Mergers, Acquisitions All Too Often Accompanied by Lawsuits

Along with the skyrocketing merger and acquisition activity during recent years, has come a general, albeit not unanimous, perception of a corresponding increase in M&A-related lawsuits-especially in California.

“I think it’s a trend in the making, and it’s going to have a pronounced impact on insurance companies,” said R. Brian Timmons, a partner of the Costa Mesa-based firm of Latham & Watkins. Timmons added that based on the number of such cases that he and his firm have been involved in over the past few years, he thinks the frequency of the litigation could actually be outstripping M&A activity.

Gail Baev, a partner of Lord Bissell & Brook in Los Angeles, said that she could not really point to any definite increase in M&A litigation in California. However, she said that a frequent litigation response to the announcement of an acquisition is a shareholders derivative action, in which some type of allegation is made that the management did not adequately represent the interests of the shareholders.

“What is normally claimed is a breach of fiduciary duty-that the directors and officers did not get enough money for the shareholders,” Baev said. “This is obviously on behalf of the selling or acquired company. Derivative actions are typically brought in state courts because the breach of fiduciary duty is a state law claim; it’s not a federal claim. The class actions now by law are almost all brought in federal court.”

Baev also said that a derivative action against the acquired company is also usually brought immediately because the shareholders will seek to block the merger, or, alternatively, get some additional compensation. There is often a non-cash settlement of these derivative actions that results in some minimal benefit for the shareholders, but that demands attorneys’ fees. “The only cash component of settlement may very well be the attorneys’ fees, ” she said.

“[M&A cases] are lawyer-driven cases, not shareholder-driven cases,” Timmons said. “In that sense they’re very much like the securities cases that spawned so much federal reform legislation over the past couple of years. Typically the plaintiffs are nominal plaintiffs who hold a nominal amount of shares…. Often they have an agreement that if the company in which they hold shares is bought in some kind of transaction, or enters into some kind of a transaction, they will agree to serve as a named point of the class action.”

How might D&O carriers be affected by any trend toward an increase in M&A litigation? “Most D&O policies provide defense costs coverage for these kinds of claims,” Timmons explained. “Some policies have exclusions that would prohibit any kind of coverage for the underlying liability or damages, but they’re all generally on the hook for defense costs. These cases can be quite expensive to litigate. Generally speaking, the cases are cheaper to settle, easier to settle than to litigate or risk interference with the underlying transaction.”

Baev agreed that M&A litigation does have an impact on D&O carriers. “I can’t see that it has impacted them from a price standpoint,” she said. “Frankly, from the carriers’ standpoint, the policies have gotten pretty dreary. With a soft market, carriers have been offering more and more coverage enhancements for less money. As a result they have very few defenses. In some respects this is positive because it gives people less to quarrel about. The least productive thing I can imagine is to have the insurer and the insureds arguing with each other all the time about the allocation percentages and the meanings of exclusions. But it also means that carriers end up paying more money. When they have losses they’re normally big ones these days.”

Out of 1,325 U.S. participants, representing all major industrial groups, in the 1999 Tillinghast-Towers Perrin Directors and Officers Liability Survey, roughly 50 percent reported experiencing merger, acquisition or divestiture activity in the last five years. Such companies were more than two times as likely to experience a claim against their directors or officers. About 93 percent of all respondents and 98 percent of banks and high technology corporations said they carried D&O insurance. While historically always of importance, in the past five to 10 years, merger and acquisition activity has emerged as a key underwriting element.

“Be it California or anyplace else, merger and acquisition activity is just an area that underwriters should and do take a look at because there are many potential ramifications from that activity,” said Jeff Gauthier, senior vice president of marketing, executive liability division of Great American Insurance Company. “Once an organization has merger and acquisition activity, we look at a snowball effect of what that might mean.”

“We see some evidence that the insurance industry is responding in a positive way to support more aggressive defense of securities cases, including M&A,” said Jonathan Dickey of Palo Alto’s Gibson Dunn & Crutcher LLP. An example of this is the modification of policy forms to permit a company to be fully reimbursed for its defense costs in the event of a successful defense. “We would encourage the insurance industry to develop additional products that would make these exposures less costly to the company and provide even further incentives to successful litigation of these cases,” Dickey said.

Topics Lawsuits California Mergers & Acquisitions Carriers Market