On January 22, 2016, the Delaware Court of Chancery, in an opinion of Chancellor Bouchard, rejected a proposed disclosure-only settlement in the context of M&A litigation that offered no new helpful information to the target’s stockholders, and provided for a broad release of all stockholders’ claims and for fees payable to the plaintiffs’ firms (In re Trulia, Inc. Stockholder Litigation, C.A. No. 10020-CB). A few days later, on January 26th, Chancellor Bouchard addressed the Northwestern Securities Regulation Institute conference and elaborated on the Trulia decision. The decision, and Chancellor Bouchard’s recent remarks, provide valuable insight into the future of “disclosure settlement” cases, i.e., settlements in which the sole or predominant consideration provided to stockholders in exchange for releasing their claims is additional disclosure to supplement the proxy materials distributed for the purpose of soliciting stockholder approval for the proposed transaction such settlements.
This opinion is a culmination of the Chancery Court’s increasing dissatisfaction with disclosure settlement cases, as they “rarely yield genuine benefits for stockholders and threaten the loss of potentially valuable claims that have not been investigated with vigor”. Now, it is clear that “things have changed” and disclosure settlements are now viewed by the Delaware Court of Chancery as “bad practice.”
The case followed what has become a familiar path for disclosure settlement cases. Trulia and Zillow entered into a merger agreement pursuant to which Zillow would acquire Trulia for approximately $3.5 billion in stock. After the merger was announced, four plaintiffs filed class action complaints with essentially identical complaints, i.e., the defendants had breached their fiduciary duties. The four cases were then consolidated and, the next day, the plaintiffs filed a motion to expedite proceedings. This motion was not even heard because the parties agreed to an expedited schedule, which was filed less than two hours later.
Approximately one month later, the parties agreed to a settlement providing for supplemental disclosures to be made in exchange for an “extremely” broad release of claims, including “unknown claims” and claims “arising under federal, state, foreign, statutory, regulatory, common law or other law or rule” and a proposed $375,000 fee for plaintiffs’ counsel. Following a settlement hearing and in response to concerns raised by Chancellor Bouchard, the release was somewhat narrowed to remove “unknown claims” and “foreign” claims and added a carve-out for any claims arising out of federal antitrust law, but otherwise encompassed any claims that any member of the proposed class held relating in any conceivable way to the transaction.
THE DISCLOSURE SETTLEMENT PROBLEM
The Trulia decision followed a series of recent Delaware decisions questioning disclosure settlements, including Acevedo v. Aeroflex Holding Corp., No. 7930-VCL-Bench Ruling (July 8, 2015) (rejecting settlement because relief obtained insufficient to support broad release), In re InterMune, Inc. Stockholder Lit., No. 10086-VCN-Bench Ruling (July 8, 2015) (deferring decision on settlement approval and questioning breadth of releases, which settlement was later approved), In re Riverbed Technology, Inc. Stockholders Lit., 2015 WL 5458041 (Del. Ch.) (approving settlement but expressing concerns over lack of adversarial presentation and limited benefits of disclosures, and indicating broad releases will not be approved going forward) and In re TW Telecom, Inc. Stockholders Lit., No. 9845-CB-Bench Ruling (August 20, 2015) (approving settlement “reluctantly” and indicating more scrutiny would be applied going forward).
Chancellor Bouchard continued the trend by devoting a significant portion of the opinion to re-examining disclosure settlements. He lamented the ubiquity of class actions alleging that target directors breached their fiduciary duties by agreeing to sell the target company for an unfair price following the announcement of virtually every transaction. In 2014, almost 95% of transactions of $100 million or more triggered stockholder litigation, and the percentage of such cases that settled solely for supplemental disclosures in 2014 was 70.6%. He noted that such class actions only occasionally generate meaningful economic benefit for stockholders and far too often only serve to generate fees for certain lawyers. Moreover, the liability releases that accompany disclosure settlements may result in the loss of potentially valuable claims that fall within those overly broad releases.
Finally, the Chancellor noted in his opinion that the lack of motion practice and limited discovery make evaluation of disclosure settlements challenging for the Court. In his January 26th remarks, Chancellor Bouchard elaborated on the difficulty in evaluating settlements because there is no effective adversity between the parties to help the court determine the usefulness of the disclosure or the fairness of the settlement. The class counsel has an interest in getting the settlement approved so that they can get their legal fees, and the defendant corporation and directors also have an interest in getting the settlement approved so that they can close their transaction. Once a deal is struck, the interest of both parties is to get the settlement approved.
THE SOLUTION FOR EVALUATING DISCLOSURE SETTLEMENTS
In Chancellor Bouchard’s opinion, the optimal means to evaluate disclosure settlements outside of the settlement process is in one of two ways:
- Preliminary Injunction Motion. The adversarial process would remain intact in a preliminary injunction motion, and the plaintiffs would bear the burden of showing that the alleged omission or misrepresentation was material.
- “Mootness Fee” Application. Under this method, plaintiffs’ counsel would apply to the Court for an award of attorneys’ fees after the defendants voluntarily supplemented their proxy materials by making one or more of the disclosures sought by plaintiffs, thereby mooting some or all of the plaintiffs’ claims. Without the need for a release, defendants would be incentivized to oppose fee requests they view as excessive, thereby retaining the adversarial process to assist the Court in its evaluation of the value of the supplemental disclosures for purposes of determining the reasonableness of the requested fee. Although no release would be obtained, the Court believes that this approach would, for practical purposes, likely result in the termination of fiduciary challenges related to the transaction. In his January 26th remarks, Chancellor Bouchard made it clear that if the benefit of the disclosure is nominal, so will be the fee.
WHAT PRACTITIONERS SHOULD EXPECT: “PLAINLY MATERIAL” STANDARD
Chancellor Bouchard concluded his re-examination of disclosure settlements with some advice for practitioners. He stated that the Court will be increasingly vigilant in assessing the “give” and “get” of disclosure settlements and will likely view them unfavorably, unless:
- the supplemental disclosures address a “plainly material” misrepresentation or omission, where “plainly material” means that “it should not be a close call” as to whether the supplemental information was material (and, if necessary, the Court may appoint an independent expert to evaluate the disclosures and provide an opposing view); and
- the release is “narrowly circumscribed” to address only disclosure claims and fiduciary duty claims relating to the sale process, if the record demonstrates that the released claims have been investigated sufficiently.
Finally, Chancellor Bouchard noted that, while such enhanced scrutiny of disclosure settlements may lead plaintiffs to other, more hospitable forums, Delaware corporations have the power to enact a forum selection bylaw to address this concern. In his January 26th remarks, Chancellor Bouchard encouraged companies to take advantage of forum selection bylaws for this purpose. But if they do not, Chancellor Bouchard expressed hope that sister courts will reach the same conclusion that the Chancery Court did if confronted with the issue.
TRULIA DECISION: REJECTION OF THE PROPOSED DISCLOSURE SETTLEMENT
After reviewing the historical practice of disclosure settlements, Chancellor Bouchard turned to the case at hand. He noted that the joint proxy that was sent to stockholders was 224 pages in length, contained extensive discussion concerning the background to the merger, prospective financial information and explanations of the opinions of each financial advisor, including a 10-page, single-spaced summary of J.P. Morgan’s opinion. The proposed settlement involved supplemental disclosures related solely to J.P. Morgan’s financial analysis. Stating that a fair summary is a summary and does not need to provide sufficient data to allow stockholders to perform their own independent valuation, Chancellor Bouchard held that the supplemental disclosures in this case provided extraneous details and did not contribute to a fair summary to add value for stockholders.
IMPLICATIONS OF TRULIA
The Trulia decision will likely have several implications for M&A litigation.
First, the “plainly material” standard means that relatively meaningless supplemental disclosure will be insufficient to sustain a disclosure settlement. Therefore, one would expect fewer lawsuits following the announcement of transactions, as plaintiffs’ counsel become more selective.
Second, with respect to suits that are actually filed, defendants cannot count on quick, pre-closing settlements. Instead, they will need to consider whether to challenge potentially meritless litigation and risk delaying the deal’s closing, or to make additional disclosures without a release in the hope of mooting the plaintiffs’ claims.
Third, plaintiffs may, at least initially, look to other jurisdictions to bring class actions in the hope of finding judges more hospitable to traditional disclosure settlements. As a result, Delaware corporations should seriously consider adopting forum selection bylaws establishing the Court of Chancery as the mandatory forum. Doing so will make them less likely to be subject to such litigation.
Finally, with the expected decrease in disclosure settlements, one would expect plaintiffs to pursue the “preferred scenario” of seeking a “mootness fee” as a more realistic option for a negotiated resolution of class actions.