March 30, 2009

Merger Litigation Sharply Rejected by the Seventh Circuit

Here is analysis of a new case from Wachtell Lipton: Long after Sam Zell’s decision to sell Equity Office Properties (EOP) at the market top in an all-cash deal was followed by a near-complete collapse of the market for REITs and commercial office space, shareholder plaintiffs continued to pursue litigation claiming that they were ill-served by the transaction.

In a decision of the United States Court of Appeals for the Seventh Circuit issued recently, Judge Richard Posner decisively rejected these claims. The opinion, which primarily affirms the dismissal of claims that EOP’s proxy solicitation was misleading, also touches on the appropriate role that break-up fee arrangements play in merger transactions as a matter of economic logic and fiduciary duty, and reaffirms the limited scope of the judicial process in supervising both the federal proxy rules and state-law fiduciary matters, correctly categorizing the plaintiff’s purpose as seeking to “sink[] the process of corporate acquisition into a sea of molasses.” Beck v. Dobrowski, et al., 2009 WL723172 (7th Cir. March 20, 2009).

The case arose out of Blackstone’s all-cash deal to acquire EOP for $55.50 per share in early 2007. Blackstone clinched the deal only after a protracted bidding battle, and with the protection of a termination fee that was negotiated upwards to $720 million by the time the Blackstone’s prevailing bid was ultimately accepted. The shareholder plaintiff brought suit under §14(a) of the Securities Exchange Act, alleging that the merger proxy should have included additional back-up valuation information and details on the benefits that top EOP executives were to receive in the Blackstone transaction, and complaining generally about the terms of the transaction and the conduct of the sale process. The complaint tacked on supplemental state law claims alleging that EOP’s directors breached their fiduciary duties, notwithstanding that fiduciary duty litigation was already pending in the courts of Maryland, the state of EOP’s incorporation.

The appeals court rejected the plaintiff’s claims. As to the §14(a) claim, Judge Posner confirmed that “the antifraud provisions of the federal securities laws are not a general charter of shareholder protection, which, the court made clear, remains the proper province of state fiduciary duty law. (The court went out of its way, however, to note that the termination fees about which plaintiff complained are “not … generally improper under any body of law with which we are familiar.”)

Then, applying the Supreme Court’s 2007 decision in Bell Atlantic v. Twombly with full force to the merger litigation context, the panel rules that plaintiff’s merger proxy claims “were too feeble to allow the suit to go forward.” The court noted that “there is nothing in the complaint to suggest that any shareholder was misled or was likely to misled,” and no suggestion that any “shareholder drew a wrong inference” from any of the alleged factual omissions. Under Twombly, defendants should not be burdened with the heavy costs of pretrial discovery … unless the complaint indicates that the plaintiff’s case is a substantial one.”

Turning to plaintiff’s supplemental state law claims, the panel struck a blow for judicial efficiency by affirming the district court’s determination to stay the Maryland fiduciary claims. To permit such claims to proceed in federal court while identical claims were pending in state court would allow “different members of what should be a single class [to] file identical suits in federal and state courts to increase their chances of a favorable settlement.”

As Judge Posner observed, “[t]he state-law issues that our plaintiff has presented to the federal court will be definitively resolved by the courts of the state whose law governs these issues, and our court would be required to defer to that resolution because state courts are the authoritative expositors of their own state’s laws.” The court thus resolved the increasingly frequent problem of multi-jurisdiction merger litigation with a bright-line ruling in favor of the courts of the incorporating state.

The Beck decision constitutes a decisive affirmation of the business judgment rule. The complaint failed because “any evidence that the plaintiff would have presented … concerning the optimal strategy for EOP to have pursued would have been heavy on hindsight and speculation, light on verifiable fact.” Such second-guessing of directors remains impermissible in the courts, state or federal, and insufficient to state a claim challenging a merger agreement entered into in good faith.