Many corporate law scholars watched in amazement as merger litigation exploded over the past fifteen years. In 2005, only 37 percent of mergers involving US public companies with a transaction size of at least $100 million were challenged in court. Today, approximately 85 percent of such mergers are challenged in court. And these suits look different than they ever did in the past. The settlements are different. Shareholders no longer receive any money from most settlements in these cases, instead receiving additional disclosures about the merger that have little value. The forums are different. Merger litigation used to be filed in Delaware and other state courts, but the cases fled to federal court after Delaware started to crack down. And the power of corporate boards is different. Delaware now gives corporate boards enhanced powers to control these suits through the adoption of procedural rules in corporations’ governing documents.
It is easy to think that these changes are unprecedented, but they are not. As I explain in my article, ‘The Lost Lessons of Shareholder Derivative Suits’, decades before these changes began in merger litigation, shareholder derivative suits experienced very similar developments. Indeed, the similarities between the history of derivative suits and the more recent changes in merger litigation are striking. In derivative suits, for example, as in merger litigation, cases rarely end with the plaintiff receiving any money as part of the settlement. Instead, non-monetary settlements where the corporation promises to make certain corporate governance reforms are far more common. Similarly, just like in merger litigation, derivative suits used to be filed primarily in state court, but they are now more commonly filed in federal court. And just as Delaware now gives corporate boards more power to rein in merger litigation, Delaware has long given corporate boards the power to limit derivative suits, through both the demand requirement and special litigation committees. When it comes to shareholder litigation, history is repeating itself.
The irony is that no one has really noticed. Scholars have long noted the common entrepreneurial roots of different types of shareholder litigation, but these suits are otherwise analyzed within their own silos. As a result, as merger litigation changed dramatically, few recognized the similarities to the earlier history of derivative suits.
These similarities matter because they reveal larger lessons about shareholder litigation. First, the similarities illustrate that the disclosure-only settlements in merger settlements are not a wholly new development. They are instead a variation on the non-monetary settlements that have long been common in corporate law. These settlements demonstrate that the agency costs of representative litigation often play out in predictable ways at the settlement table. Given this history, Delaware should not have been taken aback by the rise of these settlements in merger cases, nor should it have taken so long for courts to step in. Recognizing these patterns also provides a foundation for thinking about how to prevent these problems in the future.
Second, the similarities demonstrate the limitations of relying on any one court to police shareholder lawsuits. The Delaware Court of Chancery has played a key role in overseeing shareholder litigation, helping to ensure that shareholders can hold corporate managers accountable for their misdeeds in court while keeping the agency costs of these suits in check. Yet, in both merger litigation and derivative suits, shareholder suits have slowly moved from Delaware and other state courts to federal court, making it more difficult for Delaware to police these claims. Once derivative suits moved into federal court, they became almost invisible. It is easy for shareholder lawsuits to fall under the radar when they are not concentrated in a single forum. This forum shopping illustrates that Delaware alone cannot solve the problems with shareholder litigation. It also suggests that merger cases may fade from our attention now that they have moved into federal court.
Finally, the similarities expose the dangers of relying on corporate boards to oversee shareholder lawsuits. Over the past several years, the board of directors has emerged as the newest gatekeeper for meritless shareholder litigation. Given the bedrock principle that corporate boards oversee the business and affairs of corporations, it is not surprising that courts have looked for ways to allow boards to exercise oversight over shareholder lawsuits, either through the adoption of new rules to govern these suits in corporate bylaws and charters or through procedures such as the demand requirement and SLC committees. Yet the legal system has never fully grappled with the conflicts of interests that arise when directors’ power extends to claims that may someday be filed against them. Courts should consider a form of intermediate scrutiny that takes this bias into account and examines the objective reasonableness of any new procedural rules in shareholder litigation.
Finally, the point here is not that these different types of shareholder litigation have followed identical trajectories. There are many important differences. The rise of merger litigation, for example, was quite sudden, as was its later flight to federal court, while derivative suits have evolved more slowly and without nearly as much public attention. These suits also address different types of misconduct and are brought on behalf of different parties, so the comparison can only go so far. Yet by stepping back and analyzing their similarities, the legal system will be ready if history repeats itself yet again.
Jessica M. Erickson is Professor of Law and Associate Dean for Faculty Development at the University of Richmond, School of Law.