2019 Developments in Securities and M&A Litigation

Roger CooperJared Gerber, and Mark McDonald are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Mr. Cooper, Mr. Gerber, Mr. McDonald, Ryan Madden, and Suzannah Golick.


In 2019, the Supreme Court issued an important securities law decision in Lorenzo v. SEC, which clarified the scope of “scheme liability” under Rule 10b-5(a) and (c). However, the Supreme Court’s year was noteworthy more for the cases the Court declined to decide than for the cases it did decide. The Court declined to rule on several significant issues arising from the Ninth Circuit, including whether plaintiffs must show that the defendant acted with scienter when bringing claims under Section 14(e), whether foreign issuers can face liability with respect to unsponsored American Depositary Receipts under Morrison, and the standard for establishing loss causation.

The circuit and district courts also addressed several contested securities laws topics, including a significant ruling from the Tenth Circuit in SEC v. Scoville, which held that the Dodd-Frank Act permits the SEC to bring claims based on sales of securities that do not constitute domestic transactions within the meaning of Morrison. The Second Circuit also found limits to the extraterritorial reach of the CEA in Prime International Trading v. BP P.L.C. when the transactions at issue were “predominantly

With respect to M&A litigation, the Delaware Supreme Court continued to clarify its jurisprudence with respect to appraisal methodology as well as the protection MFW affords to controlled transactions. The Court also released important opinions pertaining to oversight duties for boards of directors and the fiduciary duties of activist investors. The Delaware Court of Chancery continued to see a rise in litigation pertaining to books and records demands under Section 220. It also issued decisions reflecting its continued strict enforcement of the plain language of provisions in merger agreements.

Delaware Supreme Court Affirms Finding Of A Breach Of Fiduciary Duty By Activist Investor

In May 2019, the Delaware Supreme Court in In re PLX Technology Inc. Stockholders Litigation affirmed a decision concerning both (i) an activist stockholder’s aiding and abetting a board’s breaches of fiduciary duty and (ii) damages.

The case arose after activist investor Potomac Capital Partners II, L.P. (“Potomac”) acquired a stake in PLX Technology Inc. (“PLX”) for the purpose of inducing (ultimately successfully) PLX to sell itself to a company called Avago. A co-managing member of Potomac, Eric Singer, attained a position on the PLX board of directors. Singer received a tip that disclosed significant information about Avago’s interest in acquiring PLX. Singer failed to disclose this tip to the rest of the PLX board, and the tip was also not disclosed to PLX stockholders. The Court of Chancery found after a trial that failing to disclose the tip to stockholders was a material omission that amounted to a breach of Singer’s duty of disclosure as a director, and that Potomac had aided and abetted the breach through Singer’s actions as an agent of Potomac.

However, the Court of Chancery also found that the plaintiffs had failed to prove any damages. The plaintiffs argued that the company should not have been sold at all and that they had suffered damages in the amount of the difference between the merger consideration and the company’s “fair” or “intrinsic” value as a going concern. The Court of Chancery disagreed. Relying on recent decisions from the Delaware Supreme Court in the context of appraisal actions, it found that the deal price was sufficiently reliable evidence of the company’s fair value notwithstanding the flaws in the sale process. On appeal, the Delaware Supreme Court affirmed the finding on damages, and therefore declined to reach the issue of breach of fiduciary duties.

This decision underscores the importance of full disclosure of material facts in cases involving potential conflicts at the board level and at the stockholder level. And it demonstrates the Delaware Supreme Court’s comfort with expanding its recent appraisal jurisprudence, which gives substantial deference to deal price in arm’s length transactions, into other contexts.

Delaware Supreme Court Clarifies Timing Requirements To Trigger “Dual Protections” Under MFW

In April, in Olenik v. Lodzinski, the Delaware Supreme Court further clarified when the “dual protections” outlined in Kahn v. M&F Worldwide Corp. (“MFW”) must be put in place in order to qualify a take-private transaction for deferential business judgment review.

Under MFW, business judgment review applies to a take-private transaction proposed by a controlling stockholder when the transaction is conditioned “ab initio” on two procedural protections: (1) the approval of an independent, adequately-empowered special committee that fulfills its duty of care; and (2) the uncoerced, informed vote of a majority of the minority stockholders. If the controlling stockholder does not commit to these dual protections from the beginning of negotiations, then the traditional entire fairness standard applies instead. Recently, the Delaware Supreme Court explained in Flood v. Synutra International, Inc., a case won by Cleary Gottlieb, that the dual protections must be put in place “early in the process and before there has been any economic horse trading.” Synutra clarified that the controlling stockholder is not required to include the dual protections in its initial written offer to receive protection under MFW.

The Olenik decision provides further guidance about the application of MFW. The transaction at issue was a stock-for-stock merger between two companies both controlled by the same stockholder, which was alleged to have actively participated in the conception and negotiation of the transaction. Minority stockholders of one of the companies challenged the transaction post-closing seeking damages. Although the Court of Chancery dismissed the claims, the Delaware Supreme Court reversed, holding that the complaint pled facts “support[ing] a reasonable inference” that the controlled companies and the controlling stockholder had effectively engaged in “substantive economic negotiations” before the dual protections were in place, and thus the complaint “should not have been dismissed on MFW grounds.”

The implication of the Court’s holding in Olenik, along with its recent holding in Synutra on the “ab initio” requirement, clarifies the line between “preliminary discussions” (which are permissible before MFW’s dual protections are put in place) and “substantive economic discussions” (which are not). For example, exploratory meetings and initial exchanges of information may be sufficiently “preliminary” such that they can be done before the dual protections are put in place without triggering entire fairness review, but a discussion of valuation or significant deal terms is likely to preclude business judgement review.

Delaware Supreme Court Reaffirms Director Oversight Obligation

In Marchand v. Barnhill, the Delaware Supreme Court reversed the Court of Chancery’s dismissal of a Caremark claim, providing guidance on the role of the board of directors in overseeing risk management. The case arose out of a listeria outbreak at Blue Bell Creameries USA in 2015, which resulted in the death of three customers, a complete product recall, a liquidity crisis, and a temporary closure of manufacturing facilities. The plaintiffs brought claims against key executives, alleging that they breached their duties of care and loyalty—specifically that deficiencies in food safety controls were uncovered, yet the board failed to discuss any problems. The Court of Chancery dismissed the claims, but in June 2019, the Delaware Supreme Court reversed, holding that the plaintiffs had sufficiently alleged that the board breached its duty of oversight by failing to make a good-faith effort to establish a board-level system to monitor food safety and compliance—a key risk facing the company. The alleged “utter failure” to attempt to develop such a reporting system constituted an unexculpated act of bad faith and a breach of the duty of loyalty. The case is a reminder that Caremark claims still have teeth, especially on facts as striking and consequential as those in this case. By the same token, boards can protect themselves from such claims by taking steps to design a functional risk management and oversight system.

Boards should ensure that protocols for regular reporting on key risks are in place and that these procedures are properly documented. The Court offered concrete suggestions, advising that boards should consider risk management efforts on quarterly or biannual bases.

In October, in In re Clovis Oncology, Inc. Derivative Litigation, the Delaware Court of Chancery denied a motion to dismiss a shareholder derivative suit, applying the “duty to monitor” doctrine expanded in Marchand v. Barnhill. Shareholders of Clovis Oncology Inc. brought a Caremark claim alleging that the board ignored red flags in the testing of a lung cancer treatment called Rocilentinib. The clinical trials for Rocilentinib failed to follow standard protocol, which would prevent the drug from gaining FDA approval. The Company allegedly made public statements about the success of trials that were inconsistent with the information the board received. When Clovis withdrew the drug from FDA consideration in 2016, the stock price plummeted.

The Delaware Court of Chancery interpreted Marchand as requiring a higher level of board oversight in industries where “externally imposed regulations govern its ‘mission critical operations.’” This decision may invite a higher volume of Caremark claims against boards of companies operating in such industries.

Delaware Court Of Chancery Strictly Enforces “End Date” Of Merger Agreement

In Vintage Rodeo Parent, LLC v. Rent-a-Center, Inc., the Delaware Court of Chancery found that a target company properly terminated a merger agreement following the passage of the specified “end date” where the buyer—apparently due to a mistake—failed to exercise its right under the agreement to give notice that it wished to extend the end date.  The Court further determined that there was no implied duty to warn a counterparty of such a mistake, and that an obligation to use commercially reasonable efforts to consummate a merger does not preclude exercise of an express right to terminate the merger agreement. The court, however, requested additional briefing regarding the enforceability in this context of the $126.5 million reverse termination fee to which the target claimed to be entitled, which constituted 15.75% of the equity value of the transaction. The case settled before that issue was decided, but the decision is a stark reminder that courts will strictly enforce the terms of a merger agreement as written, and that the failure to comply with seemingly ministerial formalities can have potentially severe consequences.

Delaware Court Of Chancery Rules On Privilege Of Pre-Merger Attorney-Client Communications

In Shareholder Representative Services LLC v. RSI Holdco, LLC, the Court of Chancery upheld a provision in a merger agreement that precluded the buyer from using the seller’s pre-merger attorney-client privileged communications in a post-closing dispute. The Court had previously addressed the issue in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, which held that privileges over attorney-client communications transfer to the surviving company unless the seller takes affirmative action to prevent it. In RSI Holdco, the seller negotiated for a provision in the merger agreement that allowed the seller to continue asserting privilege over pre-merger attorney-client communications and prohibited the buyer from using these communications in post-closing litigation. The Court held that the plain language of the contractual provision prevented the buyer from using or relying on the seller’s pre-merger privileged communications in the post-closing litigation. The Court disagreed with the buyer’s contention that the seller’s failure to excise or segregate the privileged communications from the computers that were transferred as part of the deal constituted a waiver of the privilege, reasoning that such an argument would undermine the policy behind Great Hill, which encourages “parties to negotiate for contractual protections.”

Payment of a Contractual Termination Fee Was not the Exclusive Remedy for a Breach of a Non-solicitation Clause

In Genuine Parts Co. v. Essendant, Inc., the Delaware Chancery Court denied Essendant Inc.’s motion to dismiss an action for wrongful termination of a merger agreement even though the defendant had already paid the contractually required fee. Essendant and Genuine Parts had entered into a merger agreement, which Essendant backed out of in favor of an acquisition by Staples for a higher price. The merger agreement specified a $12 million termination fee, which Essendant paid, but Genuine Parts alleged that Essendent had materially breached the contract’s non-solicitation clause, and therefore the termination fee was not the “exclusive remedy” for terminating the transaction. The court held that the contract did not clearly and unambiguously limit recovery to the termination fee in the face of a claim that the defendant had breached the contract’s non-solicitation clause.

Northern District of Illinois Rejected “Mootness Fee” as a “Racket”

Northern District of Illinois Judge Thomas Durkin abrogated a settlement agreement in the securities litigation concerning the acquisition of Akorn, Inc. by Frensenius Kabi AG, calling the lawsuit and quick settlement for attorneys’ fees a “racket.”

As has become increasingly common, once the company filed its proxy describing the proposed transaction, shareholders brought a putative class action seeking disclosure of additional information that could purportedly affect shareholder approval of the merger, and the parties settled for additional disclosures of dubious materiality and attorneys’ fees.

Although such “mootness fee” settlements do not involve any class-wide release and thus do not require court approval, Judge Durkin used Akorn as an opportunity to scrutinize this practice. The court ordered plaintiffs’ lawyers to return to Akorn a $322,000 “mootness fee.” The Court invoked its equitable power to abrogate the fees because the information sought by the lawsuit “worthless to shareholders.” An appeal is currently pending.

Delaware Court Of Chancery Holds that Documents Produced to a Special Litigation Committee are Subject to Discovery

In December, the Delaware Chancery Court issued a memorandum opinion in In re Oracle Corporation Derivative Litigation finding that the lead plaintiff in a shareholder derivative suit against Oracle’s board of directors had the right to subpoena documents relied upon by the corporation’s Special Litigation Committee (SLC) in making its determination as to whether litigation against Oracle should be allowed to proceed, including privileged documents Oracle had produced to the SLC.

The case arose from Oracle’s acquisition of Netsuite in November of 2016. Oracle’s co-founder, chairman, 35% shareholder, Lawrence J. Ellison, was also the co-founder and a 39% shareholder of Netsuite. Plaintiffs brought a shareholder derivative suit for breach of fiduciary duty against Ellison and others. The company formed the SLC to investigate the claims and represent the corporation’s interests, and in the course of its investigation the SLC accumulated a large volume of documents and communications. The SLC then decided, in an unusual move, 1) that claims against its founder and chairman should proceed, and 2) that the Lead Plaintiff should be the one to prosecute those claims. The Lead Plaintiff then subpoenaed the SLC’s documents, and the Court held that the SLC was entitled to the documents.

The Court’s decision has potential ramifications for SLCs in the future, despite the unusual posture of the decision including concerning the scope of the documents it requests, whether it seeks privileged documents, and the degree to which individuals agree to produce privileged documents. SLCs should, therefore, be cognizant of these potential ramifications when they collect and prepare documents in connection with an investigation.

Section 220 Books and Records Requests

In 2019, the Delaware Court of Chancery continued to see a rise in litigation pertaining to books and records demands under Section 220 of the Delaware General Corporation Law. Delaware courts have encouraged stockholders to seek books and records under Section 220 before filing stockholder derivative or post-merger damages suits. These decisions show that Delaware courts are increasingly willing to permit stockholders to gain access to electronic records (even, in some cases, personal emails and text messages) where there are gaps in the board’s minutes and other formal materials, although such stockholders must continue to make a threshold showing that they have a proper purpose and legitimate need before the court will order such records turned over.

In KT4 Partners LLC v. Palantir Technologies Inc., the Delaware Supreme Court clarified when emails may be available as part of a Section 220 demand. The stockholder in the case had demonstrated that the company corresponded via email in relation to the potential wrongdoing the stockholder was investigating, and the company conceded that it did not maintain traditional records related to the issue, such as board resolutions or minutes. The Court explained that “if a company … decides to conduct formal corporate business largely through informal electronic communications [rather than through formal minutes and resolutions], it cannot use its own choice of medium to keep shareholders in the dark about the substantive information to which § 220 entitles them.” But the Court emphasized that this “does not leave a respondent corporation … defenseless and presumptively required to produce e-mails and other electronic communications. If a corporation has traditional, non-electronic documents sufficient to satisfy the petitioner’s needs, the corporation should not have to produce electronic documents.”

In Tiger v. Boast Apparel, the Delaware Supreme Court held that books and records produced under Section 220 are not subject to a presumption of confidentiality, though the Chancery Court typically imposes a reasonable confidentiality order. The primary dispute was the scope of confidentiality if the documents in question were produced, and the Chancery Court eventually recommended an indefinite confidentiality period lasting until Tiger filed suit. The Delaware Chancery Court had relied on a presumption of confidentiality for Section 220 production, which the Delaware Supreme Court rejected. However, the Delaware Supreme Court found that the confidentiality agreement was reasonable in the circumstances, and thus upheld it on different grounds.

Two Court of Chancery decisions, both by Vice Chancellor Slights, illustrate what a stockholder must show to present a “credible basis” from which to infer corporate wrongdoing, as required to demonstrate a proper purpose for a Section 220 request. In Hoeller v. Tempur Sealy International, Inc., the Court found that termination of a supply contract by the company’s largest customer was not, by itself, a “credible basis” from which to infer wrongdoing. The Court emphasized that “the stockholder’s burden [is not] a mere speed bump.” By contrast, in In re Facebook, Inc. Section 220 Litigation, the Court found that a Facebook stockholder had succeeded in showing a credible basis for wrongdoing in connection with Facebook’s data privacy breaches.

The Court emphasized that it was not appropriate to assess the merits of the stockholder’s Caremark claim when adjudicating the Section 220 demand. In November in High River Ltd. P’ship v. Occidental Petroleum Corp., the Delaware Chancery Court denied a Section 220 books and records request to support a proxy contest. Plaintiffs tried to argue for expanded Section 220 access to documents for the purpose of communicating with other shareholders in a proxy contest. However, the Court declined to recognize such a categorically expanded rule, noting that there was no precedent for “compell[ing] a company to allow inspection of books and records when the stockholder’s only stated purpose for inspection is a desire to communicate with other stockholders in furtherance of a potential proxy contest.”

In Inter-Local Pension Fund GCC/IBT v. Calgon Carbon Corp., Vice Chancellor Zurn ruled that a company was not entitled to reject a Section 220 demand on the basis that it was an impermissibly lawyer-driven effort. The investment fund had certain agreements (to monitor the fund’s investments, identify potential mismanagement or wrongdoing, and pursue appropriate legal action) with the outside law firm that drafted and sent the Section 220 demand. Vice Chancellor Zurn found as a factual matter that the fund’s purpose was not different from its counsel’s purpose, and thus permitted a limited inspection to go forward. But the case is a helpful reminder that books and records actions may be dismissed if discovery shows that there are differences between the aims of the stockholder and its counsel in issuing the demand.

Director Access to Privileged Information Decisions

In Gilmore v. Turvo, the Delaware Court of Chancery explained that the general rule that a director is entitled to communications with counsel for the board has exceptions, but the threshold issue is whether the attorney involved represents the whole board, or just selected board members. The court restated the general rule that a Delaware corporation “cannot assert the privilege to deny a director access to legal advice furnished to the board during the director’s tenure.” However, an important condition to the general rule is that the legal advice be furnished to the whole board. In this case, a law firm was hired to conduct an internal investigation only by certain stockholders, and the court determined that the firm conducting that internal investigation did not represent the board as a whole. Therefore, the board member who filed a motion to compel in this case was not entitled to attorney/client communications with that firm.

In contrast, a director was entitled to access corporate records in Schnatter v. Papa John’s. The Court considered a claim under Section 220(d) of the Delaware General Corporation Law (DGCL) by the founder and largest stockholder of the Papa John’s pizza chain who was forced out as the CEO but retained his position as a director. He sought to obtain books and records in his capacity as a director to support an investigation that the other directors breached their fiduciary duties by improperly ousting him for unjustified reasons. The court emphasized the rule that directors generally have near unfettered access to the corporation’s books and records.

Appraisal Decisions

In 2019, Delaware courts issued several important decisions in statutory appraisal cases. Statutory appraisal litigation, which often follows major mergers, involves assessing the fair value of a target company’s shares, excluding any merger-created value. In accordance with the statute, the Delaware Chancery Court may consider all relevant factors, but case law has developed to put particular emphasis on two market-based valuations of share value: unaffected market price and deal price.

In April 2019, the Delaware Supreme Court in Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. clarified the extent to which the Court of Chancery may rely on stock trading prices when determining fair value in an appraisal action. In two previous opinions, the Delaware Supreme Court had emphasized that the deal price will often be the best evidence of fair value in appraisal actions involving open, competitive, and arm’s-length mergers of publicly-traded targets. However, neither prior case involved a merger where the transaction resulted in significant synergies, which are excluded statutorily from the determination of fair value. The Chancery Court sidestepped the need to precisely calculate deal synergies by finding that the fair value was the unaffected market price, calculated as the thirty day average market price at which the shares traded before the transaction was publicly reported.

In a strongly-worded per curiam opinion, the Delaware Supreme Court reversed. The Delaware Supreme Court criticized the selection of the average market price prior to public announcement, and held that the proper approach was to start with the deal price and then subtract the synergies resulting from the deal. The Delaware Supreme Court selected the company’s calculation of deal synergies to arrive at the fair value calculation.

Nevertheless, in In re Appraisal of Jarden Corporation, the Court of Chancery held that unaffected market price was the best indicator of Jarden’s fair value following its acquisition by Newell Rubbermaid, Inc., even though this resulted in a substantial 18.4% discount to the merger consideration. The court distinguished Aruba and found that the unaffected market price was a better measure because of procedural defects in the sale which affected the deal price. Jarden’s CEO had met and negotiated with Newell’s CEO on certain deal terms, including sales price, without proper Board authorization.

These procedural issues were found to have affected the final merger consideration. The unaffected market price was a better indicator of Jarden’s fair value because the stock traded in a highly efficient market, never closed above the merger price, had a low bid-ask spread and a high public float, and was frequently assessed by professional analysts. There was also no controlling stockholder. A partial reargument was granted on September 16, which adjusted the final calculation of share value due to mathematical errors, but did not disturb the Court’s reasoning.

The Chancery Court reached the opposite conclusion in assessing the acquisition of Columbia Pipeline Group, Inc., by TransCanada Corporation. In that case, deal price was a reliable indicator of fair value, because the sale had objective indicia of fairness. The transaction was a the result of an arms-length negotiation with an outsider third party, the target successfully negotiated for price increases, the purchaser conducted thorough due diligence, and there were no board conflicts. The Court considered whether management’s desire to retire immediately created a personal conflict, but concluded that this objective was not a material conflict.

While these decisions reached somewhat different results, they all found fair value to be at or below the deal price, and thus may continue to discourage the filing of appraisal arbitrage actions in Delaware.

The complete publication, including footnotes, is available here.

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