Delaware Forum Selection Bylaws After Trulia

The Delaware courts have been engaged over the past couple of years in trying to counter the “sue first, ask questions later” approach to M&A litigation that has become so prevalent. In re Trulia (Jan. 26, 2016) represents the procedural prong of the Delaware courts’ general effort to reduce the volume of unnecessary M&A litigation.

The courts already have significantly reduced the substantive risk of liability for directors in M&A litigation, with decisions reflecting a strongly increased inclination toward deference to the decisions of independent corporate directors and early dismissal of claims against them. For example, in the last two years, the Delaware Supreme Court has:

• in MFW, established a clear path to deferential business judgment review—rather than the more stringent “entire fairness” standard of review—for mergers with a controller (and, in SynQor, clarified that controller cases that otherwise meet the MFW requirements can be dismissed at the pleading stage unless the pleadings establish a basis for inferring bad faith on the part of the directors);
• in KKR Financial, provided for business judgment review of a transaction approved by a board—even one that is not independent and disinterested—so long as the disinterested stockholders approve;
• in Novell, appeared to apply a higher standard than in the past for establishing “bad faith” by directors, requiring not only that a board’s actions were outside the range of reasonableness but also that the directors were motivated by some improper purpose;
• in Cornerstone, provided for dismissal at the pleading stage of exculpated (i.e., breach of the duty of care) claims against directors, even in interested party transactions; and
• in C&J Energy, established that directors’ Revlon duties can be satisfied without active shopping of a company, before or after signing an agreement, as long as the deal protections are modest.

These substantive developments rest on the foundation that the exculpation of liability for directors, which the Delaware statute permits companies to include in their charters, establishes a high standard for permitting liability of directors—i.e., that their actions amounted to complete indifference or recklessness with respect to their duties. Even without Trulia, these substantive developments have removed much of the incentive for bringing M&A litigation—and, indeed, the volume of suits appears to already have declined.

Now, in Trulia, the Chancery Court has established that the most common disposition of M&A lawsuits—so-called disclosure-only settlements—will no longer be available, except in rare circumstances. This type of settlement has until now provided a quick, low-risk route to settlement (and the payment of plaintiffs’ counsel’s fees by defendant companies), fueling the filing of “nuisance” lawsuits based on weak claims—to the point that in recent years suits have followed virtually every announced public M&A transaction.

The typical pattern for disclosure-only settlements has involved:

• immaterial supplemental disclosure by the defendant company (larding the SEC filings with details that would appear not to make much difference to an investor’s assessment of the transaction);
• a broad release from the plaintiff stockholders of all claims (known and unknown) against the company and its directors; and
• payment of the plaintiffs’ counsel’s fees by the defendant company.

Essentially, the stockholders receive nothing of value; the defendant companies and directors eliminate all legal risk relating to the transaction going forward (“complete peace”); and the plaintiffs’ bar gets paid.

The Vice Chancellors have warned in numerous recent decisions that the court would be looking with increasing disfavor on disclosure-only settlements. In Trulia, Chancellor Bouchard refused to approve the typical disclosure-only settlement proposed by the parties, and, in a strongly worded opinion, stated that the court will no longer approve disclosure-based settlements unless (a) the supplemental disclosure to be made is “plainly material” and (b) the release is narrowly crafted.

What is the likely outcome of Trulia?

Significantly decreased risk of substantive liability, together with the unavailability of disclosure-only settlements except in rare cases, should achieve the court’s objective of meaningfully reducing “nuisance” lawsuits (those that are brought on weak claims, with the objective of obtaining a quick, low-risk disclosure-only settlement) in Delaware. The extent to which the objective is met will depend, primarily, on the extent to which the plaintiffs’ bar, in response to Trulia, develops new Delaware litigation strategies and/or shifts M&A suits from Delaware to other jurisdictions.

The likelihood of a shift of M&A suits from Delaware to other jurisdictions will depend on:

• the extent to which other jurisdictions may follow Delaware’s lead in refusing to approve disclosure-only settlements. (The New York courts, for example, before Trulia, already were warning that they would be applying increased scrutiny to these types of settlements. In Trulia, the Chancellor expressed the “trust and hope” that other jurisdictions would reject disclosure-only settlements); and
• the extent to which companies that have not already done so will now adopt Delaware-only forum selection bylaws to prevent litigation from being brought elsewhere (as discussed below).

There is some potential that, in response to Trulia, the plaintiffs’ bar could become more aggressive in the prosecution of M&A litigation in Delaware (in both motions practice and post-closing damages cases), seeking to pressure companies to provide a settlement that delivers monetary or other value for stockholders that would pass muster with the court. This strategy would involve significant increased risk for the plaintiffs’ bar because of the greater effort and expense of litigating, without any certainty that ultimately there would be claims strong enough to support ongoing litigation and a satisfactory settlement. At the same time, however, companies could be under significant pressure to settle in order to avoid the increasing legal risk, expense, and distraction of ongoing litigation, including potentially after closing of the transaction (when management will want to be focused on implementing integration and new business strategies, not providing discovery relating to the acts of the pre-closing board). We note that the success of plaintiffs’ lawyers taking this path is likely to be limited by the court’s movement toward expanded application of business judgment deference and thus a meaningfully lower likelihood than in the past in finding director liability (as discussed above).

Background

Trulia followed the standard pattern for M&A litigation. After announcement of the proposed $3.5 billion merger of Trulia, Inc. with Zillow, Inc., stockholder class actions were filed challenging the merger based on disclosure and sale process claims. Plaintiffs readily obtained expedited discovery and sought a preliminary injunction against the stockholder vote on the merger. After expedited, limited discovery, and with the preliminary injunction motion pending, the parties agreed to settle the litigation. The defendants agreed to supplemental disclosure that provided further details about the financial analysis performed by the company’s bankers in arriving at their fairness opinion for the deal, and agreed to pay the plaintiff’s counsel’s fees of $325,000. The plaintiffs agreed to a broad release by the purported stockholder class of all claims, known and unknown, against the defendants. The Chancellor refused to approve the settlement, emphasizing that, going forward, the court will view this type of settlement with “continued disfavor.” The Chancellor stated that the court will be “increasingly vigilant” in scrutinizing the “get” (i.e., the supplemental disclosure given by the company) and the “give” (i.e., the releases given by the stockholders) in proposed settlements to ensure that they are “fair and reasonable” (i.e., that the materiality of the supplemental disclosure justifies the breadth of the releases).

Practical Implications for Delaware M&A litigation:

• Only “plainly material” supplemental disclosure will support a settlement. The typical supplemental disclosure that has been made in the past (often, as in Trulia, relating to details of the banker’s financial analysis) will no longer support a settlement. The court emphasized that only “plainly material” supplemental disclosure—i.e., information as to which it is “not a close call” that it “significantly alters the total mix of information made available” to stockholders–can support a settlement. Thus, as a practical matter, a disclosure-only settlement will be possible only when the company’s disclosure was materially wrong or omitted material information.
• Only narrow releases will support a settlement. In Trulia—where, as frequently occurs, the plaintiffs focused on the disclosure claims and made only cursory mention of sale process claims—the Chancellor stated that a release must be drawn narrowly to cover only the claims that the record reflects were sufficiently prosecuted and investigated. Thus, even in the case of material supplemental disclosure being made, a release would not be sufficiently narrow unless it encompassed only the disclosure claims, and, with respect to any sale process claims, only those that the record showed had been sufficiently investigated by the plaintiffs through discovery.
• Settlement of litigation will be more difficult. To the extent that, despite the court’s new approach in rejecting disclosure-only settlements, M&A suits are brought, it will be more difficult to settle the litigation without the availability of a typical disclosure-only settlement.
• Plaintiffs may find it more difficult to obtain expedited discovery. In Trulia, the Chancellor stated that the incentives for a company to reach a disclosure-only settlement are so great that many companies “self-expedite” the litigation by “volunteering to produce ‘core documents,’ [thereby] obviating the need for plaintiffs to seek the court’s permission to expedite the proceedings in aid of a preliminary injunction application and thereby avoiding the only gating mechanism…the Court has to screen out frivolous cases and to ensure that its limited resources are used wisely.” The Chancellor cited an article by Vice Chancellor Laster that suggests that the court should provide greater judicial scrutiny of claims at the motion to expedite stage. Accordingly, it can be expected that the Chancery Court may grant motions to expedite less often than in the past.
• Court’s endorsement of “mootness fee” resolutions. In Trulia, the Chancellor endorsed the “mootness fee scenario” as a mechanism to resolve disclosure claims. Under this scenario, the parties can agree that supplemental disclosures, even if they are immaterial, result in the plaintiffs’ claims becoming moot. The plaintiffs’ attorneys can then petition the court for a “mootness fee” (although the fee could well be significantly lower than the fees the plaintiffs’ bar obtains in connection with disclosure-only settlements); the defendants can object to the amount of the fee; and the court can assess the value of the supplemental disclosures in the context of an adversarial proceeding. The Chancellor noted that, while disclosures mooting a claim do not include a class-wide release, other stockholders would be unlikely to commence litigation after a mootness dismissal. We note that—although the Chancellor commented in Trulia that the mootness scenario has become increasingly prevalent since the court has been warning against disclosure-only settlements—it would not be expected that a significant number of cases would be brought with the objective of obtaining a mootness fee.
• Companies may focus less on disclosure of details about financial advisor’s analyses. In Trulia, the supplemental disclosure, as has been typical in disclosure-only settlements, added to the proxy statement additional details about the company’s banker’s work. The initial disclosure about the banker’s work was characterized by the court as “ten single-spaced pages” that already provided a “more-than-fair summary.” The supplemental disclosure included, for example, the multiples for each of the selected comparable transactions. The court regarded this information—which was already publicly available, and was “supplemental” to the previously disclosed range of multiples for the group of comparable companies—as “not material or even helpful” to Trulia’s stockholders. Noting that required disclosure with respect to the banker’s work does not include “a cornucopia of financial data, but rather an accurate description of the advisor’s methodology and key assumptions,” the court found that Trulia’s proxy statement had provided a “fair summary” regarding the banker’s work.
• Cost of D&O insurance may decrease. A decline in “nuisance” M&A suits brought likely would lead to a decrease in the cost of directors’ and officers’ liability insurance.

Should companies adopt Delaware forum selection bylaws after Trulia?

To the extent that Trulia significantly reduces the likelihood of litigation challenging an M&A transaction—because the quick, low-risk route to settlement will no longer be available—there will be added incentive for companies that have not already adopted Delaware forum selection bylaws to now do so. It is to be noted, however, that a potential negative of adoption of Delaware forum selection bylaws is that, if other jurisdictions do not follow Delaware’s lead in rejecting disclosure-only settlements, then a company may prefer not to force litigation to Delaware where, if litigation is brought, a quick disclosure-only settlement with a broad release of claims against the company and its directors will generally not be available.

Thus, a company may wish to wait to adopt Delaware selection bylaws until it becomes clearer whether other jurisdictions will continue to approve disclosure-only settlements; or may wish to adopt the bylaws now and then eliminate them if it becomes clear that other jurisdictions will continue to approve disclosure-only settlements. Further, a company may wish to adopt the bylaws and then waive them in the context of an approved transaction when the company would prefer the certainty of a quick resolution over the prospect of lengthier litigation for vindication on the merits.

Of course, the usual benefits and disadvantages of Delaware forum selection bylaws should be considered as well. On the plus side, these bylaws protect the company against multi-jurisdictional litigation and ensure judicial resolution of litigation under Delaware law by the Delaware judiciary. On the negative side, institutional shareholders and proxy firms may disfavor the adoption of exclusive forum bylaws. There has not generally been strong institutional shareholder resistance to adoption of forum selection bylaws, however. In 2016, ISS changed its policy with respect to forum selection bylaws so that it now reviews these bylaws on a case-by-case basis. Glass Lewis’s policy is to recommend voting against the nominating and corporate governance committee chair when a forum selection bylaw is adopted without shareholder approval (other than in the case of an initial public offering, merger or spinoff, in which cases Glass Lewis will evaluate the bylaw in the context of the company’s other provisions that limit shareholder rights—such as supermajority shareholder vote requirements, a classified board and a fee-shifting bylaw).