File Early, Then Free Ride: How Delaware Law (Mis)Shapes Shareholder Class Actions

Article excerpt

Delaware courts largely have privatized enforcement of fiduciary duties in public corporations and have expressly acknowledged this judicial policy. The Delaware courts also recognize that so encouraging private enforcement creates an obvious danger: Plaintiffs' attorneys, especially in class actions where there is no strongly interested plaintiff, may make litigation-related decisions primarily with a view to advancing their own economic interests, rather than advancing the interests of the corporation or shareholders that they purport to represent. Such decisions have the potential to impose substantial, litigation-related agency costs on corporations, shareholders, and the courts, if not appropriately curbed through judicial monitoring of settlements and fee awards.

This Article examines the development of Delaware law with respect to merger-related class actions, which have become the dominant form of shareholder litigation in Delaware. We offer two broad alternative hypotheses as to what drives merger-related class actions in Delaware: a "shareholder champion" hypothesis and a "self-interested litigator" hypothesis. We then examine intensively all large mergers in 1999-2001 where the target was a publicly traded Delaware company and all class actions filed with respect to those mergers. We conduct statistical analyses as well as a detailed qualitative analysis of the 104 class actions filed during those years.

The pattern that we observe is redolent of a pattern of opportunistic filings, of a lawyer-driven process rather than a true client-driven process: systematic behavior with respect to which mergers were challenged; early and frequent complaints filed; a very high percentage of dismissed cases never reached a judgment on the merits; the absence of a single case that has been decided in favor of the plaintiffs on the merits; settlements tending to reflect free riding by plaintiffs' attorneys; plaintiffs' attorneys failing to challenge special negotiating committees' decisions or competing offers; attorneys with "real" clients and from outside the "traditional" Delaware plaintiffs' bar who were far more vigorous in their litigation efforts; no settlements overturned by the Delaware courts; plaintiffs' attorneys' fee awards in settlements usually paid by defendants and not out of common funds, and largely unchallenged; and plaintiffs' attorneys' fees representing a strikingly low percentage of claimed recoveries (but attractive on an hourly basis), which may well indicate that the attorneys added little value to the recoveries.

We then offer suggestions as to changes in pleading standards and the Delaware courts' approach to reviewing settlements and plaintiffs' attorneys' fees that would help curb the excesses of class action litigation without seriously undermining the constructive role that plaintiffs' attorneys have the potential to play in policing corporate misgovernance with respect to mergers.

I. INTRODUCTION

Delaware courts have largely privatized enforcement of fiduciary duties in public corporations. In In re Fuqua Industries, Inc. Shareholder Litigation,1 Chancellor Chandler expressly acknowledged this judicial policy. He noted that Delaware courts implement it partly by allowing private attorneys, working on a contingent fee basis, to initiate and maintain derivative and class actions in the names of "nominal shareholder plaintiffs."2 Attorneys are subject only to the relatively weak constraints that they must inform their "clients" and receive their consent before they file shareholder suits. Further, Delaware courts use cost and fee shifting mechanisms to "economically incentivize"3 those attorneys to initiate such suits.4

Chancellor Chandler also explained that Delaware courts have adopted this policy because they believe that the plaintiffs' bar is capable of performing a valuable "service on behalf of shareholders."5 Plaintiffs' attorneys understand "abstruse issues of corporate governance and fiduciary duties"6 far better than do most shareholders. …