The Shifting Tides of Merger Litigation

Steven Davidoff Solomon is a Professor of Law at UC Berkeley School of Law. This post is based on a recent paper authored by Professor Davidoff Solomon; Matthew D. Cain, Financial Economist at the U.S. Securities and Exchange Commission; Jill E. Fisch, Perry Golkin Professor of Law at the University of Pennsylvania Law School and Co-Director, Institute for Law and Economics; and Randall S. Thomas, John S. Beasley II Professor of Law & Business at Vanderbilt University Law School. This post is part of the Delaware law series; links to other posts in the series are available here.

In The Shifting Tides of Merger Litigation, we analyze the changes to the merger litigation market in the wake of the Trulia decision which limited attorneys’ fees in disclosure-only settlements. We find that overall levels of merger litigation have declined in the past year, suggesting that Delaware’s effort to reduce frivolous litigation has been at least partially successful. In 2014, 91% of all completed deals were challenged in at least one lawsuit. That number declined to 89% in 2015 and 73% in 2016.

On the other hand, plaintiffs appear, in the short term at least, to be trying to avoid the effects of the changes in Delaware law by filing their cases elsewhere. Litigation brought in the Delaware Chancery Court has declined substantially. Of the deals completed in 2016, only 32% were challenged in Delaware, while 65% were challenged in other states and 37% in federal court. The latter number, which represents a significant increase in federal court filings, seems to be an attempt to avoid the impact of forum-selection bylaws.

We also observe differences in case outcomes. In 2016, 47% of deal litigation settled compared to 63% in 2014. Within Delaware, only 11% of cases settled in 2015, the lowest rate over the past decade. We find no evidence to indicate that the quality of these settlements differs substantially from that in prior years. We also find a substantial increase in dismissals and settlement rejections; in particular, the rate at which settlements are rejected goes from near zero to above 20%. Finally, we find a rising use of dismissal combined with the mootness fee. In 2016, 18% of cases were resolved in this manner—an all-time high. We note, however that the bulk of these fee payments relate to suits brought pre-Trulia and may therefore represent a temporary phenomenon.

We find little evidence of what might be viewed as collusive efforts to avoid the effect of Trulia. In no cases in our sample did defendants appear to ignore or waive the application of a forum-selection clause in order to avoid the effect of Trulia by negotiating a disclosure settlement in another jurisdiction that included a release and fee award.

Our sample represents the first wave of litigation following significant developments in merger law. As a result, our findings are necessarily preliminary. Nonetheless, our results document what commentators have often predicted: litigation practices respond to changes in the law and, in the short term, plaintiffs’ lawyers are adaptive and will seek alternate forms of recourse if Delaware law becomes more restrictive. Another potential adaptation may be the increase in Delaware appraisal rights proceedings—an alternative mechanism for challenging a merger. Dollar value claims for the past year reached an all-time high, perhaps reflecting the difficulty of bringing fiduciary duty claims.

Our results highlight the responsiveness of shareholder litigation to changes in the law Plaintiffs’ and defendants’ attorneys will make moves and countermoves as they seek to shift venues and forms of shareholder litigation. We also consider whether these developments are of concern, and whether Delaware should do more to eradicate frivolous lawsuits. Using the prism of Type I (false positives) and Type II error (false negatives), we argue that if Delaware makes its law more unfavorable for plaintiffs to reduce the risk of frivolous lawsuits (lowering Type I error), it risks increasing Type II error by blocking out valuable that address managerial misconduct. Extreme actions to cut down on strike suits, like fee-shifting bylaws, will inevitably trade off fewer frivolous cases for fewer good cases. As a result, we counsel caution in enacting further restrictions on merger litigation, at least until other courts have had the opportunity to respond both to the changes in Delaware law and the increasing use of forum-selection bylaws.

Finally, we consider how Delaware’s adoption of new more restrictive rules will effect its competition with other states for corporate charters. We reason that other states may seek to attract litigation by offering a more attractive environment for plaintiffs’ counsel. The greater risk for Delaware than losing its cases is losing incorporations as a consequence of its efforts to adopt litigation reforms. We also argue that some Delaware corporate law stakeholders, especially Delaware lawyers, may push back against stringent standards for shareholder litigation. Adaptive responses to these regulatory changes push and pull at Delaware’s equilibrium.

The full paper is available for download here.

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