DEAL PROFESSOR | January 10, 2014, 12:20 pm

Corporate Takeover? In 2013, a Lawsuit Almost Always Followed

By  STEPHEN M. DAVIDOFF

These days, you can be sure that when a company announces it is being acquired, it will also be sued by a bevy of plaintiffs’ lawyers.

Merger litigation is a big issue in Delaware, and it reached a record rate last year. According to a new study that I prepared along with Matthew D. Cain, 97.5 percent of takeovers in 2013 with a value over $100 million experienced a shareholder lawsuit. This is even higher than the final figure in 2012 of 91.7 percent of transactions. And it is up from the rate in 2005, when only 39.3 percent of transactions attracted a lawsuit.

It is not just that merger litigation has become ubiquitous. There are more plaintiffs and law firms getting into the business. The average takeover valued greater than $100 million last year had seven lawsuits. Each of these roughly represents a different law firm. This is up from 2012, when the average was five lawsuits and triple the rate in 2005, which had 2.2 suits per transaction.

Despite the aggregate increase in the number of suits, litigation brought in more than one state decreased. In 2013, 41.6 percent of transactions with litigation had litigation in multiple states, down from 51.8 percent in 2012. If the trend continues, it is likely to be seen by some as good because multijurisdictional litigation raises the issue of plaintiffs’ lawyers trying to manipulate the system by going to the court where they will get the best treatment.

So what happened to all of this litigation?

Settlement information is still preliminary because many of these cases are making their way through the courts, but more than 70 percent have settled so far. Nearly 85 percent of the settlements — about the same rate as the 85.7 percent in 2012 — were disclosure only, which typically result in an amendment to the company’s proxy statement to provide additional disclosure to shareholders. Shareholders are not paid any amount in this settlement, but the plaintiffs’ lawyers are paid fees awarded by the court.

Because of this, disclosure-only settlements have been criticized for being “cheap” settlements that benefit only plaintiffs’ lawyers and only further encourage litigation without merit. And given that the vast majority of these settlements are disclosure only, this reinforces the critics. Defenders of this litigation say it pays for the better cases like the litigation over the Southern Peru buyout, which ended with a $2.3 billion judgment, and most recently, the litigation over Kinder Morgan’s acquisition of the El Paso Corporation, which ended in a settlement for shareholders totaling $110 million. After all, plaintiffs’ lawyers argue, these lawsuits must be brought in a wide variety of cases to conduct discovery and find the bad apples. There is also the unquantifiable benefit that companies are on their best behavior because they know they will be sued if they are not.

While the courts in Delaware have been quick to award big fees where there is wrongdoing, the judges are clearly tiring of disclosure-only settlements. Last year, in a number of cases, including the case In re Paetec Holding Corporation, Delaware judges have pushed back by scrutinizing disclosure-only settlements for the real value they provide to shareholders. In the Paetec ruling, Vice Chancellor Sam Glasscock III stated that these settlements might be the subject of collusion and that the risk is that defendants and plaintiffs have agreed to “trivial disclosures as the path of least resistance to a desired end.” He recommended that the court scrutinize disclosure-only settlements. Even so, Vice Chancellor Glasscock awarded a lawyers’ fee of $500,000 for the disclosure-only settlement in the case.

In another matter this past year, In re Gen-Probe, Vice Chancellor J. Travis Laster raised questions about the high lawyers’ fees in disclosure-only settlements and awarded only $100,000. The vice chancellor also expressed concern over the growth of this litigation. He stated that there might need to be a “recalibrating” of the idea that the court was going to give out “left and right, 500 grand for” relatively meritless disclosure-only settlements.

Lawyers’ fees awarded in litigation settlements were $485,000 per case in 2013, compared with $500,000 the year before. And in line with the growing sentiment against these cases and disclosure-only settlements, median fees were at the lowest average levels since we began tracking the data in 2005.

So what does this mean for corporate America? Many of these lawsuits have no merit, but there are a number of suits that do address real wrongdoing and should be encouraged. But any change may be a long way off. The current system benefits plaintiffs’ lawyers but also defense lawyers who earn quite a bit defending these cases. It is also a boon to buyers, who are no longer liable for future claims from shareholders. This is not a bad insurance policy for $500,000 or so.

It still remains to be determined whether the vast majority of this litigation and, in particular, disclosure-only settlements, benefit shareholders. The debate continues, but absent radical change so undoubtedly will the litigation.

Steven M. Davidoff, a professor at the Michael E. Moritz College of Law at Ohio State University, is the author of “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion.” E-mail: dealprof@nytimes.com  | Twitter: @StevenDavidoff

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