To paraphrase an Oscar-winning song, it’s hard out there for a corporate merger. In recent years, opportunistic plaintiffs’ attorneys have descended upon proposed mergers of publicly owned companies, filing lawsuits to delay the proceedings alleging that management breached its fiduciary duty to the shareholders.
But one look at the typical settlement demonstrates that these cases are almost always cash grabs for the attorneys while providing almost no benefit for the allegedly harmed shareholders. The defendant usually agrees to “disclose” additional, trivial information about the merger, while paying the plaintiffs’ attorneys thousands of dollars in legal fees. It comes as little surprise that these claims are colloquially known as “merger tax” suits, with the “tax” being the attorneys’ fees public corporations now feel obligated to pay any time they want to combine.
Thankfully, Delaware courts have begun to see the charade for what it is and rein in the “tax.” Starting with the seminal case, In re Trulia Inc. Stockholder Litig., Delaware courts have looked skeptically at merger litigation and only approved proposed settlements that actually provided shareholders with valuable, new information. Specifically, to bring a successful breach of fiduciary duty lawsuit against a board of directors, plaintiffs must request supplemental disclosures from the board that would “address a plainly material misrepresentation or omission,” and those new disclosures must be “narrowly circumscribed.”
When determining whether the additional disclosures were material to the merger, the Trulia court emphasized that courts must decide whether the new disclosures altered the “total mix” of the information available to stockholders. As Delaware leads the way in corporate law, several state and federal courts followed suit. Many courts have explicitly adopted Trulia and applied its standard.
So too did New York Supreme Court Judge Kornreich in the 2015 case City Trading Fund v. Nye. In that case, Judge Kornreich rejected a proposed settlement agreement arising out of Martin Marietta Materials’ purchase of Texas Industries at the preliminary approval stage. She found that the settlement’s proposed supplemental disclosures were immaterial to the merger and thus “worthless” to shareholders. Unfortunately, the appellate court reversed her decision on procedural ground and, in a separate case, Gordon v. Verizon Communications, Inc., declined to follow Trulia.
Instead, the appeals court reasserted the older, and less stringent In re Colt Indus. Shareholder Litigation test while adding two additional factors. Thus, under New York law, courts apply the modified Colt factors: 1) the likelihood of success, 2) the extent of support from the parties, 3) the judgment of counsel, 4) the presence of bargaining in good faith, 5) the nature of the issues of law and fact, 6) whether the proposed settlement is the best interests of the putative settlement class as a whole, and 7) whether the proposed settlement is in the best interest of the corporation. In considering the new factors, the best interests of shareholders, courts must determine whether the supplemental disclosures provide “some benefit to the shareholders.”
On remand in Nye, Judge Kornreich became one of the first New York trial judges to apply the new Gordon standard. She seemed rather frustrated that she could not apply Delaware law, going so far as to explain that under New York’s choice of law standards, the law of North Carolina (home of Martin Marietta Materials) on substantive matters applied. And because North Carolina applies Delaware law on fiduciary duty standards, Delaware law would apply to the plaintiff’s case. “That said,” she continued regretfully, “the standard for approving a class action settlement is a matter of procedural (i.e., not substantive) law, and thus it is New York’s standard that must be applied.”
Parsing the appellate court’s decision in Gordon, Judge Kornreich noted that the new Gordon factors came from Delaware case law. While Gordon’s “helpful” standard is clearly lower than Trulia’s, Judge Kornreich held that at a minimum, to be helpful supplemental disclosures would aid a reasonable shareholder in deciding whether to vote for the merger—the definition of materiality.
Turning to the specific supplemental disclosures in the proposed settlement at bar, Judge Kornreich analyzed each disclosure in turn, finding them all worthless to the reasonable shareholder. The judge explained that the proposed disclosures asked for explanations of management’s rationale for the merger; additional, repetitive analyses; and non-relevant investment positions of third-party banks. This information would be of no use for a shareholder deciding whether to approve the merger under any legal standard. Thus, the plaintiffs could not rest their lawsuit on these “utterly worthless” supplemental disclosures.
Rather than stop there, perhaps with the appellate court’s previous reversal in mind, Judge Kornreich formally applied the Gordon factors. The court quickly outlined that, based on its earlier holdings, under the first and fifth factors the facts and law made it unlikely for the plaintiffs to succeed on the merits. Judge Kornreich also noted that the only shareholder supporting the litigation was the plaintiff—several institutional shareholders routinely objected to the proceedings.
Finally, having determined that the plaintiff’s disclosures were worthless and had no benefit for the shareholders, the court also determined under the sixth and seventh Gordon factor that the settlement would have little or no benefit to the shareholders or corporation. Therefore, finding that the Gordon factors weighed against approving the proposed settlement, Judge Kornreich rejected the parties’ motion for final approval.
While it is disappointing that New York has not formally adopt Trulia, Judge Kornreich has demonstrated that even under the lower Gordon standard, judges can and should execute their duty to carefully scrutinize merger settlements. No longer should public corporations have to pay plaintiffs’ attorneys a tax simply to merge. With Delaware leading the way, the era of disclosure-only settlements may be waning. Opinions like Judge Kornreich’s will help to bring about that change.
Also published by Forbes.com on WLF’s contributor page.