Vindicating the Duty of Loyalty: Using Data Points of Successful Stockholder Litigation as a Tool for Reform

The stockholder litigation reform agenda is currently shaped by the felt necessity of the time to reduce or eliminate those types of stockholder actions that typically had been settled for nominal relief soon after filing. For example, Judge Richard Posner writes that “deal litigation” is a term used “disapprovingly” and class action settlements in which immaterial supplemental disclosures are the settlement consideration are “no better than a racket” and “must end.” [1] Stephen Bainbridge argues in favor of fee-shifting bylaws, because stockholder class action litigation is a “problem [that] has reached crisis proportions” and empirical data “suggest that the pervasive problem in this area is not breaches of duty by directors and officers but rather strike suits filed by the plaintiffs’ bar.” [2]

Judge Posner’s dicta and Bainbridge’s data sets ignore an empirical reality reflecting a parallel universe of stockholder litigation. A number of recent stockholder actions have resulted in significant damage awards for breach of fiduciary duty and/or aiding and abetting such breaches, or have settled on terms sufficiently substantial to suggest a real risk of such findings. Consider the following results obtained in the Delaware courts in 2015:

1. a $275 million settlement was approved in a class and derivative action challenging the transaction by which Vivendi S.A. divested its controlling stake in Activision Blizzard, Inc.; [3]
2. a $171 million post-trial judgment was entered in favor of limited partners challenging a “dropdown” transaction involving El Paso Pipeline Partners, L.P.;[4]
3. a $153.75 million settlement was approved in a derivative action arising out of two acquisitions by Freeport-McMoran Inc.; [5]
4. a $148 million post-trial settlement was approved after the Court of Chancery found in favor of stockholders challenging the going-private merger of Dole Food Company, Inc.; [6]
5. $97.9 million was paid by a financial advisor to satisfy an affirmed post-trial judgment, on top of a prior $11.6 million partial settlement paid on behalf of director defendants, in a class action that arose out of the acquisition of Rural/Metro Corporation; [7] and
6. a $70 million settlement (net of attorneys’ fees) was approved in a class action arising out of the acquisition of Jefferies Group, Inc. [8]

I contend in this article that data points of successful stockholder litigation outcomes should inform discussion of stockholder litigation reform. I discuss certain litigation reforms in light of the procedural history of eight “successful” deal litigation cases in which I was personally involved as plaintiffs’ counsel. These are cases in which the monetary recoveries were sufficiently substantial to reflect the actuality, probability, or realistic possibility of a finding of a breach of the duty of loyalty or aiding and abetting.

An obscure opinion by Chancellor Allen informs my approach. In 1993, he took the unusual step of issuing a written opinion memorializing his approval of an unopposed settlement. He did so “to provide a data point for those occasional studies that attempt to estimate whether stockholder actions provide net social benefits.” [9] That opinion discussed how empirical analysis of published litigation outcomes can be incomplete, and how successful stockholder cases can share characteristics that provide insight into potential litigation reforms.

In Part I of my paper I discuss my support for reforms that would expand the scenarios in which courts reject cheap, early settlements. In Part II, I question certain reforms that impede the prosecution of meritorious stockholder actions, by changing generally applicable rules respecting the financing or pleading of stockholder claims.

Part I uses data points of successful stockholder litigation to discuss why the public policy favoring settlement is misplaced in the context of early settlements of representative litigation. A number of the litigation outcomes in my data set would not have occurred if competing plaintiff’s counsel had gained control of the litigation. The cases likely (or certainly) would have settled for much less, soon after being filed.

Part II uses data points of successful stockholder litigation to argue against the following proposed reforms to legal rules: (i) authorizing fee-shifting bylaws; (ii) restricting access to expedited discovery; and (iii) broadening the application of the business judgment rule in controller transactions. These proposed reforms have been justified as necessary to limit meritless lawsuits, but they operate to prevent investigation into disloyal conduct.

Two of the cases illustrate why plaintiffs would be well advised not to file potentially meritorious cases if it meant assuming the contingent liability of paying defendants’ litigation costs. Multiple sets of defendants spend much more money defending an action than plaintiffs spend prosecuting it, and plaintiffs have limited access at the outset of litigation to the underlying facts.

All eight cases in my data set illustrate the importance of early access to discovery material in order to forestall or defeat a motion to dismiss and place a meritorious case on the track toward trial. Revisiting the Court of Chancery’s historic solicitude towards expedited discovery would restrict meritorious challenges to mergers and acquisitions tainted by undisclosed intrigue, such as manipulations by financial advisors.

Several of the cases in my data set demonstrate why it is problematic to extend business judgment rule protection to certain forms of controlling stockholder freeze-outs, or mergers that confer pro-rata treatment to stockholder/directors who may have unique agendas, such as a desire to obtain liquidity for illiquid blocks. In the freeze-out context, requiring plaintiffs to plead non-disclosure can be an invitation for controllers to commit fraud. In third-party acquisitions, blockholders who desire liquidity are compromised in their ability to monitor the conflicts of others, and their own conflicts and status can influence others to act against the interests of public stockholders.

A glut of meritless challenges to merger and acquisition transactions created pressures to approve insubstantial settlements, which, in turn, created pressure to find ways to reduce the incidence of the filings. Various reform measures appear to presume the necessity of under-deterrence of fiduciary disloyalty, without apparent regard for the relative recent abundance of data points of successful stockholder litigation. This article aims to focus the reform agenda in a manner that better subserves the duty of loyalty.

The full paper is available for download here.

Endnotes

1In re: Walgreen Co. S’holder Litig., 832 F.3d 718, 721, 724 (7th Cir. 2016).(go back)

2Stephen M. Bainbridge, Fee-Shifting: Delaware’s Self-Inflicted Wound, 40 Del. J. Corp. L. 851, 852 (2016) (citing Olga Koumrian, Cornerstone Research, Shareholder Litigation Involving Mergers and Acquisitions: Review of 2013 M&A Litigation 4 (2014)).(go back)

3In re Activision Blizzard, Inc. S’holder Litig., 124 A.3d 1025 (Del. Ch. 2015).(go back)

4In re El Paso Pipeline Partners, L.P. Deriv. Litig., 2015 WL 1815846 (Del Ch. 2015), rev’d on other grounds, El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff, — A.3d —, 2016 WL 7380418 (Del. Dec. 20, 2016) [hereinafter, “El Paso Pipeline”]. Despite reversing the judgment due to the plaintiff’s post-trial loss of standing, the Delaware Supreme Court noted that the Court of Chancery had issued a “well-reasoned” decision on the merits that “undertook a detailed analysis explaining why $171 million was a conservative estimate of the overpayment approved by the committee.” El Paso Pipeline, at *1.(go back)

5In re Freeport-McMoran Copper & Gold Inc. Deriv. Litig., 2015 WL 1565918 (Del. Ch. Apr. 7, 2015).(go back)

6In re Dole Food Co., Inc. S’holder Litig., 2015 WL 5052214 (Del. Ch. Aug. 27, 2015).(go back)

7RBC Capital Mkts., LLC v. Jervis, 129 A.3d 816 (Del. 2015).(go back)

8In re Jefferies Grp., Inc. S’holder Litig., 2015 WL 1414350 (Del. Ch., Mar. 26, 2015).(go back)

9J.L. Schiffman and Co., Inc. Profit Sharing Trust v. Standard Indus., 1993 WL 271441, at *1 (Del. Ch. July 19, 1993).(go back)