By William B. Chandler III
Confronted with a dramatic rise in deal litigation “beyond the realm of reason” in the early part of the 21st century, Delaware’s legal community struck a grand bargain with its corporate citizens. As a first step, the legislature prohibited Delaware stock companies from enacting fee-shifting bylaws in the wake of the Delaware Supreme Court’s ruling in ATP Tour, Inc. v. Deutscher Tennis Bund, despite the potential for such measures to deter “merger tax” lawsuits. Some saw fees-shifting bylaws as a threat to Delaware’s legal community, and others—including the Delaware State Bar Association (“DSBA”) and the plaintiffs’ bar—considered their likely effect on stockholder lawsuits to be “throwing the baby out with the bathwater.” In the course of promoting this legislation, the DSBA explicitly encouraged greater scrutiny of intracorporate litigation by the judiciary, and the adoption of forum selection bylaws by corporations, as an alternate means of reducing the incidence of socially wasteful litigation.
Within seven months of the ban on fee-shifting, the Delaware Court of Chancery issued the Trulia decision, widely seen as a corrective to a plague of disclosure-only settlements. Trulia’s solution rested on a number of premises: that forum selection bylaws would constrain merger litigation to Delaware; that the Delaware Courts would thus be able to divide the wheat of socially valuable cases from the chaff of meritless lawsuits; and that Delaware’s sister courts would follow the Court of Chancery’s lead in discouraging the sue-on-every-merger model of stockholder litigation.
Over a year later, however, there is reason to doubt the effectiveness of this grand bargain. Well over half of all large deals remain subject to litigation, although the overall percentage of deals challenged has fallen modestly, from a height of 96 percent in 2013 to 73 percent in 2016. The bulk of the decline appears to have occurred in early 2016, and there is reason to believe corporations may be enjoying a short-lived respite. Forum-selection provisions have not corralled plaintiffs within Delaware. To the contrary, the percentage of merger litigation filed in Delaware plummeted from 61 percent in 2014 to 32 percent in 2016. Instead, Trulia appears to have revitalized merger litigation under securities law, as plaintiffs use federal claims as a means of evading forum selection clauses.
Meanwhile, the response to Trulia in other jurisdictions has been mixed. Some, like New York, have explicitly rejected Trulia’s “plainly material” standard for the approval of disclosure settlements. Meanwhile, only two courts—the Seventh Circuit and a New Jersey trial court—have adopted Trulia’s reasoning to reject disclosure settlements. Disclosure settlements are more likely than not to be approved outside of Delaware: We gather a set of 23 such post-Trulia settlements that resulted in fee awards ranging from slightly more than $280,000 to $1 million.
One of the challenges identified in the Trulia opinion—the non-adversarial nature of the settlement process—has itself slowed the adoption of Trulia outside of Delaware. Class plaintiffs rarely cite the Trulia opinion in front of non-Delaware courts, even where they rely upon older Delaware law in support of a settlement. Thus far, the strategy has been largely successful. Based upon an evaluation of post-Trulia disclosure settlement litigation outside of Delaware, we recommend a few steps that Delaware Courts could take to encourage the spread of Trulia’s standards in other jurisdictions, including (a) rejecting class certification motions brought by plaintiffs or counsel who do not address recent Delaware rulings in non-Delaware settings; (b) publishing a database of Delaware transcript opinions so that non-Delaware jurists may easily access decisions not published in Lexis or Westlaw; and (c) adopting judicial fee-shifting for violations of forum-selection clauses.
However, if Trulia fails to eradicate the problem of socially detrimental litigation, Delaware should reconsider its prohibition on fee-shifting bylaws. Although an analysis of an “optimal” fee-shifting bylaw would be an article in itself, we address some of the common concerns regarding such provisions, and suggest that allowing the Court of Chancery to consider application of fee-shifting bylaws on a case-by-case basis—in the same manner as the Court guided the development of poison pills—is preferable to the present legislative prohibition.
After we presented this paper at a symposium, at least one paper has challenged our conclusion, suggesting that it is too early to judge Trulia’s effects on M&A litigation and that fee-shifting bylaws could curtail socially valuable litigation. The authors raise the purported trade-offs between “Type I” errors (the filing of meritless lawsuits) and “Type II” errors (the overdeterrence of meritorious lawsuits). As the authors put it:
Extreme actions to cut down on strike suits, like fee-shifting bylaws, will inevitably trade off fewer frivolous cases for fewer good cases.
This comment is typical of the largely speculative criticisms of fee-shifting bylaws that we highlight in our paper. On the one hand, the existence of Type I errors is not in doubt: few commentators would suggest that 73 percent of all large transactions actually involve a breach of fiduciary duties, let alone the 96 percent of transactions at the height of the litigation explosion.
The effect of fee-shifting bylaws on the net number of Type II errors, however, is difficult to estimate with any empirical precision. A reduction in merger litigation, and particularly merger-tax settlements, might actually reduce the number of Type II errors. Stockholders whose rights have been traded away for peppercorn disclosures (and attorney’s fees) stand to lose out if it is later discovered that a merger-tax settlement released claims that held actual value. The Trulia Court highlighted the risk of such errors as a reason for curtailing disclosure settlements.
To evaluate how the rate of Type II errors would change as a result of fee-shifting, an empirical analysis would need to balance the number of meritorious claims not brought due to fee-shifting bylaws against the number of valuable claims abandoned in swiftly-bargained releases. Those numbers are likely impossible to estimate with any precision, let alone compare. In the absence of such an analysis, we suggest that courts, which may observe the ebb and flow of litigation in real time through their dockets, are best suited to craft solutions and balance the interests and incentives of corporate constituents, rather than having their discretion curtailed by one-size-fits-all legislation.