Doing a post on Chancellor Strine’s opinion in MFW Shareholders Litigation, granting summary judgment to the defendants in a suit challenging a merger with a controlling stockholder, induces serious blogger’s guilt. It is nothing short of presumptuous to try to say anything analytical about an opinion just days after it was issued, when the opinion itself is so obviously the product of assiduous care in analyzing precedent and doctrine.

But kibitzing is an academic’s business, so here goes. First, a note to my fellow corporate law professors: if you haven’t already done so, you might as well read this opinion now. You’re going to be teaching it next year, and perhaps for quite a while after, or at least you should. There’s nothing surprising about the proposition that Leo Strine has written an opinion worth reading, but for my money this is one of his – and therefore one of the – best corporate opinions ever, on a par with or perhaps even better than my previous favorite, Pure Resources.

Several aspects of MFW make it a great opinion. First, its persuasiveness derives in large part from its modesty. (Hat tip to former Chancellor William T. Allen for teaching me the persuasive value of modesty). It is (probably quite intentionally) devoid of “because I said so” assertions. At practically every turn, the opinion acknowledges the debatability of its conclusions.

Second, the MFW opinion is a marvelous lesson in common law jurisprudence and, in particular, the meaning of the term “dictum.” Inevitably in judicial opinions, judges provide explanations or reasoning that later factual situations reveal to be overbroad or imprecise, or both. Nothing wrong with that: it’s impossible to foresee all the ramifications of any generalized statement. The MFW opinion repeatedly exposes instances in which language about standards of review and burdens of proof strays beyond the factual boundaries of its original context. More importantly, MFW then reminds us that it behooves common law judges not to become enslaved to that language in deciding subsequent cases. Rather, they have to carefully examine the extent to which such language was actually necessary to determine the outcome of the case in which the language is expressed. Where it wasn’t, it becomes important to examine whether to extend the application of that language to a different set of facts.

Finally, MFW is extraordinary for its transparency in addressing the empirical foundation of the conclusions it draws. One notable aspect of MFW’s analysis illustrates this point, and exposes the distinct possibility that the Delaware Supreme Court will reverse the grant of summary judgment. The Chancellor’s analysis emphasizes the bipartite idea that in approving a merger with a controlling stockholder, a fully empowered, independent special committee fulfills the function served by the full board of directors in an arm’s length merger, and the informed vote of a majority of the minority stockholders fulfills the function served by the statutorily required vote of stockholders on an arm’s length merger. To reach the latter aspect of this conclusion, however, the MFW opinion analyzes at some length whether the majority of the minority vote is qualitatively equivalent to the stockholder vote on an arm’s length merger.

The question is whether the stockholder vote is any less voluntary in respect of a proposed merger with a controlling stockholder than it is in respect of a merger with a third party. To answer that question, the MFW opinion notes instances in which stockholders have voted down, or threatened to vote down, merger proposals, including the pending effort by Sprint to acquire the balance of Clearwire’s equity. The opinion also reviews the increasingly concentrated holdings of institutional investors, who presumably have a greater ability to resist merger proposals they don’t like (a phenomenon facing Michael Dell at the moment).

But whether a minority stockholder vote is as voluntary as a vote in the absence of a controller is an empirical question that may be impossible to resolve definitively in any particular case, let alone as a general proposition. Moreover, it’s a question on which the Delaware Supreme Court has spoken, repeatedly. Quoting what it had held in 1990 in Citron v. E.I. duPont de Nemours, Inc. , the Supreme Court in Kahn v. Lynch Communications explained at some length why one should conclude that the minority stockholder vote is never entirely voluntary and uncoerced:

Parent subsidiary mergers, unlike stock options, are proposed by a party that controls, and will continue to control, the corporation, whether or not the minority stockholders vote to approve or reject the transaction. The controlling stockholder relationship has the potential to influence, however subtly, the vote of [ratifying] minority stockholders in a manner that is not likely to occur in a transaction with a noncontrolling party.

Even where no coercion is intended, shareholders voting on a parent subsidiary merger might perceive that their disapproval could risk retaliation of some kind by the controlling stockholder. For example, the controlling stockholder might decide to stop dividend payments or to effect a subsequent cash out merger at a less favorable price, for which the remedy would be time consuming and costly litigation. At the very least, the potential for that perception, and its possible impact upon a shareholder vote, could never be fully eliminated. Consequently, in a merger between the corporation and its controlling stockholder–even one negotiated by disinterested, independent directors–no court could be certain whether the transaction terms fully approximate what truly independent parties would have achieved in an arm’s length negotiation. Given that uncertainty, a court might well conclude that even minority shareholders who have ratified a . . . merger need procedural protections beyond those afforded by full disclosure of all material facts. One way to provide such protections would be to adhere to the more stringent entire fairness standard of judicial review.

This, of course, is a decidedly pessimistic view of the prospect that minority stockholders will vote their convictions about the value of the controller’s merger proposal. It may be that the particular retaliatory threats identified by the Supreme Court wouldn’t apply in MFW’s situation, because, for example, the controlling stockholder had committed not to proceed with a merger unless approved by both the special committee and the majority of the minority stockholders. Nevertheless, the plain language of the Supreme Court’s assessment of minority stockholder vulnerability makes it seem almost impossible to believe that a minority stockholder vote could contribute to dispensing with the obligation of the court to evaluate the fairness of a merger with a controlling stockholder. But make no mistake: the Supreme Court’s assessment of minority stockholder voting behavior was, when first announced in Citron and later reiterated in Kahn, unsupported by any empirical or even anecdotal evidence. It was simply speculation – plausible, perhaps – about the subjective state of mind of minority stockholders.

And if the Court of Chancery accurately perceived the plaintiffs’ own position in the MFW case, the Supreme Court’s empirical assessment is not shared by the plaintiffs themselves: the Chancellor noted that “the plaintiffs themselves do not argue that minority stockholders will vote against a going private transaction because of fear of retribution … .”

But the Delaware Supreme Court must inevitably make law for all cases, not just the one shaped by the position of counsel in the case before it. It remains to be seen, then, whether the empirical assessment expressed in MFW will survive appellate consideration. If it doesn’t, and if the Supreme Court adheres to its prior empirical pronouncements, it seems quite possible that the doctrinal structure advocated in MFW, in which dual approval by an effective special committee and a majority of minority stockholders obviates the need to examine fairness, will fall away, leaving entire fairness as the continuing test for evaluating mergers with controlling stockholders. The Court of Chancery rightly notes that this view would perpetuate the unfortunate result that controllers will have no incentive to seek minority stockholder approval through a vote, and will instead follow the path of a tender offer and short form merger, which provides less protection for minority stockholders but, oddly, greater protection from judicial scrutiny.

From two students at our Harrisburg campus (Julia Skinner (Class of 2013) and Corey Dietz (Class of 2014)), the following post presents some insights into uncertainty about the operation of municipal bankruptcy proceedings:

Municipalities contemplating filing for bankruptcy are met with resistance because of the fear of rogue judges taking over a city’s finances and making cuts to wherever they see fit. The deteriorating financial condition of many municipalities is bringing these fears to the forefront of the minds of city employees, officials, and citizens. Because municipal bankruptcy filings are rare, many people are uninformed about exactly how municipal bankruptcy works. Unlike individuals and business entities that file for bankruptcy, municipalities that file under chapter 9, the municipal bankruptcy chapter, maintain the freedom to control their finances and property, with judicial interference being permitted only when the municipality consents. The sometimes-stated fear of a judicial takeover of a city is far from the truth of how a chapter 9 bankruptcy works. Section 904 of the Bankruptcy Code imposes limits on the federal court to assure that powers reserved to the states are honored. The section states:

[n]otwithstanding any power of the court, unless the debtor consents or the plan so provides, the court may not, by any stay, order, or decree, in the case or otherwise, interfere with- (1) any of the political or governmental powers of the debtor; or (2) any of the property or revenues of the debtor; or (3) the debtor’s use or enjoyment of any income-producing property.

11 U.S.C. § 904. This limitation bars the possibility of rogue judges and judicial control over the city functions. The case law reinforces the concept of judicial limitations and municipal freedoms.

One of the opinions in Stockton, California’s bankruptcy case illustrates these limitations. Stockton has a population of approximately 300,000 people and on June 28, 2012, it became the largest city to ever file for bankruptcy. Stockton owes more than $350 million to bond insurers. Stockton has stopped paying some bondholders and creditors have been contesting the city’s payments to state pension fund and the California Public Employees’ Retirement System, or CalPERS. California’s Stockton can pay claim opposed by bond insurers, Reuters (Jan. 30, 2013, 7:35 PM). The retired employees of Stockton brought suit as a class action by the Association of Retired Employees of the City of Stockton (ARECOS) and 8 retirees on July 10, 2012, together with an Application for Temporary Restraining Order in order to continue the payment of the retiree health benefits. In re City of Stockton, Ca., 478 B.R. 8 (2012). The city created a new budget that reduced payments to the plaintiffs. The retirees brought suit seeking an injunction prohibiting the City from implementing the retiree health benefit reduction as part of its annual operating budget. The plaintiffs filed suit claiming that they had vested contractual rights protected by the Contracts Clause of the United States Constitution to continue the payments. Id. at 13. Judge Klein noted that “the Contracts Clause bans a state from making a law impairing the obligation of contract; it does not ban Congress from making a law impairing the obligation of contract.” Id. at 15. Therefore, the Bankruptcy Clause authorizes Congress to make such laws that would impair contracts. Specifically, § 904 forbids the court from granting such an injunction, allowing a city to control their finances without judicial interference under the Bankruptcy Clause.

Although the retirees feel that they have been wronged by having their payments reduced, § 904 prevents the court’s ability to issue an injunction whether it is fair or not. Section 904 is so comprehensive that it “functions as an anti-injunction statute- and more.” Id. at 20. In short, the § 904 limitation on the court’s authority is absolute unless a city either consents or a provision in a plan of adjustment has already been proposed. Id.

The only real remedy for the retirees is to participate in the process of formulating a plan of adjustment (a plan of adjustment is the chapter 9 equivalent to chapter 11’s plan of reorganization). According to settled bankruptcy law, Stockton may “implement interim contractual modifications before the confirmation of a chapter 9 plan of adjustment but such revisions do not, as a matter of law, become permanent unless and until made part of a confirmed plan of adjustment or otherwise voluntarily agreed.” Id. at 30. Therefore, no matter how unfair it may seem to the retirees or plaintiffs in general, the judiciary’s hands are tied under § 904.

Jefferson County, Alabama, filed the largest municipal bankruptcy measured by outstanding debt in November, 2011. The court in Jefferson County’s case applied § 904 in the same manner. Jefferson County was in a dire financial state and was seeking ways to save money. The Cooper Green Hospital operated by the county was continuously spending over budget and operating at a loss. In re Jefferson County, 484 B.R. 427, 435 (2012). The county was no longer able to fund the hospital’s deficits Id. at 434. Jefferson County decided to close the Cooper Green hospital emergency room as well as end inpatient procedures. Id. at 435. Several parties, including the city of Birmingham, employees, inpatients and the mayor, sought an injunction to prevent the county from closing the hospital. Id. at 437.

In refusing the injunction, the court discussed the powers of a municipal debtor. The court found a chapter 9 debtor retains full title over property and retains control over the properties operations. Id. at 462. The freedom of the chapter 9 debtor was incorporated in § 904 along with a restriction on the bankruptcy court’s ability to interfere with a municipal bankruptcy. Id. at 462. Without a municipal debtor’s consent a bankruptcy court may not interfere with any political or governmental powers, any of its property or revenues, or its use and enjoyment of income-producing property. Id. at 463.

In a more recent Stockton opinion the court consistently applied § 904. In In re City of Stockton, the issue was whether a Chapter 9 municipal debtor must obtain court approval under Federal Rule of Bankruptcy Procedure 9019 of any compromise or settlement the municipality makes during the course of the bankruptcy. In re City of Stockton, California, 486 B.R. 194, 195 (2013). The City of Stockton had agreed to settle a lawsuit for $55,000. Id. The capital market creditors claimed that the city must make a motion under Rule 9019 for court approval of the settlement. Id. The city’s contention was that Rule 9019 did not apply in chapter 9 cases unless the city sought court approval. Id. The court held that Rule 9019 applies to municipal bankruptcy cases only if the municipality consents to the court considering approval of a settlement or compromise. Id. at 197. However, when a chapter 9 debtor files a Rule 9019 motion to have a court approve a compromise the municipality can consent to judicial interference. Id. The court also held the city can expend its property and revenues during the chapter 9 case in any way it wants. Id. at 198. The court in this Stockton opinion maintained that the judiciary could only interfere with a municipal bankruptcy when the municipality consents to the interference.

The courts are steadfast in their interpretation of § 904 prohibiting judicial interference with a municipal bankruptcy unless the municipality consents to the interference. The fears that are prevalent among city leaders and the general public of judicial control and dominance are unfounded. Judges may not step in and control the city’s finances directly after a city has declared bankruptcy. Through § 904, Congress ensured the judiciary’s hands are tied allowing the municipality to maintain control over its property and revenues.

Benjamin P. Chapple

Widener’s Institute of Corporate & Business Law, in partnership with the law school’s Moot Court Honor Society, hosted the 25^th Annual Ruby R. Vale Interschool Corporate Moot Court Competition.  This year’s competition included a geographically diverse set of competitors, hailing from twenty different law schools.  The competition lasted four days, with the final round on March 17, 2013, judged by Delaware Supreme Court Justice Jack Jacobs, Justice Joseph Walsh (retired), Vice Chancellor J. Travis Laster, Vice Chancellor Sam Glasscock, and Judge Jed S. Rakoff of the United States District Court for the Southern District of New York.  We are extremely thankful for their generous participation.  Judge Rakoff also provided a Distinguished Scholar Lecture, in which he discussed the International Court of Commerce of Iraq and the heroism of the judges of that court who do their part to promote economic stability despite daily threats of assassination.  A summary of this year’s moot court problem and a list of award recipients are provided below.

The case appealed from involved the use of a “Don’t Ask, Don’t Waive” standstill agreement in the context of the sale of an entire company, Callison Inc., that is controlled by its 72% stockholder, Allen.  Because Allen needed funds to purchase another business—which it is contractually obligated to buy—it became interested in monetizing its 72% stake in Callison.   Allen approached Callison’s board of directors, expressing its interest in selling its holding through a sale of the entire company, and the Board—after forming an independent special committee—initiated a sale process for the Company that involved a private canvassing of the market of likely potential suitors.  Of the suitors identified, only six agreed to sign a DADW standstill.  Each of these six suitors was afforded a one-time opportunity to submit their highest and best bid to acquire the entire Company; however, each was contractually prevented—as a result of the DADW—from (1) making any further offers and (2) asking Callison’s Board for permission to do the same.

As a result of the bidding process, Vicente emerged as the highest bidder.  The Board and Vicente entered into a merger agreement that provided for a market check, but notably excluded the five unsuccessful bidders from participating in the market check.  One of these five unsuccessful bidders, Galena, approached Callison’s Board and privately requested that it waive the DADW provision so as to permit Galena to make a topping bid.  The Board, after consulting legal counsel, however, held firm to the DADW and rejected Galena’s offer.  As a result of this rejection, Galena took two actions.  First, it filed suit challenging the validity of the DADW standstill agreement, in which Galena sought a preliminary injunction to prevent Callison and/or Callison’s Board from attempting enforcement.  Second, on the same day, Galena launched a tender offer for $35.50—which is $1.50 more than the Vicente offer, representing a premium in excess of $120 million—conditioned on, inter alia, the judicial invalidation of the DADW standstill agreement. ­

In the hypothetical moot court problem, the Court of Chancery found the challenged DADW provision to be unenforceable under the Revlon/QVC “range of reasonableness” standard—thereby enjoining enforcement of the provisions.  Accordingly, it was unnecessary for the Court of Chancery to consider Galena’s argument that the more exacting entire fairness should apply.  The Delaware Supreme Court accepted an interlocutory appeal from the preliminary injunction order.   The appeal implicated two principal issues relating to the fiduciary duties of the directors of a Delaware corporation in relation to the sale of the company.  Both issues arose from the Board’s decision to accept Vicente’s indisputably lower offer in reliance upon the DADW agreement.

The first issue was the validity of the DADW standstill agreement as a matter of Delaware law.  Previous decisions of the Court of Chancery have examined this question, and concluded that these provisions are highly problematic.  In these prior decisions, the view has been that DADW standstill agreements “collectively operate to ensure an informational vacuum,” and prevent the board of directors from satisfying their duty to take care and remain informed of all material information reasonably available.  Additionally, past decisions have found that DADW provisions prevent the board from satisfying its ongoing statutory and fiduciary obligation to provide a current, candid, and accurate merger recommendation to the shareholders.  Notably, however, the Court of Chancery’s most recent decision that addressed the question—In re Ancestry.com—made clear that (1) these provisions are not per se invalid, and (2) the Court is “not prepared to rule out that [these provisions] can’t be [properly] used for value-maximizing purposes.” In re Ancestry.com Transcript, at 23.

Competitors, particularly in the final rounds, focused on Supreme Court precedent.  Appellants, on the one hand, argued that the Court has made clear that there is no single “blueprint” for the board to follow to satisfy Revlon‘s value maximization directive.  Additionally, Appellants stressed that the Appellee is a sophisticated party that knowingly entered into the DADW standstill.  Furthermore, Appellants argued the DADW standstills, here, were used in a value-maximizing manner, because the bidders were encouraged to put their best foot forward up front, thus preventing a costly protracted auction.  Appellees, on the other hand, argued that, although there is no single blueprint, Revlon and its progeny make clear that the Board’s role is to obtain the highest value reasonably available.  To that end, Appellees argued that the Callison Board’s decision to accept Vicente’s offer, which was more than $120 million less than the opposing offer, is clearly not value maximizing.  In response to Appellants’ reliance on the DADW standstill, Appellees argued contracts cannot limit a board’s fiduciary duties.  This issue, in large part, comes down to balancing two concepts: one, the Revlon/QVC directive that the target board must maximize shareholder value; and two, how much flexibility will the Court allow target boards in creating a value-maximizing sales process to satisfy this directive.

The second issue—whether the more exacting entire fairness standard should apply—arose because Callison’s majority shareholder, Allen, would incur $60 million in liquidated damages if he failed to close an independent business acquisition.  Relying on McMullin v. Beran, Appellee argued a conflict of interest was present because Allen (1) has an independent need for quick liquidity and (2) appointed all of Callison’s Directors.   Furthermore, Appellee argued that Allen dominated the sales process, making the special committee a “rubber stamp.”  Appellee’s argument, thus, implicates the duty of loyalty.  Appellants denied there was any disqualifying conflict.  They emphasized that under the Vicente offer Allen would be receiving the identical consideration (on a per share basis) as the minority, in a transaction that resulted from a deliberative process, involving a well-functioning independent special committee, which included an effective market check that allowed other topping bids to come forward to ensure value maximization.  Appellees cogently argued, however, that the market check was illusory because it excluded those most likely to making a topping bid—the DADW-bidders.

Although there were many great competitors at this year’s competition, we would like to specifically recognize:

1^st Place 

Georgetown University Law Center 

Jeffrey DeSousa

Allyson Poulos

2^nd Place

Brooklyn Law School

Andrew Ceppos

Tricia Lyon

The Donald E. Pease Best Brief Award

Michigan State University College of Law

Jeffrey Hayden

Jeffrey Mann

William Selesky

Best Oral Advocate

Georgetown University Law Center

Jeffrey DeSousa

Chancellor Strine’s March 8, 2013 opinion in Kallick v. SandRidge Energy is a welcome reaffirmation and clarification of director duties in relation to takeover deterrents built into otherwise customary commercial transactions—in this case, a put right (the “Proxy Put”) in the company’s credit agreements that would require the company to refinance debt in the event of a change in the majority of the board not approved by a majority of the pre-existing directors.

Responding to a dissident hedge fund’s consent solicitation to replace the board, the company (SandRidge) made the (in hindsight) grievous error of warning its stockholders that replacing the board could result in “mandatory refinancing of [a] magnitude [that] would present an extreme, risky and unnecessary financial burden” on the company. Talk about playing right into the dissident’s hands! You don’t have to be as smart as Chancellor Strine to figure out that this great a burden on the electoral franchise requires some explanation. Who agreed to it? Why? And why can’t the burden be avoided? The company later tried to ride a different horse, claiming that the Proxy Put was no problem after all, because refinancing would be easy and inexpensive – a better argument in light of Unocal, of course, but regrettably awkward in light of the company’s prior position .

Those first two questions—how and why did the Proxy Put get there in the first place?—didn’t get much of an answer in the record. The Chancellor usefully reminded transactional lawyers, however, that playing with matches like the Proxy Put requires some care: “the independent directors of the board should police aspects of agreements like this, to ensure that the company itself is not offering up these terms lightly precisely because of their entrenching utility, or accepting their proposal when there is no real need to do so.” SandRidge’s lawyers involved in negotiating the credit agreements may have missed that message from the Court’s 2009 opinion in San Antonio Fire & Police Pension Fund v. Amylin Pharms., Inc., 983 A.2d 304, 315 (Del. Ch. 2009) (“The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting [a Proxy Put], it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it.”).

In any event, what was done was done. The real question in the case was not how the Proxy Put got there, but what to do about it. The premise from which the Chancellor approached the question was that the board could “approve” the dissident candidates for purposes of the Proxy Put (and thereby avoid triggering it) without endorsing their candidacy. The question then became whether there was any reason not to grant such limited approval, and that’s where the defendants’ proof fell totally to the ground. The Court noted that there was nothing in the record to “indicate[] that any incumbent board member or incumbent board advisor has any reasonable basis to dispute the basic qualifications of the [dissident] slate.” And the board’s financial advisor conceded that approving the dissident slate for purposes of the proxy put wouldn’t breach any obligation to the creditors.

And most notably, the Court found that:

[T]he incumbent board and its financial advisors have failed to provide any reliable market evidence that lenders place a tangible value on a Proxy Put trigger—not a change in board composition accompanying a merger or acquisition or another type of event having consequences for the company’s capital structure, but a mere change in the board majority.

It was this failure of proof that was defendants’ undoing, given the application of a legal standard of enhanced scrutiny that requires the defendants to demonstrate at least some justification for insisting on maintaining whatever deterrent effect the Proxy Put imposed on the stockholder vote. Summarizing the governing legal rules, the Chancellor explained:

By definition, a contract that imposes a penalty on the corporation, and therefore on potential acquirers, or in this case, simply stockholders seeking to elect a new board, has clear defensive value. Such contracts are dangerous because, as will be seen here, doubt can arise whether the change of control provision was in fact sought by the third party creditors or willingly inserted by the incumbent management as a latent takeover and proxy contest defense. Unocal is the proper standard of review to examine a board’s decision to agree to a contract with such provisions and to review a board’s exercise of discretion as to the change of control provisions under such a contract.

The Court’s approach to relief bought into a nuanced alternative thoughtfully put forward by plaintiff, who had originally asked for an order requiring the board to approve the dissidents’ candidacies for purposes of the Proxy Put. Recognizing that such affirmative, mandatory relief is an uncomfortable, extraordinary thing for a court to award, the plaintiff alternatively (but no less effectively) sought an order preventing the company from soliciting revocations of stockholder consents so long as the board was declining to approve the dissidents’ candidacies. And that’s exactly what the Court granted.

Benjamin P. Chapple

On February 27, 2013, the United States Supreme Court, in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, a 6-3 decision, concluded that proof of materiality is not a prerequisite to certification of a securities-fraud action that alleges violations of §10(b) or Rule 10b–5.  Below is a summary of the Court’s decision.

In all private securities-fraud actions brought under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b–5, the plaintiff must prove, inter alia, that it relied on a misrepresentation or omission of material fact that was made by the defendant.  In Basic v. Levinson, the United States Supreme Court concluded “requiring proof of direct evidence ‘would place an unnecessarily unrealistic burden on [a] plaintiff who has traded on an impersonal market.'” Slip Op. at 1 (quoting Basic).  In order to facilitate the certification of securities-fraud class actions, the Court in Basic fashioned the fraud-on-the-market (“FOTM”) theory.  The premise of this theory is that the price of a security that is traded in an efficient market will reflect all publicly available information about a company; therefore, one who purchases a security that trades in an efficient market will be presumed to have relied on that information in purchasing the security.  Additionally, “because immaterial information, by definition, does not affect the market price, it cannot be relied upon indirectly by investors who, as the [FOTM] theory presumes, rely on the market price’s integrity.” Slip Op. at 10.  As a result, the FOTM theory is inapplicable absent a showing that the misrepresentation or omission was in fact material.

Invoking the FOTM theory, Connecticut Retirement Plans and Trust Funds (“Plaintiff”) sought certification of a securities-fraud class action under Federal Rule of Civil Procedure 23(b)(3) against biotechnology company Amgen Inc. and several of its officers (collectively, “Amgen”).  The Plaintiff claims that Amgen violated §10(b) and Rule 10b–5 when it made material misrepresentations and misleading omissions regarding the safety, efficacy, and marketing of two of Amgen’s flagship drugs.  As a result of these alleged misrepresentations and omissions, the Plaintiff contends that the price of Amgen’s stock was artificially inflated, until “the truth came to light” and the Plaintiff, among others, suffered financial losses.  The district court certified the class, and the Court of Appeals for the Ninth Circuit affirmed.  Amgen appealed, and the Supreme Court granted certiorari and heard oral argument on November 5, 2013.  The Court issued a 6-3 opinion, with Justices Thomas, Scalia, and Kennedy dissenting.

Because Amgen conceded (1) the efficiency of the market for the securities at issue, (2) the public character of the allegedly fraudulent statements on which the Plaintiff’s complaint is based, and (3) that the Plaintiff satisfied all of the class-action prerequisites stated in Rule 23(a), the issue presented to the Court concerned the requirement stated in Rule 23(b)(3) that “the questions of law or fact common to class members predominate over any questions affecting only individual members.” Put differently, as the Court stated, “the pivotal inquiry in this case is whether proof of materiality is needed to ensure that the questions of law or fact common to the class ‘will predominate over any questions affecting only individual members’ as the litigation progresses.”  Amgen claimed that to meet the predominance requirement, the Plaintiff must do more than “plausibly plead that Amgen’s alleged misrepresentations and misleading omissions materially affected Amgen’s stock price.”  According to Amgen, certification must be denied unless the Plaintiff proves materiality, because immaterial misrepresentations or omissions, by definition, would have no impact on Amgen’s stock price in an efficient market.  To this end, Amgen claimed the key question in this case was whether materiality is an essential predicate of the FOTM theory.

Although agreeing with Amgen that “materiality is an essential predicate” of the FOTM theory, the Court explained that the “pivotal inquiry” in this case is whether proof of materiality is needed to ensure that the questions of law or fact common to the class will “predominate over any questions affecting only individual members” as the litigation progresses. Slip Op. at 10 (citing Fed. R. Civ. P. 23(b)(3)).  The Court answered this question in the negative for two reasons; thereby holding that proof of materiality is not a prerequisite to  class certification.  First, because the question of materiality is judged according to an objective standard, viewing the significance of an omitted or misrepresented fact from the purview of a reasonable investor, materiality can be proved through evidence common to the class.  As a result, the Court concluded, materiality is a common question for Rule 23(b)(3). Slip Op. at 11 (quoting Basic, where the Court listed “materiality” as one of the questions common to the Basic class members).   Second, because materiality is an essential element of a Rule 10b–5 claim, if the Plaintiff fails to present sufficient evidence of materiality, individual reliance questions will not overwhelm the questions common to the class.  Instead, the Court concluded, if the Plaintiff failed to establish materiality, whether upon summary-judgment or at trial, it “would end the case for one and for all; no claim would remain in which individual reliance issues could potentially predominate.” Id.

As is usual with most recent decisions from the United States Supreme Court, the conclusion that proof of materiality is not a prerequisite to class certification was not unanimous.  However, before turning to the dissenting views of Justices Thomas, Kennedy, and Scalia, attention should be paid to Justice Alito’s concurring opinion.  Although brief, Justice Alito explains: “As the dissent observes, more recent evidence suggests that the [FOTM] presumption may rest on a faulty economic promise.  In light of this development, reconsideration of the Basic presumption may be appropriate.” Alito, J. Concurring Op. at 1.

 Justice Thomas dissented, with Justice Kennedy joining fully, and Scalia joining only in part.  Justice Thomas explained:

Without demonstrating materiality at certification, plaintiffs cannot establish Basic‘s fraud-on-the-market presumption.  Without proof of fraud on the market, plaintiffs cannot show the otherwise individualized questions of reliance will predominate, as required by Rule 23(b)(3).  And without satisfying Rule 23(b)(3), class certification is improper.  Fraud on the market is thus a condition precedent to class certification, without which individualized claims of reliance will defeat certification.

Moreover, Justice Thomas stated that the majority opinion “transform[ed] the predicate certification inquiry into a novel either-or inquiry occurring much later on the merits.”  To this end, he explained:

According to the [majority], either (1) plaintiffs will prove materiality on the merits, thus demonstrating ex post that common questions predominated at class certification, or (2) they will fail to prove materiality, at which point they will learn ex post that certification was inappropriate because reliance was not, in fact, a common question.  In the [majority’s] second scenario, fraud on the market was never established, reliance for each class member was inherently individualized, and Rule 23(b)(3) in fact should have barred certification long ago.  The [majority] suggests that the problem created by the second scenario is excusable because the plaintiffs will lose anyway on alternative grounds, and the case will be over.  But nothing in logic or precedent justifies ignoring at certification whether reliance is susceptible to Rule 23(b)(3) classwide proof simply because one predicate of reliance—materiality—will be resolved, if at all, much later in the litigation on an independent merits element.

In addition to joining in Justice Thomas’s dissent, Justice Scalia also wrote a separate dissenting opinion, which in part stated that he views the FOTM theory as governing not only the question of whether class certification is proper, but also the question of substantive liability. But see Thomas, J. Dissenting Op. at 11 (“The result [of the majority’s error] is that [it] effectively equates §10(b) materiality with fraud-on-the-market materiality and elides reliance as a §10(b) element.”).  In accord with Justice Thomas’s dissenting opinion, Justice Scalia wrote that, in his view, “it makes no sense to ‘presume reliance’ on the misrepresentation merely because the plaintiff relied on the market price, unless the alleged misrepresentation would likely have affected the market price—that is, unless it was material.”  Scalia, J. Dissenting Op. at 2.  Finally, recognizing the practical import of the majority’s decision, Justice Scalia explained how “[c]ertification of the class is often, if not usually, the prelude to a substantial settlement by the defendant because the costs and risks of litigating further are so high.”

Our faculty member Christine Allie published a nice commentary in the Wilmington News-Journal over the weekend on the public benefits of the Earned Income Tax Credit.

We’ve embarked on an interesting new course here: a series of classes led by experts in a variety of aspects of whistleblowing. Our first class featured Jordan Thomas, currently at Labaton Sucharow in New York, and formerly the Assistant Director of the SEC’s Division of Enforcement. Jordan led the students through a terrific exercise in identifying competing policy considerations behind the Dodd-Frank whistleblowing program and the SEC’s implementing rules. [For a recent story on the SEC’s whistleblower program, see this write-up by John Kiernan for CardHub.]

Yesterday’s class was led by Virginia Gibson, currently with Hogan Lovells in Philadelphia, and former director of the civil division of the U.S. Attorney’s office in Philadelphia. She brought her extensive enforcement experience to introduce students to the qui tam provisions of the False Claims Act, which permit citizens to initiate litigation asserting claims of fraud against the federal government.

Having just released a working paper that sharply criticizes the “first-filed” rule in corporate shareholder representative litigation, I was struck by the fairly strict “first to file rule” in Section 3730(b)(5) of the False Claims Act. That rule apparently has its supporters, but it’s hard to see how it doesn’t inappropriately encourage whistleblowers to file claims before developing and maturely evaluating the facts. Ginny Gibson explained that situations with multiple relators (whistleblowers) are becoming increasingly common, but priority (and sharing in a potential recovery) often gets negotiated during the “quiet period” after the complaints are filed but before the Government decides whether to intervene and the complaints become unsealed. Still, I worry that the first to file rule gives the first filer an inappropriate advantage. Hat tip to my student Kerrin Cahill (Widener ’13) whose paper pointed out that the qui tam first to file rule could use a little nuance. (And hat tip to the Ruby R. Vale Foundation for its support of this series of classes).

We’re looking forward to the other speakers in this series, including former Delaware Supreme Court Chief Justice E. Norman Veasey, DuPont General Counsel Thomas Sager, and Prof. Kathleen Clark of Washington University Law School in St. Louis, who also teaches an entire course devoted to whistleblowing.

This post describes the January 2013 working paper by Chancellor Leo E. Strine, Jr., Prof. Lawrence A. Hamermesh, and Matthew Jennejohn on the subject of multi-forum litigation and forum choice rules. The post’s summary of the paper is a little more illuminating than the paper’s abstract, and a lot shorter than the paper itself.

Two seemingly disparate recent Delaware court opinions provide an intriguing contrast in the approach to judicial review of fiduciary conduct. In its very brief opinion of January 14, 2013 in Freedman v. Adams,, et al, the Delaware Supreme Court affirmed the dismissal of a claim that the directors of XTO Energy breached their fiduciary duty by awarding $130 million in executive bonuses without doing so through a stockholder-approved plan (a Section 162(m) plan) that might have permitted the company to save $40 million by deducting the cost of the bonuses for income tax purposes. The board recited the belief that insistence on granting bonuses through a Section 162(m) plan “would constrain the compensation committee in its determination of appropriate bonuses.” And, according to the Supreme Court’s opinion, “The decision to sacrifice some tax savings in order to retain flexibility in compensation decisions is a classic exercise of business judgment. Even if the decision was a poor one for the reasons alleged by Freedman, it was not unconscionable or irrational.” The opinion does not indicate that XTO provided any explanation of what constraints the stockholder-approved plan would have imposed, or why the company chose not to pay the bonuses through such a plan.

Eleven days earlier the Court of Chancery’s opinion in the Novell shareholder litigation denied a motion to dismiss claims that a disinterested, independent board of directors acted in bad faith in selling the company, because of the absence of explanation for the decision to inform the successful bidder of a sale of a line of patents while not informing a competing bidder of that sale. The court’s opinion noted:

Why the Novell Defendants did not tell Party C about the proceeds of the Patent Sale has no apparent answer in the record before the Court. That conduct, coupled with the fact that Novell kept Attachmate fully informed, is enough for pleading stage purposes to support an inference that the Board’s actions were in bad faith.

So to editorialize a bit, the Delaware Supreme Court in Freedman might have similarly said:

Why the [XTO] Defendants did not [pay the bonuses through a Section 162(m) plan] has no apparent answer in the record before the Court. That conduct, coupled with the fact that [the Board did not explain in any specific way how use of such a plan could have constrained the determination of bonus awards], is enough for pleading stage purposes to support an inference that the Board’s actions were in bad faith.

But of course, the Supreme Court didn’t say that. Were they wrong? Was the Court of Chancery wrong in Novell? Or neither – are the two opinions consistent? In which case should the courts have been more inclined to defer to board judgment?

On a clean slate, I would have thought that the executive compensation decision at issue in Freedman would be more suspect than the conduct of an arm’s length sale of the company to a third party. In Freedman, one of the recipients of the bonuses was the company’s CEO, who was also a member of the Board. Not to put too fine a point on it, the bonus payments to him were a self-dealing transaction – one perhaps well considered and justified by an independent compensation committee, but one in respect of which the motives that implicate the duty of loyalty were present. In contrast, in Novell none of the directors had any direct conflict of interest.

It’s challenging to think of a doctrinal structure in which these two opinions can co-exist.

Professor Lawrence A. Hamermesh

The Delaware Supreme Court handed down an interesting decision on December 27, 2012 in the Celera merger class action litigation.  The underlying litigation was a challenge to a squeeze-out tender offer and merger, and involved some hot button issues (“don’t ask/don’t waive” standstill agreements and a top-up option), but the opinion wasn’t really about them.

The Supreme Court’s opinion instead reviewed a decision by the Court of Chancery to approve a class action settlement without opt-out rights.  The original plaintiff, New Orleans Employee Retirement System (NOERS), had owned 10,000 Celera shares, which it sold in the market (at a price slightly higher than the $8.00/share deal price) before the second-step merger was completed.  The settlement, reached a year or so after that merger, when any possibility of injunctive relief was pretty much history, would as usual have barred all other stockholders from pursuing further litigation challenging the deal.

That bar would have affected BVF Partners, which owned over 5% of the stock when the deal was announced, and 24.5% by the time of the merger. BVF objected to the settlement on a variety of grounds, including the lack of opt-out rights in the settlement.

As is common in Delaware in this sort of litigation, the Court of Chancery certified a class, for settlement purposes, under Court of Chancery Rules 23(b)(1) and (b)(2), under which opt-out rights aren’t required.  The Supreme Court didn’t find fault with that certification; it didn’t reverse the determination to accept the settlement; and it didn’t accept BVF’s arguments that NOERS lacked standing because it sold its shares before the merger, or that NOERS was an inadequate class representative because it was a “frequent filer,” a term that the Supreme Court said it has not yet even recognized.

What the Supreme Court reversed was the determination not to require opt out rights.  In the following short analysis, the Court found that determination to have constituted an abuse of discretion:

The court could not deny a discretionary opt-out right where the policy favoring a global settlement was outweighed by due process concerns. Here, the class representative was “barely” adequate, the objector was a significant shareholder prepared independently to prosecute a clearly identified and supportable claim for substantial money damages, and the only claims realistically being settled at the time of the certification hearing nearly a year after the merger were for money damages. Under these particular facts and circumstances, the Court of Chancery had to provide an opt-out right.

What’s intriguing–and perhaps unsettling–about this brief analysis is whether it has logical limits in future litigation challenging mergers that are consummated after the litigation begins. If there were “due process concerns,” why should it matter that the objector was a “significant shareholder?” Are those concerns less pressing when the objector has only 100 shares? Why so, when even a 100-share holder can hire effective class counsel who could pursue the litigation effectively? Is adequacy a sliding scale? If so, what are the measuring marks on that scale, if, as the Court held, NOERS clearly had standing because it held shares when the merger was approved?

And most important, what do future settlement hearings now have to evaluate? Before denying opt-out rights, will the court have to examine the size of shareholdings of unrepresented class members in order to determine whether any of those stockholders own enough shares so that due process rights are offended?  Or does this responsibility arise only when an objection to the settlement is lodged?

The result in this case may have been the right one:  with the no opt-out condition of the settlement no longer satisfied, I imagine that the case will now proceed, perhaps to a revised settlement with BVF, or perhaps to full-blown litigation.  And there surely was something unseemly about a holder of 10,000 shares that weren’t even directly affected by the challenged transaction being able to achieve preclusion of the claims of a 24.5% stockholder.  But in achieving what may have been a good result, the Court has perhaps created an element of uncertainty over how to handle settlements in common deal litigation.