Volcano, which extended Corwin’s cleansing effect to public tender offers (under section 251(h)). In the coming months, the Delaware Supreme Court is scheduled to address (in City of Miami General Employees v. Comstock (Del. Ch. 2016)) whether claim extinguishment applies when the deal was approved by an allegedly conflicted board. Notwithstanding that appeal, this line of cases (i.e., Corwin, Volcano, and their progeny) make clear that, for most deals where there is no plausible alleged conflict, the Court will not second-guess the board’s decisions if the transaction was approved by the disinterested stockholders in a fully-informed and non-coerced vote or tender of shares.
Some plaintiffs have shifted strategy in response to Corwin and are challenging the validity of the stockholder vote by alleging problems with the deal disclosures. Helpfully, recent cases have held that, while the directors have the burden to prove that the disclosures were adequate for stockholder ratification, plaintiffs have the burden to plead a disclosure violation in the first place or the claim will be dismissed. It is therefore imperative that disclosures to stockholders in the proxy or recommendation statement are sufficient and robust, and are provided at the outset.
In order to ensure that deal claims are heard in Delaware and to benefit from the recent case law, targets now routinely adopt bylaws designating Delaware as the exclusive forum for breach of fiduciary duty and other intra-corporate claims in advance of signing a deal. This too has had a dampening effect on the frequency of M&A claims as more and more non-Delaware forums have enforced them.