Shareholder Litigation

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Counsel for public companies—it may be time to take another look at your litigation disclosures. A recent federal district court opinion held that one company’s use of the phrase “without merit” to describe ongoing litigation in its public filings could give rise to federal securities fraud claims. The ruling serves as the latest admonition to exercise care in crafting litigation disclosures.

Corporate boards are subject to a duty of oversight, as part of their duty of loyalty to their company.  As outlined by Delaware’s famously stringent Caremark standard, pleading a violation of that duty is often difficult.  However, the Delaware Court of Chancery has issued several recent opinions addressing duty of oversight claims where they held the plaintiffs successfully met the Caremark standard.  These decisions serve as important reminders for corporate boards to thoughtfully carry out their oversight duties, in order to ensure that their internal controls, reporting systems, and other oversight-related practices are sufficiently comprehensive.

The COVID-19 pandemic has brought great economic uncertainty and significant market volatility, creating an environment where investors that are trying to assess the financial impact of the virus are looking to glean any insight they can from a company’s disclosures and are hanging on every statement made by company leaders. This environment of heightened investor focus has, not surprisingly, increased the legal risks that companies, their officers, and their directors face when informing the market about the impact of COVID-19. The coming months are likely to see increased activity from both the SEC Enforcement Division and from plaintiffs’ firms bringing shareholder suits challenging overly optimistic disclosures companies make about their capacity to manage the challenges presented by the pandemic. Consequently, disclosures concerning the business and financial risks to a company posed by COVID-19 must be made with the utmost prudence and caution to limit a company’s exposure to actions brought by the SEC Enforcement Division or shareholder suits.

In Salladay v. Lev, the Delaware Chancery Court elaborated on how early a corporate board must take protective measures to shield a conflicted transaction from entire fairness review.

Salladay involved a motion to dismiss a challenge to a merger agreement based on alleged director conflicts at the target company. The defendants argued that the transaction was approved by an independent committee of directors and a shareholder vote, warranting deferential business judgment review and, in turn, dismissal. The court held that business judgment review was inappropriate because the independent committee only became involved in negotiations after they had begun—too late to “replicate the value-enhancing structure of an arms-length transaction”—and the shareholder vote was not fully informed. Instead, the much stricter standard of entire fairness applied, rather than the more lenient business judgment rule, and therefore dismissal was inappropriate.

In Jinnaras v. Alfant, decided on May 5, 2016, the New York Court of Appeals rejected a proposed settlement of a shareholder class action, where the proposed settlement would have deprived out-of-state class members of a “cognizable property interest” by failing to provide a mechanism for class members residing…