Delaware Court Scrutinizes Settlement Process and Replaces Lead Counsel in Shareholder Class Action Suit
A recent opinion of the Delaware Chancery Court ordered the replacement of plaintiffs’ lead counsel in a shareholder class action suit challenging the takeover of a publicly traded Delaware corporation by its controlling shareholder. In his opinion, Vice Chancellor Travis Laster criticized the removed counsel for failing to litigate the case adequately and for exaggerating their role in reaching a proposed settlement.
Vice Chancellor Laster’s opinion can be found online here.
Proposed Merger and Tender Offer
On April 13, 2009, MacAndrews & Forbes Holdings Inc. (“MacAndrews & Forbes”), the controlling shareholder of Revlon, Inc. (“Revlon”), proposed a merger to Revlon that would result in (i) MacAndrews & Forbes acquiring all of Revlon’s outstanding publicly traded Class A common stock and (ii) the minority Class A common stockholders receiving shares of a new Series A preferred stock (entitling its holders to certain liquidation, dividend, redemption and limited voting rights). The Revlon board formed a Special Committee to evaluate the merger and make a recommendation to the board. During the three weeks following the announcement of the proposed merger, four separate but substantively similar representative actions were filed in Delaware by counsel described in Vice Chancellor Laster’s opinion as “frequent filers.” Each complaint generally alleged that Revlon’s directors breached their fiduciary duties because the proposed transaction (which included modification of a $170 million senior subordinated term loan between Revlon’s operating subsidiary, as borrower, and MacAndrews & Forbes, as lender) would enable MacAndrews & Forbes to capture the benefits of an internal Revlon restructuring before such benefits were recognized by the market. As frequently happens in shareholder class action suits of this kind, the nine counsel that filed the four original complaints resolved their dispute regarding, and agreed upon, the status of each counsel in the action, including the selection of lead counsel.
In May 2009, the financial advisor to the Revlon Special Committee indicated that it would not be able to render a fairness opinion on the merger, and the Special Committee advised MacAndrews & Forbes that it could not recommend the merger to the full Revlon board. Thereafter, the structure of the transaction was changed from a merger to an exchange offer in which Revlon stockholders could exchange their Class A shares for the shares of the Series A preferred stock, and the Revlon Special Committee disbanded. In July 2009, the full Revlon board authorized Revlon to proceed with the exchange offer without recommending to the Class A shareholders that they tender their shares. In August 2009, the plaintiffs and defendants in the shareholder litigation entered into a Memorandum of Understanding (“MOU”) setting forth the initial terms of settlement, which included only minor modifications to the transaction terms and no monetary consideration. When the tender offer’s majority-of-the-minority condition was not met, the condition’s threshold was lowered below the number of shares tendered, constituting a de facto waiver that was agreed to by plaintiffs’ counsel in an amendment to the MOU. Revlon closed its exchange offer on October 8, 2009, with none of the original plaintiffs tendering their shares of Class A common stock.
Replacement of Plaintiffs’ Lead Counsel
In his opinion, Vice Chancellor Laster stated that “a systemic problem emerges when entrepreneurial litigators pursue a strategy of filing a large number of actions, investing relatively little time or energy in any single case, and settling the cases early to minimize case-specific investment and maximize net profit” and cited the court’s obligation to alter the leadership structure for a representative action if existing counsel fails to provide adequate representation. The opinion highlighted key factors in determining whether such representation is adequate: (i) the quality of the filings submitted by plaintiffs’ counsel; (ii) the willingness and ability of all contestants to litigate vigorously on behalf of an entire class of shareholders; and (iii) the enthusiasm or vigor with which the various contestants have prosecuted the lawsuit.
In replacing plaintiffs’ lead counsel with counsel filing claims following the close of the exchange offer, the court criticized the removed counsel as:
- failing to conduct a meaningful assessment of the class claims;
- overlooking and/or ignoring serious problems with the proposed transaction, including the inability of the Revlon Special Committee’s financial advisor to provide a fairness opinion and the waiver of the exchange offer’s majority-of-the-minority condition;
- offering to settle outstanding claims without conducting legal research, discovery or substantive investigation;
- offering to settle outstanding claims after learning that no fairness opinion would be provided;
- taking action “only when there was a dispute over control of the case and [their] path to a fee”;
- agreeing to an MOU that “raises serious questions about whether they focused foremost on the interests of the class, or instead settled on terms that would be easy gives for the defendants while still arguably sufficient to support a release and a fee”; and
- impairing their credibility with the court by including in the MOU questionable assertions regarding the basis for settlement and numerous factual inconsistencies with the Schedule TO filed by Revlon in connection with the exchange offer.
In addition to replacing lead counsel, the court directed the newly appointed lead counsel to evaluate the settlement and conduct confirmatory discovery, including investigation of the nature and extent of the removed lead counsel’s work, time and basis for its determination that the settlement was fair and adequate.
Going Forward
Vice Chancellor Laster’s opinion represents a warning shot across the bow of all participants in litigation over proposed mergers and other major transactions. The opinion is critical of plaintiffs’ firms that routinely file class actions on the heels of the announcement of a transaction before conducting any meaningful investigation as to whether the suit may have merit. Vice Chancellor Laster also expressed skepticism as to the value added to shareholders in settlements where deal terms are not substantially revised, and the opinion suggests that Delaware courts will scrutinize more closely the fairness of settlements in which class members get little of significance (whether “additional disclosures” or otherwise), plaintiff’s counsel receive an award of fees, and defendants obtain a broad release. For corporate officers and in-house lawyers, the opinion sends the message that when a class settlement is desired, the company’s lawyers should ensure the creation of a record of sufficient merit to justify both the terms of the settlement (and the factual representations set forth in any settlement documents) and the basis of plaintiffs’ counsel’s fees; the opinion suggests that in the absence of such a record, the court may scrutinize and question the validity of a settlement it determines to be the product of insufficient representation of the applicable plaintiffs.
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