U.S. corporate law adopts a regulation-by-litigation model where the efficient balance between incentives and filters is essential for litigation to perform its function. In this model, over-litigation is not only a detrimental distortion but also a significant indication that the regulating mechanism is not efficiently working and that some corrective actions are required.

Given the dramatic increase in M&A litigation in recent years, culminating in 2014 with challenges to 95 percent of deals valued at more than $100 million,  a correction was to a certain extent predictable. It came from the Delaware Court of Chancery in 2016 with In re Trulia, which marked a doctrinal shift in the standard of judicial review for disclosure-only settlements in merger objection lawsuits.

Other decisions of Delaware courts can also be considered as part of a (presumably synchronised) response to overlitigation: C&J Energy Services and Corwin were all issued in less than 14 months. But Trulia addresses the core of a disturbing practice underpinning M&A litigation and indicating the frivolous and vexatious nature of many if not most of those lawsuits: shortly after the announcement of a merger, plaintiffs’ attorneys would file a case challenging the deal and then quickly settle it on non-monetary terms. The agreement typically provided for modest supplemental disclosures in exchange for blanket class releases and attorneys’ fee awards – relying upon courts’ routine practice of approving any settlement. Even in the absence of a misstatement, mistake, or omission in connection with the deal, this scheme would impose a levy on the transaction. That is why it was commonly known as a “deal tax” or “transaction tax,” and the disclosure-only settlements were often referred to as “peppercorn settlements.”

By requiring that disclosures deliver a “plainly material benefit” to stockholders and that the related release be “narrowly circumscribed,” the Trulia court aimed to neutralise those collusive dynamics, which were undermining the basic mechanism of regulation-by-litigation.

Yet, a closer look casts doubt on the legal grounds for the new standard and also on its effectiveness in deterring nuisance litigation.

Some commentators have argued that directors have a pre-existing duty to disclose all material information, and enforcing that duty by demanding supplemental disclosure cannot provide the consideration necessary for a settlement. What’s more, the requirement to disclose material information could paradoxically give directors an incentive to withhold information  in anticipation of a prospective settlement.

As predicted in Trulia, the success of the new standard in curbing nuisance litigation rests on the premise that Delaware companies would constrain merger lawsuits with forum-selection bylaws, now expressly allowed by that state legislation, or that other jurisdictions would follow Delaware’s lead and constrain disclosure-only settlements. Otherwise, should the sister courts not adopt the stricter standard and should the companies not introduce forum-selection provisions in their bylaws, plaintiffs’ attorneys might merely file the case in other jurisdictions to avoid Delaware’s limits. That would result in a migration of litigation more than in a reduction of it.

In the case In Re Walgreen, the U.S. Court of Appeals for the 7^th Circuit promptly followed and backed up Trulia, so decisively that the standard is now referred to as the Trulia-Walgreen rule. The federal court called the practice a “racket” and stated that “no class action settlement that yields zero benefits for the class should be approved, and a class action that seeks only worthless benefits for the class should be dismissed out of hand.”

Other states, however, have been slow and sometimes reluctant  to follow Trulia . One reason may be that those jurisdictions are tempted to set a lower standard for disclosure-only settlements in order to attract corporate litigation and challenge Delaware’s dominance.

Furthermore, although widely implemented in Delaware, forum selection bylaws are less common than expected. They are not self- executing in the sense that a defendant corporation must invoke them before a court can enforce them. The board of directors may opt to waive application of forum selection provisions and accede to a lawsuit before a non-Delaware forum in order to negotiate a broad release on terms that currently would not be approved in Delaware under Trulia.

Indeed, some critics see Trulia as part of a grand bargain that the Delaware’s legal community struck with its corporate citizens: on one side, the Delaware legislature prohibited Delaware companies from enacting fee-shifting bylaws (which require plaintiffs to reimburse a company for an unsuccessful lawsuit), and on the other side, about seven months after that ban on fee-shifting, the Delaware Court of Chancery issued the Trulia decision as an alternative way to reduce wasteful litigation. The fee-shifting bylaws had an undeniable potential to deter frivolous lawsuits, and, before the mentioned ban, Delaware Supreme Court (in ATP Tour, Inc. v. Deutscher Tennis Bund) upheld their validity. But many – including the Delaware State Bar Association – saw fee-shifting as a threat to all corporate litigation, as a solution that threw the baby out with the bathwater.

So, were Trulia to fail in reducing nuisance litigation, it would mean that Delaware’s regulators and judiciary opted for a bad deal. That could also contribute to the decline of Delaware’s dominance in corporate law.

The rise of a new tactic: voluntary dismissal and mootness fees

Even if Trulia succeeds in restricting disclosure-only settlements, however, another tactic has arisen to replace it: the mootness dismissal, a voluntary dismissal coupled with the payment of a mootness fee to plaintiffs’ attorneys by the defendant. The scheme is pretty simple: Plaintiffs voluntarily dismiss their case without settling, and the defendant pays a mootness fee on the grounds that the mere filing of the case prompted increased disclosures that benefited the shareholders. In other words, the payment is justified because of that benefit rather than on the grounds of a beneficial settlement of the class action between the parties – a settlement that might be scrutinised by a court under the new standard set in Trulia.

Unlike in the disclosure-only settlement cases, in this scheme the dismissal is without prejudice for the class, and the defendant obtains no release from future claims. Mootness fees are also on average much lower than the attorneys’ fees granted in a typical disclosure-only settlement. On these grounds, mootness fees are subject to the more lenient standard set forth in Trulia, according to which a court does not need to weigh the benefit – the “get,” in the court’s words – of the supplemental disclosures against the cost – the “give” – of a release when determining whether to grant an award of fees. In federal courts, the mootness dismissal and the related fees are not even subject to a judge’s approval.

Empirical data on dismissals of M&A lawsuits based on mootness fees for the last two years confirm that those dismissals have displaced and substituted for disclosure-only settlements, proving the effectiveness of plaintiffs’ attorneys’ tactics in the search for litigation opportunities.

Like a roller coaster, M&A litigation follows the ups and downs of the adaptive responses of courts and plaintiffs’ attorneys.

The response to mootness fee practice: House v. Akorn

On June 24, 2019, in House v. Akorn, a U.S. District Court in Illinois scrutinised an out-of-court agreement to pay mootness fees to plaintiffs’ counsel after supplemental disclosures and a voluntary dismissal. No class-action settlement was filed that would have required court approval – covered under the Trulia-Walgreen standard.

Nevertheless, an Akorn shareholder challenged the scheme and moved to enjoin the mootness fee. The judge seized the opportunity to scrutinise the additional disclosure and found it not material; accordingly, he abrogated the agreement and ordered the plaintiffs’ attorneys to return the fees to Akorn. As the Federal Rules of Civil Procedure do not expressly allow a court to review mootness fees, the Akorn court invoked its equitable powers – its “inherent authority,” in Judge Durkin’s words – and extended Walgreen, imposing a standard stricter than the one applicable to mootness fees under Trulia.

An appeal is pending at the 7^th Circuit – the same court that in Walgreen embraced Trulia. A landmark decision could be in the offing, signalling the demise of mootness fees as a substitute for the peppercorn and fee settlements.

The swift rise of mootness fees and the hesitation to follow Trulia could call into question the litigation system as an effective response to plaintiffs’ lawyers’ tactics. A failure by the 7^th Circuit to adequately address the issue could even call into question the litigation model for regulating corporate law, and open the door for new models: The transaction could be strictly regulated by legislation and, if beyond a threshold, scrutinised by an administrative panel. This model might be more predictable and more flexible in providing remedies. Nevertheless, there would be costs: Understaffed panels could create distortions and would require time to develop precedents and  expertise comparable to those in Delaware. In this respect, the Anglo-Irish code and panel-based model could be a source of inspiration.

Other approaches could also be explored, such as the private ordering solutions of no pay bylaws – barring corporations and their directors from compensating plaintiff’s attorneys in any case. The no pay bylaws would deprive plaintiffs’ attorneys acting like bounty hunters of their reason to file a groundless case.  Another solution might be an amendment to the Federal Rules of Civil Procedure: Parties could be required to provide notice of any mootness fee and to apply for judicial approval, so that objectors could have the opportunity to make their case in court, and the courts could assess whether the payment is justified.

In any event, the outcome of the Akorn appeal could offer fresh guidance on merger objection lawsuits and the future of corporate litigation. The thrilling ride on the roller coaster of M&A litigation is far from being on its last lap.

This post comes to use from Pierluigi Matera, a professor of comparative law at Link Campus University of Rome and a visiting fellow at Wolfson College in Cambridge (UK), and Ferruccio M. Sbarbaro, a professor of company law at Link Campus University of Rome.