COLUMN-Appeals court bans 'worthless' M&A deal tax suits: Frankel

(The opinions expressed here are those of the author, a columnist for Reuters.)

NEW YORK Aug 10 (Reuters) - The 7th U.S. Circuit Court of Appeals sent an unequivocal message Wednesday to the shareholder class action bar: not in our backyard.

In an opinion by Judge Richard Posner, a three-judge 7th Circuit panel rejected a settlement that purported to resolve a shareholder challenge to Walgreens’ 2014 merger with Alliance Boots. The settlement called for Walgreens to make six additional disclosures about the deal in its proxy materials and for plaintiffs’ lawyers to receive $370,000 in fees.

The appellate court said those fees were completely undeserved. According to Judge Posner’s opinion, the benefit to shareholders from the additional disclosures “was not meager; it was nonexistent,” he wrote.

“The type of class action illustrated by this case - the class action that yields fees for class counsel and nothing for the class - is no better than a racket. It must end. 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.”

The 7th Circuit’s decision comes at a pivotal moment in litigation over M&A deals. Up until the summer of 2015, nearly every deal worth more than $100 million was followed by a class action claiming investors were being shortchanged.

Occasionally, in these “deal tax” cases, plaintiffs’ lawyers uncovered serious conflicts of interest or other significant flaws in the sale process. More often, they reached settlements in which the target company agreed to make additional proxy disclosures in exchange for broad releases from future shareholder claims.

Judges in Delaware Chancery Court routinely approved these “disclosure-only” settlements, awarding plaintiffs’ lawyers hundreds of thousands of dollars a case.

That ended last summer. In a series of decisions culminating in Chancellor Andre Bouchard’s January 2016 ruling in In re Trulia, Chancery Court judges said they would no longer reflexively approve disclosure-only settlements that delivered no material benefit to shareholders.

Plaintiffs’ lawyers responded to the Delaware clampdown like the rational economic actors they are.


As Cornerstone Research reported last week, shareholder suits challenging M&A deals have dropped off dramatically. In the first half of 2016, investors sued in the wake of 64 percent of deal announcements, down from a peak of 94 percent in 2013.

More significantly, the shareholder bar took its business out of Delaware Chancery Court.

Only 26 percent of the suits challenging M&A transactions were filed in Delaware in the first half of 2016. It is increasingly likely, in other words, that judges outside of Delaware - including federal judges - will hear deal-tax shareholder class actions.

But if those judges preside in federal courtrooms in Illinois, Indiana and Wisconsin, they are now bound to apply Delaware’s tough standard for disclosure-only settlements.

The 7th Circuit’s Walgreens opinion explicitly endorsed Chancellor Bouchard’s Trulia decision, which Judge Posner quoted at length. If plaintiffs’ lawyers thought they could evade Trulia by suing in federal court in the 7th Circuit, they will have to think again.

“Plaintiffs lawyers like to play whack-a-mole - if you beat them in one jurisdiction, they go to another,” said Ted Frank of the Competitive Enterprise Institute, which represented a shareholder who objected to the Walgreens settlement and brought the appeal at the 7th Circuit. Judge Posner’s decision, he said, will help put an end to such gamesmanship.

Frank said his group had been looking for a test case to challenge a disclosure-only settlement in the 7th Circuit, which is known for setting important class action precedent. Chancellor Bouchard’s Trulia decision came out just before briefing was due in the Walgreens appeal. “The timing was perfect,” Frank said.

The plaintiffs’ firms in the Walgreens case - Pomerantz and Friedman Oster & Tejtel - argued that their settlement was a response to the problem of reflexive deal-tax litigation, not a symptom of it.

According to their brief to the 7th Circuit, the additional disclosures they obtained were meaningful to shareholders and the release they granted Walgreens was narrowly tailored, in contrast to the global releases Delaware judges have criticized.

The shareholder who objected “apparently concludes that because the settlement is a disclosureonly settlement, it must necessarily also derive from a merger strike suit,” the plaintiffs’ firms said. “That is false. Disclosurebased settlements can and often do provide salutary benefits, and the action and settlement present neither of the essential elements of the ‘merger strike suit.’”

Judge Posner, whose opinion was written for him and 7th Circuit Judge Diane Sykes, analyzed each of the supplemental disclosures and concluded none of them added materially to the mix of information available to shareholders. (The third member of the panel, U.S. District Judge Staci Yandle of Benton, Illinois, sitting by designation, dissented from Judge Posner’s opinion.)

The 7th Circuit questioned whether any disclosure-only settlement benefits shareholders, citing a 2015 academic study, “Confronting the Peppercorn Settlement in Merger Litigation.” One of the authors of the study, Fordham law professor Sean Griffith, has begun litigating to block such settlements in Delaware and beyond.

He predicted Judge Posner’s opinion would resonate even outside of the 7th Circuit. “You’ve got one of the most respected members of the federal bench saying Trulia applies,” Griffith said. “This is a wonderful thing.”

Reporting by Alison Frankel. Editing by Alessandra Rafferty.