In August, Google Inc. agreed to buy Motorola Mobility Holdings Inc. for $12.5 billion in cash, a 62% premium. Motorola Inc. had just completed the spinout of its smartphone unit that January under pressure from Carl Icahn, who called for Motorola Mobility to maximize the value of its patent portfolio in July after seeing a group of technology companies led by Apple Inc. shell out $4.5 billion for Nortel Inc.'s patents. Google lost out to its Silicon Valley rival in the Nortel auction and needed desperately to strengthen its own patent portfolio. The Motorola Mobility M&A deal was a classic arm's length transaction that seemed perfectly timed to maximize the target's value.
Within days, however, various Motorola Mobility shareholders filed lawsuits claiming that the company's directors and senior executives had violated their fiduciary duties to shareholders by approving the transaction. Motorola Mobility is based in Libertyville, Ill., and like Mountain View, Calif.-based Google is incorporated in Delaware. The target's shareholders filed at least 17 suits in the Delaware Court of Chancery, Illinois federal court and two Illinois state courts, one of which, in Cook County, will hear the matter. (For regulatory reasons, the deal has yet to close, and the suits are still pending.)
Far smaller deals attract similar attention. According to a study done by Cornerstone Research and Robert Daines, a professor at Stanford Law School, "almost every acquisition over $100 million" announced last year attracted multiple lawsuits by target shareholders, who rarely received additional compensation as a result. Instead, targets generally settled by agreeing to disclose additional information, which never led shareholders to reject a deal, or by making changes to the merger agreement, which never achieved their intended effect of attracting a higher bid from another party. Nevertheless, courts awarded fees to shareholders' lawyers in just about every case, just as the companies' lawyers were paid to defend the lawsuits -- expenses that have raised the cost of making an acquisition. Delaware courts alone awarded plaintiffs lawyers some $77 million in stockholder actions in 2011, a figure that does not include fees granted by the courts of other states or the costs that companies incurred in defending the suits.
As M&A-related shareholder suits have become ubiquitous, they've also become the most important vehicle for the development of Delaware corporate law. In February, Chancellor Leo E. Strine Jr. warned about problematic behavior on the part of CEOs who consider management buyouts in a case brought by shareholders of El Paso Corp. challenging the company's $37 billion sale to Kinder Morgan Inc.
Last year, Vice Chancellor J. Travis Laster shone a spotlight on investment banker conflicts in a case brought by shareholders who opposed the $5.3 billion sale of Del Monte Foods Co. to a group led by Kohlberg Kravis Roberts & Co. LP. The robust Delaware jurisprudence on disclosure is also a product of shareholder litigation, as is much of the recent law on contractual provisions used to protect an existing deal from being topped. Corporate lawyers now study even the transcripts of settlement hearings in cases brought by shareholders for clues on which way the law may be headed. Because shareholder litigation often raises important issues of Delaware law, Strine and Laster argue that such cases should be brought in the state's courts when they involve a Delaware corporation. The courts of other states should defer to Delaware, they say.
M&A-related shareholder litigation has become a significant expense and a topic of controversy, and corporate litigators, plaintiffs' lawyers and Delaware judges vigorously debate various aspects of the issue, from the reasons for the trend and the challenges of managing it to the awarding of fees to plaintiffs' attorneys and the possibility of reforming the current system.
The discussion often degenerates into finger-pointing. Corporate litigators blame plaintiffs' lawyers for suing everywhere on every deal. Plaintiffs' lawyers respond by claiming that companies have encouraged the trend by their willingness to settle rather than litigate dubious claims. Academics and some lawyers on both sides think judges on the Delaware Court of Chancery are motivated by a desire to maximize their share of important cases and protect their franchise in corporate law. Each side has its motivations, and their incompatibilities helps explain the tumult.
But what can't be denied is that shareholder litigators have bellied their way up to the M&A table, where all parties involved in a transaction -- financial and legal advisers, accountants and public-relations firms, writers of fairness opinions, experts in due diligence and post-merger integration -- gather to divide up the fees. It's unlikely they'll be persuaded to leave anytime soon.
The dramatic increase in M&A-related shareholder litigation stems from an evolution in legal practice rather than changes in Delaware law. The key case is the 1986 ruling in Revlon Inc. v. MacAndrews & Forbes Holdings Inc., says Lawrence Hamermesh, a professor at Widener University School of Law in Wilmington, Del. In Revlon, the Delaware Supreme Court held that a target board must get the best price reasonably available for the company once it decides to sell. Thereafter, Hamermesh says, shareholders have "at least a theoretical claim in any deal, and if it turns out that the original deal gets topped, you're passing up money as a plaintiffs' lawyer if you fail to allege that the initial deal wasn't sufficiently shopped or was unduly deterrent to higher bids."
In hostile deals before and after Revlon, enterprising plaintiffs' lawyers found an individual shareholder as a client, sued the target board and then were assigned a monitoring role that left them spectators to the struggle between bidder and target. Shareholders often challenged two other kinds of transactions: management-led leveraged buyouts and deals in which a controlling shareholder was acquiring the public float in a controlled subsidiary, both of which raised conflicts for the target board and executives that resulted in increased scrutiny from Delaware courts.
These three kinds of deals supported a few firms in Wilmington that remain active, but the corporate plaintiffs' bar in the '80s and '90s was far more focused on the securities class-action litigation that flourished thanks to the seemingly endless supply of newly public tech companies. Led by Melvin Weiss and William Lerach of Milberg Weiss LLP, the attorneys who brought such cases were reviled in corporate America, which successfully persuaded Congress to tackle legislation meant to limit the practice.
Legislators responded by passing three laws: the Private Securities Litigation Reform Act of 1995, the Securities Litigation Uniform Standards Act of 1998 and the Class Action Fairness Act of 2005. The trio sharply limits the ability of state courts to adjudicate federal securities law claims and makes it harder to bring such cases even in federal courts.
Many lawyers believe that plaintiffs' lawyers have responded by turning to M&A litigation, which can still be brought in state court because it involves issues of state corporate law as well as federal securities law.
"It's an offshoot of the slowdown in securities litigation work," says Stuart Grant of Grant & Eisenhofer PA, a leading Wilmington plaintiffs' lawyer. "There are all these small firms that didn't have securities litigation and decided to move into this area."
Jennifer Johnson, a professor at Lewis & Clark Law School in Portland, Ore., makes a lengthy argument for that view in her article "Securities Class Actions in State Court," forthcoming from the University of Cincinnati Law Review. "M&A objection cases have replaced traditional stock-drop cases as the lawsuit of choice for plaintiffs' securities lawyers," she writes, and they're a better business. Not only can the former still be brought in state court; they can be filed and settled quickly, and in the courts of multiple states. As a result, she writes, "Plaintiffs pursue relatively few class actions in state court outside of the M&A arena."
But the PSLRA was passed at least a decade before the dramatic increase in M&A litigation, which Johnson believes began in 2005 and thus coincided with the start of a two-year, private equity-fueled M&A boom. Daines found that only half of the deals worth $500 million or more that were announced in 2007 attracted such suits. Neither the academics nor any lawyer could point to a specific case that inspired other lawyers to enter the field or that changed the law in a way that made M&A-related shareholder litigation more lucrative.
Instead, it's surprising that plaintiffs' lawyers took so long to seize on a form of litigation with obvious advantages for them. "I think the most fundamental cause is just that the deals must get done, and the litigation is a holdup problem that has to be solved," says William B. Chandler III, the former chancellor of Delaware's Court of Chancery and now a partner at Wilson Sonsini Goodrich & Rosati PC. "Enterprising folks in the plaintiffs' bar understand this and love the leverage it gives them." And, he adds, Delaware law sets a high bar for granting defendants' motions to dismiss fiduciary duty claims. That means defense lawyers have to litigate or settle, and they prefer the latter. "Understanding this, plaintiffs' lawyers can take on an immense inventory of cases with no worry that they're going to have to litigate most of them," Chandler says.
But as Daines notes, "Critics say that there's no other way of knowing what went on [in a deal] other than to file a suit and get discovery."
"Every deal is sued on," says Randy Baron of Robbins Geller Rudman & Dowd LLP in San Diego. "So what? In every one of these deals, shareholders are at an informational disadvantage. No one wants to pay the SEC for a lawyer who has the subpoena power to get all of the information and put it before a three-judge panel." He argues that he and lawyers like him play that role.
Grant aims to be more selective in the deals he challenges for the institutional investors he represents, but he says that in deciding whether to bring a case his clients often think about more than the possible benefits to be reaped in a particular situation. Clients also focus on potential effect of a positive resolution on their entire portfolio of companies -- on the market as a whole, in other words.
William D. Savitt, a litigation partner at Wachtell, Lipton, Rosen & Katz, said something similar this fall at a conference at Columbia Law School. As a result of ubiquitous shareholder litigation, he said, the Delaware Court of Chancery has come to enjoy some of the benefits of an administrative law court because its judges see just about every deal and are able to set standards on a range of practices.
Judges oversee the plaintiffs' lawyers at two key points on the way to a settlement, regardless of where suits are brought. First, in deals where two or more shareholders bring different lawsuits in the same court, the judge must determine which one will be the lead plaintiff. That shareholder's legal team will control the course of the litigation and receive the lion's share of the fees that come from a settlement or, if the case proceeds to trial, a judgment. Second, because cases are brought as class actions, the possibility exists that the interests of lawyer and client may diverge, since the lawyer could negotiate a settlement that leaves him with a generous fee while getting little for a dispersed group of clients. Thus courts must approve the proposed settlement of class-action litigation.
The easiest way for a judge to determine a lead plaintiff is to award the status to the first one to file suit in a case. Some states favor the "first to file" rule. Delaware judges think that it favors speed over quality and prefer a multifactored analysis that considers the quality of the pleadings, the economic stake of the plaintiff and the reputation of the plaintiff's lawyers -- a version of the "most adequate plaintiff" doctrine that Congress adopted in the 1995 PSLRA.
Chandler himself helped establish those standards in a 2000 case that also marked Grant's emergence as a player in the plaintiffs' bar. In the 1980s, the plaintiffs in shareholder suits challenging the behavior of target companies in hostile deals tended to be individuals who often held only a modest stake in the target, just as Mel Weiss and Bill Lerach represented groups of individuals. As a young lawyer at Skadden, Arps, Slate, Meagher & Flom LLP in Wilmington in the late 1980s, Grant worked on litigation for the firm's clients, and saw that Milberg Weiss was the dominant force on the individual plaintiff's side.
But, Grant says, "[v]ery few firms were representing institutional investors, and no one was doing litigation for them." He and fellow associate Jay Eisenhofer started to cultivate relationships among public pension funds and private money managers, but they couldn't represent them at Skadden because of the firm's corporate client base.
Instead, Grant and Eisenhofer opened the Wilmington office of Philadelphia law firm Blank Rome LLP in 1994 and two years later struck out on their own. Their firm focused on securities and corporate litigation and developed relationships with the State of Wisconsin Investment Board and the California Public Employees' Retirement System, better known as CalPERS, among others. Representing Trust Co. of the West, Grant sued the conflicted directors of Digex Inc., a controlled subsidiary of Intermedia Communications Inc., for approving a deal in which Intermedia would have sold to WorldCom Inc. but left Digex as a public company.
Lawyers for several other clients also sued, but Chandler selected Grant as the lead. The judge later found that the five Intermedia directors who were also on Digex's board had violated their fiduciary duties to Digex shareholders in approving the transaction on the subsidiary's behalf. Digex shareholders ended up with a settlement of $180 million in WorldCom stock and a commercial and corporate governance agreement valued at about $240 million at the time. Chandler awarded Grant $12.3 million in fees, which was half of what Grant, with TCW's backing, had asked for. (The two independent Digex directors who formed the company's special committee opposed the settlement because they claimed that it overvalued Grant's contribution to the resolution of the case and understated their own.)
Getting $25 million for such a recovery now seems modest, and Grant has gone on to obtain five of the six largest recoveries in Chancery, including $90 million for Del Monte shareholders (a case where Robbins Geller's Baron was a co-lead) and $205 million for American International Group Inc. shareholders in litigation arising from fraud at the company. Success has beget success. "Grant & Eisenhofer's track record stands out," Laster said in a 2010 hearing where he selected the firm as co-lead counsel in the Del Monte litigation. The judge offered similar praise for Baron as well as Wilmington's Bouchard, Margules & Friedlander PA, whose name partner Andre Bouchard was an associate with both Grant and Eisenhofer at Skadden.
Other firms have been less lucky. In a 2010 case, Laster deposed a group of plaintiffs' firms as lead counsel for minority shareholders of Revlon, whose controlling shareholder, Ronald Perelman's MacAndrews & Forbes, had bought out the public float because he thought they had not been vigorous enough in litigating the case. He selected Wilmington's Smith, Katzenstein & Furlow LLP as lead counsel because it "frequently represents paying clients and does not appear to litigate plaintiffs' cases using a portfolio strategy." Furthermore, he wrote, the firm's lawyers "have built up reputational capital with the court and have proven willing to engage in the hard work of actual litigation." In 2008, then-Vice Chancellor Stephen Lamb accused the plaintiff in another case, Dean Drulias, of running "a litigation kennel" and being nothing but "a professional plaintiff," insults that didn't bode well for him or Richard Brualdi, the lawyer he often used.
Thus Delaware judges, like those in many jurisdictions, respect some lawyers -- many of them local -- and scorn others, some of whom are also local. The former have strong incentive to file in Delaware, the latter to bring their cases elsewhere, especially when they're out-of-towners. As M&A-related litigation has become more common, that's what's happened. "In any case that's good, you'll see 10 complaints or more," says Grant. "We get involved in good cases, and there are all these other firms who are not equipped to lead an expedited litigation who also file complaints. Everyone wants a role and piece of work, and so what happens is a firm like mine ends up doing most of the work and gets a small percentage of the fee. I'm not complaining -- we do well -- but the large number of firms involved drives up the cost and adds little to the benefits achieved."
Daines finds that Delaware attracts at least as high a percentage of M&A-related litigation involving its companies as it did five years ago; what has changed is that suits are filed in other states even in deals involving Delaware corporations. Federal courts can easily consolidate lawsuits arising from the same set of facts in one venue, but state courts cannot, a problem that Chandler, Laster and Strine have all bemoaned.
In some situations judges from various states will consult informally and agree that one of them will manage the litigation; in others, cases in different courts proceed independently.
Regardless, defendants do not want to negotiate settlements of the various suits in the deal individually; instead, they want a global settlement that will resolve all of the litigation confronting them. A judge (or judges) must approve the settlement and a fee that reflects the court's assessment of its value to shareholders.
The debate over fee awards is a proxy for the debate over the value of M&A litigation generally. Says Chandler, "Neither the SEC nor any other entity polices the fiduciary duties of private actors. We've effectively left that role to private attorneys general. For that service, those lawyers must be adequately compensated. So attorneys' fees aren't going anywhere, nor should they."
Judges are happy to award large fees in cases such as Digex, AIG or Del Monte in which shareholders receive money. Last fall, for example, Strine awarded Southern Peru Copper Corp. $2 billion in a derivative suit brought by shareholders who challenged the mining company's sale to controlling shareholder Grupo México SAB de CV. The judge granted the plaintiff's lawyers a $300 million fee, which is now on appeal to the Delaware Supreme Court along with the ruling. Laster awarded Grant and his co-counsel $22 million in Del Monte, where KKR agreed to pay the target's shareholders $89 million.
But shareholders are far more likely to get additional disclosure on a deal or modifications to deal protections. Daines found that shareholders received additional compensation in only 10 of the 190 reported settlements in 2010 and 2011 deals, while 13% "included merger agreement changes other than payments to shareholders," and 82% resulted only in additional disclosures of uncertain value. "We have not encountered a case in which shareholders rejected the deal after the additional disclosures were provided," Daines' report for Cornerstone found.
Delaware judges have been particularly skeptical of disclosure-only settlements. In a case last year, Strine questioned the value of settlements that do little more than "provide additional comfort [about] why a deal is fair." Disclosure settlements are particularly susceptible to such suspicions because there's always something more a company can tell shareholders about a deal, especially given the uncertain nature of the law in the area and the conflicting precedent on what information companies must disclose to shareholders.
The judges on the Court of Chancery often express displeasure by awarding comparatively modest plaintiffs' fees in the low hundreds of thousands of dollars, but that can still translate into a very comfortable living for plaintiffs' lawyers who use a standardized complaint to challenge dozens of deals a year.
Laster has favored awarding higher fees to lawyers who litigate aggressively even if they don't win, a strategy that makes settlement harder and pushes companies to agree to modifications in the terms of a merger agreement that may do little to attract a competing bid but support a more generous fee request from the plaintiffs' lawyers than they would be able to make for a disclosure-only settlement.
Both solutions have side effects. Rewarding aggressive litigation generates more of it even in cases where it isn't warranted. Slashing attorneys' fees encourages them to sue elsewhere. Laster and Strine recognize the incentive effects of fee awards, but regardless of their intent, the incentives seem to favor more litigation in more places.
Lewis & Clark's Johnson believes that "only a national solution brokered by Congress would truly solve this multiforum dilemma." She thinks business lobbyists will push Congress to amend a provision of the Securities Litigation Uniform Standards Act that allows plaintiffs to bring class actions in state court if the suit is based on state corporate law -- the so-called Delaware carve-out -- because it allows the state (and courts of every other state) to hear these cases. Congress could repeal the Delaware carve-out or amend it to allow cases to be brought only in a company's state of incorporation.
But there is no single industry to press aggressively for such action as the technology industry did for the PSLRA, and the increase in M&A-related shareholder litigation comes at a time of popular suspicion of Wall Street. In the absence of a federal response, individual companies can amend their bylaws to require that all shareholders bring all litigation in the courts of the state of incorporation.
By one count, 195 companies, including Berkshire Hathaway Inc., had adopted such bylaws as of the end of 2011, though they may not do much good; in a 2011 case, a California federal judge declined to enforce one adopted by Oracle Corp. Private companies can put such a provision in their charter before going public; Facebook Inc. did so, as did LinkedIn Corp.
In the absence of congressional reform, most acquirers will be forced to manage shareholder litigation when they agree to buy a public company. Perhaps, as Baron claims, the accompanying scrutiny will keep both buyer and seller honest. Over time, the results of such litigation may improve the M&A process, as the Del Monte decision did by focusing attention on stapled financing. Regardless, the suits will continue. It's just another cost of doing M&A.