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Two recent multimillion-dollar settlements of shareholder derivative lawsuits are expected to lead to more litigation and even larger settlements.
Experts say derivative actions are a growing problem for companies, driven in part by a plaintiffs bar seeking revenue as a shrinking number of publicly traded companies leads to fewer securities class actions.
Some observers expect companies engaging in mergers and acquisitions to purchase more Side A directors and officers liability cover, which protects them from personal liability when a company cannot or will not indemnify them.
A derivative lawsuit is filed by a shareholder on a company's behalf. They typically alleged wrongdoing by directors and officers and money recovered after legal fees is returned to the company.
Two recent cases that were settled involved mergers and acquisitions and charged directors and officers with conflicts of interest.
In November, Santa Monica, California-based Activision Blizzard Inc. announced a $275 million settlement of consolidated derivative and class action shareholder litigation in the October 2013 purchase by the video game company and a shareholder group of 88% of Paris-based Vivendi S.A.'s shares in the firm best known for its “World of Warcraft” and “Call of Duty” games.
In addition, Phoenix-based Freeport-McMoRan Inc. an-nounced in December a $137.5 million settlement of a derivative lawsuit in its purchase of two oil and gas companies.
These followed 2013's $139.3 million News Corp. settlement.
“You get a $275 million settlement and that gets people's attention,” said Kevin LaCroix, an attorney and executive vice president at RT ProExec, a unit of R-T Specialty L.L.C. in Beachwood, Ohio.
“At this point, the pattern has been established that there will be these larger settlements, which will create a ratchet effect when it comes to settlement trends,” Mr. LaCroix said.
Shareholder derivative litigation first gained popularity several years ago over options backdating.
Derivative litigation generally is filed in state court, and multiple suits may be filed in multiple states, unlike securities class actions that typically are filed in federal court and consolidated. Also unlike securities class actions, derivative suits do not require a drop in a company's stock price to file suit.
A derivative plaintiff must demand that the board take action before going to court, or plead doing so would be futile, and companies have more legal defenses available, such as the business judgment rule that begins with a presumption that the directors and officers acted reasonably.
Despite those defenses, derivative litigation is growing, although there are no official statistics available on this issue.
“We absolutely saw an uptick in derivative litigation last year and believe we will continue to see an increase in derivative litigation in 2015” that seeks higher recoveries, said Will Fahey, New York-based senior vice president at Zurich North America's management liability group.
“Because there are fewer securities class actions for the plaintiffs bar to prosecute and generate significant fees, the plaintiffs bar has turned as an alternative revenue source to filing more derivative shareholder lawsuits,” said Dan A. Bailey, a member of law firm Bailey Cavalieri L.L.C. in Columbus, Ohio.
“There's also been some increase in regulatory action that's been resulting in large fines and penalties,” and plaintiff attorneys are trying to chase derivative settlements associated with those issues “with not much success,” said Steve Boughal, New York-based vice president and chief underwriting officer of Hartford Financial Products, a unit of The Hartford Financial Services Group Inc.
Mr. Fahey also said cyber-related D&O litigation has been brought as derivative suits.
The question is whether the large settlements in the derivative cases are an anomaly.
“We're going to have to wait and see how that plays out,” said Robbyn Reichman, co-leader of Aon Risk Solutions' legal and claims practice group.
One factor that may help companies facing derivative litigation is a recent Delaware ruling that firms domiciled in the state, which accounts for more than half of publicly held companies, may include in their bylaws a requirement that derivative litigation be filed in one particular jurisdiction.
The Delaware Supreme Court also upheld a bylaw that requires plaintiff shareholders who lose derivative litigation to pay defense costs, which can be a significant deterrent to litigation, although this may eventually be overturned by the state Legislature.
Companies face more stringent enforcement of laws that target corporate wrongdoing, ranging from the Dodd-Frank Wall Street Reform and Consumer Protection Act to the Foreign Corrupt Practices Act, as well as new regulatory tools — including one dubbed RoboCop.