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Ending Frivolous M&A Litigation

Bruce Carton | November 13, 2012

Shareholder litigation challenging a merger or acquisition now follows nearly every deal.

In fact, a report released by Cornerstone Research earlier this year found that no less than 91 percent of deals valued at more than $100 million became the subject of lawsuits in 2010 and 2011. The percentages were even higher for larger deals, with 95 percent of all proposed acquisitions valued at more than $500 million attacking subsequent lawsuits in those years.

Shareholders typically file these M&A lawsuits shortly after the announcement of a deal and seek to prevent the deal from going forward, as well as monetary damages, improved disclosure, or some combination of these demands. Shareholders in these cases routinely claim that the company is being sold for too little or that the board of the target company breached its duty to seek out higher bids.

The near-certainty that a lawsuit will now follow a proposed merger or acquisition is a recent phenomenon. In 2005, for example, lawsuits followed just 39 percent of deals valued at more than $100 million. In 2007, only 53 percent of proposed acquisitions valued at over $500 million produced lawsuits.

So why is just about every announced deal fodder for lawsuits?  There are numerous factors, but the top reason is that they are easy money for plaintiffs' lawyers, who have learned that the defendant corporations in such cases will almost always agree to settle the case. An October 2012 report by the U.S. Chamber of Commerce, titled “The Trial Lawyers' New Merger Tax,” labeled M&A litigation as “extortion through litigation.” The report asserts that “trial lawyers hold transactions hostage until they collect a ‘litigation tax,' draining a share of the merger's economic benefit away from shareholders and into the lawyers' own pockets.” The Chamber is now actively lobbying Congress to reform the laws in this area.

Other factors have come together to make M&A litigation so prevalent today, including:

Speedy settlements: Research shows that nearly 70 percent of the M&A cases filed in 2010 and 2011 settled. Of these settlements, approximately 95 percent were reached before the merger closed, and the median time between the filing of a lawsuit and settlement in this sample was just forty-four days. By comparison, securities fraud cases typically don't settle until after a motion to dismiss is litigated by the parties—a costly phase that can last for years. Defendants in these cases have no strong incentive to settle early, as many cases are dismissed by the court, and that risk, combined with the cost of ongoing litigation, are big weapons for defendants.

So why is just about every announced deal fodder for lawsuits? There are numerous factors, but the top reason is that they are easy money for plaintiffs' lawyers, who have learned that the defendant corporations in such cases will almost always agree to settle the case.

Defendants in M&A lawsuits, on the other hand, have an enormous incentive to settle promptly, even if the cases lack merit, since they desire to eliminate any obstacles to, or uncertainty regarding, the proposed transaction. In short, there is a unique sense of urgency for defendants to resolve M&A cases because, as one academic put it, if companies “want their deal to go through, they don't have time to win” the case in court.

Relatively low-cost settlements: Viewed as an incremental cost of the merger or acquisition, most M&A lawsuit settlements are simply not significant, relative to the amounts involved in the overall transaction. This is particularly true given the fact that, according to Cornerstone Research, only 5 percent of M&A lawsuit settlements in 2010 and 2011 resulted in any payments to shareholders. The other 95 percent were either “disclosure only” settlements (changes or additions to language in the merger documents) or settlements involving other, often unimportant, merger agreement changes. This is a significant departure from M&A settlements as recently as 1999-2000, when over half of them included cash awards for shareholders.

In the absence of monetary awards to shareholders, defendants are usually able to resolve cases by paying only the attorneys' fees for plaintiffs' counsel. According to Cornerstone Research, public information available for 81 of the 190 settlements in 2010-2011 shows an average attorney's fee of $1.2 million—a figure inflated by a few large awards. In 43 percent of the settlements reported attorneys' fees were $500,000 or less.

Unfocused Laws

In the 1990s, Congress addressed what it viewed as abusive practices in securities class litigation by enacting the Private Securities Litigation Reform Act and the Securities Litigation Uniform Standards Act. Together, these statutes put standards and rules in place to attempt to curtail the “stock drop” lawsuits that were then being filed whenever a company's stock price declined, regardless of whether there was fraud involved or not.

The current state of M&A litigation is reminiscent, in several ways, of the securities class-action world prior to these statutes. For instance:

  • M&A lawsuits are filed routinely, following virtually every M&A announcement;
  • The pre-PSLRA  “race to the courthouse” practice still exists in M&A litigation, as  many courts continue to give control of the litigation to the first plaintiff to file an M&A lawsuit. As such, many M&A lawsuits are filed within days of the announcement, before plaintiffs' counsel has had a reasonable amount of time to investigate whether the defendant's board violated its duties;
  • M&A lawsuits are, with very few exceptions, resolved through settlements that result in fees for lawyers but do not provide much benefit to shareholders.

As the U.S. Chamber report puts it, “entrepreneurial trial lawyers have thus found a way to circumvent Congress's reform of federal class actions and embark on a whole new category of abusive securities litigation.” It is not accurate to say that all M&A lawsuits are meritless, of course. Some M&A lawsuits have led to improved corporate accountability. But when essentially every deal is challenged, as is now the case, it necessarily results in a great deal of unnecessary litigation and settlements.

The U.S. Chamber report offers several legislative approaches Congress could take to help address the M&A lawsuit problem. Primarily, it suggests, Congress could require all M&A lawsuits to be brought in the state of incorporation of the defendant company. While most companies (and almost two-thirds of the Fortune 500) are incorporated in Delaware, a recent study by NERA Consulting showed that only about one-third of M&A lawsuits were filed in Delaware and just 20 percent were filed only in Delaware. Douglas Greene, a partner in the law firm Lane Powell, says that this type of reform could have several positive effects. These might include fewer M&A cases brought against Delaware corporations (“because plaintiffs' lawyers are more reluctant to file bad cases in Delaware,” he says); and the fact that M&A lawsuits would become centralized in the experienced Delaware courts, which could then “manage and resolve cases in ways that would tend to minimize or solve the problems.”

In the absence of any such reforms to date, some companies have tried to help themselves by amending their charters or bylaws to provide that shareholder suits must be filed exclusively in the Delaware Court of Chancery.  These exclusive forum selection bylaws have been challenged by shareholders, however, who argue that there is no “mutual consent” by the shareholders. Moreover, at least one federal court has rejected a defendant's argument of “improper venue” based on this type of exclusive jurisdiction provision.

With a corporation's chances of being sued following a merger or acquisition announcement now closing in on 100 percent, a change is needed in the way these cases are handled and dispensed with in the courts. While it may be simple enough for individual companies to settle these “one-off” cases and move on, the broader picture of a “litigation tax” confronting each M&A participant presents a problem requiring a real solution.