Claim Extinguishment in M&A Litigation
January 17, 2017
In 2016, Delaware courts considerably narrowed post-closing challenges to mergers by reasserting the deference for corporate decisions approved by fully informed, disinterested, and uncoerced stockholders. By extinguishing breach of fiduciary duty claims entirely, such approval now provides a useful cost-effective path to early dismissal of lawsuits. Claim extinguishment, however, is only available when forthright disclosures fully inform stockholders and there are no conflicts of interest that require heightened scrutiny under the entire fairness standard. Going forward, boards and their counsel must not only ensure well-run sale processes, but also identify and disclose any material issues so that stockholders can be apprised before approving a transaction.
Even after successful mergers, plaintiffs’ lawyers frequently bring post-closing breach of fiduciary duty claims seeking damages. In the past, such claims against disinterested directors have required plaintiffs to demonstrate gross negligence by these directors. Recent Delaware decisions have clarified that fully-informed stockholder approval of a transaction will extinguish all claims except waste unless the transaction is subject to the entire fairness standard. And since Delaware courts believe rational stockholders would not approve a wasteful transaction, such post-closing damages claims will generally be dismissed. Indeed, the Delaware Supreme Court has now twice held that claim extinguishment requires dismissal of breach of fiduciary duty claims concerning transactions approved by fully-informed stockholders, and lower courts have done so repeatedly as well, including twice with respect to mergers approved by stockholders tendering shares in a two-step merger.
Because claim extinguishment requires fully informed approval, disclosures to stockholders are more important now than ever. Boards and counsel should focus not only on running an effective sale process but also on identifying all material issues and disclosing them to stockholders. When the facts that form the basis of breach of fiduciary duty allegations have already been described in the proxy or recommendation statement, courts can find that the stockholders were fully informed about the relevant issues but voted to proceed with the transaction nonetheless. If a majority of those stockholders approved the transactions, Delaware courts will not second guess that judgment.
Disclosure is particularly important regarding financial advisor conflicts of interest, which have been the basis of several breach of fiduciary duty claims. Underscoring the benefits of identifying conflicts early in the sale process, Delaware courts have applied claim extinguishment after reviewing disclosures and finding that stockholders were fully informed about such alleged conflicts before they approved the transaction. Since these decisions further held that stockholder approval also extinguishes claims against financial advisors, who may be alleged to have aided and abetted the board’s breach of fiduciary duties, advisors should likewise focus on facilitating early, thorough disclosure.Given the protections afforded by claim extinguishment, we expect plaintiffs’ lawyers will try even harder to invoke the entire fairness standard by alleging conflicts of interest that supposedly taint oversight of the sale process. While the Court of Chancery has rejected these efforts in certain recent cases, the Delaware Supreme Court has yet to weigh in. Wherever these efforts lead, an ounce of disclosure is worth a pound of post-closing litigation, and boards and their counsel should act accordingly.