Those who follow class action law probably will be familiar with In re Trulia (2016), the seminal decision of the Delaware Court of Chancery that put the brakes on disclosure-only settlements. Before Trulia, these controversial settlements were ubiquitous in deal litigation, in which shareholders of a company file a class action lawsuit seeking to stop the company from engaging in a merger or acquisition on the ground the company failed to disclose sufficient information about the transaction. Under a typical disclosure-only settlement, the company agrees to supplement its disclosures and pay the (often hefty) fees of class counsel. In return, the company obtains a release from the shareholder class, and the deal can proceed.
That changed with Trulia. The court lamented that disclosure-only settlements are often raw deals for shareholders, who release potentially valuable claims in exchange for no monetary compensation, but only additional disclosures that may be insignificant. Compounding the problem is that, because both class counsel and the company are aligned in supporting the settlement, the court is on its own to determine whether the settlement is fair and reasonable to absent shareholders. True, the Trulia court noted, courts face that task any time they evaluate a proposed class action settlement that has no objectors. But the court said the task is especially difficult in deal litigation, because disclosure-only settlements are usually reached quickly, before there has been any significant discovery into the potential value of the shareholders’ soon-to-be-released claims. The Trulia court drew a line in the sand, holding that Delaware law looks with “disfavor” on these settlements and would allow them only if the supplemental disclosures were “plainly material” and the shareholder releases were “narrowly circumscribed.”
Court watchers viewed Trulia as the death knell to deal litigation in Delaware and have wondered whether the plaintiffs’ bar would migrate to other jurisdictions that might be more hospitable. That is why the Business Court’s recent approval of a disclosure-only settlement in the Krispy Kreme shareholder litigation provides a significant data point. The litigation arose from a shareholder challenge to Krispy Kreme’s proposed acquisition by another company. The settlement called for supplemental disclosures and payment of class counsel’s fees, in return for a shareholder release.
Chief Judge Gale analyzed Trulia and discussed the standard North Carolina law should apply to review the reasonableness of disclosure-only settlements. Judge Gale said he is “fully in accord with Trulia’s enhanced scrutiny to determine whether the release is narrowly circumscribed.” At the same time, however, he said that “[a]s the scope of the release narrows,” the “Court’s inquiry as to the materiality of supplemental disclosures and their adequacy to support the release tends to a more traditional settlement inquiry where the judgment of competent counsel is accorded significant weight.” Here is how he summarized the test:
In sum, the Court must examine the materiality of any supplemental disclosures and find that they provide reasonable consideration for the class release. But where there is little or no opposition by class members, the Court is reluctant to set aside a fair arm’s length settlement negotiated between competent counsel if the disclosures are not plainly immaterial and the release is reasonable. The Court is less reluctant to exercise a more searching inquiry when deciding upon a fee request that does not depend on the validity of the settlement.
Judge Gale then applied this test and concluded that the release at issue was reasonable in view of Krispy Kreme’s supplemental disclosures. He focused mainly on the company’s disclosures about the discounted cash flow (DCF) analysis performed by its financial advisor. In a nutshell, the proxy statements had disclosed that the DCF estimate was based on certain projected free cash flows, but did not disclose the cash flows themselves. As it turned out, the cash flows described in the proxy statements differed somewhat from the cash flows the financial advisor used in its actual calculation. As Judge Gale noted, “[c]ounsel acknowledged that while the differences may be slight in any particular year, the differences over time have greater significance.” Judge Gale concluded from this that the company’s supplemental disclosures, which contained cash flow information not found in the proxy statements, were material and supported the shareholder release, which was “not significantly broader than the effect of the Shareholder Vote” approving the merger.
As to the question of attorneys’ fees, Judge Gale deferred ruling on that issue. One shareholder had filed an objection opposing the award of fees but not otherwise opposing the settlement. Judge Gale concluded that he could “uncouple” the fee request from the rest of the settlement because the settlement expressly said that its approval was not dependent on a fee award. This uncoupling would have the benefit of allowing the company to advocate on the fee question without fear of jeopardizing the settlement and release.1
Time will tell whether deal litigation and the accompanying disclosure-only settlements, which now are disfavored in Delaware, will find a home in North Carolina. Nominally, Judge Gale’s formulation of the standard for reviewing these settlements—which favors approval so long as the disclosures are not “plainly immaterial”—seems more deferential than Trulia’s—which requires the disclosures to be “plainly material” (my emphasis). But at least arguably, the Krispy Kreme disclosures might have satisfied the Trulia standard too. And, settlement approval was facilitated by the fact that Judge Gale was able to reserve decision on the request for fees; had he been forced to rule on the reasonableness of the fees and supplemental disclosures together, he may have shown greater skepticism of the settlement. Regardless, Judge Gale’s approval of the Krispy Kreme settlement shows that North Carolina law has, at minimum, not sworn off approval of disclosure-only settlements.
1 Judge Gale noted that the Court of Chancery has approved of a “mootness dismissal” procedure that allows the court to evaluate the fee request independent of the substantive settlement. Under that procedure, the “selling company issues supplemental disclosures, the class representative dismisses the class action with a release that binds only the named plaintiff, and class counsel applies for a fee award based on efforts to secure the supplemental disclosures.” Judge Gale explained that North Carolina law “has not expressly adopted such a process or procedure,” and he found it unnecessary to decide whether to recognize the procedure in this case.