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Record settlements will shape the direction of shareholder derivative litigation in 2015 and beyond. Stephanie Resnick and John C. Fuller, corporate governance attorneys at Fox Rothschild L.L.P., explore the situation and see some relief in the form bylaws that shift legal fees.
In 2015, trends in shareholder litigation are certain to be affected by two recent developments. First, the stakes for directors and officers, and their insurers, rose significantly when two shareholder derivative actions were settled last year for $275 million and $154 million, respectively — two of the largest settlements in history. Second, at the same time, courts have increased the risk for shareholders bringing derivative actions by upholding fee-shifting bylaws, which allow corporations to seek legal fees from unsuccessful shareholder plaintiffs.
At first blush, these two developments appear to be inconsistent. However, their combined effect may create a new equilibrium in shareholder derivative litigation, in which both sides have more at risk than ever before.
Corporations and shareholders will closely monitor “test” cases, which will define how broadly fee-shifting bylaws will be accepted, as well as potential legislative responses. However, directors, officers and their insurers must keep in mind the massive awards of the past year when approaching any shareholder dispute. Until courts fully realize significant disincentives to unsuccessful shareholder plaintiffs, the tendency is that courts will continue to approve record-setting settlements.
In November 2014, the largest shareholder derivative settlement ever, $275 million, was announced in an action brought against video-game maker Activision Blizzard, Inc. in the Delaware Chancery Court.
The Activision lawsuit involved an $8 billion transaction in which two of Activision's senior officers used an outside entity to secretly take a controlling interest in Activision. Through the entity, the officers purchased a substantial portion of Activision's outstanding stock from Activision's controlling shareholder, French media conglomerate Vivendi S.A.
In a statement after the announcement of the settlement in the suit alleging breach of fiduciary duty, Activision said the settlement would be paid by “multiple insurance companies, along with various defendants.” Some $207 million of the settlement amount is to be paid by Activision's directors and officers and their insurers, while $67.5 million will come from Vivendi.
The second massive shareholder derivative settlement involved fuel exploration company Freeport-McMoRan Inc. The $154 million settlement was first announced in late 2014 and approved by the Delaware Chancery Court in April 2015. The settlement resolved a dispute regarding alleged conflicts of interest among Freeport board members when the company purchased McMoRan Exploration Co. and another company for $9 billion in 2013. The shareholders alleged that the conflicts of interest led to Freeport paying an inflated price to acquire the two companies.
Though none of the defendants admitted liability, according to the settlement agreement, Freeport's D&O insurers will pay $115 million of the settlement, while the Freeport will contribute $22.5 million and Credit Suisse, the financial advisors to Freeport's board during the transaction, will supply the remaining amount through a combination of cash and credits to Freeport.
To reimburse the shareholders, the settlement proceeds, less attorneys' fees, will be paid in a special dividend. The payment of a special dividend is unusual because most successful derivative actions, which are brought on behalf of the corporation, result in payments made to the company.
Whether a settlement structure that involves the use of dividends to distribute proceeds to shareholders will become commonplace is hard to determine, but it does show potential for making shareholders whole when there has been a clearly discernible injury to the value of their investment.
It is also difficult to say what has prompted the trend of massive shareholder derivative settlements. Perhaps most troubling for directors and officers, and their insurers, is the emboldening effect such settlements may have on plaintiffs attorneys as they approach the settlement table.
In the face of record settlements in shareholder derivative actions, the potential liability for directors and officers may never have been higher. However, 2014 also saw the advent of fee-shifting bylaws that raise the stakes for shareholders and that, hopefully, will create a deterrent against plaintiffs who seek the next mega-award.
Fee-shifting provisions in bylaws allow corporations to seek legal fees from shareholders who bring unsuccessful derivative actions. Such provisions were upheld as facially valid by the Delaware Chancery Court in ATP Tour Inc. v. Deutscher Tennis Bund.
ATP Tour is a Delaware membership corporation that includes professional tennis players and the owners of professional tennis tournaments. In 2006, ATP amended its bylaws so if a member brought an action against the ATP but did not obtain a judgment on the merits that “substantially achieved” the remedy sought, the member would be required to reimburse ATP for all attorneys fees, costs and expenses.
In 2007, after the ATP moved two national tennis federations to a lower tier of competition, the federations sued ATP and its directors, claiming antitrust violations and breach of fiduciary duty. ATP and the directors prevailed and moved to recover fees and costs under its bylaws.
Though ATP is a non-stock corporation, the reasoning and broadly applicable precedents cited by the court likely indicate that the decision will be applied to Delaware stock corporations. The ruling reinforces the concept that bylaws are part of the contract between a corporation and its interest holders and that the contract may be amended when proper procedures are followed.
As expected, the ramifications of the ATP Tour decision already are being tested by corporations amending their bylaws to limit their exposure and shareholders seeking to secure their right to sue. For example, in Kastis et al. v. Carter et al., before the Delaware Chancery Court, the shareholders filed a motion to invalidate the fee-shifting bylaw adopted just days after ATP Tour was decided. Significantly, the bylaw provision at issue in Kastis provided for the payment of fees in any unsuccessful litigation that began or continued after the bylaw was adopted. Unfortunately, the court declined to hear arguments on the validity of the bylaw, finding that it was inapplicable to the issues in that case.
Delaware takes a stand
As additional challenges arise without clear resolution, the Delaware Legislature has also recently taken up the issue of fee-shifting bylaws. On May 12, 2015, the Delaware Senate passed S.B. 75, which would prohibit fee-shifting provisions in the bylaws of stock corporations. The bill is currently under consideration by the Delaware House of Representatives.
The record-setting settlements of 2014 present a troubling trend for directors and officers. With the sky as the apparent limit for shareholders, the only glimpse of a silver lining from the year for directors and officers are fee-shifting bylaws. This year, all insurers should be tuned to the Delaware courts and the Delaware Legislature to see whether such bylaws will be accepted in other corporate forms and with what scope bylaws can be used to insulate directors and officers from impending, or even ongoing, litigation.
Stephanie Resnick is a partner with Fox Rothschild L.L.P. and chair of the firm's directors and officers liability and corporate governance practice. She can be reached at firstname.lastname@example.org and 215-299-2082.
John C. Fuller is an attorney with the firm and can be reached at email@example.com and 215-299-3815.
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