Editor: There has been a lot of focus recently on the prevalence of litigation around public M&A transactions. Can you give us your views on why there has been an increase in this type of litigation?
Myers: The lawsuits challenging M&A transactions are coming from several sources. As soon as a large public acquisition is announced, the plaintiffs' bar springs into action looking for shareholders willing to participate in a suit. In addition, there are the suits from other potential buyers who may have been outbid in a sales process or who learn about a company being sold and want to submit a topping bid. Those types of approaches are becoming more prevalent and also often result in a lawsuit challenging the deal process that was conducted, the deal protections that were adopted and whether the board's fiduciary duties have been satisfied.
Plaintiffs generally seek a preliminary injunction to stop the deal from moving towards closing, so they have time to engage in discovery and prove their case. By the time a large public deal is announced, a lot of time and effort has gone into negotiating and structuring the transaction, and a board of directors has gone on record as determining that the deal is in the best interests of the company. Terminating a deal or even having significant delays is therefore generally very disruptive, and can be bad for business and a company's stock price, at least in the short term, for a public target, so the parties have every incentive to bring a transaction to closing as quickly as possible. Plaintiffs' lawyers understand this and try to leverage off of this dynamic. So, in the current environment, large public deals almost always result in multiple lawsuits. In fact, over the past couple of years, over 90 percent of acquisitions of public companies valued at over $100 million resulted in multiple lawsuits being filed.
Masella: Compounding the issue are some of the noteworthy recent cases that have been critical of advisors due to perceived conflicts of interests. While courts have long been watchful of potential conflicts, the high-profile nature and substantial monetary sums involved in recent cases have created intense focus on this area for the plaintiffs' bar. No longer is the plaintiffs' bar primarily focused on the traditional complaint regarding improper disclosure of methodologies used in fairness opinions. Instead, the complaints are increasingly casting a wide net to discover facts that could be used to create a specter of conflicts.
Editor: Has the proliferation of litigation changed the way deals are done?
Presant: Yes. Because such a high percentage of M&A transactions involving public companies result in litigation, there is a greater focus on board process and documenting that process as a means of defending against lawsuits that inevitably will be filed regardless of how well a deal process may have been conducted, the fairness of the deal to shareholders and the fullness of disclosure. It has become increasingly important to keep a record that demonstrates not only the number of times the board or committees of the board convened but also the alternatives the board considered before arriving at a decision to engage in a transaction. The record-keeping effort needs to be focused from the beginning of the consideration of a deal. Much of the litigation around public M&A transactions alleges breach of fiduciary duty. Good record keeping helps demonstrate that those duties have been fulfilled.
When you review the court decisions and even commentary by Delaware judges outside of the context of a specific case, it becomes clear that the written record that deal lawyers help create can make or break the defense of a fiduciary duty case. If there are gaps in the written record or the record is inconsistent or unclear, that is going to hurt the defense of a case. When directors consider an issue, that should be reflected in board minutes at the appropriate level of abstraction. Not every point discussed needs to or should be reflected. Timing of creation of the minutes is also very important. Courts can look with suspicion on minutes created long after the fact and that appear to be a rewriting of history to suit a company’s current litigation/defense needs.
Cosentino: With such an active plaintiffs' bar, every court decision gets intensely analyzed and serves as a portion of the roadmap for plaintiffs' lawyers and boards of directors and their advisors. Recent cases have increased focus on analyzing conflicts of interest and the appearance of conflicts of interest with respect to directors and every member of a deal team. Well-advised directors are very aware that potential conflicts need to be fully disclosed and considered in the decision-making process.
The dynamic between boards of directors and outside advisors has also changed somewhat. There has been increased focus by boards of directors, in light of recent cases, when engaging financial advisors to define more precisely the parameters of what actions the financial advisors are authorized to take, and to make sure the advisors are reporting back to the directors on the progress and developments of the process the directors are ultimately responsible for overseeing. Investment banks have also re-focused on addressing conflicts and the appearance of conflicts in transactions. The materials provided to the board by bankers, lawyers and management are also more carefully considered these days. Documenting that the board received and considered fulsome information and good advice goes a long way in protecting the board's decision making.
Myers: Boards of directors are also very aware, often from having gone through the experience previously, that a significant M&A transaction is likely to draw multiple lawsuits. So, quite often boards of directors are asking questions at the very beginning of a process regarding litigation exposure and what they can expect once a deal is announced. From a deal execution perspective, this means a more integrated team approach between the M&A corporate lawyers and the M&A litigators earlier on and often throughout a deal process.
Masella: Boards of directors generally are becoming very attuned to the importance of a well disciplined process, in terms of both the strategy to maximize value and the importance of maintaining a precise record of deliberations. Scrutiny on boards and processes is not new. One must remember that the line of Delaware cases on fiduciary duties spans decades. One could argue, however, that the awareness of the importance of active and engaged deliberations is much broader today. This awareness comes at a time of increasing challenges facing boards. Boards are confronting an increasingly complex transaction, business and regulatory environment. From a deal execution perspective, these factors are collectively forcing board members to be deeply engaged.
Editor: Has the proliferation of litigation affected the negotiation or structure of transaction documents?
Presant: I think it has focused deal teams on representations and conditions in merger agreements regarding litigation. Deal lawyers understand that it has always been an issue to negotiate whether representations regarding litigation speak only as of the time the merger agreement is signed or are remade at closing. But it is now a point to be emphasized to the entire deal team because the negotiation of this point reflects an allocation of risk between buyers and sellers as to litigation brought after signing and announcing a transaction but before closing.
As we have discussed, some form of litigation is now viewed as almost inevitable. Deal teams should focus on the distinction between third party litigation and litigation brought by a governmental authority. The conditions have evolved to reflect, first, that litigation is going to occur and, second, that it’s important to try to distinguish ordinary litigation from real risks to the integrity of the transaction and the parties' bargain.
These issues also arise in the material adverse effect clause (MAE) and the negotiation of whether litigation arising from the transaction should be carved out from the types of events that would be considered in determining whether an MAE has occurred. Even though MAE as viewed by New York and Delaware courts is generally an extremely high standard, it doesn’t stop a buyer from claiming an MAE in order to renegotiate price.
The negotiation of deal protections also has taken a somewhat different tone. While deal professionals representing buyers and sellers can disagree on the appropriate level and package of deal protections, both sides generally know there is limited utility in pushing the envelope too far, as those provisions are easy targets in litigation and can delay a deal and frustrate the parties' goals in getting to a successful closing as expeditiously as possible.
Cosentino: Recent cases like Complete Genomics and Ancestry.com also have focused deal teams on provisions in ancillary agreements like confidentiality and standstill agreements. So-called "don't ask, don’t waive provisions" that seek to restrict the ability of a bidder to request a waiver of the standstill in order, for example, to submit a topping bid if another buyer executes a merger agreement with a target have been the subject of litigation. Parties are now looking at these provisions more critically, and the determination and negotiation of when and if such provisions should be included have taken on a much different tone. The considered guidance on this point is really indicative of how certain issues can spur a trend in claims across multiple deals and in the willingness of courts to dig into the provisions in all the deal documents when considering the legality of actions taken in connection with public M&A transactions.
Editor: What types of transactions result in lawsuits that are the most difficult to defend?
Myers: Cases involving an actual conflict of interest tend to leave a board's decision making most exposed, whether that conflict arises because of the existence of a controlling stockholder, a relationship or interest a board member may have or a relationship or interest of one of the advisors. In Delaware, cases involving a conflict of interest may be subject to an "entire fairness" review by courts. This means that proponents of a transaction must prove both the fairness of the deal process and the price obtained. Courts have been clear that conflict situations must be fully disclosed and processes developed to ensure fairness to stockholders. A classic example of a transaction of this kind is a going private transaction.
Presant: Going private transactions generally receive a higher level of scrutiny from shareholders, courts and the SEC. In a true 13e-3 going private transaction, where an affiliated buyer or management team appears to be on both sides of a transaction, there are additional disclosure requirements applicable – even drafts of materials submitted to the board may need to be disclosed under the federal securities laws. Careful consideration and control of these materials needs to be exercised throughout the deal process.
Because of the realities of corporate governance and management, it is not realistic to expect the various persons managing a corporation to perfectly observe the rules about what they should or shouldn't do or say and whom they should or shouldn't involve in each decision. That's as true in a corporation as it is in any other aspect or endeavor of life. In a conflicted transaction context, there are more rules and more persons/negotiating parties, and this makes for more fertile ground for litigation. Much of the jurisprudence is based on general principles and not clear lines, as must be the case, so it's easier for plaintiffs to survive a motion for summary judgment, and therefore it's easier to get into a position where one has real leverage to extract a settlement.
Masella: Going private transactions force the board and its advisors to carefully consider the structure of the special committee considering the transaction and the scope of the committee's authority. The recent Southern Peru case reminds practitioners of a well-established principle in Delaware – a properly functioning special committee should have a broad mandate, including the authority to select independent advisors, the ability to consider transaction alternatives and the ability to reject any and all transactions. Going private transactions also further highlight the importance of deliberative and comprehensive processes. In S. Muoio & Co. LLC v. Hallmark Entertainment Investments, the Chancery Court held that the transaction was entirely fair and noted that the target's board of directors formed a strong special committee that displayed a robust process – the special committee met 29 times over a nine-month period to consider the transaction and potential alternatives.
Editor: Are there deals that tend not to attract litigation?
Myers: Smaller deals tend to attract less litigation. Also, deals not involving a change of control and requiring a stockholder vote tend to attract less litigation because directors’ actions are usually presumed to be appropriate under the business judgment rule in Delaware and are very difficult cases for plaintiffs to ultimately prevail.
Editor: How much risk of personal liability do board members typically have when they approve a major transaction?
Myers: In our experience board members tend to be focused and diligent and do satisfy their fundamental duties of care and loyalty, so the likelihood of a board member being held personally liable in litigation regarding an M&A transaction is actually very low. A company's charter can exculpate a director from personal liability for monetary damages for failure to satisfy the duty of care. In addition, in most public company charters, directors are indemnified for actions taken in the capacity of directors. These protections are supplemented by directors and officers insurance. In the rare cases where directors have been held personally liable, there tends to have been some personal gain on the part of the director through actions approaching fraud.
Editor: Besides the fact that there is more litigation, have you seen other trends in M&A litigation in recent years?
Myers: Litigation filed in multiple jurisdictions over the same issues on the same transaction is more common. Delaware courts have a tremendous amount of experience in M&A litigation and may not be seen as plaintiff-friendly. Therefore, in addition to litigation being filed in Delaware, which is generally the state of incorporation of the corporate parties to a transaction, lawsuits are filed in other jurisdictions as well, for example, in the state where a corporation may have its principal place of business. In addition, plaintiffs may assert federal securities law violations and file suit in federal court. This makes defending against these suits more complex.
Editor: So is litigation really just an additional cost of doing business or is there ever any real value derived from litigation?
Presant: Litigation certainly can add time and expense to a deal process. While we have seen many suits filed that in our view do not have much merit, at a minimum, the knowledge that litigation will likely arise keeps deal teams focused on creating a clear, defensible process and transaction structure. Directors are now very deliberate in the decisions they make in connection with M&A transactions. In the current environment, where directors understand litigation is nearly inevitable, they generally make sure they are asking questions and getting answers that make sense to them. In fact, in our experience, directors are very diligent in considering the issues and the choices the companies face and what's really best for the stockholders and not at all afraid to challenge management.
Editor: How does most M&A litigation get resolved?
Myers: The majority of cases are settled through an agreement to supplement disclosure or adjustments to the deal protection in the merger agreement.
Editor: In your view, will this trend of litigation on nearly every public M&A transaction continue?
Myers: There have been some recent court decisions that may help temper the current litigation frenzy. In the Transatlantic case, Chancellor Strine refused to approve a disclosure-only settlement where the disclosure did not, in his view, provide sufficient benefits to shareholders to warrant a release of claims and an award of attorneys' fees to the plaintiff's lawyers. In the Paetec case, Vice Chancellor Glasscock voiced many of the same concerns as Chancellor Strine, although the settlement was approved in that case. So we think we will see fee awards and disclosure-only settlements being highly scrutinized by the courts in Delaware, which could cause plaintiffs' lawyers to think twice before filing some of the weaker cases. In a case in the District Court of Appeals in Texas, Kazman v. Frontier Oil, the court held that the Texas Rules of Civil Procedure require cash benefits to shareholders for attorneys' fees to be awarded.