Litigation in Mergers and Acquisitions

Randall Thomas is a Professor of Law and Business at Vanderbilt University. This post relates to a recent paper by Professor Thomas, C. N. V. Krishnan, Ronald W. Masulis and Robert B. Thompson; that paper is available here.

Litigation is often triggered by the announcement of a merger or acquisition (M&A) proposal. Using hand-collected data, we document the types of suits triggered by M&A offers, the factors that influence whether offers are targeted by litigation, the impact of M&A lawsuits on offer outcomes (offer completion rates and takeover premium in completed deals), and the factors that influence whether these cases settle for positive monetary damages.

We find that about 12% of M&A offers announced in our sample period, 1999-2000, lead to litigation. Shareholder lawsuits form the vast majority of all lawsuits. We document that (a) federal court lawsuits, though far fewer than state court lawsuits, attract a significantly higher proportion of bidder and target initiated litigation than state courts; (b) bidder and target lawsuits have significantly lower rates of settlements than other types of lawsuits, and deals involving target lawsuits have lower completion rates, but higher takeover premiums if completed. Target managers typically want to either kill the deal as originally proposed or obtain a higher premium, which will lead to both a lower completion rate and a higher average premium in completed deals; and (c) Offer completion rates are the highest for controlling shareholder squeeze-out offers relative to other M&A offer types. This is not surprising given that a controlling shareholder can unilaterally insure that a deal is completed, simply by having a target board of directors propose a merger transaction and then voting its controlling share interest in favor of the transaction.

Turning to the characteristics of the deals that generate litigation, we document that larger offers (that involve larger sums of money and therefore higher potential damages for plaintiffs), hostile offers (that raise potential board entrenchment motives), offers with target termination fee provisions (that can result in challenges to the size of breakup fees), offers with a higher percentage of cash financing (that trigger strict Revlon duties for target company boards of directors), and controlling shareholder squeeze-outs (where concentrated shareholders try to influence deal terms in their favor) are associated with significantly more litigation.

We find, after controlling for offer features and M&A financial and legal advisor reputation, industry and time fixed effects, as well as for selection bias, that offers subject to lawsuits are completed at a significantly lower rate than offers that are not subject to litigation. Litigation is also associated with a significant increase in takeover premiums for completed deals. Shareholder lawsuits form the vast majority of lawsuits in our sample, which is consistent with the claim that litigation causes or aids in obtaining higher bid premiums because bidders often raise their bids in order to respond to the target shareholders’ claims of an unreasonably low initial offer price, so as to increase target shareholder support for the bid. The economic effects of litigation is such that while the probability of deal completion decreases by 5.8%, the takeover premium in completed deals increases by about 9% after controlling for other offer features. Moreover, the expected rise in the takeover premium more than offsets the expected fall in the probability of deal completion, raising the expected takeover premium paid in offers that are subject to pre-deal-completion litigation.

Examining settlements of shareholder lawsuits, we find, as expected, that deal completion rates are significantly associated with more settlements, after controlling for offer characteristics and the reputations of legal and financial advisors. Occasionally a terminated deal produces gains for target shareholders, but in most cases positive settlements only occur if the deal closes. Lawsuits challenging controlling shareholder squeeze-outs have significantly higher probabilities of settlement with cash consideration resulting for the plaintiff shareholders, due to the more plaintiff-friendly legal regime that applies in these situations. However, if a controlling shareholder uses a tender offer, there is a fall in the likelihood of settlement, reflecting a legal carveout of these transactions from the otherwise plaintiff-friendly legal regime.

Finally, turning to M&A advisor reputation effects, we find that top target law firms significantly impede litigation settlements, supporting the claim that top law firms would vigorously pursue efforts to obtain M&A litigation dismissals. However, top bidder law firms are associated with significantly more lawsuit settlements, supporting the premise that bidder legal advisers strive to settle M&A lawsuits in order to insure deal completion. Top target and bidder law firms are both positively associated with cash settlements of lawsuits. This is likely to be consistent with client objectives in the sense that top target law firms negotiate settlements in only the strong cases that support increased payment to shareholders, while top bidder law firms are amenable to larger payments to facilitate suit settlement and deal completion.

The full paper is available here.

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