– by John Jenkins, Calfee Halter & Griswold
Kevin Miller’s recent blog on Berger v. Pubco touched on a recurring topic of discussion in the Delaware courts – the extent to which projections need to be disclosed to shareholders in connection with a merger. Delaware courts have spent a lot of time on this issue, but it’s a topic on which their decisions have shed plenty more heat than light.
Questions about projections frequently are raised in connection with claims concerning the overall adequacy of fairness opinion disclosure. It is probably fair to say that Vice Chancellor Strine’s view in Pure Resources that shareholders are entitled to a “fair summary” of the investment banker’s work has been accepted by other members of the Chancery Court, but what a “fair summary” requires in terms of disclosure about projections is an issue that the judges have really struggled to resolve. Their struggles are reflected in a series of opinions that involve a lot of hair-splitting and not much in the way of useful guidance.
Unfortunately, the Delaware courts do not appear to have an easy way out of this messy, ad hoc approach to projection disclosure, and M&A lawyers are likely to struggle with very murky guidance on this topic for quite some time. That raises a question: just exactly how did Delaware get into this situation in the first place?
The roots of Delaware’s projections problem go back to the mid-1980s, and specifically to a case called Weinberger v. Rio Grande Indus., Inc., 519 A.2d 116 (Del. Ch. 1986). In that case, the Chancery Court adopted the Third Circuit’s test for determining whether projections need to be disclosed. In Flynn v. Bass Brothers, 744 F.2d 978, 988 (3d Cir 1984), the Third Circuit held that for purposes of the federal securities laws, the existence of a duty to disclose projections should be determined on a case-by-case basis “by weighing the potential aid such information will give a shareholder against the potential harm, such as undue reliance, if the information is released with a proper cautionary note.”
The Flynn court’s take on disclosure of projections represents a minority position among federal circuit courts. Most appellate courts that have addressed the issue take the position that the federal securities laws do not impose an obligation upon an issuer to disclose projections. See, e.g., Glassman v. Computervision, 90 F.3d 617, 631 (1st Cir. 1996). The Sixth Circuit, which probably continues to reflect the view of most circuit courts that have addressed the issue, has criticized the Third Circuit’s standard, noting that it is “uncertain and unpredictable judicial cost-benefit analysis.” In the Sixth Circuit, soft information is only required to be disclosed if it is “virtually as certain as hard facts.” Starkman v. Marathon, 772 F.2d 231 (6th Cir. 1985).
Obviously, the disclosure gurus among our readers know that I’m painting with a very broad brush here, and there are a number of nuances that can result in exceptions to the “majority view” that disclosure of projections is not required. What’s more, as a practical matter, the SEC Staff will frequently push for disclosure of information about projections if it is not contained in a summary of the fairness opinion including in a merger proxy statement.
My point is only that by adopting the Third Circuit’s position as the starting point, the nation’s most influential state corporate law court has adopted the least influential federal approach to the issue of disclosure of soft information, and the consequences of that decision for M&A litigation have been far reaching. In fact, it seems fair to say that adoption of the facts and circumstances-based Flynn standard made the subsequent unpredictability of Delaware’s case law on projections almost inevitable. What’s more, adoption of that standard also guaranteed that there would be plenty of cases in which disclosure of projections would be at issue.
In order to understand why both of these outcomes were likely, you need to appreciate that disclosure litigation in Delaware offers some real advantages to a plaintiff to begin with. The business judgment rule does not protect against disclosure claims, because a decision about disclosure is not “a decision concerning the management of the business and affairs of the enterprise.” In re Anderson, Clayton Shareholders Litig., 519 A.2d 669 (Del. Ch. 1986). Disclosure claims have proven to be an effective way for plaintiffs to obtain an injunction against a pending merger transaction, which maximizes their potential leverage in negotiating a settlement.
When you add Flynn‘s plaintiff-friendly disclosure standard into the mix with the existing advantages of disclosure litigation, you can see why disclosure of projections is raised as an issue in so many M&A cases. There seems to be no reason to expect that the Delaware courts will see less of these cases in the years to come and, unfortunately, there also seems to be no reason to expect that these new cases will provide clearer guidance on when projections will need to be disclosed or how much will need to be said about them.