Gibson Dunn Discusses M&A Disclosure-Only Settlements

On January 22, 2016, the Delaware Court of Chancery signaled the demise of “disclosure-only” settlements in M&A stockholder lawsuits with its decision in In re Trulia, Inc. Stockholder Litigation.[1] Arguing that the “optimal means by which disclosure claims in deal litigation” should be through adjudication rather than the settlement process, the Chancery Court cautioned that it would “continue to be increasingly vigilant in applying its independent judgment to its case-by-case assessment of the reasonableness of the ‘give’ and ‘get'” of disclosure-only settlements. The Chancery Court offered its “hope and trust that [its] sister courts will reach the same conclusion if confronted with the same issue.”

On February 2, 2017, in Gordon v. Verizon Communications, Inc., the Appellate Division for the First Department in New York announced a different approach in reversing a lower court’s rejection of a “disclosure-only” settlement.[2] The Gordon litigation arose from a putative class action relating to Vodafone Group plc’s sale of its 45% minority stake in Cellco Partnership, Inc. (“Cellco”) to Verizon Communications, Inc. (“Verizon”) for $130 billion in stock and cash. The plaintiffs alleged that Verizon’s board of directors had breached its fiduciary duties to Verizon’s shareholders by causing Verizon to overpay for Cellco stock and that Verizon had failed to disclose material information in its preliminary proxy statement concerning the transaction. The parties reached an agreement to settle the action pursuant to which Verizon agreed (a) to provide its shareholders with additional disclosures in its definitive proxy statement, (b) to obtain a fairness opinion from an independent financial advisor if Verizon entered into certain material transactions during the subsequent three years and (c) not to oppose the fee and expense application of plaintiffs’ counsel up to a cap. Following a hearing, the lower court declined to approve the settlement, finding that the incremental disclosures “individually and collectively fail[ed] to materially enhance the shareholders’ knowledge about the merger” and “provide[d] no legally cognizable benefit to the shareholder class” and, as such, was not “fair, adequate, reasonable and in the best interests of the class members.”

The First Department reversed the lower court’s decision and entered an order approving the settlement. The Court initially applied the five-factor test for evaluating a settlement of merger litigation announced previously in In re Colt Industry Shareholders Litigation: (i) the likelihood of success on the merits, (ii) the extent of support from the parties for the proposed settlement, (iii) the judgment and experience level of the plaintiffs’ counsel, (iv) the presence of bargaining in good faith and (v) the “nature of the issues of law and fact” (that is, whether the process for negotiating a settlement agreement itself would be appropriate for the resolution of the plaintiffs’ claims). The Court found that the proposed settlement satisfied these five factors.

The Court then proceeded to explain that the “need to curtail excesses not only on the part of corporate management, but also on the part of overzealous litigating shareholders and their counsel” necessitated the introduction of two new factors to evaluate proposed litigation settlements: (a) “whether the proposed settlement is in the best interests of the putative settlement class as a whole” and (b) “whether the settlement is in the best interest of the corporation.” In considering the first factor, the Court found that certain of the incremental disclosures required by the settlement agreement, such as disclosing the identities of the financial advisors that valued the interest in Cellco as well as providing further detail on the financial advisors’ valuation methods, were “of some benefit to the shareholders.” The Court ascribed particular weight to the requirement that Verizon obtain a fairness opinion from an independent financial advisor for certain future transactions because the “prospective corporate governance reform provided a benefit to Verizon shareholders in mandating an independent valuation, without restricting the flexibility of directors in making a pricing determination.” As to the second factor, the Court noted that the “lack of a monetary or quantifiable benefit to the corporation does not necessarily preclude” a finding that the settlement is in the best interest of the corporation. The Court then concluded that the settlement benefited the corporation because it allowed Verizon to provide input into the additional disclosures to be made to shareholders while allowing Verizon to avoid incurring the additional expenses of a trial.

The Gordon decision has several significant implications for deal litigation in New York that both companies and practitioners should consider:

First, the Gordon decision has received attention for suggesting that New York is more receptive than Delaware to disclosure-only M&A settlements. However, practitioners should not ignore the Court’s focus on the settlement agreement’s requirement that Verizon retain an independent financial advisor in the future in connection with certain material transactions, which the Court described as a “corporate governance reform in place to safeguard the valuation of corporate assets” that “constitutes a sufficient benefit to the putative class of shareholders as a whole to warrant approval of the proposed settlement.” While the Court acknowledged that requirements of this nature should not unduly restrict the “flexibility of directors in making a pricing determination,” the use of similar covenants in settlements of M&A litigation may make them more palatable to New York courts irrespective of the incremental disclosure requirements.

Second, the Gordon Court responded to concerns about the breadth of the release granted in the settlement agreement–an issue identified in the Trulia decision as a reason to be skeptical of disclosure-only settlements–by noting that (i) all shareholders had the right to seek exclusion from the settlement to the extent necessary to preserve their monetary claims, (ii) only two shareholders (out of more than two million) appeared at the fairness hearing held by the lower court and (iii) ultimately none of the shareholders objected to the settlement. On this basis, the Court found that “none of the shareholders was divested of his or her rights.” This suggests that New York courts may consider the factual record in respect of the conduct of the shareholders to determine whether the scope of the release is appropriate in a given litigation settlement.

Third, it is worth noting that New York law continues to evolve and bears watching in this arena. A separate concurring opinion emphasized that none of the parties had addressed the adequacy of the five-factor Colt test in gauging settlement agreements and cited to opinions of the New York Court of Appeals that declined to address matters not briefed by the parties. In addition, other New York courts have expressed skepticism of disclosure-only settlements in terms that echo those used in Trulia.[3] As such, whether other judicial departments and/or the New York Court of Appeals will adopt the expanded test set forth by the First Department in Gordon remains to be seen.

ENDNOTES

[1] 129 A.3d 884 (Del. Ch. 2016). See our discussion of Trulia here.

[2] No. 653084/13, 2017 WL 442871 (N.Y. App. Div. Feb. 2, 2017).

[3] See, e.g., In re Allied Healthcare S’holder Litig., 43 Misc.3d 1210(A), 2015 WL 6499467, at *3 (N.Y. Sup. Ct. Oct. 23, 2015); City Trading Fund v. Nye, 46 Misc.3d 1206(A), 2015 WL 93894, at *14 (N.Y. Sup. Ct. Jan. 7, 2015), rev’d on other grounds, 144 A.D.3d 595 (N.Y. App. Div. 2016).

This post comes to us from Gibson, Dunn & Crutcher LLP. It is based on the firm’s memorandum, “M&A Report- New York and Delaware Part Ways on M&A ‘Disclosure-Only’ Settlements,” dated February 17, 2017, and available here.