Merger Lawsuits Often Mean No Cash for Investors
By Ann Woolner, Phil Milford and Rodney Yap – Feb 16, 2012 12:00 AM ET
A shareholder lawyer told a Delaware judge at a midsummer court hearing two years ago that his team deserved $700,000 for work on a lawsuit in which his clients received nothing.
Shareholders of BJ Services Co., an oilfield services company now owned by Baker Hughes Inc. (BHI), claimed its sale to the former parent would undervalue their holdings. The settlement of the case gave investors “crucial” data such as performance projections for five more years, Shane T. Rowley of Faruqi & Faruqi LLP told the judge, seeking to justify the legal fees.
“I can’t think of fruit that’s closer to the ground,” Chancery Court Judge John W. Noble responded. Still, the judge awarded Rowley and his colleagues $500,000 for their efforts.
Scenarios like the one played out at the July 2010 hearing in Wilmington are common in the Delaware court, the chief U.S. venue for mergers and acquisitions suits, Bloomberg Businessweek reports in its Feb. 20 issue. Of 57 such investor class actions settled or otherwise concluded there in 2010 and 2011, 40 — or 70 percent — made money for plaintiffs’ lawyers but not clients, according to data compiled by Bloomberg News.
“The greatest benefit is for the plaintiffs’ attorneys” in such litigation, said John C. Coffee Jr., a Columbia University professor who teaches securities law.
None of the 10 cases that New York-based Faruqi & Faruqi helped to settle during the two years produced cash for clients, according to court records. Legal fees in those 10 cases totaled $6 million, split among plaintiffs’ firms.
Millions in Fees
Overall, lawyers won $32.4 million for themselves in the 40 cases that generated no money for clients. The lowest legal fee award was $150,000; the highest was $4 million. The median came to $512,500, according to the data.
The 17 M&A lawsuits that resulted in cash for clients produced $350 million for the shareholders. The largest, a Del Monte Foods Inc. case, gave plaintiffs $89.4 million. Of that amount, attorneys were paid $22.3 million.
Even without consistent monetary awards, such lawsuits let shareholders scrutinize transactions and gain changes in terms, according to defenders of M&A litigation. Deal-makers, knowing their work will be closely evaluated by lawyers, produce fairer, more transparent transactions as a result, he said.
The “policing” effects of litigation have “real value,” Bernard Black, a Northwestern University law and finance professor who co-wrote an academic study of the Delaware courts, said. That “might well justify the money we throw at plaintiffs’ lawyers.”
No ‘Substantive Benefit’
Jim Woolery, co-head of North American mergers and acquisitions for JPMorgan Chase & Co., disagreed.
“The overwhelming — overwhelming — majority of these cases do not result in any substantive benefit for shareholders,” Woolery, a former senior partner at the law firm Cravath, Swaine & Moore LLP, said in an interview.
“If you can get $500,000 for increased disclosures and not one nickel for shareholders, who’s paying that?” Johnson said. “It’s coming out of shareholders’ pockets” because the companies pay the lawyers’ bills.
Companies settle almost all cases without trials, according to the data.
“If they want their deal to go through, they don’t have time to win,” Johnson said.
Fastest Growing Suits
M&A class actions are the fastest-growing type of securities litigation, according to Cornerstone Research. Among deals of $100 million or more announced in the past two years, 91 percent were challenged in court, the legal research firm said in a report.
The filing of lawsuits is so predictable that companies factor in legal bills as a sort of “transaction tax,” said Woolery, who has advised on multibillion-dollar deals. Among them was history’s largest leveraged buyout, the 2007 private- equity purchase of electricity provider TXU Corp., now known as Energy Future Holdings Corp., for $43.2 billion.
Minority stockholders who file M&A lawsuits often seek to halt a transaction, damages or both. Typically they file claims alleging they’ve been shortchanged, that management didn’t strive for higher bids, or that the board rigged the deal to keep out other possible buyers. A common claim is that a deal undervalues a company on the verge of explosive growth.
Bad Track Record
“Corporate America doesn’t have a great track record for policing itself,” said Christine S. Azar, the Wilmington managing partner for Labaton Sucharow LLP. “If we weren’t there for our clients, who knows what would happen?”
Her 65-lawyer New York-based firm helped settle four of the cases examined in the study. Two of them produced compensation for stockholders totaling $26 million.
M&A lawsuits let investor lawyers study internal documents and question managers, Azar said. Settlements can alter deal terms to encourage other bids, by easing “no-shop” clauses so boards can seek other buyers, she added.
Rolling back measures to protect deals “provides the opportunity for a topping bid, and this benefit exists whether or not a competing bidder materializes,” wrote J. Travis Laster, the newest judge in Delaware’s Chancery Court, in a legal-fee opinion last year. Directors aren’t required to get the best price, only to make a good-faith effort, he said.
Laster and Chief Chancery Court Judge Leo E. Strine Jr. declined requests for interviews on M&A lawsuits in their court.
Of the 40 settlements examined that resulted in investors getting no money, 19 included changes in deal terms, such as easing no-shop provisions or cutting termination fees paid if the seller backs out.
Twenty-one of the accords provided plaintiffs nothing but new information, such as details on efforts to sell the company and calculations behind financial projections.
Woolery said that, to settle a case, a company “might agree in the settlement, OK, we’ll change the following 25 words.”
Among plaintiffs’ firms with leading roles in five or more M&A settlements, Grant & Eisenhofer PA and Prickett, Jones & Elliott PA, both Wilmington-based, were most likely to get financial recoveries for investors, the data showed.
Prickett Jones did so in 58 percent of cases it helped settle as lead or co-lead counsel; Grant & Eisenhofer did so in 50 percent of such cases.
As for the sums that went to investors, Grant & Eisenhofer led with $253.9 million in four cases in which it played a key role. Attorneys took $53.1 million of that amount in fees.
Next was New York-based Bernstein Litowitz Berger & Grossman LLP, with settlements grossing $164.5 million for clients in three cases where it played a key role.
How work and money are divided among different firms in the same case isn’t disclosed, so the recovery amount is ascribed to each law firm that worked as lead, co-lead or so-called of counsel — typically out-of-state firms co-piloting a case.
The Faruqi law firm played a leading role in 10 of the 57 suits, making it second to Prickett in settlement activity during the two years measured here. Among firms settling five or more cases, only Faruqi’s clients ended up empty handed in cases it helped direct. In nine of its 10 settlements, Faruqi’s clients received only additional information on the deals.
Nadeem Faruqi and Rowley, the Faruqi law firm partner in the BJ Services case, didn’t return telephone and e-mail messages seeking comment on their lawsuits.
Judge Strine remarked on the frequency of disclosure-only settlements at an October hearing in a Faruqi case. He quipped that shareholders “seem to be hungry readers,” as they always want more information about deals, and then settle their cases when they get it.
Besides the 57 cases settled and closed, 10 M&A class actions were dismissed without settlements or trials, leaving the attorneys and their clients with nothing to show for suing.
Scores of other suits were consolidated with complaints challenging the same deals. Where multiple cases were filed over one deal, only the lead suit was analyzed.
Of the 17 class actions that brought minority shareholders money, two were also filed as so-called derivative suits, in which shareholders sue directors on behalf of the company.
Cases filed solely as derivative suits were excluded from the study because awards in those cases go to the companies, not directly to shareholders. One such suit led to a trial and the biggest verdict measured here, $2 billion, to Southern Copper Corp. (SCCO) It benefited shareholders by about $800 million, Northwestern’s Black said.
Quick to Sue
Law firms often move quickly to sue after a deal is announced. Two hours and 27 minutes after a Dec. 27 Business Wire press release that Ventas Inc. (VTR), a Chicago-based owner of senior housing and medical properties, would acquire Cogdell Spencer Inc. (CSA), the law firm Rigrodsky & Long PA posted a notice that it was investigating whether directors sought the best price.
Some lawyers sue the day after a merger announcement, as happened in BJ Services case. For the cases in this study, the median interval was eight days, according to court records.
“Every single deal, as soon as it gets announced, websites go up and notices go up on the Internet that this and that plaintiffs’ firm is investigating,” Woolery said. “What they are doing is trolling for plaintiffs.”
‘It’s Not Trolling’
“It’s not trolling,” Seth D. Rigrodsky, a principal in the six-lawyer Wilmington firm, said in an interview. “It’s letting investors know that there’s possible legal relief available.”
Labaton Sucharow, which represents institutional investors rather than individuals, never posts notices of investigations, said Azar.
She said Labaton monitors its clients’ portfolios, watching for deals involving their holdings. Its investigators “look at what the street is saying about the deal, what’s gone on over the last year or two” and whether “this is a company that’s on the rise,” Azar said.
The firm studies the numbers and looks for possible conflicts of interest among advisers and board members, she said. That can all happen within a few days, said Azar.
“Sometimes you file quickly because it is a very quickly moving deal,” she said.
Within four days of a merger agreement’s signing, a proxy statement must be filed with the U.S. Securities and Exchange Commission spelling out the terms. Such a filing can follow the initial public announcement by several weeks.
By that time, Azar said, other lawyers may have sued, reducing her firm’s chance of becoming lead counsel and directing the litigation for its clients. Lead counsel also usually reap the largest share of fees.
“If they want us to have a seat at the table, and if we wait for the proxy to come out, then we lose that opportunity,” she said.
In the cases reviewed, lawyers fared better when they got to court quickly. The 29 suits filed within eight days of the deals’ announcement led to a median legal fee of $700,000. The figure was $568,750 for the 28 filed later.
The reverse was true when it came to cash for shareholders. Investors got money in 24 percent of the more quickly filed cases and 36 percent of the later ones.
‘Less Thoughtful’ Lawsuits
“The quicker the suit, the less thoughtful the suit,” said Charles M. Elson, director of the University of Delaware’s John L. Weinberg Center for Corporate Governance. “You’re striking on the mere announcement of the merger,” with little information about its fairness, he said.
The Chancery Court is the country’s leader in securities lawsuits, largely because Delaware is the favorite place for companies to incorporate. It’s the legal home of more than half of all publicly traded U.S. companies, according to the state.
Being the nation’s corporate-law leader is “the gross domestic product of Delaware,” Coffee said.
In recent years, the state’s dominance in M&A cases has eroded as attorneys increasingly sue elsewhere, opting for federal courts or states where companies are based, according to a 2011 study.
“Delaware could risk losing its status as the de facto national corporate law court,” according to the study, “Delaware’s Balancing Act,” written by Black at Northwestern and professors at the University of Cambridge and University of Oxford.
In the Forefront
The desire to keep Delaware in the forefront of business litigation presents the state’s judges with a dilemma as they rule on fees for lawyers who file weak cases, Coffee said.
“If they got really punitive” by cutting fees, he said, “litigation would begin to flee Delaware.” Conversely, companies might be less likely to incorporate in Delaware if judges become too generous to lawyers, according to the study.
Chancery judges have voiced increasing reluctance at settlement hearings to approve what they call large legal bills for small results.
Judges regularly grill shareholder lawyers about why they sued and how a disclosure benefits their clients, discounting cosmetic deal changes as meaningless, according to hearing transcripts.
“They got wise to all that,” Woolery said.
A turning point may have been a 2005 ruling in litigation involving Cox Communications Inc., which was going private.
Strine began an 85-page decision by rebuking the plaintiffs’ lawyers for filing “premature, hastily drafted, makeweight complaints.”
He ruled the litigation was without merit and played little if any role in boosting the share price for minority stockholders. He approved $1.3 million in legal fees, compared with $5 million sought.
As judges examined claims, facts, settlement terms and legal fees in the cases evaluated here, they sometimes chided attorneys for making unsupported claims and rewarded others for work deemed well done, according to court transcripts.
Laster complimented the plaintiffs’ lawyers in the Del Monte Foods case, calling their work “an excellent effort.”
The attorneys unearthed what the judge found was a serious conflict of interest by Barclays Bank Plc.
While acting as Del Monte’s adviser, London-based Barclays “secretly and selfishly manipulated the sale process” to “obtain lucrative buy-side financing fees,” the judge wrote.
The bank withheld information from the San Francisco-based food company’s board while it helped two private-equity firms, KKR & Co. and Vestar Capital Partners, unite in a single buyout bid instead of competing, Laster wrote.
Barclays said it didn’t have a chance to give its side of the story in court because it wasn’t a party to the suit.
“We believe that the sale process leading up to the merger achieved the best price reasonably available for Del Monte stockholders,” Kerrie-Ann Cohen, a spokeswoman for the bank, said in a Jan. 27 e-mail.
The settlement gave shareholders $89.4 million, which included $22.3 million in attorney fees. Of the total settlement, Barclays paid $23.7 million.
“The banks now try not to be on both sides of a deal,” said Stuart Grant of Grant & Eisenhofer, lead plaintiffs’ firm in the case. “When you see a case done right, you start seeing behavior being changed in the boardroom.”
In cases where shareholders get no financial recovery, judges are faced with an “almost metaphysical question” as they decide the legal work’s value, Judge William B. Chandler III said in a 2010 hearing when he headed the Chancery court.
In approving fees, judges consider the usefulness of new disclosures and deal modifications, legal skill, hours worked, difficulty of issues, and the contingency basis on which lawyers take cases with no guarantee of payment, according to court transcripts.
If all sides agree to a sum for legal bills, judges often accept the agreement unless the amount is “outlandish,” as Laster said in one case.
One example involved the low-hanging fruit described by Judge Noble in the BJ Services suit. In that case, plaintiff lawyers got $500,000, 29 percent less than the $700,000 requested.
Removed Three Firms
And in 2010, the year after he joined the court, Laster removed three law firms from leadership roles in a suit filed by minority stockholders of Revlon Inc. (REV)
In that case, investors claimed they would be underpaid when the controlling shareholder, MacAndrews & Forbes Holdings Inc., owned by billionaire Ronald Perelman, acquired all of the company’s publicly traded stock in exchange for new preferred shares.
In seeking fees, the judge wrote, plaintiffs’ attorneys appeared to have claimed undeserved credit for changes in the deal’s terms, exaggerated the benefits of “tweaks” and failed to notice red flags pointing to the transaction’s unfairness.
The attorneys tried to help New York-based Revlon circumvent a requirement that stockholders tender at least half of shares not held by New York-based MacAndrews, Laster wrote. Only 42 percent were tendered, he said.
That was “an aberration” for his firm, Rigrodsky said in an interview.
“Laster has had no problem appointing my firm lead counsel in many cases since then,” the lawyer said.
Laster, in a later hearing in a case involving Rigrodsky’s firm, said he didn’t think the firm was responsible for the failings in the Revlon case, according to a transcript.
Joseph A. Rosenthal of Rosenthal Monhait didn’t respond to telephone and e-mail requests for comment on the case. A Wolf Popper attorney involved in the Revlon case, Robert M. Kornreich, declined to comment on it.
Judges also balk at high fees when a complaint’s allegations prove to be untrue.
In what he called a “stinky” case, Strine complained at an October fee hearing about “mundane” disclosures touted as significant in an accord reached by the Faruqi firm.
The law firm said one of its biggest achievements in the case was learning the fee arrangement that Danvers Bancorp Inc. had with Endicott Financial Advisors. The Massachusetts-based bank holding company was to be sold to People’s United Financial Inc. (PBCT) in a $480 million deal. Initial documents omitted the payment to Endicott, which turned out to be unremarkable.
“So you have no basis to believe Endicott had some unusual incentive?” Strine asked Faruqi’s Adam Gonelli.
“We were suspicious that there might be,” which was a key reason to sue, Gonelli said.
“And then it turned out to get what is a fairly standard fee, right?” Strine asked.
“Yes, your honor.”
The judge approved a $150,000 fee — 80 percent less than the $750,000 initially requested by the plaintiffs, and 61 percent below the $380,000 fee to which the defense agreed.
When almost every merger or acquisition is challenged in court, no matter how good the deal is for investors, the deterrent value of such litigation disappears, Columbia’s Coffee said.
Delaware courts could avoid such an eventuality if they punish lawyers who file frivolous cases by denying them fees, he suggested.
“If you pay the class counsel a fee in any case, it’s like putting a saucer of milk for a kitten at your back door,” Coffee explained. “Overnight you’ll have 20 cats.”
Delaware Chancery Court Class Action M&A Suits
Settled and Completed, 2010-2011
Law Firms With a Leading Role in Five or More Cases
================================================================ Cases Cases as Lead, With Amount Legal Fees Co-Lead or Shareholder Recovered Awarded@ Plaintiffs’ Firm of Counsel* Recovery ($M) ($M) ================================================================ Prickett Jones 12 7 46.6 21.1 Faruqi & Faruqi 10 0 0.0 6.0 Rosenthal Monhait 9 1 18.4 5.5 Grant & Eisenhofer 8 4 253.9 66.2 Robbins Geller 8 2 107.8 31.3 Bernstein Litowitz 7 3 164.5 43.1 Kessler Topaz# 6 2 14.0 9.8 Levi & Korinsky 6 1 18.4 5.3 Rigrodsky & Long 6 2 17.7 10.0 Weiser 5 2 17.7 7.7 * -- Leadership roles sometimes filled by multiple firms. @ -- Includes cases with no shareholder recovery. Also includes total of fees shared by multiple firms. The full amount of fees was included in each firm’s total as breakdown isn’t disclosed. # -- Formerly Barroway Topaz Kessler Meltzer & Check LLP
To contact the reporters on this story: Ann Woolner in Atlanta at firstname.lastname@example.org; Phil Milford in Wilmington, Delaware, at email@example.com; Rodney Yap in Los Angeles at firstname.lastname@example.org.