Appeals court gives companies two new reasons to resist settling M&A class actions

A boardroom is seen in an office building in Manhattan, New York City, New York, U.S., May 24, 2021. REUTERS/Andrew Kelly

(Reuters) - Federal court shareholder class actions challenging run-of-the-mill M&A transactions appear to be going the way of dinosaurs and dodo birds, but if companies needed an extra incentive to resist settling what remains of this once-ubiquitous litigation, they got it on Monday from the 7th U.S. Circuit Court of Appeals.

Let’s talk first about the ever-shrinking docket of federal court class action challenges to announced M&A deals. Between 2016 and 2019, plaintiffs' lawyers filed these cases by the bushel, claiming that companies had violated the Securities Exchange Act by omitting important information in proxy disclosures about their proposed deals. (Shareholders, as you surely recall, migrated to federal court after Delaware Chancery Court clamped down on attorneys’ fees for disclosure-only M&A settlements.)

But over the years, as I’ve reported, plaintiffs' lawyers refined their business model. Instead of filing proxy disclosure cases as class actions, they began suing on behalf of individual shareholders – making it easier to dismiss suits and collect mootness fees.

You can chart the impact of that shift away from class actions in the brand-new report from NERA Economic Consulting on 2022 trends in securities class action litigation. Shareholder class action filings, NERA reported, have been in decline for four years, from a high of 431 new cases in 2018 to only 205 in 2022. And the primary reason for the drop, NERA said, is the dramatic evaporation of class action challenges to M&A deals, from more than 200 M&A class actions filed in 2017 to a paltry eight new cases filed in 2022.

NERA reported a similar trend in the resolution of class action M&A challenges. On average, about 130 cases a year were resolved, by settlement or dismissal, between 2017 and 2020. Last year, by contrast, a grand total of 14 M&A class actions were resolved: 11 cases were dismissed and three were settled.

Given that context, Monday’s ruling from the 7th Circuit in Komatsu Mining Corp v. Columbia Casualty Co is not as consequential as it might have been a few years ago, when companies were still paying millions to settle these cases. In fact, the appeal — which addressed director and officer liability insurance coverage for settlements of proxy disclosure class actions challenging mine equipment maker Komatsu's $3.7 billion acquisition of Joy Global Inc in 2017 — is a bit of a throwback to the old days of M&A shareholder litigation.

But in two different ways, the 7th Circuit ruling should stiffen the litigation resolve of any company that’s sued in federal court for allegedly violating the Exchange Act by misrepresenting the true value of a target company.

The appeals court held, in an opinion written by Judge Frank Easterbrook for a panel that also included Judges David Hamilton and Thomas Kirsch, that Joy Global’s D&O insurers are not on the hook for $21 million the companies paid out to settle several federal court class actions. Shareholders in the underlying cases had alleged that Joy Global breached the Exchange Act by failing to disclose information that suggested Komatsu’s acquisition price was too low. The appeals court ruled that the settlement therefore fell under an exclusion in Joy’s insurance policies for “any inadequate consideration claim.”

Komatsu’s lawyers from Covington & Burling, who did not respond to my email query, had argued that the underlying shareholder claims were for a violation of the Exchange Act’s disclosure requirements (and for a breach of duty to shareholders under state law). But the 7th Circuit agreed with the insurers’ lawyers from Wiley Rein, who contended that the premise of the shareholder cases was that Joy deprived investors of the true value of their shares by issuing deceptive proxy materials. Those allegations, Easterbrook said, amount to a claim of inadequate consideration.

“The federal claim was assertedly inadequate disclosure," the judge wrote. "But the loss from any legal wrong depended on a conclusion that the price offered in the merger was too low.”

Interestingly, the insurers did not contest that Joy and Komatsu were entitled to insurance coverage for the cost of defending the shareholder M&A class actions. So the 7th Circuit’s decision incentivizes corporate defendants in Exchange Act M&A disclosure class actions to take their chances in litigation, with insurers footing the bill, instead of agreeing to a settlement that’s not covered by D&O insurance.

That’s exactly the opposite of Joy’s approach in the litigation underlying the insurance coverage appeal. Joy settled most of the suits alleging disclosure violations before the Komatsu deal closed, agreeing to beef up disclosures and pay shareholder lawyers $800,000. The company settled the remaining class action for $20 million after the deal closed. At the time of the settlement, the company’s dismissal motion had been briefed but not decided.

Going forward, companies in the 7th Circuit’s purview may be likelier to keep litigating if shareholder claims are based on an allegedly inadequate deal price.

The second takeaway from the 7th Circuit ruling gives corporate defendants all the more reason to fight instead of settling. In dicta, Easterbrook cast doubt on the whole basis of shareholders’ Exchange Act claims in the 7th Circuit. For those claims to have any significant value, investors must allege that defendants’ disclosure violations deprived them of fair value for their shares. But according to the 7th Circuit, the U.S. Supreme Court’s decision in 1977’s Santa Fe Industries Inc v. Green holds that shareholders cannot use securities laws “to contend that a corporate transaction did not fetch the best price.”

The 2nd Circuit, Easterbrook wrote, has allowed shareholders to evade Santa Fe, but the 7th Circuit “has deprecated that approach and said that arguments about price belong entirely under state law,” not under the Exchange Act. (Easterbrook cited one of his own opinions, from way back in 1987, in support.)

Under 7th Circuit precedent, the opinion said, it’s “doubtful” that the shareholder class actions against Joy and Komatsu even “stated good federal claims.”

You can bet that if M&A class action challenges stage a comeback, defendants will remember that sentence.

Read more:

No fees for you! N.Y. judge rejects lawyers' $250K request in M&A suit

Solving the mystery of the vanishing M&A shareholder class action

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Alison Frankel has covered high-stakes commercial litigation as a columnist for Reuters since 2011. A Dartmouth college graduate, she has worked as a journalist in New York covering the legal industry and the law for more than three decades. Before joining Reuters, she was a writer and editor at The American Lawyer. Frankel is the author of Double Eagle: The Epic Story of the World’s Most Valuable Coin.