Federal Courts Turn Away Delaware’s Redirected Merger Suits

David McKinley

Between 2015 and 2017, Delaware state courts made substantial efforts to reduce their volume of merger litigation by (1) expanding the business judgment review to cover a broader swath of mergers and (2) denying plaintiffs attorneys’ fees in disclosure suits if their lawsuits do not confer a substantial benefit on shareholders. These measures were effective; in May 2017, Law360 published an article on the “exodus” of deal suits from Delaware’s Chancery Court.[1] The exodus, it turned out, was simply a migration to federal court, and in September 2019, federal courts attempted to stem this migration. In Scott v. DST Systems, a Delaware federal judge denied plaintiff-shareholders attorneys’ fees stemming from their suit over an allegedly misleading merger proxy statement.[2] The case followed a typical pattern of M&A strike suits. A strike suit is typically a derivative action, “often based on no valid claim, brought either for nuisance value or as leverage to obtain a favorable or inflated settlement.”[3] In February 2018, DST Systems solicited shareholder support for a proposed $5.4 billion acquisition by SS&C Technologies. A few weeks after the DST board published its initial proxy statement, plaintiff DST shareholders filed suit alleging material deficiencies in the proxy disclosures. The board responded with a supplemental proxy statement, curing the alleged deficiencies and mooting the plaintiffs’ suit. The plaintiffs then moved for attorneys’ fees.

The Delaware federal court relied heavily on Delaware state court precedent in finding the plaintiffs failed to sufficiently demonstrate the materiality of the omitted proxy materials. Although not discussed in DST Systems, the relevant state court precedent begins with the 2015 Delaware Supreme Court ruling in Corwin v. KKR Financial Holdings.[4] In that case, the court held that the business judgment rule applies to a derivative merger suit when the merger was approved in a fully informed, uncoerced vote by a majority of disinterested shareholders. Although unrelated to attorneys’ fees, this ruling substantially disincentivized tenuous post-merger litigation because defendants could more easily be granted a motion to dismiss, thus eliminating much of plaintiffs’ leverage. Since 2015, the rate of litigation over large mergers in Delaware state court has fallen from nearly 60 percent to just 5 percent.[5]  At the same time, the rate of litigation in federal court has climbed from 19 percent to 92 percent.[6]

Although the Corwin ruling played a role in shunting shareholders and their lawyers out of Delaware state court (and—at least until DST Systems—mostly into federal court), another decision was particularly effective at pushing less than meritorious claims out of the Delaware Chancery Court: In re Trulia. That case, decided in 2016, precipitated from the proposed Trulia-Zillow merger.[7] Trulia shareholders claimed that deficiencies in the board’s proxy statement misled shareholders as to the value of the merger. When Trulia quickly cured the alleged deficiencies, the plaintiffs moved for attorneys’ fees as part of their settlement. The court denied the fees, solidifying Delaware courts’ position that disclosure-only settlements are appropriate only when plaintiffs can demonstrate that a misstatement or omission would have substantially affected a shareholder vote. Here, 99 percent of Trulia shareholders approved the merger, and the court categorized the alleged omissions as financial minutiae that likely played little role in influencing shareholder voting. Toward the end of the decision, the Delaware Chancery Court recognized the possibility that following its own crackdown, strike suits with similar “mootness fees” might be redirected to other state courts or federal courts. It expressed “hope and trust that [its] sister courts [would] reach the same conclusion if confronted with the issue.”[8]

By extending the Trulia ruling to the District of Delaware, the decision in DST Systems may be exactly the affirmation of trust the Delaware Chancery Court sought. In the interim between Trulia and DST Systems, a substantial number of strike suits and mootness fee litigations shifted to federal court, but DST Systems may stem this tide—at least in the Third Circuit.[9] It remains possible that other circuits will remain friendly to such litigation, raising concerns about forum shopping.[10]

Ultimately, the most affected parties are likely to be plaintiffs’ lawyers in Delaware. Eliminating the bulk of strike suits will do little to affect shareholders and will only marginally expedite mergers. Although the attorneys’ fees at issue run from the low six-figures to the low seven-figures, they ultimately amount to drops in the bucket for most corporate defendants. Still, estimated to be worth a collective $23.3 million in 2017, the fees are “not insignificant” in the aggregate.[11] In general, the filtering of shareholder suits—both at the state and federal levels—is part of a broader trend away from relying on the Delaware courts as arbiters of intra-corporate disputes.[12] Notwithstanding this general trend, however, many parties remain unsure about the potential effects of DST Systems. While Trulia only redirected merger litigation related to disclosure issues, DST Systems has the potential to substantially eliminate it. What effect this development will have on proxy statements, shareholder votes, and the Delaware plaintiffs’ bar remains uncertain. One possible result is more elaborate disputes over the materiality of disclosure omissions. The court also hinted that expert opinions on materiality might satisfy the plaintiff’s burden under the Trulia standard.[13] In that case, a new battle of the experts may emerge, and the courts may find themselves with a fresh docket of merger challenges—as well as experts’ and attorneys’ fees.

 

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[1] Matt Chiappardi, Del. Plaintiffs Attys Fear Exodus Of Chancery Deal Suits, Law360 (May 19, 2017), https://www.law360.com/articles/926199/del-plaintiffs-attys-fear-exodus-of-chancery-deal-suits.

[2] Scott v. DST Sys., Inc., No. 1:18-cv-00286-RGA, 2019 WL 3997097, at *7 (D. Del. Aug. 23, 2019).

[3] Strike Suit, Black’s Law Dictionary (11th ed. 2019).

[4] Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015).

[5] Matthew D. Cain et al., Mootness Fees, 72 Vand. L. Rev. 1777, 1787 (2019).

[6] Id.

[7] In re Trulia, Inc. Stockholder Litig., 129 A.3d 884 (Del. Ch. 2016).

[8] Id. at 899.

[9] Cain, supra note 5.

[10] Note, however, that in 2016, the 7th Circuit also adopted the Trulia standard. In re Walgreen Co. S'holder Litig., 832 F.3d 718 (7th Cir. 2016).

[11] Cain, supra note 5, at 1805.

[12] See Zohar Goshen & Sharon Hannes, The Death of Corporate Law, 94 N.Y.U. L. Rev. 263 (2019).

[13] DST Sys., 2019 WL 3997097, at *7 (noting that plaintiffs’ primary shortcoming was their failure to “develop a factual record or proffer expert opinions in support of their motions.”).