(Article from Securities Law Alert, January 2016)
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On January 22, 2016, the Delaware Chancery Court rejected a proposed disclosure-only settlement of a stockholder class action challenging the stock-for-stock merger of two online real estate companies, Zillow and Trulia. In re Trulia S’holder Litig., 2016 WL 270821 (Del. Ch. 2016) (Bouchard, C.). The court found the supplemental disclosures neither “material” nor “even helpful to Trulia’s stockholders,” and therefore concluded that the proposed settlement did “not afford [Trulia’s stockholders] any meaningful consideration to warrant providing a release of claims to the defendants.”
The court discussed at length the proliferation of disclosure-only settlements in the context of merger litigation. Finding numerous inherent problems with such settlements, the court cautioned that “disclosure settlements are likely to be met with continued disfavor in the future unless 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 sales process, if the record shows that such claims have been investigated sufficiently.”
Background
Following the announcement of the Trulia-Zillow merger, Trulia’s stockholders brought suit alleging that the company’s directors had “breached their fiduciary duties in approving the proposed merger at an unfair exchange ratio.” The parties reached a settlement in principle a few months later. Pursuant to the terms of the settlement, defendants agreed to provide supplemental disclosures to the section of the Proxy statement summarizing the analysis of Trulia’s financial advisor. In exchange, plaintiffs agreed to a broad release of “‘any claims arising under federal, state, statutory, regulatory, common law, or other law or rule’ held by any member of the proposed class relating in any conceivable way to the transaction, with the exception of the carve-out for claims arising under state and federal antitrust law.” The settlement provided for “the payment of a fee to plaintiffs’ counsel,” but no financial award for Trulia’s stockholders.
Court Finds Disclosure-Only Settlements Warrant Careful Judicial Scrutiny
The Trulia court explained that while “Delaware has long favored the voluntary settlement of litigation, the fiduciary character of a class action requires the [c]ourt to independently examine the fairness of a class action settlement before approving it.” The court stated that “[a]pproval of a class action settlement requires more than a cursory scrutiny by the court of the issues presented.” Rather, “[t]he [c]ourt must exercise its own judgment to determine whether the settlement is reasonable and intrinsically fair” in order to protect “the legal rights of absent class members.”
The court noted that there has been a “proliferation” of disclosure-only settlements in recent years. The court observed that “the public announcement of virtually every transaction involving the acquisition of a public corporation provokes a flurry of class action lawsuits” that “often . . . serve[ ] no useful purpose for stockholders.” Plaintiffs have substantial leverage in these suits because they can threaten an injunction to prevent the closing of the deal. “Faced with that threat, defendants are incentivized to settle quickly in order to mitigate the considerable expense of litigation and the distraction it entails, to achieve closing certainty, and to obtain broad releases as a form of ‘deal insurance.’”
The court found that “[t]he most common currency used to procure a settlement is the issuance of supplemental disclosures to the target’s stockholders before they are asked to vote on the proposed transaction.” These disclosures typically consist of “a laundry list of minutiae in a financial advisor’s board presentation that does not appear in the summary of the advisor’s analysis in the proxy materials.” The court explained that “providing supplemental disclosures is a particularly easy ‘give’ for defendants to make in exchange for a release.”
Once the parties reach a settlement in principle, plaintiffs and defendants then work together in a “non-adversarial way” to obtain court approval of the settlement. In the usual case, “little or no motion practice has occurred and the discovery record is sparse.” Courts have nevertheless been “willing[ ] . . . to approve disclosure settlements of marginal value and to routinely grant broad releases to defendants and six-figure fees to plaintiffs’ counsel in the process.”
The Trulia court found that this practice has “caused deal litigation to explode in the United States beyond the realm of reason.” The court noted that “[t]he increased prevalence of deal litigation and disclosure settlements has drawn the attention of academics, practitioners, and the judiciary.” Legal scholars have “criticized disclosure settlements” on the grounds that the “non-material supplemental disclosures provide no benefit to stockholders . . . while the liability releases that accompany settlements threaten the loss of potentially valuable claims.”
The Trulia court found that the “historical [judicial] predisposition toward approving disclosure settlements needs to be reexamined.” The court cautioned that going forward, “practitioners should expect that disclosure settlements are likely to be met with . . . disfavor . . . unless 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, if the record shows that such claims have been investigated sufficiently.” In cases “[w]here the supplemental information is not plainly material, it may be appropriate for the [c]ourt to appoint an amicus curiae to assist the [c]ourt in its evaluation of the alleged benefits of the supplemental disclosures.”
As to “concern[s] that enhanced judicial scrutiny of disclosure settlements could lead plaintiffs to sue fiduciaries of Delaware corporations in other jurisdictions,” the court expressed its “hope and trust” that courts in other states would “reach the same conclusion.”