The Viability of the Disclosure Only Settlement
For corporations facing stockholder litigation challenging a proposed business combination, negotiating a settlement in which the corporation agrees to provide additional disclosures without any increased consideration can be an efficient means of avoiding the risk of litigation. The benefit created by the additional disclosures means the plaintiff’s lawyer can apply for a fee while the corporation and its directors get a release of all claims.
Some recent decisions of the Court of Chancery, however, have cast some doubt on the ability of a "disclosure only" settlement to serve as the sole consideration for a settlement or a substantial fee. Practitioners on both sides should be aware of these developments when negotiating a settlement of litigation challenging transactions.
Although the Court of Chancery has not recently issued a written opinion refusing to approve a "disclosure only" settlement, there is precedent for doing so — e.g., the Delaware Court of Chancery's 2006 opinion in In re SS & C Technologies Inc. The issue most recently came to light in Scully v. Nighthawk Radiology Holdings Inc., a much discussed case in which the court appointed special counsel to report on whether the settlement in that case was collusive and improper.
There, the plaintiffs sought expedited proceedings to enjoin a merger between Nighthawk Radiology Holdings Inc. and another party based solely on claims of inadequate disclosures. The court denied the motion, in part, because the court felt the disclosure claims were not meritorious and, indeed, would not support a "disclosure only" settlement. The corporation then reached a "disclosure only" settlement with the plaintiffs in a parallel proceeding in Arizona and agreed to present the settlement for approval to that court. The Court of Chancery viewed this as an attempt to avoid its earlier admonition that a disclosure only settlement would not be adequate consideration to support a release for defendants, and appointed special counsel to investigate the matter.
While the special counsel in Nighthawk ultimately concluded that no collusion was present, the healthy skepticism of "disclosure only" settlements expressed by the Court of Chancery should be noted. Courts appear to be scrutinizing closely "disclosure only" settlements as part of a Delaware court’s independent duty to ensure that a settlement is fair and reasonable — e.g., the Chancery Court's 2005 opinion In re Cox Communications Inc. Shareholders Litigation. That skepticism is most clearly manifested in recent decisions analyzing fee requests in which disclosures were part of the benefit created.
For instance, on April 30's In re Sauer-Danfoss Inc. Shareholder Litigation, Consol, the Court of Chancery considered a request for $750,000 by plaintiffs’ attorneys who claimed they caused the corporation to issue corrective disclosures before the transaction was ultimately abandoned. After first determining that the plaintiffs were entitled to credit for only one of the purported 11 additional disclosures, the court began its discussion of the fee to which the plaintiffs were entitled by noting that "all supplemental disclosures are not equal." When quantifying the fee award for additional disclosures, the court "evaluates the qualitative importance of the disclosures obtained." While one or two meaningful additional disclosures might merit an award of $500,000, prior precedent in contested fee cases reveals that less meaningful disclosures yield much lower awards. With that in mind, the court awarded $80,000, in large part because the disclosures were not particularly meaningful and the plaintiffs had not actively litigated the case after filing, instead seeking to negotiate a settlement.
The court used three recent opinions to support its conclusion that an award of only $80,000 was sufficient under the circumstance. In the 2006 case In re Triarc Companies Shareholders Litigation, the court awarded $75,000 in fees and expenses for the additional disclosure that the chairman of the special committee thought the deal price was inadequate where the plaintiffs had done nothing after the disclosure mooted the claims in the amended complaint to create any benefit.
In the 2009 Chancery Court case In re BEA Systems Inc. Shareholders Litigation, the court awarded fees and expenses of $81,297 where supplemental disclosures were made before discovery, preliminary injunction briefing and hearing, but the injunction was denied.
Finally, in 2010's Brinckerhoff v. Texas Eastern Products Pipeline Co., the Chancery Court awarded fees and expenses of $80,000 to an objector to a settlement who settled his objection in exchange for additional disclosure from the corporation as Form 8-K.
The consistent thread throughout these opinions, including the recent Sauer-Danfoss decision, is that non-meaningful disclosures that were agreed to after little work by plaintiffs will not merit substantial fee awards.
What effect, then, does the court’s reluctance to award large fees for additional disclosures combined with the court’s criticism of "disclosure only" settlements have on class action and derivative litigation going forward?
First, it may provide a disincentive for plaintiffs firms to continue to file litigation in Delaware challenging transactions. The data showing a decrease in the number of lawsuits filed in the Court of Chancery has been readily available for some time now. While smaller fee awards and higher criticism of "disclosure only" settlements cannot be the sole basis for the decrease in filings in the Court of Chancery, it likely plays some role.
Second, the use of the "disclosure only" settlement may become a thing of the past due to the risk for both sides. Plaintiffs may not be willing to enter into a "disclosure only" settlement because they know they are at risk they will not be awarded a substantial fee. Defendants may not be willing to enter into a "disclosure only" settlement because they do not want to put at risk their global release if the settlement is rejected as unfair.
To be clear, there is nothing in the Court of Chancery’s current jurisprudence to suggest that a "disclosure only" settlement is per se impermissible. What is clear, however, is that to the extent that the parties to stockholder litigation challenging a business combination believed they could settle a case for the relatively inexpensive cost of making additional information available to the stockholders, that path must be followed carefully while keeping in mind the authorities cited above.
Peter B. Ladig ( firstname.lastname@example.org) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group. He represents both stockholders and directors in corporate litigation. The majority of his practice is in the Delaware Court of Chancery, although he has extensive experience in the other state and federal courts in Delaware and has been involved in over 50 published decisions. The views expressed herein are his alone and not those of his firm or any of the firm's clients.