Stockholder lawsuits invariably follow a public company’s announcement of a merger. More than 97 % of mergers of significant size attract at least one stockholder lawsuit, and many attract several lawsuits across various jurisdictions. As Judge Shirley Werner Kornreich observed in Nye, “[t]he lawsuits are filed only a relatively short time before the shareholder vote, and all it takes is a remote threat of injunction or delay to rationally incentivize settlement, even if defendants firmly and rightfully believe the lawsuit has no merit and would be disposed of on a motion to dismiss or at the summary judgment stage.” In other words, “[t]he defendant corporation’s cost-benefit calculus almost always leads the company to settle”—and settle quickly—to minimize costs and potential risks to the merger. The settlements usually involve the defendant corporation’s agreement to supplemental disclosures and the payment of plaintiff’s attorneys’ fees.
The courts in Nye (Judge Kornreich) and Gordon (Judge Melvin Schweitzer) confronted merger lawsuits involving proposed disclosure-based settlements. In Nye, a stockholder of Martin Marietta Materials, Inc. (MMM) brought suit after MMM announced that it had entered into a merger agreement under which it would acquire all of Texas Industries, Inc.’s (TXI) outstanding stock. In Gordon, a stockholder of Verizon Communications, Inc. (Verizon) brought suit after Verizon announced that it had agreed to acquire certain subsidiaries of Vodafone Group PLC (Vodafone). In both cases, the plaintiffs alleged that the boards of directors breached their fiduciary duties to their respective stockholders based on, among other things, inadequate disclosures relating to the transactions. And in both cases, the parties promptly reached settlements that would involve the companies’ dissemination of certain supplemental disclosures.
Stockholders are entitled only to material disclosures. A fact is material if there is a substantial likelihood that the information significantly altered the total mix of information about the proposed transaction. In that regard, while directors must give stockholders a full and accurate description of the events leading up to the board’s decision, they need not give a “play-by-play description” of every consideration or action that they took. Against that backdrop, the courts in Nye and Gordon addressed the materiality of the disclosures that the plaintiffs alleged were inadequate and required enhancement.
The courts generally considered three types of allegedly deficient disclosures and determined that none of alleged omissions or proposed corrections were material:
- Quantitative analysis in support of valuations and projections. Chief among the plaintiffs’ objections to the disclosures were that the companies did not provide enough quantitative detail to support their valuations and projections for the deals. For example, the plaintiff in Nye claimed that MMM’s advisors did not show the work behind their analysis of their EBITDA projections, while the plaintiff in Gordon believed that certain additional financial data regarding comparable companies and information on previous comparable deals were lacking. The courts concluded that the addition of such “granular detail” could not by definition be material. And as Judge Kornreich cautioned, “the ‘tell me more about your analysis’ complaint can be a never ending slippery slope. Should the backup demanded by plaintiffs be proffered in future proxies, a plaintiff can always demand further backup, such as, for instance, the banking analysts’ internal emails to see what they really thought of the data and projections.”
- Specific director discussions at board meetings. The stockholder plaintiff in Nye sought details of the substance of the board’s discussions leading up to the merger. Plaintiff argued that it needed those details to assess whether the directors “complied with their duties of loyalty and care to protect the best interests of [the Company’s] public shareholders.” The court rejected this argument: “This is the language of a fishing expedition. Plaintiffs do not claim the board did anything wrong or that it was improperly motivated. Rather, plaintiffs want more information about the board’s thought processes to explore if the board acted disloyally.”
- Details surrounding potential conflicts of interest. The stockholder plaintiff in Nye also wanted specific information concerning MMM’s three financial advisors—i.e., the precise amount of fees that one financial advisor charged a TXI stockholder for banking services (where MMM already had disclosed the theoretical conflict of interest and that the advisor charged “customary fees”) and the value of each financial advisor’s positions in TXI securities (where MMM already had disclosed that the financial advisors may own some TXI stock). The court held that none of these alleged omissions was material, especially where “[n]o one is asserting a claim for illegal insider trading, nor is there any reason to think the banks’ advice was rendered to profit from the merger. . . .”
Judge Schweitzer summarized the rationale underlying each court’s materiality analysis:
“Merely providing additional information—unless the additional information offers a contrary perspective on what has previously been disclosed—does not constitute material disclosure. . . . Even when the additional information goes to the sensitive details of a financial advisor’s fairness analysis, the information becomes material only when it corrects a valuation parameter or uncovers a conflict.”
Judge Kornreich echoed this rationale and noted that “had plaintiffs alleged material omissions or settled for material supplemental disclosures, the court would have approved the settlement” and later “limited the attorneys’ fees award to an amount commensurate with the value of the disclosures.”
Judge Kornreich also discussed two unique aspects of Nye (“notwithstanding the current climate of merger litigation, this case still stands out”) that further compelled her to reject the parties’ disclosure-based settlement. First, the suit was brought by stockholders of the acquiring company—not the selling company—even though “merger tax suits are usually brought by the shareholders of the company being acquired.” Second, the court was troubled by plaintiffs’ delay in seeking to enjoin the merger (less than one month before the shareholder vote), because “Plaintiffs could have commenced their lawsuit after the preliminary proxy was filed, which would have given shareholders and the court an extra two months to consider the disclosures.” This timing choice “would have drastically reduced the risk that the lawsuit would impact the Merger” as well as “the Company’s incentive to settle if, as it firmly believes (for good reason), the lawsuit should be dismissed because it is frivolous.”
The Nye and Gordon rulings together demonstrate that New York courts—like the Delaware Court of Chancery—will carefully scrutinize disclosure-based settlements to ensure that the supplemental disclosures benefit the company’s stockholders. This scrutiny should help to protect public companies and their directors from meritless lawsuits brought by plaintiffs who may now think twice before bringing a lawsuit that relies primarily on allegedly inadequate disclosures.
But at the same time, the increased scrutiny injects an element of uncertainty into the merger lawsuits that plaintiffs do in fact bring. Public companies that rationally accept disclosure-based settlements as a merger tax that quickly and inexpensively eliminates these lawsuits—and the threat of an injunction that sometimes accompanies them—should now expect more protracted litigation that involves higher costs. As Judge Kornreich observed, for defendant directors who have “lived up to the very aspirational fiduciary duties merger class actions are supposed to incentivize, [it] is somewhat unfortunate that they still find themselves as defendants in a lawsuit.” Even as the nature and scope of merger lawsuits may change as judicial scrutiny of settlements increases, the boards of public companies should continue to exercise honest business judgment, consult with company counsel, and disclose material information—from valuations to potential conflicts of interest—surrounding the merger.