When Hewlett-Packard Co. agreed to acquire Aruba Networks earlier this year, the immediate influx of shotty merger lawsuits against the deal was expected. This type of litigation is present for nearly every merger and acquisition deal. When an M&A event is announced, lawyers band together to represent the shareholders of the target and claim that management violated its fiduciary duty by accepting the proposed deal terms. The plaintiffs’ lawyers’ allegations are based on the notion that the deal would degrade shareholder value, but the typical resolution of the lawsuit provides no increase in shareholder value over the original deal. In fact, the go-to resolution is typically just an increase of deal transparency via a revised SEC filing, in addition to six-figure payouts to the lawyers.
It is clear why the lawyers love these “disclosure-only” settlements. They raise bogus complaints and get paid handsomely to do so. But why do the defendants agree to pay large sums when the litigation is so often baseless? When litigation takes place on behalf of shareholders and a settlement is made, there is a “release” from future shareholder complaints on the deal. Thus, the companies are essentially purchasing future litigation protection, ensuring a smoother deal process.
This exchange of legal fees and deal security has been under scrutiny recently, as highlighted by Delaware Vice Chancellor J. Travis Laster’s rejection of a disclosure-only settlement in the H-P and Aruba Networks deal. Laster “sharply criticized the plaintiffs’ case in Aruba as thin and said they didn’t investigate deeply enough to determine whether there were actual problems with the transaction. He dismissed the case on the grounds that the lawyers didn’t adequately represent shareholders’ interests”. The settlement called only for H-P to disclose additional information about the sale process, but it would still provide universal immunity to the deal. The Vice Chancellor is concerned that earning complete immunity by providing slightly more transparency into the deal is an unfair trade for shareholders. It prevents litigation of actual issues that could truly impair shareholder value and distorts incentive dynamics for both companies and lawyers.
If the Delaware Court of Chancery were to take an oppositional stance against disclosure-only settlements, there could be significant ramifications for merger litigation nationally. It is common for U.S. corporations to incorporate in Delaware to take advantage of the business-friendly state government. So if the state pursues value creation for shareholders more aggressively in merger settlements, plaintiff lawyers will be pressed to conduct more diligent investigations and company directors can be expected to push for better deals – all on a national scale.
-- Brandon Russo