Correcting Corporate Benefit: Curing What Ails Shareholder Litigation

Sometimes the remedy is worse than the disease. This, it seems, is the implicit view of the Delaware State Bar Association’s Corporation Law Council (the “Council”) with regard to fee-shifting in shareholder litigation. The Council’s second proposal on fee-shifting, circulated in early March 2015, [1] is much like their first, circulated in May 2014 in the wake of ATP Tour v. Deutscher Tennis Bund. [2] Both would prevent corporations from seeking to saddle shareholders with the cost of shareholder litigation by means of a fee-shifting provision, whether adopted in the charter or the bylaws.

What the Council neglected to point out is that shareholders already bear the cost of shareholder litigation because most such claims settle, typically for non-pecuniary relief, with the corporation paying attorney’s fees on both sides. Shareholder litigation thus counts as an exception to the so-called “American Rule” on attorneys’ fees, under which each side pays its own way. Instead, shareholders must live with the “Delaware Rule,” under which the corporation always pays.

When corporations pay, of course, shareholder wealth is reduced. CEOs do not write personal checks to pay corporate lawyers. The money comes from the assets of all shareholders. This is the problem that fee-shifting bylaws were meant to solve. By making unsuccessful plaintiffs not only bear their own costs but also reimburse the fees and expenses of the corporation, most fee-shifting proposals moved towards the “English Rule,” under which the loser in litigation pays the fees on both sides. There are good reasons to believe, as the Council apparently did, that such a rule would go too far and result in the deterrence of good and bad claims alike.

But when you stop treatment without curing the disease, the patient is still sick. And there is plenty of evidence that American corporations are suffering under an epidemic of shareholder litigation. The problem is especially pronounced in merger litigation, where shareholder suits are brought in 98% of deals, and settled 70% of the time. [3] Such settlements hardly ever result in monetary relief for the shareholder class. [4] A typical settlement instead contains a package of supplemental disclosures in the merger proxy and, occasionally, revision of the merger agreement’s deal protection terms. [5] Judges routinely award fees to plaintiffs’ attorneys for having produced this meager “corporate benefit.”

The easy availability of fees caused the outbreak of shareholder litigation and fueled its spread. The Council’s hope appears to be that judges—specifically Delaware judges—will contain it. [6] But judges have not solved the problem yet. Instead, most judges continue to award mid-six figure fees for highly questionable disclosure settlements. Moreover, empirical analysis shows no meaningful relationship between fees awards and shareholder voting patterns, suggesting that judges are not doing a good job of awarding high fees when disclosures are meaningful and low fees when they are not. [7] Finally, the Council’s recommendation neglects the significant administrative costs associated with a rule requiring judges to weigh the benefit of every settlement in a public hearing.

The way to cure a disease is to aim at the cause. My article, Correcting Corporate Benefit: How to Fix Shareholder Litigation by Shifting the Doctrine on Fees, seeks to fix shareholder litigation by eliminating attorneys’ fees for low-value settlements. [8] The problem is the current interpretation of the “corporate benefit doctrine.” The solution is three-fold:

• First, corporate benefit should no longer be recognized as a basis for awarding attorneys’ fees in non-derivative suits. The corporate benefit doctrine grew up in the context of derivative suits, where there are significant procedural protections against non-meritorious claims. Returning the doctrine to that context would eliminate low-value settlements in merger class actions, where the problem is most severe, while still preserving the possibility of monetary recoveries for such claims.
• Second, the burden for establishing causation of the benefit should be shifted to plaintiffs in certain cases. In the context of “mootness fees,” where corporate defendants taken an action recommended by plaintiffs but dispute the plaintiffs’ causal role, the current presumption in favor of causation is appropriate. However, in the context of settlements where defense attorneys and plaintiffs’ attorneys have joined hands, such an inference can only harm shareholders concerned about collusive settlement practices. The burden on causation should therefore be shifted to plaintiffs in the presence of shareholder objectors.
• Third and finally, the scope of the litigation release received by defendants in connection with settlement should be made proportional to the value recovered for the plaintiff class. If low-value settlements were no longer eligible for the broad “global releases” currently favored, defendants would not be so tempted to pay attorneys’ fees for low-value settlements and would once again have an incentive to fight non-meritorious claims.

Ultimately, these reforms amount to a kind of fee-shifting, not all the way to the English Rule, but rather back to the old American way of doing things and away from the current Delaware Rule, under which the corporation always pays.

The full article is available for download here.

Endnotes:

[1] See https://www.documentcloud.org/documents/1683690-council-fee-shifting-draft.html (the proposal); https://www.documentcloud.org/documents/1683691-council-second-proposal-explanatory-paper-3-6-15.html (explanatory statement).
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[2] 91 A.3d 554 (Del. 2014).
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[3] Jill E. Fisch, Sean J. Griffith, and Steven Davidoff Solomon, Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform, 93 Texas Law Review 557, 559 (2015), available at http://ssrn.com/abstract=2398023.
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[4] Id., at 581, tbl. II.B. (finding 12 settlements resulting in an increase in merger consideration over a sample of 453 large public company mergers from 2005 through 2012).
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[5] Id. (finding 153 disclosure-only settlements and 26 amendment settlements over a sample of 453 large public company mergers from 2005 through 2012).
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[6] The Council’s recommended revisions to the Delaware General Corporation Law contain a provision expressly authorizing Delaware corporations to adopt forum-selection bylaws. Proposed §115. See proposal, supra note 1.
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[7] Id., at 588, tbl. IV.
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[8] 56 Boston College Law Review 1 (2015), available at: http://ssrn.com/abstract=2496395.
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