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“Utterly Useless” Disclosure-Only Settlement In Merger Objection Lawsuit Rejected By Court

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  • Posted on: Feb 28 2018

Since the summer of 2015, the Delaware Chancery Court has issued a series of rulings in which disclosure-only settlements in merger objection lawsuits have been rejected. Those rulings culminated with the decision by Chancellor Andre Bouchard in January 2016, in which he confirmed that parties submitting disclosure-only settlements to Chancery Court judges should expect enhanced scrutiny of such settlements.  In In Re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016) (here), Chancellor Bouchard rejected a proposed disclosure-only settlement of a shareholder lawsuit arising from the February 2015 acquisition of Trulia, Inc. by Zillow, Inc. In doing so, Chancellor Bouchard found that because “none of the supplemental disclosures were material or even helpful to Trulia’s stockholders,” the proposed settlement did “not afford them meaningful consideration to warrant providing a claim release.”

In rejecting the settlement, Chancellor Bouchard reviewed “the dynamics that have led to the proliferation of disclosure settlements.”  “[N]oting the concerns that scholars, practitioners and members of the judiciary have expressed” about these settlements – they “rarely yield genuine benefits for stockholders and threaten the loss of potentially valuable claims that have not been investigated with rigor” –  Chancellor Bouchard warned practitioners to expect the Court to “be increasingly vigilant in scrutinizing the ‘give’ and the ‘get’ of such settlements to ensure that they are genuinely fair and reasonable to the absent class members.” 129 A.3d at 887.

In the wake of the Chancery Courts’ hostility to disclosure-only settlements, shareholders have sought redress in other jurisdictions, namely in federal court and/or the courts in other states. But, most of those courts have not been as receptive as shareholders expected. For instance, in In Re: Walgreen Co. Stockholder Litigation, 832 F.3d 718 (7th Cir. 2016), the Seventh Circuit overturned the approval of a disclosure-only settlement, while referencing with approval Chancellor Bouchard’s opinion in Trulia. Writing for the court, Judge Richard Posner expressed skepticism about merger objection litigation and of disclosure-only settlements.

Other jurisdictions have applied a less hostile approach to disclosure-only settlements. In New York, for example, the Appellate Division, First Department, reaffirmed, with some refinement, its more lenient standard for reviewing disclosure-only settlements in Gordon v. Verizon, 148 A.D.3d 146 (1st Dep’t 2017) (citing Matter of Colt Indus. Shareholder Litig., 155 A.D.2d 154, 160 (1st Dep’t 1990), mod on other grounds, 77 N.Y.2d 185 (1991)). In Gordon, the First Department held that “a court conducting a settlement review in a putative shareholders’ class action has a responsibility to preserve the viability of those nonmonetary settlements that prove to be beneficial to both shareholders and corporations, while protecting against the problems with such settlements recognized [by the Trulia court and other courts in New York] …, in order to promote fairness to all parties.” The court identified seven factors for the trial courts to consider in reaching a determination as to whether it is appropriate to approve a disclosure-only settlement. These factors are: the likelihood of success, the extent of support from the parties, the judgment of counsel, the presence of bargaining in good faith, the nature of the issues of law and fact, whether the proposed settlement is in the best interests of the class (i.e., whether the supplemental disclosures provide “some benefit to the shareholders”), and whether the proposed settlement is in the best interest of the corporation. 148 A.D.3d at 156, 158-59, 161.

City Trading Fund v. Nye

Applying the seven Gordon factors, Justice Shirley Werner Kornreich of the Supreme Court, New York County, Commercial Division, recently rejected a proposed disclosure-only settlement of a shareholder lawsuit challenging Martin Marietta’s 2014 acquisition of Texas Industries. In a scathing opinion (here), Justice Kornreich rejected the proposed settlement as “utterly useless to shareholders.” City Trading Fund v. Nye, 2018 N.Y. Slip Op. 28030 (Sup. Ct. N.Y. County Feb. 8, 2018).

Background

The case arose from the acquisition of Texas Industries, Inc. by Martin Marietta Materials, Inc. (the “Company”). The plaintiffs, shareholders of the Company, sought to enjoin the merger on the grounds that the disclosures regarding the transaction were inadequate.  The plaintiffs alleged that the Company breached its fiduciary duties to its shareholders by making material misstatements and omissions in the definitive proxy, which was provided to shareholders for the purpose of evaluating and voting on the proposed merger.

The plaintiffs moved for a preliminary injunction, and on the eve of the hearing, the parties settled the action for a “peppercorn and a fee.” “In other words, they entered into a ‘disclosure-only’ settlement that provides no monetary relief to the stockholders, but which calls for a significant payment of attorneys’ fees to plaintiffs’ counsel (here, $500,000).” The “supplemental disclosures” purportedly remedied the alleged deficiencies in the proxy statement by providing shareholders with additional information sufficient to allow them to make a more informed decision about the merger.

In January 2015, Justice Kornreich rejected the plaintiff’s motion for preliminary approval of the settlement, based on, among other things, her analysis of the “immateriality” of the additional disclosures. She also noted “the public policy concerns that arise from worthless disclosure-only settlements of strike suits that seek to enjoin mergers of publicly traded corporations,” and the decisions from other courts that “have addressed worthless disclosure-only settlements.” (Citing Trulia).

The plaintiffs appealed. The First Department “reversed [the] court’s denial of preliminary approval, remanded the case, and directed [the] court to hold a fairness hearing to determine whether final approval of the settlement should be granted.” In reversing the court’s ruling, the First Department found that “the shareholders obtained a number of additional disclosures reflected in the supplemental proxy statement, including disclosures of additional information regarding the investment banks’ conflicts of interest and the projections upon which they relied in rendering their fairness opinions, that were arguably beneficial.” (Emphasis added.)

The February 8, 2018 Opinion

After discussing the choice of law, Judge Kornreich turned to the change in judicial attitudes toward disclosure-only settlements since her January 2015 ruling rejecting preliminary approval of the proposed settlement.  Describing the Trulia decision as “a thorough and compelling decision,” and “the culmination of the Chancery Court’s negative experience with such strike-suits,” Justice Kornreich noted that Delaware courts would approve disclosure-only settlements only when the supplemental disclosures were “plainly material” and the releases “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.” Citing Trulia, 129 A.3d at 888.

By “plainly material,” Justice Kornreich noted that Delaware courts leave no room for disclosures that are “‘arguably beneficial’” or “provide ‘some benefit.’”

“In using the term ‘plainly material,’” the Chancellor explained that he meant “that it should not be a close call that the supplemental information is material as that term is defined under Delaware law.” Id. (emphasis added). In other words, approval requires a clear showing that the supplemental disclosures were more than “arguably beneficial” or that they may provide “some benefit.” Rather, it must be clear that the new disclosures would clearly aid shareholders in deciding whether to vote on the merger by significantly altering the “total mix” of available information.

Citing Trulia, 129 A.3d at 899.

In contrast to the Delaware courts, and the Fifth and Seventh Circuits, which followed the lead of Chancellor Bouchard in Trulia, the First Department adopted what Justice Kornreich described as a “more lenient approval standard” in Gordon. Though less exacting than the Delaware materiality standard, Justice Kornreich explained that Gordon’s “some benefit test” required the court “to plausibly conclude that the supplemental disclosures would, in fact, aid a reasonable shareholder in deciding whether to vote for the merger.” Thus, “[i]f the supplemental disclosures would not do so, then there is no basis to conclude that such disclosures were of any benefit to the shareholders.”

That being said, regardless of whether Gordon’s some benefit test was intended to mirror the Delaware mootness fee standard, the only reasonable way to interpret “some benefit” is that while the plaintiff need not (as under Trulia) rule out all doubts as to the materiality of the supplemental disclosures, the court must be able to plausibly conclude that the supplemental disclosures would, in fact, aid a reasonable shareholder in deciding whether to vote for the merger. If the supplemental disclosures would not do so, then there is no basis to conclude that such disclosures were of any benefit to the shareholders. After all, the whole point of a lawsuit challenging the sufficiency of pre-merger disclosures is to ensure that shareholders have all the information they need to make an informed vote on the merger’s wisdom. For the relief in such a suit to be beneficial, the procured new disclosures must actually be useful to the shareholders — that is, the disclosures must aid them in the decision-making process. If the disclosures reveal information that has no bearing on the wisdom of the merger — such as a disclosure of the CEO’s favorite baseball team — no one would contend such revelation makes a shred of difference to … voting shareholders. There is no benefit to such disclosure. [Emphasis added.]

Analyzing the supplemental disclosures against the Gordon factors, Justice Kornreich found that the disclosures were “utterly worthless — because they would not matter to any reasonable shareholder and provide[d] no benefit to the class….” The Court noted that it was “not a close call” reaching that conclusion.

After finding the settlement to be of no benefit, Justice Kornreich concluded with a policy discussion about “utterly worthless” disclosure-only settlements, such as the one before her. In that regard, she explained that such settlements were detrimental to shareholders and benefited only the lawyers who propose them.

The supplemental disclosures, at best, are of the “tell me more” sort that countless courts have recognized are of little to no value, and which certainly do not substantially alter the total mix of available information. In other words, after having received the supplemental disclosures, the universe of information upon which shareholders decided whether to vote in favor of the merger did not meaningfully change …To be sure, under controlling (i.e., Gordon) and persuasive (i.e., Delaware) authority, a stockholder’s counsel deserves at least some reward if he can procure information that, while not landscape changing (i.e., material), is of some benefit to the stockholders. Plaintiffs’ counsel has not done so in this case. The shareholders are not better off. In fact, the shareholders are net losers here, for at least two reasons. The first, obvious reason, is the payment of counsel fees in exchange for worthless supplemental disclosures. The second, less obvious reason is that there is a cost to the shareholders if, in fact, management concealed material facts about the merger. Even though the settlement only calls for a release of disclosure violations (i.e., it is not a galactic release), there is no reason the shareholders should lose the right to eventually file a post-closing action alleging inadequate disclosures if, in fact, some subsequent revelation makes clear that, unlike those at issue in this case, there were material facts withheld from them. To be clear, the court has no reason to believe that is the case here. However, shareholders do not benefit from giving up the right to pursue future meritorious claims in exchange for relief from patently baseless ones. In other words, settling a baseless claim should not create immunity for a related, but currently unknown meritorious claim.

Takeaway

In Trulia, Chancellor Bouchard expressed “hope” that courts outside of Delaware will apply a materiality standard to the consideration of disclosure-only settlements. While the First Department in Gordon chose not to follow suit, it remains to be seen whether the other appellate courts in New York, including the Court of Appeals, will adopt the Gordon standard.

Whatever happens going forward on the appellate level in New York, City Trading makes it clear that disclosure-only settlements providing no value for shareholders will face heightened judicial scrutiny, even under the “more lenient settlement approval standard” set forth in Gordon. In light of such scrutiny, “utterly worthless” disclosure-only settlements will not be tolerated. Therefore, practitioners presenting a disclosure-only settlement for approval in New York should ask: “Are the company and its shareholders better off if the court permits plaintiffs’ disclosure claims to be settled in consideration for the supplemental disclosures and a substantial attorneys’ fees award?” If “[t]he answer is no,” they should expect enhanced scrutiny from the reviewing judge.

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