Many corporate law scholars watched in amazement as merger litigation exploded over the past 15 years. In 2005, only 37 percent of mergers involving U.S. public companies and with a transaction size of at least $100 million were challenged in court. Today, approximately 85 percent of such mergers are challenged in court. And these suits look different from the merger suits of the past. Instead of money, for example, shareholders today typically receive additional disclosures about the merger that have little value. Instead of being filed in Delaware and other state courts, more cases are brought in federal court. And corporate boards now have more power under Delaware law to control these suits through the adoption of procedural rules in corporations’ governing documents.
These changes are far from unprecedented. As I explain in my article, The Lost Lessons of Shareholder Derivative Suits, shareholder derivative suits experienced strikingly similar changes decades ago. In derivative suits, for example, as in merger litigation, plaintiffs rarely receive any money as part of a settlement. More common are non-monetary settlements where the corporation promises to make certain corporate governance reforms. Similarly, just as in merger litigation, derivative suits are now more commonly filed in federal rather than state court. And just as corporate boards have more power to rein in merger litigation, they have, under Delaware law, long had the power to limit derivative suits through special litigation committees and the requirement that a shareholder first make a demand on the board to bring the suit. When it comes to shareholder litigation, history is repeating itself.
These similarities matter because they reveal larger lessons about shareholder litigation. First, the similarities illustrate that the disclosure-only settlements in merger settlements are not a wholly new development. They are instead a variation on the non-monetary settlements that have long been common in corporate law. These settlements suggest that the agency costs of representative litigation often play out in predictable ways at the settlement table. Given this history, Delaware should not have been taken aback by the rise of these settlements in merger cases, nor should it have taken so long for courts to limit them, as the Delaware Court of Chancery did in the 2016 Trulia decision. Recognizing these patterns also provides a foundation for thinking about how to prevent these problems in the future.
Second, the similarities demonstrate the limitations of relying on any one court to police shareholder lawsuits. The Delaware Court of Chancery has played a key role in overseeing shareholder litigation, helping to ensure that shareholders can hold corporate managers accountable in court for their misdeeds and keep the agency costs of these suits in check. Yet, the move of both merger litigation and derivative suits into federal court has made it more difficult for Delaware to police them. It is also easy for shareholder lawsuits to fall under the radar when they are not concentrated in a single forum. This forum shopping illustrates that Delaware alone cannot solve the problems with shareholder litigation.
Finally, the similarities expose the dangers of relying on corporate boards to oversee shareholder lawsuits. Given that corporate boards oversee the business and affairs of corporations, it is not surprising that courts have looked to them to police shareholder lawsuits, either through the adoption of new rules in corporate bylaws and charters or through procedures such as the demand requirement and special litigation committees. Yet the legal system has never fully grappled with the conflicts of interests that arise when directors’ power extends to claims that may someday be filed against them. Courts should consider a form of intermediate scrutiny that takes these conflicts into account and examines the objective reasonableness of any new procedural rules in shareholder litigation.
Finally, the point here is not that these different types of shareholder litigation have followed identical trajectories. There are many important differences. The rise of merger litigation, for example, was quite sudden, as was its later flight to federal court, while derivative suits have evolved more slowly and without nearly as much public attention. These suits also address different types of misconduct and are brought on behalf of different parties, so the comparison can only go so far. Yet by stepping back and analyzing their similarities, the legal system will be ready if history repeats itself yet again.
This post comes to us from Professor Jessica Erickson at the University of Richmond School of Law. It is based on her recent article, “The Lost Lessons of Shareholder Derivative Suits,” available here.