Fixing Merger Litigation

Steven M. Davidoff is Professor of Law and Finance at Ohio State University College of Law. As of July 2014, Professor Davidoff will be Professor of Law at the University of California, Berkeley School of Law. Jill E. Fisch is Perry Golkin Professor of Law and Co-Director of the Institute for Law & Economics at the University of Pennsylvania Law School. Sean J. Griffith is T.J. Maloney Chair in Business Law at Fordham University School of Law. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In the US, every M&A deal of any significant size generates litigation. The vast majority of these lawsuits settle, and the vast majority of these settlements are for non-pecuniary relief, most commonly supplemental disclosures in the merger proxy.

The engine that drives this litigation is the concept of “corporate benefit.” Under judge-made law, litigation that produces a corporate benefit allows the court to order plaintiffs’ attorneys’ fees to be paid directly by the defendants provided that the outcome of the litigation is beneficial to the corporation and its shareholders. In a negotiated settlement, plaintiffs will characterize supplemental disclosures in the merger proxy as producing a corporate benefit, and defendants will typically not oppose the characterization, as they are happy to pay off the plaintiffs’ lawyers and get on with the deal. The supposed benefits of these settlements thus are rarely tested in adversarial proceedings. Knowing this creates a strong incentive for plaintiffs’ attorneys to file claims, put in limited effort, and negotiate a settlement consisting exclusively of corrective disclosures. But is there any real value to these settlements?

Our answer to this question, based on a new empirical study, is no.

In our forthcoming article in the Texas Law Review, Confronting the Peppercorn Settlement in Merger Litigation: An Empirical Analysis and a Proposal for Reform, we study shareholder voting behavior in a hand-collected sample of 453 large public company mergers from 2005-2012. We hypothesize that supplemental disclosures, because they are in effect “compelled” by the settlement, should produce new and unfavorable information about the merger and therefore reduce the percentage of shares voted in favor of the deal. By contrast, amendment settlements—that is, non-pecuniary relief focusing on revisions to the merger agreement, most often the termination fee or other deal protections—should result in a higher percentage of shares voted in favor of the deal.

Our regression analyses find some support for the later hypothesis but no support at all for the former. In short, we find no relationship at all between supplemental disclosures and shareholder voting behavior. Disclosure-only settlements appear to have no effect on shareholder voting.

We also study the relationship between attorney fee awards and voting behavior. Our hypothesis is that, if judges are willing to award higher fees in cases in which the disclosure is most meaningful, those cases should be associated with fewer votes in favor of the merger. This second hypothesis similarly lacks empirical support—there is no relationship between the size of the fee award and shareholder voting behavior. We conclude that shareholder voting fails to provide evidence of a beneficial impact from disclosure-only settlements.

We therefore conclude that courts should reject disclosure-only settlements as a basis for attorney fee awards. We argue that the simplest mechanism for achieving this result would be for courts to stop recognizing supplemental disclosures as a basis for “corporate benefit.” This change would strike directly at the engine that empowers excess litigation activity. In advancing this claim, we argue for strengthening the conceptual separation between state merger law and the federal securities laws. In effect, we maintain that corporate disclosures are and should be policed by the federal securities laws and that state courts should focus on their fundamental role of evaluating the fairness of the merger process and price. We demonstrate how this efficient specialization would redress the problem of excessive and wasteful merger litigation.

The full article is available for download here.


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