The informed choice of independent, uncoerced shareholders to approve an M&A transaction is being given more weight in the United States following a recent line of Delaware decisions.
The U.S. courts are deferring to the business judgment of directors in M&A transactions that have been properly approved by shareholders. This deference is making it more difficult for disgruntled investors to advance post-closing damages claims. The net effect? Declining M&A litigation in the U.S., and alignment with the Canadian courts’ approach to reviewing M&A transactions.
Delaware courts raise bar for M&A litigation
In recent years in the U.S., shareholder lawsuits challenging M&A transactions reached explosive levels. Between 2010 and 2014, over 90% of announced public company transactions valued over US$100 million attracted shareholder litigation.1 Deal litigation has usually taken the form of a putative class action, commonly alleging breaches of fiduciary duties by the target board in running the deal process and inadequate disclosure.
Following the landmark decision of the Delaware Supreme Court in Corwin et al. v. KKR Financial Holdings LLC,2 in post-closing claims, the Delaware courts will now apply the most deferential business judgment rule standard in reviewing M&A transactions with non-controlling shareholders, so long as the transaction was approved by a majority of the target’s disinterested shareholders following an informed and uncoerced vote.
In an article anticipating Corwin, Chancellor Travis Laster provided a rationale for this approach based on a “qualified decision maker” approving the transaction. He writes: “when a stockholder plaintiff claims that a corporate decision constituted a breach of fiduciary duty, a court applying Delaware law searches for an independent, disinterested and sufficiently informed decision maker. […] Only in the absence of a qualified decision maker will the court assume that role for itself.”3
The growing weight placed by U.S. courts on the informed shareholder vote to shield M&A transactions from post-closing disputes is perhaps a reflection of the large institutional shareholder base in corporate America.
Now, if the conditions in Corwin are met, the deferential business judgment rule will apply. As a result, post-closing damages claims in non-controller transactions are much more challenging for investors. However, structurally conflicted transactions involving controlling shareholders will attract the most rigorous “entire fairness” standard, where the court will consider whether the transaction was procedurally and substantively fair.
Post-Corwin, more U.S. shareholder lawsuits disputing M&A transactions post-closing are being dismissed. This development is expected to contribute to the ongoing decline of M&A litigation. According to Cornerstone, in the first half of 2016, just 64% of announced M&A transactions were challenged in litigation – a marked drop from the high of 90% just a few years earlier.
The growing weight placed by the U.S. courts on the informed shareholder vote to shield M&A transactions from post-closing disputes is perhaps a reflection of the large institutional shareholder base in corporate America. Over 70% of the top 500 U.S. corporations is now held by institutional investors,4 and the courts may be more willing to defer to decisions made by sophisticated investors that are well-positioned to assess the merits of a transaction. In any event, it remains to be seen whether the new challenges in bringing post-closing actions in damages cause parties to shift their focus to bringing litigation in non-Delaware jurisdictions or to appraisal litigation as a way to improve deal terms.
Alignment with Canadian approach
From a Canadian perspective, Corwin essentially brings the Delaware approach in line with how Canadian courts review M&A transactions in similar cases. A Canadian target board’s decision in a change-of-control transaction is subject to deference under the business judgment rule.
As in Corwin, Canadian courts afford significant weight to the affirmative vote of shareholders in support of an M&A transaction. Arrangement transactions, which are the most frequently used structure for implementing a friendly deal in Canada, involve shareholder approval and an application to the court to determine that the transaction is fair and reasonable, a determination that relies to a large extent on the shareholder vote.5
In deals involving controlling shareholders, Canadian securities and corporate law and the requirements developed by Delaware courts are also aligning in accordance with the “qualified decision-maker” principle. In the leading Delaware decision, In Re MFW Shareholders Litigation,6 the court held that a freeze-out merger with a controlling shareholder that was conditioned from the outset on (i) negotiation and approval by a fully empowered special committee of independent directors, and (ii) approval by an uncoerced and fully informed vote of a majority of the minority shareholders, would qualify for the deferential business judgment rule standard of review, rather than be subject to the more exacting “entire fairness” standard.
The process with special committee and minority approval endorsed in In Re MFW Shareholders Litigation is similar to the requirements for going-private transactions involving significant shareholders under Canada’s Multilateral Instrument 61-101. Whereas the ruling in MFW is intended to create an incentive for transaction participants to adopt these procedural protections, in Canada, those protections are mandatory.7
Importance of shareholder disclosure
Obtaining the benefit of Corwin depends in part on disclosure to shareholders. Good disclosure will assist shareholders in making an informed vote, but it may not cleanse inherent procedural deficiencies and pervasive conflicts of interest of a target board in certain M&A transactions, and in those cases, transactions remain open to “enhanced scrutiny” review.
As demonstrated by the recent InterOil plan of arrangement litigation in Canada, Canadian courts will also be reluctant to decide that an arrangement is fair where they consider that the shareholders’ approval of the transaction was not fully informed. In that decision, the court questioned the disclosure regarding the financial analysis underlying the fairness opinion in support of the transaction and the compensation paid to the financial advisers.8
As sophisticated, informed shareholders continue to make their mark on the public M&A landscape, we are likely to see a continuation of the current downward trend on deal litigation—and a continued convergence in the Canadian and U.S. judiciaries’ approach to deal reviews.
1 See Cornerstone Research – Shareholder Litigation Involving Acquisitions of Public Companies, Review of 2015 and 1H 2016 M&A Litigation.
2 No. 629, 2014 (Del. Oct. 2, 2015); see, for example, Singh v. Attenborough, 137 A. 3d 151 (Del. 2016); Larkin v. Shah; and In Re Cyan, Inc. Stockholders Litigation, C.A. No. 11714-CB (Del. May 11, 2017)
3 T. Laster, “The Effect of Stockholder Approval on Enhanced Scrutiny”, (2014) William Mitchell Law Review, Vol. 40. Iss. 4, Article 8 at 1443.
4 See “The Structure of Corporate Ownership and Control,” Sophia Dai, University of Pennsylvania, and Christian Helfrich, Goethe University, Spring 2016.
5 In Magna International Inc., 2010 ONSC 4123, the result of the shareholder vote on an arrangement proposing the collapsing of the company’s dual-class share structure was given significant weight, and the arrangement was approved relying on that vote where many other indicia of fairness were absent (there was no fairness opinion, and no recommendation from the company’s board or a determination by the board that the arrangement was fair).
6 67 A. 3d 496 (Del. Ch. 2013).
7 For details, see Torys’ publications: “The Special Committee Will Take Centre Stage” and “Effective Special Committees: Lessons from Courts and Regulators.”
8 For further details, see Torys’ publications: “Deal Litigation Puts Growing Pressure on Financial Advice.”
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