After nearly a decade of prominence, disclosure-only settlements may be going extinct. These settlements occur in class action cases arising from the announcement of a merger or acquisition. The plaintiff class alleges that the defendants – typically the merging companies and their executives – failed to adequately disclose the impending transaction to the affected shareholders and failed to discharge their fiduciary duties of care and loyalty in entering into the transaction. Rather than litigate these cases, the parties often settle them soon after their commencement. These settlements typically require the defendants to make supplemental disclosures and pay the attorneys' fees of the plaintiff class. In exchange, the plaintiff class agrees to drop the suit and release the defendants from other disclosure-related and breach of fiduciary duty claims that shareholders may have against them, including unknown claims at the time of settlement.
From 2005 to 2014, disclosure-only settlements in cases arising from a merger or acquisition with a nominal value in excess of $100 million increased from 40 percent to nearly 95 percent, due in large part to the courts' willingness to approve these settlements. But in 2014, Delaware courts (where most of these cases are brought) began to criticize this practice as an "epidemic" that was short-selling investors and over-insuring companies. This tension came to a head in In re Trulia Inc. Shareholder Litigation, 129 A.3d 887 (Del. Ch. 2016), when the Delaware Chancery Court "reexamined" the merits of disclosure-only settlements. The result was a new test that limited the viability of disclosure-only settlements to very narrow circumstances and virtually foreclosed the practice of including unreasonably broad litigation releases to the defendants in these cases. Since Trulia, disclosure-only settlements have predictably, and significantly, dropped in number. This trend is likely to continue in the wake of Judge Richard A. Posner's recent decision in Hays v. Walgreen Co. (In re Walgreen Co. Stockholder Litigation), 832 F.3d 718 (7th Cir. 2016), where the Seventh Circuit Court of Appeals endorsed Trulia and rebuked the phenomenon of disclosure-only settlements.
The Landmark Trulia Decision
As disclosure-only settlements became increasingly popular, courts began to express their concerns with this practice. Their main concern is whether the supplemental disclosures are adequate consideration for the plaintiff class, given that these disclosures are often trivial or unrelated to the issues the plaintiff class alleges were not adequately disclosed and the claims being released extended beyond the disclosures to substantive breach of fiduciary duty claims. As one court put it, these disclosures tend to "fix something that didn't need fixing."1 So why do these settlements happen? One court noted that the answer is that there tends to be an "agency problem" inherent in these types of cases where, even though the consideration is arguably inadequate for the plaintiff class, the lawyers for the plaintiff class recommend these settlements because they assure the payment of their fees and allow them to pursue other interests.2
Chancellor Andre G. Bouchard squarely addressed this agency problem in Trulia. He noted that "far too often" the practice of disclosure-only settlements "serves no useful purpose for stockholders. Instead, it serves only to generate fees for certain lawyers who are regular players in the enterprise of routinely filing hastily drafted complaints on behalf of stockholders on the heels of the public announcement of a deal and settling quickly on terms that yield no monetary compensation to the stockholders they represent."3 He also noted that the defendants in these actions are almost always amenable to disclosure-only settlements because these settlements mitigate litigation damages and allow them to meet their closing deadlines for their pending merger or acquisition. But there is an even more "potent" incentive. Disclosure-only settlements typically provide the defendants with broad litigation releases that foreclose not just any future disclosure-related claim but also breach of fiduciary duty claims that the plaintiff class may have arising from the proposed transaction. As Chancellor Bouchard put it, this means that the practice of disclosure-only settlements acts as a form of "deal insurance" for defendants.
Chancellor Bouchard concluded that the root of these problems is the "lack of an adversarial process" with respect to disclosure-only settlements, since both the defendants and the plaintiff class's lawyers are incentivized to enter into such agreements. This requires the court to "play devil's advocate in probing the value of the 'get' for stockholders." Chancellor Bouchard suggested that the better method to adjudicate the merits of the disclosure claims is "in an adversarial process where the defendants' desire to obtain a release does not hang in the balance." One such method is the "mootness" method, where plaintiffs' counsel applies to the court for an award of attorneys' fees after defendants moot their claims by supplementing the proxy materials with the disclosures that were allegedly missing. Another method is to seek a "preliminary injunction," where the plaintiff class bears the burden of showing that the court should enjoin the proposed transaction based on a likelihood of success on the merits of the disclosure and breach of fiduciary duty claims.4
To the extent that the parties decide to continue entering into disclosure-only settlements, Chancellor Bouchard held that such settlements will be approved only if "the supplemental disclosures address a plainly material misrepresentation or omission, and the subject matter of the proposed release is narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process."5 He added that by "plainly material" he means "that it should not be a close call that the supplemental information is material as that term is defined under Delaware law." Chancellor Bouchard then analyzed the merits of the disclosure-only settlement before him and concluded that the supplemental disclosures proposed by the parties were not plainly material and, hence, denied the proposed settlement as providing inadequate consideration to the plaintiff class.6
The Decline in Disclosure-Only Settlements Post-Trulia
Since Trulia, disclosure-related litigation has declined. In the first half of 2016, only 64 percent of merger and acquisition deals valued at more than $100 million were the subject of litigation, compared with 84 percent in 2015 and more than 90 percent in 2014. The average number of lawsuits per deal also declined from 4.1 in 2015 to 2.9 in the first half of 2016. Not surprisingly, litigants are bringing these suits in Delaware state court at a much lower rate than before Trulia. For example, in cases where the acquired company was incorporated in Delaware, plaintiffs brought these cases in Delaware state court only 36 percent of the time in the first half of 2016, compared with 74 percent of the time in 2015.7
But the recent Seventh Circuit Court of Appeals' decision in Walgreen – the only reported case outside Delaware that has analyzed disclosure-only settlements post-Trulia – suggests that forum shopping will prove ineffective for litigants who want a court to rubber stamp a disclosure-only settlement. In Walgreen, the Seventh Circuit Court of Appeals overturned a lower court order approving a disclosure-only settlement, using the rationale in Trulia. Judge Posner, writing on behalf of the appellate panel, explained that Trulia's "plainly material" standard is correct because it cannot be enough that the supplemental disclosure simply adds more information than previously available to shareholders. If the supplemental disclosure is not plainly material, then it "does nothing for the shareholders." Judge Posner added that, for a supplemental disclosure to be plainly material, it must "correct" a misrepresentation or omission that would be likely to matter to a reasonable investor. He then concluded that the disclosure-only settlement before the Seventh Circuit failed to meet this high benchmark, irrespective of the lower court's finding that the proposed supplemental disclosures may have been helpful to reasonable shareholders.8
The Walgreen decision will likely continue the year-long trend of fewer and fewer disclosure-related and breach of fiduciary duty cases concerning proposed mergers and acquisitions. Plaintiff classes that buck this trend and bring these cases are unlikely to enter into disclosure-only settlements to resolve them. Judge Posner's full-throated endorsement of Trulia is binding on all federal courts in the Seventh Circuit, and should persuade other courts outside the Seventh Circuit to apply the "plainly material" standard when adjudicating similar settlements. This would mean that litigants presenting disclosure-only settlements will have to show that the proposed supplemental disclosures correct material misrepresentations or omissions in the proxy materials. Otherwise, these supplemental disclosures will not suffice. And if the disclosure-only settlement includes a litigation release for defendants, the litigants will have to tailor the releases to the relevant omissions or misrepresentations, as courts will no longer accept sweepingly broad releases that encompass "unknown claims" or general language that encompasses any claim under any laws.
Because of the increased judicial scrutiny of disclosure-only settlements, the more likely outcome is that well-supported breach of fiduciary duty claims will be pursued through preliminary injunctions against the transaction, and in disclosure-related litigation, the plaintiff class will pursue the "mootness" option suggested in Trulia. As explained earlier, this mootness option allows for defendants to make supplemental disclosures tied to those claims, effectively mooting the litigation. At that point, the plaintiff class's attorneys can seek an award for attorneys' fees. The recent decision in In re Xoom Corporation Stockholder Litigation, No. 11265-VCG, 2016 WL 4146425 (Del. Ch. Aug. 4, 2016) suggests that this outcome is less likely to face judicial resistance because it is not in the context of a settlement. There, the court held that it need not determine whether the supplemental disclosures in that case were "plainly material" because in the mootness context "there is no 'give' to balance against the disclosure 'get'; the benefit is the 'get' of the disclosures, with no waiver of class rights to be set against that benefit."9 The court went on to hold that attorneys' fees "can be awarded if the disclosure provides some benefit to stockholders, whether or not material to the vote."10
1 Acevedo v. Aeroflex Holding Corp., No. 7930-VCL (Del. Ch. July 8, 2015).
2 In re Riverbed Tech. Inc. S'holders Litig., No. 10484-VCG, 2015 WL 5458041, at *3-8 (Del Ch. Sept. 17, 2015).
3 Trulia, 129 A.3d at 891-92.
4 Id. at 894-96.
5 Id. at 898 (emphasis added).
6 Id. at 899-908.
7 Ravi Sinha, Shareholder Litigation Involving Acquisitions of Public Companies: Review of 2015 and 1H 2016 M&A Litigation, Cornerstone Research, pp. 1, 3.
8 Walgreen, 832 F.3d at 724-26.
9 Xoom, 2015 WL 4146425, at *3.
10 Id. (emphasis added).
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