A series of recent Delaware court decisions have caused some plaintiffs law firms to decide stockholder litigation should no longer be filed in the Delaware courts. This article will first explain the background to their views and then discuss whether they are right to be concerned about the future of stockholder litigation under Delaware corporate law. We first wrote about these developments in our April 22, 2017 article, available on our blog. This is an update.
The concern arises out of three developments in Delaware corporate litigation. First, in In re Trulia Stockholders Litigation, 129 A.3d 884 (Del. Ch. 2016), the Delaware Court of Chancery discouraged the filing of so-called “merger objection” suits that attacked almost every merger under Delaware law. The court refused to approve “disclosure-only” settlements of those suits that provide handsome fees to the plaintiffs lawyers in return for modest supplemental proxy disclosures. As a result, the plaintiffs bar largely stopped filing those suits in Delaware state courts and instead filed them in various federal courts alleging securities law violations. That trend has continued, even though the Trulia rationale has been increasingly followed by other courts.
Second, in Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015), the Delaware Supreme Court held that the approval of a transaction by an adequately informed, uncoerced majority of a corporation’s disinterested stockholders would provide business judgment rule protection for directors. That led to the dismissal at the pleadings stage of many complaints that did not allege facts sufficient to show the directors acted disloyally. Corwin has now been applied in several additional contexts, such as when a tender offer gains the support of stockholders followed by a merger without a formal stockholder vote.
Third, and more recently, the Delaware courts have repeatedly found in stock appraisal cases that the “fair value” of stock is equal to or even less than the deal price in a merger. That means the plaintiffs (and their lawyers) lost millions of dollars in those suits, in terms of the legal and expert witness fees and in some cases failing to receive even the merger price for their stock.
The impact of these appraisal decisions may even extend beyond appraisal litigation. For example, in some breach of fiduciary duty litigation, any damages will be measured by the value of a corporation’s stock. That would be the case if the suit alleged an unfair sale of stock to corporate controllers. But if the sale took place at the current market price and “fair value” is to be measured by the market price, there are no damages as a result if those appraised decisions apply.
The appraisal decisions will also impact how mergers are documented. Decisions holding that the fair value of a target’s stock is less than the actual deal price support that result by finding the deal price included synergies—benefits that arose only because of the merger. At least until now, the Delaware courts have held that the Delaware appraisal statute does not permit the value of synergies to be included in determining the fair value of dissenters’ stock. As a result, it is expected that every acquirer will contend in its documentation of the deal (and have its investment banker advise it) that the deal price included synergies. That claim may be hard to disprove. Appraisal petitioners need to worry about that issue.
While these developments are of understandable concern to the plaintiffs bar, their actual impact is yet to be seen outside of the decline in merger-objection litigation. Here are some of the reasons why stockholder litigation will continue in Delaware. First, Delaware continues to insist that full disclosure is necessary to obtain the benefits of the “Corwinprotection.” On Feb. 20, the Delaware Supreme Court in Appel v. Berkman, (C.A. 316, 2017) held that Corwin did not apply when the proxy materials failed to disclose that the chairman of the board had declined to vote for the merger because he believed it was not a good deal. That decision arguably changed prior law that mere opinions of a director need not be disclosed. This shows that Corwin protection is not automatically invoked.
Second, Delaware continues to permit broad stockholder rights of inspection of corporate records. While that right is conditional on a showing of a proper purpose, that showing has been characterized as involving the “lowest possible burden of proof.” Thus, just as recently as Feb. 22, in KT4 Partners v. Palantin Technologies, (Del. Ch. C.A. 2017-0177-JRS), the Court of Chancery upheld inspection rights as a way to compensate for the corporation’s failure to otherwise properly communicate with stockholders. While admittedly there were other reasons to permit the inspection sought, KT4 does show how broad that right is in practice. Broad inspection rights may permit litigants to adequately plead enough facts to support a stockholder’s rights to litigate claims in Delaware.
Third, Delaware law on stockholder litigation still provides favorable treatment of many claims, including requiring the close scrutiny of transactions involving conflicted directors. As held on Feb. 6, 2018, in In re PLX Technology Stockholders Litigation, (Del. Ch. C.A. No. 9880-VCL) (Order), the Court of Chancery declined to grant summary judgment because the Delaware law was still unsettled on the standard of review to be used in such cases. There is room for plaintiffs to win their case.
Ultimately, the Delaware Supreme Court will resolve the proper role of stockholder litigation in Delaware corporation law. It may well be that the court will decide that reliance on stockholder action, by voting for a transaction or accepting a merger, is preferable to the uncertainty of litigation. After all, litigation in itself is not a desirable way to balance competing interests when the parties involved are able to do that themselves. When there is no other way in place to protect stockholder interests, then stockholder litigation has its proper place. The Delaware Supreme Court is on its way to figuring out that balance.