On October 24, Kevin LaCroix’s D&O Diary discussed a report called “The Trial Lawyers’ New Merger Tax,” published by the U.S. Chamber Institute for Legal Reform.  The report proposes several legislative approaches that would funnel all shareholder lawsuits challenging mergers to the seller corporation’s state of incorporation.  Kevin has been a leading commentator in the discussion of the M&A-case problem.  I started to write a reply to his October 24 post but my reply became too involved for a simple comment.  So, I decided to turn it into a post here.

I doubt I need to convince many people, including a great many plaintiffs’ lawyers, that the explosion of M&A cases is a problem.  The problem, of course, is not that shareholders bring lawsuits challenging mergers.  Challenges to transactions based on problematic processes, such as the one at issue in Smith v. Van Gorkom, have improved corporate decision-making.  Rather, the problem is that virtually every acquisition of a public company draws a lawsuit, even though very few transactions are actually problematic, and most cases are filed very quickly, before plaintiffs’ lawyers could possibly have enough information to decide whether the case might have merit.

The result is spurious and wasteful litigation.  But very few cases present significant risk, so the vast majority of cases present a simple nuisance that can be resolved through painless additions to the proxy statement and a relatively small payment to the plaintiffs’ lawyers.  Although companies that are sued bemoan the macro M&A-case problem, each individual company understandably focuses on its own case, and the vast majority conclude that it’s best to settle it rather than defend it to the bitter end.  Collectively, however, the M&A-case problem is significant and needs to be addressed.

Everyone suffers from the M&A-case problem.  Public companies being acquired now expect to be sued, regardless how favorable the transaction and how pristine the process, and are paying higher D&O insurance premiums.  D&O insurers collectively have suffered the full brunt of the problem through payment of defense costs and settlements.  Plaintiffs’ securities lawyers who don’t bring M&A cases, or who bring them more thoughtfully than others, suffer from guilt by association.  Defense lawyers’ law practices have benefited from the increase in M&A cases, but I for one – and I’d bet that the vast majority of my peers would agree with me – would prefer to defend more legitimate M&A cases or other types of matters than the type of M&A cases I’m addressing.

I believe there are two sets of related root causes of the M&A-case problem:

1. There are too many plaintiffs’ lawyers who bring M&A cases, and too many lawyers file cases over the same transaction with too little coordination among the cases.
2. Too few cases are weeded out on a motion to dismiss, before the time to settle arrives.  This is due to a number of factors and dynamics, including pleading standards, expedited discovery, and the timing of the transaction.

These sets of causes are intertwined.  Companies are willing to settle because they want certainty that the deal will close on time.  They need to settle to ensure certainty, even if the case lacks merit, because too few cases are dismissed.  They are able to settle because they usually can do so quickly and cheaply.  This is so because few of the plaintiffs’ M&A firms are set up to vigorously litigate even a small percentage of the cases they file; instead, these law firms take a low-intensity, high-volume approach.  Such firms can survive in the M&A-case “market” because of the two root causes: (1) there is too little coordination of the cases – which means that firms often obtain some recovery just by filing a case – and (2) too few cases are weeded out at the dismissal stage – which means that companies must settle to obtain certainty that the deal will close on time.

All of the foregoing adds up to make the M&A litigation business an attractive one for certain plaintiffs’ lawyers.  That attraction increases the number of plaintiffs’ lawyers trolling for cases, which in turn leads to more filings.Continue Reading M&A Litigation: A Potential Partial Solution to a Big Problem