It is striking that a vast majority of deals involving a controlling stockholder lead to litigation filed within days, if not hours, of the public announcement of the transaction. In fact, sometimes litigation is filed even before an actual transaction is announced, simply upon notice that a transaction may be proposed soon. It strains credulity to believe that today so many deals involving controlling stockholders are actionable for breach of fiduciary duty or failure to properly disclose the background to the deal.
Of course, the reality is that these early filings seldom involve a meaningful analysis of the merits. Instead, these early filings represent a race to the courthouse by plaintiffs law firms. The race begins when a law firm first posts on its website or on a company blog set up by day traders that the firm is "investigating" a proposed deal with a controlling stockholder. Soon, the firm and other plaintiffs firms find stockholders who are willing to be their plaintiffs, and the suits follow immediately. Once the company's public filings are made, the various complaints may be amended to attack the filings as inadequate or misleading. Too often, negotiations with the plaintiffs' lawyers immediately follow. A settlement is reached with some modest benefit conferred on the stockholder class and with attorney fees included. This form of "pay-off" is cheaper than litigating all the suits and gains a class-wide release of stockholder claims that adds certainty to the final deal terms.
Is this an ideal system? The amount of cash involved with these settlements usually is comparatively small. The plaintiffs' lawyers do perform some functions because they do review the disclosures for accuracy, and their very presence in the "game" may tend to keep the controlling stockholders more in line, if not entirely fair to the other stockholders.
Yet this type of litigation generally gives stockholder litigation a bad name in corporate America. Directors understandably do not like being sued. In this Internet Age, the record of a director being sued for breach of fiduciary duty exists in perpetuity. The haste these suits involve clearly establishes that little investigation went into the merits of the suits, despite the harsh allegations often found in the complaints. The very idea of then paying the plaintiffs' lawyers hundreds of thousands or even millions of dollars for having cast doubt on directors' integrity seems too much.
At least until recently, this system was often rationalized as costing less money and time than the alternative of actually going to court to establish at trial the falsity of the claims. Asking the court to dismiss these suits at the outset seemed impossible. The court rules did not permit defendants to show a complaint's allegations were false without first going through pretrial discovery. The Delaware Supreme Court's Lynch doctrine held that the controlling stockholder has the burden of proving the deal he or she proposes is entirely fair to the other stockholders. That showing usually required a trial, as a motion to dismiss at the inception of the litigation had little chance of success.
This dance may now be changing. The Court of Chancery seems to have signaled a greater willingness to dismiss stockholder suits at earlier stages of litigation. The plaintiffs' main pressure point of causing a deal to be delayed absent settlement may be disappearing. Hence, the system of racing to the courthouse may be coming to an end. Of course, any such change will invite plaintiffs to fight back. We will see if they do.
A few recent decisions illustrate the Delaware Court of Chancery's increasing willingness to dismiss some stockholder claims before trial. In Monroe County Employees' Retirement System v. Carlson,2010 WL 2376890 (Del. Ch. June 7, 2010), the court dismissed a complaint that alleged a controlling stockholder profited by an unfair management services agreement with the controlled company. Chancellor William B. Chandler III concluded that the plaintiff had failed to plead concrete facts that would show the services agreement was unfair. Similarly, if a complaint simply alleges that a controlling stockholder is eliminating the minority stockholders at an unfair price (as many of these race-to-the-courthouse suits allege), that too should be deficient. Such a complaint should then be dismissed.
More recently, in a decision that may mark a significant change in Delaware jurisprudence, the Court of Chancery held that the business judgment rule should be applied to a deal that mimics third-party transactional approvals via use of a well-functioning, independent special committee and a majority-of-the-minority vote requirement. See In re CNX Corp. Stockholders Litigation, 4 A.3d 397 (2010). Vice Chancellor J. Travis Laster's holding suggests that, assuming certain procedural protections, defendants may quickly win dismissal even in a challenge to a controlling stockholder acquisition if the allegations simply are that the transaction is "not fair." In re CNX also suggests that, at least when a publicly traded company is involved, the court can consider public filings in deciding if a motion to dismiss should be granted. If those public filings indicate that an independent special committee seriously negotiated the transaction and was properly advised, and that the transaction was subject to the approval of a majority of the minority stockholders, mere allegations of unfairness may lack the factual support to sustain the complaint.
Viewing recent case law in this light suggests that, moving forward, if a defendant makes the right argument, the Court of Chancery may well dismiss a fast-filed complaint. While an appeal to the Delaware Supreme Court will likely follow, that court has demonstrated it too can act quickly. If a motion to dismiss is granted and upheld, it may represent the beginning of the end of suits racing their way to the courthouse.
This article was originally published in the Delaware Business Court Insider | August 29, 2012