Is the Court of Chancery Reforming Stockholder Litigation?
A real change is going on in stockholder litigation in Delaware. Yet it is largely unnoticed because of the uproar over what will someday be seen as just a Supreme Court decision that did not have a lasting impact. We need a longer perspective to appreciate what is happening.
First, however, we need to understand the recent problems in stockholder litigation that have provoked such ire. For several years now, almost every significant corporate merger of public companies has attracted litigation. Lawyers for small stockholders file these suits as soon as a possible deal is announced and even before the details are established. Compounding the costs of this litigation, these suits are often filed in several jurisdictions, forcing companies to defend themselves against the same allegations in multiple forums. The speed with which these suits are filed must mean that little, if any, real factual investigation is done before allegations of wrongdoing are made. It is no wonder corporate defendants find this litigation vexatious.
To add salt to the wound, the plaintiffs lawyers are almost always paid off by a fast settlement with only some slight additional corporate disclosures to stockholders that serve to justify a fee award to the lawyers. Neither the company nor the stockholders benefit from this widespread practice.
There is no easy way to fix this practice, either. After all, regularly a truly meritorious case turns up serious abuses by insiders and boards of directors and substantial damages are won that really benefit stockholders. Without the policing effect of stockholder litigation, there is little doubt that wrongdoing would multiply. Thus, simply barring stockholder litigation is not a good idea.
Two solutions have recently been proposed. First, to stop multiple lawsuits in different jurisdictions, corporations have begun adopting forum-selection bylaws. Those bylaws pick an exclusive forum for intercompany disputes, typically Delaware. The courts have upheld those bylaws and dismissed suits filed in a jurisdiction not selected or enjoined prosecution of suits filed in the wrong jurisdiction. Nonetheless, addressing the multiple suit problem by a forum-selection bylaw does not stop unjustified litigation in the chosen forum. More needs to be done.
The boldest proposal was to adopt a corporate bylaw that required the payment of attorney fees by a stockholder plaintiff who lost a suit against the corporation or its directors. Because the risk involved in litigating (the payment of fees) outweighed so much the possible small recovery an individual stockholder might win, the fee-shifting bylaw would effectively end most stockholder litigation. Only a foolish stockholder would take the risk involved in litigating. When the Delaware Supreme Court in ATP Tour v. Deutscher Tennis Bund, No. 534,2013 (May 8, 2014), upheld such a bylaw, the end of stockholder litigation seemed near.
Of course, some commentators argued that corporations would not rush to adopt fee-shifting bylaws out of fear of alienating institutional investors. But many others lacked such faith in the benevolence of corporate insiders. While there have been attempts to draft narrowly focused fee-shifting bylaws that would only discourage unfounded litigation, that is very hard to do. For Delaware especially, the fear is that fee-shifting bylaws would end Delaware courts' role as the neutral adjudicator of corporate disputes.
The Delaware corporate bar reacted quickly. By proposing legislation that would overrule ATP Tour, they intend to preserve Delaware's role in corporate disputes that properly balance stockholder rights to remedy abuse while not subjecting directors to liability for business judgments. As this is written, it remains unclear if that legislation will be enacted. While such legislation may be a good idea, it will still leave untouched stockholder litigation that really is abusive at its worst and too often unjustified in terms of the little benefits generated.
It is this area of problem litigation that the Delaware courts are slowly, but steadily stepping in to offer a solution. To begin with, the courts are expanding the applicability of the business judgment rule to protect transactions against stockholder attacks. For example, the courts have held that stockholder-protection procedures (such as majority of minority voting requirements and special independent negotiating committees) may mean an even otherwise-conflicted transaction with a majority stockholder will be subject to the protections of the business judgment rule. That discourages stockholder litigation when it is so difficult to prevail as a plaintiff.
Less well-noticed but probably just as effective over the long-term, the Delaware courts are more carefully reviewing settlements of stockholder litigation. Much more frequently, the Court of Chancery is refusing to approve settlements that provide little benefit to stockholders or their corporation. Minor additional disclosures no longer will justify a settlement. And even when the settlement is approved, the fees awarded to the plaintiffs lawyers are decreasing. Lousy additional disclosures mean much-reduced fees, if any at all. While hard statistics are difficult to come by because most settlement hearings do not result in written opinions, it is probable that over the last 12 months, more settlements have been rejected and fee awards decreased than in any long comparable period in the past. Our research documents six such decisions in the last 12 months alone. Over time, this should lead to less hasty and unfounded stockholder litigation.
This case-by-case development of the law is in the best tradition of the common law. That may be hard to accept for some in our age of instant exploitation of even minor events. But while this trend may not be readily apparent to all, the gradual approach of the Delaware courts is surely the preferable course for now. The knowledgeable plaintiffs bar has taken notice, we are told. Hopefully, these recent decisions will discourage bad cases, but still encourage the plaintiffs attorney with a good case to press ahead.