Empirical scholars of corporate law are uncovering a rapidly changing and depressing pattern in M&A litigation. This new research dates from a series of articles in 2012 by professors John Armour, Bernard Black and Brian Cheffins, which announced that Delaware was "losing" its cases, as plaintiff's attorneys migrated to other jurisdictions where they could expect lower dismissal rates and/or higher fee awards.1 This year, a newer study by professors Matthew Cain and Steven Davidoff covers 1,117 merger transactions between 2005 and 2011 and reports more surprising and complex findings.2 But the key question has not been faced by these empiricists: What policy response is appropriate?
Most of the recent studies have hypothesized an assumed competition among jurisdictions for M&A litigation.3 This assumes what is to be proved, because (with the notable exception of Delaware) most jurisdictions do not have a clear incentive to seek more corporate litigation at a time when their courts already perceive themselves as overburdened. Further, this competitive model cannot easily explain the rapidity of recent change. To cite one statistic, in 2005, 39.5 percent of corporate merger transactions with a value over $100 million attracted litigation, but in 2010 and 2011, this rate rose to 87.3 percent and 92.1 percent, respectively.4 That a merger transaction will be attacked in court is now the new norm, not the exception.
Moreover, how it will be attacked has also changed dramatically. In 2005, when a merger attracted litigation, an average of 2.2 complaints were filed, and multi-forum litigation (i.e., actions in multiple jurisdictions) accounted for only 8.3 percent of all merger transactions that attracted litigation.5 But by 2011, an average of five lawsuits were filed if the merger attracted litigation, and multi-forum litigation occurred in 53 percent of all transactions with litigation.6 Almost all this litigation is brought in state court, and professors Cain and Davidoff report that "less than 2% of transactions file exclusively in federal courts."7
The final distinctive factor about the "new" M&A litigation is that it produces little, if any, discernible benefit for the shareholder class. In the Cain and Davidoff study, 71.6 percent of the cases settled, while 28.4 percent were dismissed.8 But these settlements rarely involve monetary relief (under 5 percent in both the Cain and Davidoff study and a similar Cornerstone Research study).9 Instead, the vast majority of these cases settle on a "disclosure only" basis, with some additional disclosures about the transaction being made to the shareholders. Despite the plaintiff's attorneys make out like bandits, receiving a mean fee award in the Cain and Davidoff study of $1.413 million.10 Because the median time in their study between the lawsuit's filing and settlement was only 44 days, this seems a very lucrative return on a brief investment of time. Thus, if nearly 70 percent of all merger cases settle and the fees are this high, we can realistically expect more and more attorneys to enter this field, attracted by this combination of low risk and relatively high return.
The net result is both a "deal tax" that reduces shareholder wealth and a waste of judicial resources. Such litigation is not only duplicative, but, as a Delaware Vice Chancellor has aptly phrased it, it is "feigned litigation" because no serious effort is made to conduct discovery, take depositions or pursue a preliminary injunction.11 Still, there may be limits. Possibly the most surprising recent development was the decision last month of Delaware Chancellor Leo Strine to reject a negotiated settlement in a "disclosure only" merger class action because it provided no discernible value or benefit to shareholders.12 Commendable as this decision is, it may only fuel the migration out of Delaware by the lawyers filing the weakest actions. Often in cases settled outside of Delaware, the factor most leading defendants to settle is the uncertainty about what an inexperienced judge might do, who has seen few other merger cases and is approached often at the last minute for a preliminary injunction. Because any delay might seriously disrupt the merging companies' plans, even a small risk of delay may justify the payment of plaintiff's attorneys fees, which are, after all, only a "rounding error" in terms of the transaction's overall scale and cost.
The bottom line answer appears then to be that migration out of Delaware better enables plaintiff's attorneys to hold the corporation hostagebut for the attorneys' benefit, not the benefit of shareholders. In addition, the migration phenomenon may compel Delaware to award higher fees in response, but this is less certain. Plaintiff's attorneys discovered the attractiveness of non-Delaware forums over the last decade and are finding merger cases a welcome substitute for harder-to-win securities class actions (where they must have an institutional client to even play).
Academics surveying this evidence have tended to leap quickly to the theoretical level to present it as a form of market competition.13 Professors Armour, Black and Cheffins originally suggested that Delaware was "losing" this competition, and Cain and Davidoff identify the current winners in this competition as California, Texas, Florida, New Jersey, Nevada and Tennessee.14 But it is far from clear that any jurisdiction is truly attempting on an organized basis to compete with Delaware. Inherently, most states have an advantage over Delaware that naturally attracts plaintiff's attorneys: They do not have a Chancery Court and thus offer jury trials (which defendants fear). Some jurisdictions may also have a lower dismissal rate at the pretrial stage than does Delaware. But these are preexisting, built-in advantages, and there is no evidence that any jurisdiction has modified its rules or practices to attract merger litigation.15 Indeed, even if such a step were desired by the local plaintiff's bar (or even the entire state bar), it is not clear that the judiciary in any of these "competing" jurisdictions would accommodate such a desire because overworked judges generally do not want to lengthen their dockets or increase their workloads. Professors Cain and Davidoff suggest (and many others have speculated) that Delaware may have recently liberalized its fee award standards (which were already generous) in order to offset the impact of its higher dismissal rate,16 but they also recognize that over the duration of their study, there is "no empirical evidence that…Delaware adjusts its fee awards in response to attorney forum shopping."17 In short, although the theory of a market for litigation is plausible, the evidence supporting it is thin.
But even if jurisdictions are not competing for merger litigation, this does not make the current problem any less intractable. Teams of plaintiff's attorneys clearly are competing, some trying to avoid Delaware at all costs, others seeking a home court advantage by filing in the jurisdiction of the company's principal place of business. All are, however, waiting for the defendant to open settlement discussions. This leads to the critical point that my academic colleagues seem to have missed: Multi-forum litigation is inherently dysfunctional. The simple economic truth is that once parallel litigation begins in two or more forums, each team of plaintiff's attorneys has a reduced incentive to invest in the action (by conducting discovery or taking dispositions) because it lacks any property right in the action and will be left out in the cold if defendants settle with others. In fact, the more a plaintiff's team seeks to actively litigate the case, the more defendants may rationally seek to find another team to settle with (because the latter team, having expended less in time and money, can afford to settle cheaper).
Given this predicament, what policy prescriptions make sense? Chancellor Strine has been urging other state courts to apply the doctrine of forum non conveniens and stay their actions in favor of Delaware's.18 Although that would resolve the multi-forum problem, New York state courts have been resisting for some time.19 This does not mean that he is wrong, but the solution seems unpromising at present.
Three other general approaches may work, but two would require either federal or state legislation. First, the one answer that does not require legislation is the forum selection clause. Either a shareholder-adopted bylaw or an amendment to the corporation's certificate of incorporation could provide that Delaware is the exclusive forum for the resolution of any action asserting a breach of fiduciary duties, or other wrongdoing, by the merging corporation's officers or directors. One recent decision, Galaviz v. Berg,20 made it uncertain whether a board-adopted bylaw can be enforced, because such action can be regarded as a form of self-dealing by directors seeking insulation. However, any shadow that that case cast over forum selection clauses has been substantially alleviated by a decision in February by U.S. District Judge Robert W. Sweet in In re Facebook IPO Securities and Derivative Litigation.21