June 06, 2013
Why Merger Cases Settle
by Doug Clark, Wilson Sonsini Goodrich & Rosati
A lot of ink has been spilled about lawsuits filed immediately after a
public company sale or merger is announced. The consulting firms that
historically tracked only traditional securities class actions now
assiduously monitor M&A litigation and the outcomes of those cases.
As a consequence, we now know things about this particular species of
litigation that we previously just thought we knew. For example: 96
percent of 2012 M&A deals valued at more than $500 million attracted
lawsuits. We also know that it was right to use the plural in
describing the number of suits: 5.4 lawsuits per deal were filed.
Finally, we know that the cases settle. Sixty-four percent of 2012
cases with ascertainable outcomes were settled. Most of those cases
were settled with the target making additional disclosures (i.e., no
increase in the deal consideration) and the payment of a fee to
plaintiff’s counsel. There is a general, and I believe accurate,
perception that the lawsuits are just opportunistic strike suits that
amount to a tax on sound transactions. So, if indeed they have no
merit, why do the cases settle? This article offers a few
explanations, as well as some suggestions for altering the landscape
to make settlement a less obvious result.
People, Including Public Company Directors, Dislike Litigation
And they want someone to make it go away. Imagine you are a
public company director and that you have worked hard for many years
to make conscientious decisions in the best interests of the
corporation and the shareholders whom you serve. Imagine further that
the company receives an offer that represents a premium to its current
stock price and that the offered price exceeds reachable expectations
for the company’s performance on a standalone basis. Such an offer
results in a lot of work for company directors and officers, including
numerous meetings with bankers and lawyers in addition to meetings
with suitors for the company. A significant milestone in the
transaction is the announcement of the deal. Minutes after that
announcement, the first of many press releases by plaintiffs’ law
firms begin to appear, seeking to investigate “potential breaches of
fiduciary duty” by the target company’s board of directors for its
decision to sell the company. Actual lawsuits are filed soon after,
often in more than one jurisdiction.
This article won’t belabor the litigation steps a merger suit entails
but, in a nutshell, the sequence includes: document retention, hiring
of counsel, trying to get the case in a single jurisdiction, fighting
or acceding to expedited document production, depositions, filing of
amended complaints, a motion to enjoin the transaction, a hearing on
the injunction, and, if the case doesn’t settle, two or three years of
litigation activity leading to a trial. All of this is time consuming
and expensive, even through the injunctive relief phase. Typical
merger cases, last year, settled for an average of $540,000.
So, if you are in the position of our not-so-hypothetical public
company director or general counsel, do you wish to engage in
litigation activity that may result in your deposition or those of
your bosses—not to mention company-wide disruption and
inconvenience—when you can settle the matter, once and for all, for an
amount equal to or less than defense costs? Add to this mosaic some
quantum of risk that a good transaction gets delayed or enjoined, and
the cost-benefit decision gains greater clarity.
Even at this fairly straightforward juncture of our analysis, the
decision is pretty clear. Settling makes a lot of sense. The
discussion below makes the decision even easier.
Post-Merger Litigation: The Gift that Keeps on Giving
It is not uncommon for plaintiffs contesting a merger to fail in
their quest to enjoin a deal prior to a shareholder vote or the close
of a tender offer. The parties to the transaction, the defendant
directors, and the stockholders who voted in favor of the deal or
tendered their shares have moments of joy. A spurious lawsuit has
been “defeated.” Except that it hasn’t. The case is not over, only
the plaintiff’s request for an injunction has been rebuffed. The case
has not been dismissed. The deal concludes and the litigation often
continues. The litigation is different, however, in a variety of
ways. Some of the differences pose real risks to the defendant
directors of the acquired company.
First, it’s not as time sensitive or interesting. The risk to the
transaction is past and with it goes the temporal urgency. There are
no frequent updates on the transaction and the litigation threatening
the transaction. There may be the long delays between events as is
typical in ordinary, non-expedited litigation. Defendants may begin
to feel disconnected from the day-to-day activity, which is
unsurprising as the company at issue and the board seats of the
defendant directors no longer exist.
Second, the litigation has a new “boss.” The acquiring company
assumed the litigation along with the rest of the target company. The
in-house team monitoring the litigation may never have met the
director defendants or met them only in passing. The acquiring
company’s directors are not defendants, so the litigation doesn’t
present the same political dynamic as it did within the old company.
To the extent the acquiring company has an incentive to get rid of the
case, it is a financial one. The acquiring company often is a
defendant in merger cases, on the theory that it aided or abetted the
target company defendants’ breaches of fiduciary duty. The cost of
that defense, which should be much less than the cost of defending the
main claims, is not covered by insurance.
Finally—and this one is critical—post-merger cases are very difficult,
if not impossible, to settle. This is true based on several factors
that weave together. They are:
• Most merger cases settle before the closing of the transaction based
on the allegations that the disclosures relating to the transaction
were insufficient, not the allegation that the price was inadequate.
As noted above, the settlement consists of additional disclosures and
court-approved attorneys’ fees. After the close, one can’t issue
additional disclosures, so the most common and cheapest avenue of
settlement is gone.
• In most circumstances, a disclosure-based settlement also provides
releases for all claims that were brought or could have been brought,
including those based on inadequate process or price, thereby giving
the defendants the certainty that the litigation is over.
• The disclosure-based settlements referenced above often are paid for
in whole or in part by Directors and Officers Insurance, which does
cover allegedly deficient or fraudulent disclosures.
• The obvious way to settle the case, post-close, is to increase the
amount the acquiring company paid for the target and distribute the
proceeds, less attorneys’ fees, to the stockholder class of the
• Directors and Officers Insurance does not cover increases in merger
• Directors and Officers Insurance does pay for defense costs in
post-merger cases, however, so the litigation does not impose a cost
burden on the acquiring company.
• The acquiring company thus would have to pay to settle a case out of
its own coffers, but fighting is free.
• Acquiring companies understandably are reluctant to increase the
consideration post-close to the detriment of their balance sheets,
share prices, and stockholders. This is particularly true given that
the cases rarely have merit.
It Matters Because There Is Risk
Acquiring companies inherit the acquired company’s indemnification
obligations. Even under Delaware law, however, there are limits to
the power to indemnify. It would be difficult for a company to
indemnify directors for breaches of the duty of loyalty—the duty to
act in good faith to advance the interests of the corporation and its
stockholders. As Delaware Chancellor Strine wrote, “Although [the
Delaware indemnification statute] never uses the word loyalty, there
seems to be little doubt that the statute’s use of the words that
traditionally define it in business judgment cases was intended as a
general prohibition against the indemnification of directors breaching
the duty of loyalty.”
So, should plaintiffs obtain a verdict after trial holding that the
directors violated their duty of loyalty by selling the target company
at a certain price or for reasons that exhibit a conscious disregard
of their fiduciary duties, there is a risk that the award against the
directors will not be indemnifiable. There is a similar risk that
Directors and Officers Insurance will not cover the loss or that there
will not be enough insurance to cover the potential damages.
Given the cost-benefit analysis discussed earlier, 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.
Modest Proposals for Change
Actually, these proposals for change will not be modest. They
cannot be. It’s important to bear a couple of things in mind. We’re
talking about cases filed reflexively immediately after transactions
are announced by a business-minded plaintiffs’ bar. Those cases are
adjudicated by very able judges across the country and particularly in
the Delaware Chancery Court. Those judges use the tools at their
disposal to dismiss cases when they should be dismissed and permit
settlements when they are in the best interests of a class. Judges
cannot prevent cases from being filed, nor can they alter the cost of
litigation or change the rules of civil procedure.
• Delaware has a procedure obtaining an “appraisal” for shares
post-merger. The appraisal statute should be modified to encompass
post-merger class claims. This would have the effect of compelling
anyone who wished to have a post-merger recovery to vote “no” on the
merger or decline to tender one’s shares to a tender offer. This
should be the exclusive remedy for post-merger claims. Appraisal
claims are more efficient to litigate and place the financial risk on
the acquiring company, not the directors of the old target.
• If importing the appraisal remedy is too extreme, Delaware law
should be changed to limit classes to persons who voted “no” on a
merger or did not tender their shares. This would limit theoretical
damages considerably and reduce the leverage plaintiffs have in a
post-close case where they are bringing claims on behalf of class
members that, in fact, did not object to the deal.
• Another way to limit the class, and therefore the damages, is to
require an opt-in class. That is, in order to recover in a class
action, an absent class member must affirmatively choose to be a
member of the class at the certification stage. This would limit the
size of the class because the former shareholders often are content or
disinterested in the litigation.
• The courts should take a harder look at the plaintiffs in these
cases to see if they are proper representatives of the class that they
purport to represent. In a significant number of cases challenging
mergers, the plaintiffs are small holders with no real financial
interest in the case or repeat “professional” plaintiffs who serve as
nothing but a figurehead for plaintiffs’ counsel. As with the abuses
that led Congress to change the federal securities laws in the 1990s
to require that the plaintiffs in those cases be bona fide plaintiffs,
the merger litigation landscape is littered with bad plaintiffs.
• In California and other states, post-close consideration claims are
considered derivative claims and cannot be pursued post-close. In
light of Delaware Supreme Court law to the contrary, the Delaware
legislature would have to pass a law rendering these cases
derivative. Because of the continuous holding requirement in a
derivative case, plaintiffs would not be able to establish standing
and there would be no post-merger consideration claims.
Absent marked changes in the legal landscape such as those
described above or other, better ideas, there is no reason to believe
that the current deal litigation realities will change. Plaintiffs’
lawyers will sue on virtually every deal, and defendants will have
rational incentives to settle.
Douglas J. Clark is co-managing partner of Wilson Sonsini Goodrich
& Rosati and is based in the firm’s Palo Alto headquarters. Since
joining the firm in 1993, Doug has focused primarily on securities
litigation, representing defendants in more than 70 class and
derivative actions. He also has represented numerous companies in SEC
investigations and exchange inquiries, and advises companies and their
boards of directors on governance, investigatory, and compliance
matters. Doug can be reached at