Recently, the Delaware Court of Chancery has found wrongful conduct but denied the remedy plaintiffs sought. The El Paso case is a prime example.
The court found the board of directors and, particularly, El Paso’s president had failed to act properly in negotiating a merger. Even the company’s investment bankers had a conflict of interests, yet, despite critical language in its opinion, the court refused to enjoin the merger.
Thus, stockholders on notice their interests had been harmed must wonder: "What do I do next?" A stockholder may well ask if he or she should accept what is offered in the merger or refuse the merger consideration to be entitled to damages later.
This is not an easy question to answer. In fact, a variation of this dilemma happens all the time. Consider the victim of an accident who is offered a settlement that is below what she feels is fair. American law forces her to make a hard decision – to take the money offered now or sue to try to get more in damages. She cannot do both, and if she wants to sue for more, she must forgo even the pittance offered now. Is that fair?
The standard justifications for this universal rule that forces a tough choice are that it encourages settlement and has a certain reciprocal aspect to it. After all, the wrongdoer is encouraged to offer enough to avoid potentially more costly litigation. Hence, all the leverage is not just on one side of the negotiations. Why then is that choice between taking the money now or forgoing it to sue not also a fair rule in stockholder litigation over a merger?
Indeed, some might argue that is the current law governing a stockholder class member’s choice when faced with a merger achieved through known misconduct that goes through anyway. The stockholder has to choose whether or not to accept the merger consideration. There is case law that suggests that a fully informed stockholder who accepts what he or she is offered for his or her stock as a result of a merger is barred from taking the money and also continuing to seek damages for breach of fiduciary duty. That is definitely true for stockholders who might consider filing an appraisal action. They cannot both take the merger consideration for all their shares and sue for appraisal.
The recent decision by the Court of Chancery in In re Celera Shareholders Litigation, Del. Ch. C.A. 6304-VCP (March 23), addressed these issues. Celera was a class action in which the plaintiffs contended a merger was unfair to the class of stockholders who were to be cashed out in a merger. The class representative filed a motion to enjoin the merger, signed a preliminary settlement agreement just before the hearing on its motion, and then before the merger closed, sold his stock on the market for slightly more than the merger price. When another stockholder who objected to the settlement heard of the class representative’s sale, it sought to disqualify the class representative on the grounds it no longer had any claim to settle, but had instead acquiesced in the merger.
The court held that the sale of the class representative’s stock did not deprive it of its claim the merger was tainted by a breach of fiduciary duty. Hence, the representative still had a claim to settle and the court could then approve the proposed settlement for all the other members of the class. Though this procedural posture is unusual, the court’s discussion of when a stockholder loses the right to continue litigating a claim for damages is instructive in more typical circumstances.
Space limitations here do not permit a full review of the extensive discussion of the reasoning in the Celera decision. What should be welcome is the court’s sensitivity to the collective action problem confronting stockholders with real claims, but who are unable to stop a merger because most of their fellow stockholders want to take the money and move on.
The Delaware court recognizes that those stockholders who want to cash out for a premium over market should be able to do so. Hence, as in In re El Paso Shareholder Litigation, the court may refuse to enjoin the merger even if there is evidence of wrongdoing in the merger negotiations. If the stockholders who do take the money are then deemed to no longer be part of a class of stockholder claimants, the utility of the class action as a check on corporate insider abuse would be severely diminished. Indeed, that is why appraisal actions are fairly rare. Most stockholders, however reluctantly, just take what they are offered rather than go through the time-consuming and expensive appraisal process. As a result, there are often too few qualifying stockholders to make appraisal proceedings worthwhile.
To cut through these issues, the court in Celera set out the following rules that apply when stockholders are fully informed of any problems in a merger process, but when the merger is not enjoined: First, a stockholder must not vote for the merger or accept any tender offer for his or her stock prior to the merger if he or she wants to continue to seek damages. Second, a stockholder may accept the merger consideration and still retain his or her rights to seek damages in an action for breach of fiduciary duty, provided he or she has not voted for the merger. Third, acceptance of the merger consideration does constitute abandonment of appraisal rights. Hopefully, that is clear.