Everyone knows that a public company merger is a feeding frenzy for service providers. When you’re writing a multi-billion dollar check for a transformative acquisition, you’re not so worried about a million in fees here and there. So bankers make a lot, lawyers make a bit less, and printers and accountants and proxy solicitors and the SEC all get a piece of the cash cheerfully handed out by acquirers. What is less obvious to people outside the M&A business is that there’s also a tax paid to a group of securities plaintiffs lawyers, who make it their business to sue the board of every company involved in a merger.
The process is pretty straightforward. A merger is announced. A group of law firms sue, on behalf of the target’s shareholders, claiming that the board followed a defective process, had a variety of conflicts of interest, and obtained an inadequate price. The board disagrees, but doesn’t want to run the risk of a court holding up the merger and so agrees to pay off the law firms. It’s not legal just to pay them to go away – they represent shareholders, after all, so they have to get something for those shareholders.
Occasionally what they get is a 5 or 10 cent increase in the merger price, but more often it’s just some added disclosure in the merger proxy. The company amends its proxy to say “we forgot to mention that our lead banker plays a lot of golf with the acquirer’s CEO so he was probably talking smack about us on the side,” the lawyers can say that they got something for the shareholders, and everyone signs a settlement that the judge can approve and that includes a $500k payoff to the law firm. Shareholders get nothing other than additional reading material, but it’s a pretty profitable business for the law firms.
Today's WSJ has an excellent story about how judges in Delaware have started taking a closer look at these cases:
In recent months, however, the court's judges have been more discerning, according to plaintiffs and defense lawyers as well as court officials. In several cases, they have been less willing to sign off on standard fees for lawyers who have done relatively little and more willing to grant high payouts when they think lawyers have worked to earn them.
The good news here is that plaintiffs' lawyers are not rewarded for bringing clearly nonsense cases:
[I]n several cases in the past year, judges significantly reduced requested plaintiffs attorneys fees, to $75,000, for example. "Delaware is now almost actively hostile toward cases they think are without merit," said Larry Hamermesh, a professor at Widener's Institute of Delaware Corporate Law. "They are saying, 'Don't waste my time with this stuff.'"
But the bad news is that the court is increasing incentives to sue by awarding big fees in more serious cases. The Journal cites In re Del Monte Foods Company Shareholders Litigation, which to be fair does seem to have been a pretty terrible case. There, the court found that Barclays, acting as Del Monte’s advisor, steered the company to a private equity consortium led by KKR because the bank wanted to earn financing fees from KKR - which were bigger than its M&A fees from Del Monte. The court did not trust that Barclays had run a fair “go-shop” process to find new bidders after the merger agreement was signed, and ordered Del Monte to delay closing by 20 days to allow its other advisors (Perella Weinberg) to run another go-shop.
From the opinion Barclays doesn’t exactly seem to have covered itself in glory. Still, it seems to have gotten the best deal available:
On February 17, 2011 [after the injunction], Del Monte directed Perella Weinberg to contact third parties about potentially acquiring the Company. Perella contacted 70 parties, 53 of whom previously had been contacted during the 45-day go-shop provided in the Merger Agreement. Del Monte did not receive a topping bid during the additional window.
This is not too much of a surprise - the second go-shop followed two sale processes, a public announcement of the merger, the contractual go-shop period, and a lot of publicity around the court case. Anyone who was actually looking to top KKR had ample opportunity to show up, and the fact that they hadn’t done so already made it unlikely that they were just waiting for a personal invitation from a Delaware court. In any case, when the 20-day period expired, 99% of Del Monte’s shareholders who bothered to vote voted to approve the merger, and it closed on March 8.
The court was not troubled by the fact that the lawsuit did not result in a higher offer for Del Monte’s shareholders and delayed their payment by 20 days (costing them a couple million bucks in time value). Vice Chancellor Travis Laster analogized the additional go-shop to an insurance policy and computed that there was a 6.25% to 23% probability that it would have resulted in a topping bid. This is based on a paper on go-shops that used data from 2006 and 2007 (when there was just a bit more financing available for LBO bidding wars) to show that go-shops actually work – and disregards the fact that Del Monte had already tried a go-shop without any additional bidders.
The court also created a menu of sorts computing the value of each disclosure, finding that disclosures of previously unknown financial adviser conflicts were worth $800,000 to $1.6 million, disclosures about bankers’ financial analysis and fees were worth $350,000 to $550,000 (per bank), and disclosures of certain executive compensation provisions were worth $200,000.
We’re not big fans of these lawsuits, which, although they sometimes ferret out misbehavior and encourage good board behavior, are mostly just a shareholder-unfriendly tax imposed by self-appointed lawyers on all mergers. And we think that the court's new approach runs the risk of over-rewarding law firms for obtaining deal modifications that don’t help shareholders but that do delay and confuse the process.
But most of these deals settle for disclosure changes, and so we're pretty happy with Vice Chancellor Laster’s menu of how much each revelation is worth. Settlement negotiations in these suits revolve around creating enough disclosure to justify attorneys’ fees, and are often difficult because no one knows exactly how much is enough. A clear price list would make this already pretty meaningless process even easier – everyone could agree on how much to pay the law firm, look up what disclosure is required, and drop that into the proxy. The lawyers didn’t do much and just want a quick payoff? Add some disclosure that your CFO would get paid less if he got fired without a merger than with one, and bang, $200k. The lawyers missed their kids’ soccer game to sue your ass? Add a list of comparable deals that the banker used to derive an EBITDA multiple and pay them $500k. Mix and match and you can figure out exactly how much to pay the lawyers without ever having to worry about whether the disclosure is useful to shareholders. It’s not exactly pretty – but we’re not sure the current process is either.