The Delaware Court of Chancery has made its strongest statement yet in the ongoing conversation about shareholder “disclosure settlements,” i.e., settlements in which the sole or primary consideration received by shareholders in exchange for releasing their claims is the dissemination of one or more disclosures to supplement the proxy materials soliciting their approval for the challenged transaction.

In his recent opinion in In re Trulia, Inc. Stockholder Litigation,¹ Chancellor Bouchard advised that “to the extent that litigants continue to pursue disclosure settlements, they can expect that the Court will be increasingly vigilant in scrutinizing the ‘give’ and the ‘get’ of such settlements to ensure that they are genuinely fair and reasonable to the absent class members.”

The Chancellor declined to approve the disclosure settlement proffered in Trulia, which sought to resolve breach of fiduciary duty claims challenging the fairness of a stock-for-stock merger transaction through a remarkably broad release of all claims purchased with disclosure enhancements (which the Chancellor determined were immaterial and not helpful to shareholders) and a payment of attorney fees to plaintiffs’ counsel.

Under Trulia, litigants should expect an abrupt departure from the historic predisposition toward approving disclosure settlements, and assume that such settlements from this point forward will be subjected to heightened judicial scrutiny.

Disclosure Settlements in Deal Litigation: The Big Picture

Trulia pulls no punches: “Today, the public announcement of virtually every transaction involving the acquisition of a public corporation provokes a flurry of class action lawsuits alleging that the target directors breached their fiduciary duties by agreeing to sell the corporation for an unfair price.” The leverage wielded by the plaintiffs in these lawsuits flows from the threat of an injunction preventing the deal from closing. This, writes the Chancellor, incentivizes the deal proponents (i.e., the defendants) to negotiate for a broad release of all claims early, which release often is purchased with supplemental disclosures that furnish no material value to shareholders. Consequently, pre-closing deal cases have proliferated, and the economic beneficiary of that proliferation too often has been a cadre of plaintiff firms (the “usual players”) who extract a fee as a term of settlement.

Specific Concerns Implicated by Disclosure Settlements

Substantively, non-material disclosure supplements provide no benefit to shareholders and amount to little more than deal “rents” or “taxes.” By contrast, the liability releases that accompany settlements threaten the loss of potentially valuable claims related to (and sometimes going beyond) the challenged transaction. Procedurally, after a putative disclosure settlement is reached by the parties, the litigation takes on a non-adversarial character, with both sides (their interests now aligned) advocating the merits of the proffered resolution.

Consequently, to assist it in the approval process (by which the Court safeguards the interests of the absent shareholders), the Court has on hand briefs and affidavits from plaintiffs’ counsel extolling the virtues of the settlement, but typically no submission from the defendant or otherwise critically evaluating the settlement unless, as rarely occurs in such settlements, an objector materializes. (When an objector does materialize, of course, the Court once again faces the prospect of an attorney-driven advocate whose interests may diverge from those of the absent shareholders.) Compounding this challenge, the discovery record to which the Court can refer often is scant, offering little documentary evidence and the testimony of a few witnesses who were subjected to post-settlement, “confirmatory” deposition examination.

Disclosure Settlements Will Be Subjected To Heightened Judicial Scrutiny

Trulia signals an express departure from “the Court’s historical predisposition toward approving disclosure settlements,” advising that practitioners “should expect that disclosure settlements are likely to be met with continued disfavor unless the supplemental disclosures address a plainly material misrepresentation or omission, and the subject matter of the of the proposed release is narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently.”

Does this sound the death-knell for the early resolution of deal litigation through enhanced proxy disclosures? No. The Chancellor writes that there are at least two pathways to early disposition within the adversarial construct: First, the Court can weigh the merits of disclosure claims in the context of a preliminary injunction proceeding, in which the plaintiff would bear the burden of demonstrating on a developed record a reasonable likelihood of proving that the alleged omission or misrepresentation is material.

Alternatively, the Court can assess the merits of disclosure supplements in the context of an attorney fee application. This would occur after defendants voluntarily supplement the proxy materials, thereby mooting the asserted disclosure claims.

The fee application process would be adversarial, in that the defendants would not be attempting to secure a release and would be motivated to challenge the attorney fee sought as unwarranted or excessive. As to the latter pathway, the Chancellor notes that although the “defendants will not have obtained a formal release, the filing of a stipulation of dismissal likely represents the end of fiduciary challenges over the transaction as a practical matter.”

_{¹ Consolidated C.A. No. 10020-CB (January 22, 2016).}