On February 28, 2013, Chancellor Leo E. Strine, Jr. of the Delaware Chancery Court issued a rare bench ruling rejecting a disclosure-only, negotiated settlement of an M&A stockholder lawsuit.  The decision, in In re Transatlantic Holdings Inc. Shareholders Litigation, Case No. 6574-CS, signals that the Chancery Court will carefully scrutinize the terms of negotiated settlements to ensure that named stockholder plaintiffs are adequate class representatives and that the additional disclosures provided some benefit to the purported stockholder class.  At the same time, the decision represents an unmistakable warning to plaintiffs’ firms that they cannot continue to count on paydays through the settlement of meritless lawsuits filed in the wake of announced deals.

The litigation arose out of the sale of the reinsurance organization Transatlantic Holdings Inc. to Alleghany Corporation in early 2012, after Transatlantic terminated a prior merger agreement with Allied World.[1]  In connection with the proposed transaction, several stockholder plaintiffs filed suit in Delaware against Transatlantic, members of the Transatlantic Board, Alleghany, and Allied World.  The stockholder plaintiffs alleged in a consolidated complaint that the directors of Transatlantic breached their fiduciary duties in connection with the approval of a merger of Transatlantic and Alleghany, and that Alleghany aided and abetted the alleged breaches.  Plaintiffs also alleged that the preliminary proxy statement issued in connection with the Transatlantic-Alleghany merger failed to provide Transatlantic stockholders with information necessary to make an informed decision with respect to the stockholder vote and sought to enjoin the consummation of the merger.  Plaintiffs also claimed that Allied World aided and abetted breaches of the Transatlantic directors’ fiduciary duty and was unjustly enriched in connection with the payment of a termination fee to Allied World.  The complaint sought, among other things, to enjoin a vote by Transatlantic stockholders on the Alleghany transaction in light of the alleged deficiencies in the proxy statement. 

In early 2012, the parties reached a preliminary agreement to resolve the litigation, with Transatlantic agreeing to make additional disclosures to its stockholders in advance of the vote, and with no monetary consideration paid to the purported class.  In late January 2012, Transatlantic filed a Form 8-K containing disclosures supplementing the proxy statement issued in connection with the merger.  These additional disclosures included: (i) disclosure of Alleghany’s projected expense ratio (a measure of operating expenses to premium income); (ii) disclosure of the total amount of premium value that Transatlantic might lose if all of its policyholders terminated their insurance contracts after the merger; (iii) disclosures concerning the financial advisors’ compensation and relationships with Alleghany and Transatlantic; and (iv) additional disclosures concerning the background to the merger.  As set forth in the settlement papers, defendants agreed to these disclosures in order to resolve the litigation, not because they thought any of the disclosures were material to stockholders voting on the deal.  Following the execution of a memorandum of understanding relating to the resolution of this litigation, Transatlantic stockholders voted overwhelmingly in favor of a merger with Alleghany.  99.85% of the total shares that were voted, representing 92.53% of the total outstanding shares of Transatlantic as of the record date, voted in favor of the deal. 

On February 28, 2013, Chancellor Strine held a hearing to consider the settlement and plaintiff counsel’s application for attorney’s fees.  Focusing on the content of the additional disclosures provided to Transatlantic stockholders as part of the settlement, Chancellor Strine noted that the plaintiffs had failed to show why the additional disclosures “would have been meaningful, would have been interesting, in any real way to someone voting on this transaction,” and that the disclosures did not in any way “contradict or meaningfully affect the flow of information in a way that’s different from what the board is suggesting” about the transaction.  Turning to the named plaintiffs, Chancellor Strine noted that it was the Court’s obligation to “have some confidence that the class is actually represented in the right way.”  The Chancellor found it “very telling” that the two named stockholders who brought the litigation were small stockholders (in one case, holding only two shares of Transatlantic stock); that one of the stockholders acknowledged that it did not vote on the transaction; and that the other stockholder could not remember whether he voted.  “I don’t fault the defendants,” Chancellor Strine stated in language that undoubtedly resonates with M&A defendants, for whom “the cost of getting rid of non-meritorious claims . . . exceeds settling by giving out information . . . which doesn’t possibly impair the vote.”  Because plaintiffs had failed to show that the disclosures were material to Transatlantic stockholders, and in light of the inadequacy of the named plaintiffs, the court rejected the settlement, noting that plaintiffs’ counsel had failed to provide the Court with any “examination of the grounds for liability, which also suggests that there probably wasn’t any, really, grounds to bring this suit to begin with.”

While it is too early to tell whether plaintiff’s firms will heed Chancellor Strine’s admonition to refrain from bringing meritless M&A lawsuits on behalf of absentee plaintiffs in the hope of securing a settlement and payday for the plaintiff’s lawyers, defendants in M&A litigation can take comfort in this decision—from the most powerful voice in deal litigation— that when M&A lawsuits are settled, their underlying merits and the existence of an actual, involved plaintiff in the litigation will be carefully evaluated by the Chancery Court, where more M&A lawsuits are filed than anywhere else. 

   [1]   Gibson Dunn served as counsel to Transatlantic and its Board in the transaction and litigation.