2016 Year In Review: Corporate Governance Litigation And Regulation

[co-authors: Jaclyn Hall - Law Clerk, Alejandra Contreras - Law Clerk, Hyungjoo Han - Law Clerk]

2016 saw many notable developments in corporate governance litigation and related regulatory developments. In this article, we discuss significant judicial and regulatory developments in the following areas:

• Mergers and Acquisitions (“M&A”): 2016 was a particularly significant year in M&A litigation. In Delaware, courts issued important decisions that impose enhanced scrutiny on disclosure-only M&A settlements; confirm the application of the business judgment rule to mergers approved by a fully informed, disinterested, non-coerced shareholder vote; inform the proper composition of special litigation committees; define financial advisors’ liability for breaches of fiduciary duty by their clients; and offer additional guidance for calculating fair value in appraisal proceedings.
• Controlling Shareholders: Delaware courts issued important decisions clarifying when a person with less than majority stock ownership qualifies as a controller, when a shareholder may bring a quasi-appraisal action in a controlling shareholder going-private merger, and when the business judgment rule applies to controlling shareholder transactions. In New York, the Court of Appeals followed Delaware’s guidance as to when the business judgment rule applies to a controlling shareholder squeeze-out merger.
• Indemnification and Jurisdiction: Delaware courts issued decisions clarifying which employees qualify as officers for the purpose of indemnification and articulating an updated standard for exercising jurisdiction in Delaware over actions based on conduct undertaken by foreign corporations outside of the state.
• Shareholder Activism and Proxy Access: Shareholder activists remained busy in 2016, including mounting successful campaigns to replace CEOs and board members at Chipotle and Hertz. Additionally, the SEC’s new interpretation of RuRule 14a-8as limited the ability of management to exclude a shareholder proposal from a proxy statement on the grounds that it conflicts with a management proposal. Also, some companies have adopted “proxy rights” bylaws, which codify a shareholder’s right to directly nominate board members.

In January 2016, the Delaware Court of Chancery issued an important decision, In re Trulia, Inc. Stockholder Litigation, making clear the court’s renewed scrutiny of—and skepticism towards—so-called disclosure-only settlements of shareholder class actions. In Trulia, shareholders sought to block the merger of real estate websites Zillow and Trulia. After litigation was commenced, the parties agreed to a settlement in which Trulia would make additional disclosures in proxy materials seeking shareholder approval of the transaction in exchange for a broad release of present and future claims by the class and fees for plaintiffs’ counsel.

Chancellor Bouchard rejected the proposed settlement and criticized disclosure-only settlements as generally unfair to shareholders. Chancellor Bouchard noted that the Court of Chancery had previously expressed concerns regarding the incentives of plaintiff counsel to settle class action claims in which broad releases were granted in exchange “for a peppercorn and a fee”—i.e., for fees and immaterial disclosures that provided little benefit to shareholders. According to the Court, “these settlements rarely yield genuine benefits for stockholders and threaten the loss of potentially valuable claims that have not been investigated with vigor.”

In connection with its assessment of the reasonableness of the “give” and the “get” of such settlements, the Court announced a new materiality standard, holding that supplemental disclosures must address a “plainly material” misrepresentation or omission. Chancellor Bouchard explained that “plainly material” meant “that it should not be a close call” that the supplemental disclosures would be viewed as significantly altering the total mix of information made available to shareholders. The Court cautioned that where supplemental disclosures do not contain “plainly material” information, the Court may appoint an amicus curiae to evaluate the alleged benefits of the disclosures, with the associated costs potentially “taxed to the parties.” Moreover, the Court held that even if the supplemental disclosures are “plainly material,” the settlement will only be approved if the proposed releases are “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.” Chancellor Bouchard also expressed a preference that disclosure claims be resolved through stipulated dismissals based on mootness (not wide-ranging releases), which would preserve claims for the shareholder class.

Trulia shaped subsequent discussion about disclosure-only settlements in 2016, both in Delaware and elsewhere. In the wake of Trulia, Delaware courts have routinely declined to approve class-wide releases in disclosure-only settlements and have instead approved narrower applications for attorney’s fees based on mootness. The case has also informed the evaluation of disclosure-only settlements in other jurisdictions. Most notably, Judge Posner embraced the Trulia standard in the Seventh Circuit. Overturning the approval of a disclosure-only settlement agreement based on Walgreen Co.’s acquisition of Swiss pharmaceutical company Alliance Boots Gmb, Judge Posner warned that (as in Trulia) “the misrepresentation or omission that the supplemental disclosures correct must be ‘plainly material’” to be considered sufficient consideration for the shareholder class. To discourage forum shopping, we expect federal and state courts around the country to follow Delaware’s and the Seventh Circuit’s lead. North Carolina, for example, has acknowledged the Trulia framework in evaluating disclosure-only settlements.

Trulia and its progeny have perhaps been responsible, at least in part, for the sharp drop in M&A filings in 2016. In the first six months of 2016, 64% of M&A deals valued over $100 million were litigated, compared with 84% in 2015. Also, the average number of lawsuits per deal declined to 2.9 in the first two quarters of 2016, from 4.1 in 2015. Those shareholders who did file suit often opted against filing in Delaware. In the first half of 2016, the percent of suits filed in Delaware where the acquired company was incorporated in Delaware fell to 36% from 74% in 2015.

In its 2015 decision Corwin v. KKR Financial Holdings LLC, the Delaware Supreme Court held that, where the entire fairness standard does not apply because there is no controlling shareholder, a fully informed, disinterested and uncoerced shareholder vote to approve a transaction will make the business judgment rule the “presumptively correct” standard for review. In Corwin, KKR & Co. L.P. acquired KKR Financial Holdings LLC in a stock-for-stock merger. The LLC’s shareholders filed suit alleging breach of fiduciary duty by its directors. The merger had been approved by both the independent board and an uncoerced, informed vote of the shareholders. On that basis, the Court held that the proper standard of review was the business judgment rule, not Revlon, and affirmed the lower court’s dismissal of the suit. Chief Justice Strine emphasized that “the long-standing policy of our law has been to avoid the uncertainties and costs of judicial second-guessing when the disinterested shareholders have had the free and informed chance to decide on the economic merits of a transaction for themselves.”

In 2016, Delaware courts applied the new standard set forth in Corwin to dismiss several shareholder suits. First, in Singh v. Attenborough, the Delaware Supreme Court reiterated that, where there is an informed, uncoerced vote of the disinterested shareholders, the business judgment rule applies and is irrebuttable absent allegations of waste. Singh affirmed the Court of Chancery’s dismissal of claims against Merrill Lynch, an advisor to Zale Corporation in its merger with Signet Jewelers Limited. Significantly, the Court explained that, when there is a fully informed, non-coerced vote, “dismissal is typically the result.” That is because the only remaining claims are for waste, a concept that has “little real-world relevance” since “stockholders would be unlikely to approve a transaction that is wasteful.”

The Court of Chancery also has applied Corwin in dismissing merger challenges. In Miami v. Comstock, shareholders brought a post-closing challenge to the merger of C&J Energy Services, Inc. and a subsidiary of Nabors Industries Ltd. The Court found that the transaction had been approved by 97.6% of the voting shares in a fully informed, disinterested and non-coerced vote and granted defendant’s motion to dismiss. The Court of Chancery also extended Corwin to tender offers pursuant to a Section 251(h) merger. In In re Volcano Corp. Stockholder Litigation, shareholders challenged a two-step merger where the majority of shares in Volcano Corp. were tendered in response to an offer by Philips Holding USA Inc. In dismissing the suit, the Court held that acceptance of a tender offer by a majority of the fully informed, disinterested and non-coerced shareholders had the same cleansing effect as a similar shareholder vote because “the first-step tender offer essentially replicates a statutorily required stockholder vote in favor of a merger in that both require approval.” The Court of Chancery reached the same result in Larkin v. Shah, dismissing a shareholder challenge to the acquisition of Auspex Pharmaceuticals, Inc. by Teva, Inc. because 70% of the fully informed, disinterested and non-coerced...