Divided Loyalties? The Role of Defense Litigation Counsel in Shareholder M&A Litigation

C. N. V. Krishnan is Professor of Banking and Finance at Case Western Reserve University. This post is based on a recent paper by Professor Krishnan; Randall Thomas, Vanderbilt University; and Steven Davidoff Solomon, University of California Berkeley School of Law.

In our paper Divided Loyalties? The Role of Defense Litigation Counsel in Shareholder M&A Litigation, we examine the role of defense litigation counsel in merger and acquisitions (M&A) litigation. We theorize that defense litigation counsel may have two possibly conflicting roles in this litigation. First, defense litigation counsel will aim to defend the target company and its directors from claims that the directors breached their fiduciary duties to the target’s shareholders. Second, counsel will seek to ensure that the negotiated transaction is not enjoined, or otherwise halted by shareholders, and that in the absence of competing bidders, the transaction completes on its initial terms and price. These two goals may conflict as defense litigation counsel seeks to settle potentially worthy claims quickly and cheaply in order to ensure deal completion.

To test our theories, we use a hand collected sample of 1,087 M&A lawsuits spanning the ten-year period from January 1, 2003 through December 31, 2012. We first determine the identities of defense litigation counsel in M&A litigation. In an approach consistent with annual league-table ranks of financial advisors (investment banks) and legal advisors (law firms) used in the prior literature, we identify top defense litigation counsel based on the number of appearances in the annual top-10 league tables from 2006 through 2012, where top 10 league tables are defined by number of appearances during the immediate past rolling three-year window, to avoid look-ahead bias. These firms include well-known names such as Skadden Arps Slate Meagher & Flom, Wachtell Lipton Rosen & Katz, and Simpson Thacher & Bartlett, all three of which are in the top-10 league tables every year of our final sample period.

We find that these firms are more likely to appear in cases defending transactions with significantly lower target takeover premiums, on average, as compared to non-top defense litigation counsel. When we probe deeper into this finding, we find that top defense litigation counsel is involved in a significantly higher proportion of cash deals, non-same-industry deals (implying a lower possibility of anti-trust-related concerns), and friendlier deals, all of which could lead to smaller negotiated takeover premiums. Perhaps because of this smaller negotiated takeover premium, we find that retention of top defense litigation counsel is associated with a greater likelihood of multijurisdictional deal litigation, that is, that top defense litigation counsel is hired in transactions involving a significantly higher proportion of suits filed in multiple states, where they may be able to conduct reverse auctions to extract better settlement results for their clients.

We find that the presence of top defense litigation counsel is associated with significantly lower target takeover premiums on deal completion. We find, after controlling for endogeneity, that top defense litigation counsel appear successful in settling suits cheaply and quickly to avoid increasing the premium. These findings are in line with our hypothesis that defense litigation counsel may favor the interests of management who prefer deal completion over the interests of shareholders, who may prefer a higher takeover premium.

Our results have important policy and legal implications. First, since the end of our sample period in 2012, most public companies have adopted exclusive forum selection bylaws. These bylaws were recently blessed by the Delaware legislature and courts. However, these bylaws will have a direct effect on top defense litigation counsel by sharply reducing top defense litigation counsel’s ability to run reverse auctions to settle difficult cases cheaply with selected plaintiffs’ firms. An incidental effect of this change will also presumably help top plaintiffs’ law firms, who will now be able to stop worrying about non-top plaintiffs’ law firms undercutting them by settling cases where the top firms have invested a lot of resources.

Second, our findings show that top defense litigation counsel make heavier use of amendment and disclosure settlements. The Delaware courts’ recent crackdown on disclosure settlements will reduce top defense litigation counsel’s ability to offer this form of quick and cheap settlement to get rid of strong cases. This will reduce those firms’ value relative to non-top defense litigation counsel. In addition, when combined with the exclusive forum bylaw effect mentioned above (improving top plaintiffs’ firms’ leverage), this may lead to more consideration settlements between top plaintiffs’ firms and defense firms.

Third, top defense litigation counsels’ advantages really show up in cases against the weaker plaintiffs’ firms. There should now be fewer of those cases as multistate M&A litigation contracts, which will erode these top firms’ relative strength. If there are really cost differences (that is that target firms pay more to get the more experienced firms), then with the benefits of retaining them decreasing, we predict that cheaper firms will start being more competitive. This could erode cost differences between the two types of defense litigation firms or it could lead to shifts in their relative market share.

The full paper is available for download here.

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