There days, virtually
every M&A transaction attracts litigation, usually involving multiple
lawsuits. These cases have proven attractive to plaintiffs' lawyers because the
pressure to close the deal affords claimants leverage to extract a quick
settlement, often involving an agreement to publish additional disclosures and
to pay the plaintiffs' attorneys' fees.
Clark of the Wilson Sonsini law firm notes in his June 6, 2013 article,
"Why Merger Cases Settle" (here),
there is a "general perception" -- which he describes as "accurate" -- that
"the lawsuits are just opportunistic strike suits that amount to tax on sound
transactions." Clark asks, given this general perception that these cases
"have no merit," why do they usually settle? Why are the parties willing to pay
off the plaintiffs' lawyers and increase the transaction costs of the deal for
lawsuits they perceive to be meritless?
Clark suggests two reasons the cases settle. The first is
that the litigation is time=consuming and expensive. Most targets of this type
of litigation just "want someone to make it go away," and the settlement allows
the defendants to avoid the irksome and expensive litigation activity. Based on
these considerations, the decision for most defendants in this type of
litigation is "pretty clear" because "settling makes a lot of sense."
But, according to Clark, there is a second reason these
cases settle. Clark's observations about this additional reason is the more
interesting part of Clark's analysis. According to Clark, another reason the
cases settle is that post-merger litigation can drag on interminably because it
can be difficult to resolve. The difficulty of resolving the litigation
post-close provides another incentive for the defendants to try to resolve the
case prior to the transaction closing.
As Clark points out, if the plaintiffs fail as an initial
matter to enjoin the transaction and the deal closes, the case isn't over - the
litigation often continues. (Indeed, as Clark's partner at Wilson Sonsini, Boris
Feldman, noted in a November 9, 2012 blog post on the Harvard Law School
Forum on Corporate Governance and Financial Reform, here,
at least some plaintiffs' lawyers have "refined their business model" and now
they aim to "keep the litigation alive post-close.")
There are a number of reasons why the post-close case can
be difficult to resolve. The first is that the post-merger case is neither
time-sensitive nor interesting. There is no longer any sense of urgency. The
defendants may begin to feel "disconnected" from the case, which is
"unsurprising as the company at issue and the board seats of the defendant
directors no longer exist."
Another reason that it is harder to settle the case
post-close is that the acquiring company and its officers and directors are in
charge of the case after the merger. The acquiring company's directors are not
defendants and so the dynamics change.
A third reason the post-merger cases are "very difficult,
if not impossible, to settle" is that the easy settlement options available
prior to the merger (like agreeing to some additional disclosures in the proxy)
are no longer available. The most "obvious way" to settle the case post-close
is to increase the amount that the acquiring company pays for the target, with
the additional amounts to be distributed to the shareholders of the acquiring
company. The problem with this option is that increased deal consideration will
not be insured under the acquired company's D&O policy - though the ongoing
defense fees will be.
Because the defense fees are covered, the continuing case
is not a burden on the acquiring company, but if the acquiring company were to
increase the deal consideration post-close in order to try to resolve the case,
it would be to "the detriment of their balance sheet, share prices and
stockholders." At the same time, however, there is a risk to the directors of
the acquired company if the case does not settle and if it were to go to trial;
there could be liability determination that would preclude the directors'
indemnification and insurance.
As Clark puts it, given "the difficulty of settling cases
post-close, and the risk of a judgment that is neither insurable nor
indemnifiable, one understands why merger cases settle before the deal closes."
Clark proposes a number of ways to try to address this
situation. He suggests amendment to the Delaware appraisal statute, to
encompass post-merger claims. This remedy would entail a post-merger appraisal
of the shares as the exclusive remedy for post-merger claims. In order to be a
member of the post-merger appraisal class, the claimant would be required to
vote "no" on the merger or to decline to tender shares in response to a tender
As an alternative to this appraisal remedy, Clark
suggests changing Delaware law to limit the classes of persons who can pursue
post-merger claims to those who voted "no" on a merger or who did not tender
their shares. This would "limit theoretical damages" and reduce the plaintiffs
can extract from the mere continued existence of the claim.
Clark suggests another option, which is to make the class
a post-merger claim an "opt-in" class (as opposed to the current procedural
model where classes are organized on an "opt-out" basis) This would require
prospective class members to affirmatively choose to be a part of the class.
Another suggestion is to "take a harder look at the
plaintiffs in these cases to see if they are proper representatives" and that
they are "bona fide plaintiffs," as "the merger litigation landscape is
littered with "bad plaintiffs" who may be small holders with no real financial
interest in the case or repeat "professional" plaintiffs who serve as "nothing
but a figurehead for plaintiffs' counsel."
Finally, Clark suggests that Delaware should (as
California and other states already do) make the post-merger consideration
cases derivative cases so that post-merger the plaintiffs would lose their
derivative plaintiff standing, as they are no longer shareholders.
Clark's observations about the difficult of settling
cases post-merger and the incentives these difficulties provide the defendants
to try to settle the cases prior to the merger are interesting. His description
of the post-close dynamics and the difficulties they create to try to settle
the cases are quite sobering. It is hard to read this description without
reaching the conclusion that something has to change.
Clark's proposed solutions are also quite interesting,
even creative. However, they also represent significant legal or procedural
changes. The magnitude of the change required could be a barrier, as
legislatures might draw back from changes to remedies or established procedures.
However, even if the Delaware legislature were willing to go along, the changes
would only prove beneficial when the post-merger litigation goes forward in
Delaware. Plaintiffs' lawyers, eager to circumvent these kinds of restrictions,
would have every incentive to press their litigation elsewhere.
One of the great curses of the current wave of
M&A-related litigation is that competing groups of plaintiffs are already
pursuing litigation in multiple jurisdictions. If Delaware's legislature were
to make its courts less amenable to post-merger cases, the various plaintiffs
would have even greater incentives to press their claims outside Delaware.
Just the same, there is still good reason to consider
trying to implement reforms. Perhaps if Delaware were to take the lead, others
states might follow. Of course, even that optimistic outcome would take
considerable time, and meanwhile the curse of post-merger litigation would
For now, many litigants caught up in post-merger lawsuits
may conclude they have only one practical alternative to costly capitulation -
and that is to fight these cases. Indeed, that is the suggestion raised by
Clark's law partner, Boris Feldman, in his earlier blog post cited above.
Feldman suggests that defendants may want to push for summary judgment; he
suggests that more courts may be willing to grant summary judgment in
post-close cases. Feldman argues that owing to the general weakness of these
cases and the scope of the exculpatory provisions in the Delaware Corporations
Code, even if the plaintiffs keep their cases alive post-merger, they will have
difficulty figuring out "a way to monetize them that survives judicial
Though there are legislative reforms that might help and
though fighting the cases might be successful, the likelier outcome for now is
that defendant companies caught up in these kinds of cases will, as the
plaintiffs' undoubtedly hope, tire of the cases and seek some type of
compromise -- which increases the likelihood that the plaintiffs will continue
to file these cases and continue to pursue them, even post-merger.
We can only hope that eventually a consensus will emerge
in legislatures or the courts to make this racket less rewarding for the
D&O Insurance for U.S.-Listed Chinese
Companies: As readers of this blog well know, securities class
action lawsuits against U.S.-listed Chinese companies surged in 2011 and even
continued into 2012. As a result of this flood of litigation and of the nature
of the accounting violations raised in many of the cases, "the cost of
insurance to cover directors and officers of Chinese companies against lawsuits
has skyrocketed," according to a June 17, 2013 Bloomberg article entitled
"Directors Refuse to Go Naked for Chinese IPOs" (here).
The article details the way that the insurance
marketplace reacted to the surge in litigation involving Chinese companies. The
article further describes how, as the insurers cranked up the rates and
restricted coverage, some Chinese companies reacted by scaling back their
coverage, by acquiring insurance with lower limits of liability. However, the
article quotes several non-Chinese members of Chinese company corporate boards
as saying that they would refuse to serve if their companies did not carry
D&O insurance (that is, if their companies went "naked").
These questions about the cost and availability of
coverage for U.S. companies have taken on a renewed relevance as Chinese
companies now return to the U.S. for listings on the U.S. exchanges. According
to the article, there has already been one U.S. IPO of a Chinese company in 2013,
and apparently there are more in the pipeline. Even though the wave of scandals
involving U.S.-listed Chinese companies appears to have played itself out,
these new IPO companies continue to have to pay "about two-to-three times more
than what a comparable U.S.-domiciled company would pay." Just the same,
according to commentators quoted in the article, some carriers "are going back
in" to the marketplace for U.S.-listed Chinese companies.
From my perspective, the article's general observation
about the D&O insurance market for U.S.-listed Chinese companies is more or
less accurate. Insurers continue to perceive Chinese companies as a tough class
of business. The article is also accurate when it says that some Chinese
companies reacted to the price rises by cutting back. Indeed, in some
instances, the companies simply declined to purchase the insurance because they
found it so costly. However, companies that take that step will have difficulty
attracting and retaining the most highly qualified non-Chinese directors, who,
like several individuals quoted in the article, will refuse to serve if the
company "goes naked" and discontinues its D&O insurance.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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