A troubling litigation trend in recent years has been the surge in lawsuits related to mergers and acquisitions. My first introduction to this phenomenon came in 2011 while representing a publicly traded bank in the Southeast that sold to a larger, stronger in-state buyer. Within an hour of announcing the deal, multiple class action lawsuits were filed in a variety of different states. Proponents of these suits contended that the sale process was flawed and that directors breached their fiduciary duties by not maximizing shareholder value. They cited the existence of restrictive deal protections that discouraged additional bids and conflicts of interest, such as change-of-control payments as well as insufficient disclosure in the proxy statement. The suit in 2011 was eventually settled with the selling shareholders receiving “beefed-up” disclosure with no increase in consideration. Plaintiffs’ lawyers, however, were awarded significant fees. These suits have become a given in virtually all transactions involving public sellers, including very small transactions. While essentially none of these lawsuits seem to have any true merit, they must be dealt with and settled in order to avoid costly and protracted litigation, including the risk of injunction that could block a deal.
In a paper originally published in January 2012 and subsequently published in January 2013 entitled “A Great Game: The Dynamics of State Competition and Litigation,” Matthew Cain, a Notre Dame business professor, and Ohio State University Associate Professor of Law Steven Davidoff reviewed all merger transactions since 2005 with over $100 million in deal value that involved publicly traded targets. They found a disturbing trend. According to the research, approximately 40 percent of deals in 2005 attracted litigation, whereas 97.5 percent (78 out of 80) of deals in 2013 resulted in a shareholder lawsuit. As the authors observe, “in plain English, if a target announces a takeover, it should assume that it and its directors will be sued.” The primary driver of this increased litigation, of course, is the money to be made in the settlement process. While fees paid to plaintiffs’ attorneys have been coming down over the years, the median fee paid in 2013 was still a hefty $485,000. The court system does seem to be coming around to the dubious nature of these suits with judges knocking down attorney’s fees, especially on disclosure-only settlements which made up nearly 85 percent of settlements in 2013. With these types of lawsuits following even the smallest bank transactions, there is increasing hope that reduced fees will discourage the practice.
Although there appears to be very little benefit to selling shareholders in these lawsuits, they are likely here to stay since large fees can sometimes be extracted in the process. It’s important for a board to understand this reality and be prepared for it. While these suits rarely derail a well-constructed M&A transaction, settling and paying this “merger tax” often makes the most sense to ensure a smooth close. Buyers should factor in this added cost to their purchase price and deal with the lawsuits accordingly. Until legal fees in unmeritorious lawsuits are knocked down in a way that discourages their filing, they will remain an unfortunate reality in M&A.