If you thought every corporate merger was unique, you’d be wrong. Over 90% of merger deals over $100 million have at least one thing in common: They are challenged in a strike suit—or subject to what essentially amounts to legalized extortion.
On June 5, 2017, CEI argued before the U.S. Court of Appeals for the Fifth Circuit to stop one example of such socially wasteful litigation and extend the landmark ruling it achieved last year in In re Walgreen Co. Stockholder Litigation, 832 F.3d 718 (7th Cir. 2016). As Judge Posner remarked in that decision, this type of litigation is a “racket” that “must end.”
The strike suit at issue follows a familiar pattern: Shortly after Crestwood Midstream publicly announced a merger, or “simplification transaction,” to become a wholly-owned subsidiary of Crestwood Equity, Crestwood Midstream unitholder Isaac Aron filed suit. He claimed that the proxy issued to provide shareholders with details about the transaction contained material omissions. In a move straight out of the strike-suit playbook, he attempted to hold up the merger—and put pressure on the merging entities that already had invested significant time and resources in the merger—by asking court to block the shareholder vote until Crestwood disclosed certain information.
The parties settled on the eve of the court hearing on Aron’s motion to block the vote. The settlement provided shareholders with just two tables of financial information that already had been incorporated into the valuation analyses provided to them weeks earlier. But, wouldn’t you know it, the plaintiffs’ attorneys would receive over half a million dollars in fees. The shareholders went on to approve the merger in an overwhelmingly positive vote. Thus, the legalized extortion: Crestwood paid a six-figure fee to the lawyers in order to ensure that the transaction would go forward as planned, while the shareholders were left with nothing of value.
These strike suits plague the M&A landscape in large part because of the dynamics at play. Courts rarely have the benefit of adversarial briefing, as both the plaintiffs’ lawyers and defendants are asking the court to approve the settlement. In this case, unitholder David G. Duggan stepped forward to object to the settlement. The district court nevertheless failed to assess the materiality of the supplemental disclosures—an analysis that would determine if they benefited the shareholders—and refused to follow Walgreen because it was not Fifth Circuit precedent.
CEI took the case on appeal to try to change that. The surest way to end the “merger tax” that strike suits impose on the shareholders of merging companies is for courts to adopt standards requiring courts to closely scrutinize proposed settlements. After Walgreen and an earlier decision by the Delaware Court of Chancery, In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884, 894 (Del. Ch. 2016) that criticized strike suits and required supplemental disclosures to be “plainly material,” plaintiffs’ lawyers are looking for jurisdictions that are more willing to turn a blind eye to their pernicious but highly lucrative rent-seeking. It is thus critical for shareholders to come forward to object to strike-suit settlements and reduce the number of friendly forums.