United States: Parties Involved In Major Corporate Transactions May Find New York A Hospitable Forum For Defending Stockholder Actions

Appeared in Law360 on February 22, 2016. Originally appeared in the Kaye Scholer Securities & Derivative Litigation Report. 

Although Delaware still reigns as the leading forum for merger and acquisition litigation, stockholder plaintiffs have, in recent years, filed a substantial number of lawsuits in other jurisdictions. They have sometimes done so even when the corporate bylaws designated the Delaware Court of Chancery as the exclusive forum for such lawsuits. In many cases, this is an attempt to shop for more plaintiff-friendly judges or procedural rules as a path of least resistance to court-approved attorneys' fees. However, the New York Supreme Court, Commercial Division, in which many M&A lawsuits outside of Delaware are filed, has generally proven to be a favorable venue for corporate, director and officer defendants.

Consistent with our recent experience litigating M&A actions in New York in In re Kenneth Cole Productions Inc. Shareholder Litigation and In re Baltic Trading, Ltd. Stockholder Litigation, the Commercial Division is as business-minded and pragmatic as its Delaware counterpart. It has generally followed Delaware on key issues of corporate law; enforced New York procedural rules by rejecting meritless pre-closing preliminary injunction motions and limiting expedited proceedings; and demonstrated a reasonable skepticism of reactionary plaintiffs' bar strike suits.

In the absence of a conflict, New York courts look to Delaware precedent in deciding issues of corporate law. That was the case in Kenneth Cole, where the New York Appellate Division, First Department, recently affirmed the early dismissal of a lawsuit by a minority stockholder challenging a going-private merger with a controlling stockholder.

In Kenneth Cole, the chairman, namesake and controlling stockholder of Kenneth Cole Productions Inc. (KCP) made an offer to acquire KCP pursuant to a going-private merger. In order to eliminate any potential conflicts of interest that might have clouded the KCP board's consideration of the offer, KCP (1) formed a special committee of disinterested directors to evaluate and approve the transaction and (2) conditioned approval of the transaction on the vote of a majority of the minority of KCP's public stockholders.

In a case of first impression under New York law, the First Department held—consistent with the Delaware Supreme Court's decision in Kahn v. M&F Worldwide Corp.—that when a corporation establishes special committee and majority-of-the-minority procedural protections, a controlling stockholder merger is subject to review under the business judgment rule. Transactions subject to the business judgment standard of review, as opposed to the entire fairness standard, are open to dismissal at an early stage of the litigation. Thus, the Kenneth Cole decision, which is currently on appeal to the New York Court of Appeals, is important because it gives parties to controlling stockholder mergers the opportunity to circumvent burdensome discovery and prolonged proceedings.

Most commercial lawsuits follow a common path: after a plaintiff files a complaint, the defendant either answers the complaint or moves to dismiss it for failure to state a cause of action or on some other ground. It often takes courts months to decide motions to dismiss, during which time discovery is commonly stayed under NY CPLR 3214(b)[1] and the proceedings essentially grind to a halt. Stockholder plaintiffs challenging M&A transactions cannot afford to wait if they wish to prevent those transactions from closing. They must ask the court for extraordinary relief in the form of a preliminary injunction and expedited proceedings and often wait to do so until just before the stockholder vote on the proposed transaction. New York courts have demonstrated a reluctance to grant such relief.

For example, in In re Cybex International Securities Litigation in 2013, Commercial Division Justice Kornreich denied a motion to preliminarily enjoin a stockholder vote on a controlling stockholder merger where the plaintiff made that motion shortly before the vote was to occur and could have been adequately compensated by traditional money damages instead of injunctive relief. Earlier this year in City Trading Fund v. Nye, Justice Kornreich declined to issue a temporary restraining order or to grant expedited discovery in an action to enjoin a stockholder vote on a merger where the plaintiffs waited until shortly before the vote to make their motion and where the court found the plaintiffs' proxy disclosure claims were without merit.

Likewise, in Baltic Trading, which also involved a controlling stockholder merger, the plaintiffs made an eleventh-hour request to take depositions in support of their bid to preliminarily enjoin the stockholder vote on the basis that the target company's proxy statement omitted material information. Having denied the plaintiffs' request for expedited depositions, the court then rejected their preliminary injunction motion because the plaintiffs failed to show a likelihood of success on their disclosure claims, failed to show irreparable harm, and failed to show a balance of the equities in their favor. The First Department denied the plaintiffs' application to reconsider the lower court's decision, and the merger closed without any further issue.

New York courts have caught on to the phenomenon of "merger tax" litigation, which now accompanies 93 percent of M&A transactions valued over $100 million. As Justice Kornreich observed in Nye, "the ubiquity and multiplicity of merger lawsuits, colloquially known as a 'merger tax,' has caused many to view such lawsuits with a certain degree of skepticism." Indeed, not only did she deny a TRO and expedited discovery in that case, she denied the plaintiffs' motion for preliminary approval of their class settlement because approving the settlement "would incentivize plaintiffs to file frivolous disclosure lawsuits shortly before a merger, knowing they will always procure a settlement and attorneys' fees under conditions of duress. . . ."

Stockholder plaintiffs will likely continue to file M&A lawsuits in New York, especially in light of the Delaware Chancery Court's recent condemnation of disclosure-only settlements, which may further push plaintiffs to sue outside of Delaware. That is not a bad thing for parties defending these lawsuits. Assuming New York courts continue to view themselves as gatekeepers for baseless merger tax litigation, corporate and D&O defendants can expect a fair and commercial audience in the judges of these courts.

» Click here to read more articles from our latest Securities & Derivative Litigation Report

[1] Some of the Justices of the New York Supreme Court, Commercial Division, have issued individual rules that diverge from CPLR 3214(b) and permit discovery during the pendency of a dispositive motion.

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