Shareholder lawsuits: “Shark Attack”

by Walter Olson on June 9, 2012

The Economist on “Why American firms cannot do deals without being sued”:

In 2005, 39% of M&A deals were challenged by lawsuits, one study found. By 2011 a hefty 96% of acquisitions worth more than $500m were attracting suits…

J. Travis Laster of Delaware’s Chancery Court [has] become an outspoken public critic of “worthless”, “sue-on-every-deal” lawsuits. In March he told one group of plaintiffs’ lawyers: “I don’t think for a moment that 90%—or based on recent numbers, 95%—of deals are the result of a breach of fiduciary duty.”

{ 18 comments }

1 Andromachos 06.09.12 at 10:27 am

I am no fan of limiting litigation (why am I here?). But, when a common and generally legal private transaction is court challenged on collateral grounds 95% of the time, even I can agree that there is a problem – Authority that I am :)

The quick and dirty solution – use the British system and, for this particular issue, where, it appears the litigants probably have resources, make the challengers responsible for the defendant’s legal fees in the event that they can not carry their burden. And, as always, enforce Rule 11 (or the local equivalent).

2 Ron Miller 06.09.12 at 1:08 pm

I do think there is some truth to the idea that many of these suits are filed hoping for a settlement, regardless of the actual merits of the case.

What plaintiffs’ lawyers understand – and I am one – is “go fly a kite, we are going to try this case.” Do things the right way with your merger, tell the plaintiffs’ lawyer there are not going to be any settlement talks, and let the chips fall where they may. This will lead to a lot less “I’m looking for a settlement to go away” lawsuits.

3 John Rohan 06.09.12 at 10:55 pm

Ron,

I wish a lot more corporations had that attitude. And in regard to any lawsuit, not just for M&As.

4 OBQuiet 06.09.12 at 11:06 pm

Ron,

Wouldn’t that position amount to a breach of duty in many cases? I am no lawyer, but knowing there are costs involved in bring the case to trial and that defendants rarely recover these costs when they win, Doesn’t it make economic sense, INDIVIDUALLY, for these clients to settle?

A solution would be to minimize societal costs with( as Andromachos suggests) a loser pays approach.

5 Max Kennerly 06.09.12 at 11:19 pm

What a pointless and venal article. “There are a lot of lawsuits, many of which are meritorious, many of which aren’t, and so… well, we don’t know, we just wanted to bitch for a little bit.” There are some crappy M&A suits. There are also some strong and meritorious claims that recover hundreds of millions for investors whose companies were literally stolen out from under them. What do we do, throw the baby out with the bathwater? What kind of policy goal does that support, other than to punish plaintiff’s lawyers?

6 Walter Olson 06.10.12 at 7:54 am

So, Max, I’m wondering how you’d react to an article implying that doctors now push some costly and injurious therapy on nearly every affluent patient even though a large share show no particular signs of requiring it. “There are a lot of therapies, many of which are meritorious, many of which aren’t, and so… well, we don’t know, we just wanted to bitch for a little bit. …There are some patients who benefit from that therapy. What do we do, throw out the baby with the bathwater?” And do you have some particular evidence to offer that the Economist was being “venal,” defined in the first dictionary I consulted as “Open to bribery; mercenary: a venal police officer. b. Capable of betraying honor, duty, or scruples for a price; corruptible. 2. Marked by corrupt dealings…” etc.

7 Jerry Vandesic 06.10.12 at 12:53 pm

“In 2005, 39% of M&A deals were challenged by lawsuits, one study found. By 2011 a hefty 96% of acquisitions worth more than $500m were attracting suits …”

Looks like apples and organges from a statistical point of view. The first statistic covers all deals, the second covers only deals > $500M. For the 2005 statistic, what percentage of deals > $500 M were challenged? For the 2011 statistic, what percentage of all deals were challenged? Does the limitation to $500M and above change things much? I can’t tell from this.

When I see an analysis that changes in the middle of things, I immediately wonder if the analyst is trying to mine the data for a patter than makes his/her point, even if it isn’t broadly applicable.

8 Joyce 06.10.12 at 3:24 pm

And this doesn’t even include all the actions that are filed as soon as a stock drops more than 15% or so in a couple of days. BTW, Max, how is it that these actions are literally filed within hours of the corporate event? Have the plaintiff’s attorneys really had time to study the matter and decide if a lawsuit really has merit? I’ll answer it for you… No way! We need the British system NOW.

9 Ron Miller 06.10.12 at 3:37 pm

OBQuiet, I think you defend a “we are going to try every case we think has no merit” philosophy to your shareholders by taking the long view that it will discourage more frivolous claims in the future.

10 Max Kennerly 06.10.12 at 6:34 pm

I think the “venal” part speaks for itself — have you ever seen The Economist favor shareholders over management? Small investors over wealthy investors? The public over banks? The Economist and its pathetic short form pieces exist not to inform anyone about any issue, but to confirm the prejudices of a very narrow selection of the top 2% of wealth holders.

In terms of the analogy to doctors, if you showed me evidence “doctors now push some costly and injurious therapy on nearly every affluent patient even though a large share show no particular signs of requiring it,” I’d say that’s probably common and hard to prevent without prohibiting real, necessary medicine, and so my views are the same: it’s regrettable, but what can we do about it?

It’s similar to what happens once a practice buys a CT scan: scans ordered goes way, way, way up. I guess we could analogize that it’s a similar level of harm, too: much like how a weak case is of minimal cost to a company, a CT scan increases the risk of cancer by some very small, but not zero, amount. Would I recommend banning CT scans? Of course not, CT scans save more lives than they hurt. So my position is the same: it’s not laudable, but it’s part of the cost of an overall positive good for society.

11 Max Kennerly 06.10.12 at 6:40 pm

Joyce, You said: BTW, Max, how is it that these actions are literally filed within hours of the corporate event? Have the plaintiff’s attorneys really had time to study the matter and decide if a lawsuit really has merit? I’ll answer it for you… No way!

You should spend some time researching plaintiff’s securities firms. It’s not like they get a call from some investor saying “the company was just bought!” and then they fire off a lawsuit hours later. These firms monitor every publicly traded company as a free service to pension funds and other large investors, and they advise those investors as the deal progresses. Once the deal is being consummated, they’ve already figured out the math on the deal, have discussed litigation with the clients, and have the complaint drafted and ready to go.

Being surprised by the timing of filing is like being surprised that states sued to declare the Affordable Care Act almost immediately after it was passed — they had ample notice of it and its details.

12 Joyce 06.10.12 at 7:08 pm

Max- I am referring to deal announcements.. None of these firms actually wait until a deal is consummated to sue. You are the person that should spend some time researching this subject. These firms routinely sue within hours of a buyout ANNOUNCEMENT, not consummation.

13 Ted 06.10.12 at 7:27 pm

Max, if you believe that all of these cases are meritorious, you should be especially furious that virtually all of them settle for no money for the shareholders, token changes in the disclosures, and very profitable payoffs for the attorneys, usually protected by clear-sailing agreements. This rent-seeking is not good for society by any stretch of the imagination.

14 Max Kennerly 06.10.12 at 9:46 pm

@Julie – I think we’re using different terminology. The announcement usually follows consummation of the deal. The deal is then closed / finalized later. Maybe you first hear of deals when they’re announced, but that’s not true of your typical plaintiff’s side shareholder firm.

@Ted – So what do you propose as a solution? I assume you have some laundry list of demands that will, as a coincidental byproduct, gut meritorious suits that recover billions annually for shareholders in service of preventing meritless suits that cost mere millions annually. I’m saying that’s a bad idea. If we have to tolerate some nuisance suits that add trivial amounts to the bottom line, it’s worth it to prevent insider interests from stealing value from shareholders. Do you want an marketplace in which investors can’t be confident that their investment won’t be sabotaged by an unfair merger? Capitalism depends upon enforceable investor rights.

15 OBQuiet 06.11.12 at 10:05 am

Ron,

But that seems to be more toward the protection of OTHER peoples interests. My costly fight lowers the cost to others, not to myself. Unless I assume that we will be be merged again and that my refusal to yield would change the system.

This seems a bit like the Prisoner’s Dilemma. With the added twist that should corporations collaborate, it might be seen as conspiracy or and Antitrust violation.

16 DEM 06.11.12 at 10:22 am

Ron said: “OBQuiet, I think you defend a “we are going to try every case we think has no merit” philosophy to your shareholders by taking the long view that it will discourage more frivolous claims in the future.”

This may be true as applied to routine lawsuits like slip-and-falls at Wal-Mart, but companies don’t engage in mergers everyday. More specifically, the target company (the one being acquired) sells itself once, and that’s it. So one company cannot possibly establish the sort of “no settlement” mentality as to merger litigation that might fend off plaintiffs law firms. (The acquiror is often named in merger litigation as a mere formaility and is not the real target of the suit.)

Moreover, in the context of merger litigation, pretty much the whole ball of wax is the preliminary injunction hearing where the court either enjoins the deal or lets it close. And many companies do, in fact, go through with the PI hearing. The plaintiffs are not deterred by this because losing the PI often does not result in the court’s refusal to award a fee. If, for example, the company made some minor tweak to its proxy disclosure prior to the PI hearing, the plainitffs always take credit for it and ask for a fee award. And the court often grants it. The PI is therefore gravy.

Finally, asking a board of directors that has negotiated a large premium for its shareholders to risk an injunction for the sake of principle is a large ask. Often, the money at stake in the merger is well into the billions with shareholders standing to reap large gains if the merger closes. (I recently defended a merger where an early stage phrama company with no earnings was bought out at a 165% premium. Even that deal attracted multiple lawsuits.) If it doesn’t close, shareholders may get nothing. If the company can preserve a billion dollar deal by paying a $500k settlement, it’s a rational economic decision given the inherent risks of litigation. That is especially so when just about every deal is now the subject of multiple lawsuits in multiple jurisdictions. The plaintiffs firms are feeding off this inherent imbalance inthe defendants’ risk/reward calculus.

17 Ron Miller 06.11.12 at 12:59 pm

I think a “don’t screw with us if we are certain we are not wrong” transcends just M&A. I agree it is a one stop shot but it sends messages to other plaintiffs in all types of litigation (including the ones that put them at the greatest risk for a big hit – some OTHER company as opposed to an individual plaintiff).

So my point is that the message would go beyond just that particular M&A case. But as for some of the nuances DEM is addressing, they are above my pay grade.

18 OBQuiet 06.11.12 at 5:33 pm

Ron,

OK, assume Company X fights the lawsuit and wins. It costs them $5M in legal fees, discovery costs and wasted manpower to do that and they had the chance to settle for $2M. But now the company is worth $5M less. I think this would be a much clearer case for arguing that management failed in their fiduciary duties.

As I said, it is in EVERYONE’S best interest for everyone to fight but in no ONE company’s interest to do so. This is one of the places where I see value in the government stepping in. If the rules were such the the winner of a lawsuit did not suffer harm, then every company has an incentive to defend itself rather than surrender to legalized extortion.

I think we agree on the GOAL(fighting back). I just think we need to give corporations a better reason than ‘its the best solution long term for everyone that you suffer now’. The reason I suggest giving is Loser Pays.

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