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Important Seventh Circuit ruling against shareholder derivative strike suits

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As both Daniel Fisher and the Economist documented recently, the percentage of M&A transactions worth over $500 million that result in shareholder derivative suits has risen from 39% to 96%. [Fisher; Economist; Reuters (quoting me); OL; see also Johnson @ SSRN]

It's surely not the case that every merger is the result of a breach of fiduciary duty. What's happening is that entrepreneurial lawyers have discovered a profitable means of rent-seeking: with the help of a cooperative shareholder, bring a meritless shareholder derivative suit on some technical ground or the other, threaten to impose millions of dollars of discovery expenses and hassle on the officers and directors of the company, and collect an attorneys' fee for settling the case for a token change of no benefit to the shareholders. As I told Reuters in 2011, "Judges should consider whether these provisions actually create value for shareholders, or amount to a rearranging of the deck chairs to create the illusion of value to justify attorneys' fees."

Under FRCP 23.1(a) and its state-law equivalents, a shareholder derivative suit isn't supposed to proceed unless the shareholders bringing the suit adequately represent the shareholders. If the suit is meant to profit the plaintiffs' lawyers at the expense of the corporation (and thus the shareholders), how can the bringers of a strike suit be adequate representatives of the shareholders? I've thus argued that the correct role for courts in such situations is to throw these cases out entirely (or approve the settlement but award only a token amount in attorneys' fees).

I found myself the "beneficiary" of one of these $0 strike-suit settlements in Robert F. Booth Trust v. Crowley; the settlement would have paid the attorneys $925,000 under a clear-sailing clause, and, when the district court rejected my attempt to intervene to dismiss the suit, I appealed to the Seventh Circuit.

Yesterday, I won a complete victory with a landmark Frank Easterbrook opinion that I hope will provide protection for shareholders against future shareholder derivative strike suits. The suit, the Court said, "serves no goal other than to move money from the corporate treasury to the attorneys' coffers.... It is an abuse of the legal system to cram unnecessary litigation down the throats of firms ... and then use the high costs ... to extort settlements (including undeserved attorneys' fees) from the targets." It thus reversed the district court's denial of my motion to intervene, and remanded with instructions to dismiss the case, as I had asked below. [Reuters; Fisher @ Forbes; analysis by Wolfman; WSJ Law Blog (failing to recognize that the case involves a lawyer they profiled in October); Bashman; Overlawyered; Litigation Daily ($) ("Ted Frank, the indefatigable scourge of underwhelming class action settlements, scored a remarkable win on Wednesday"); Volokh on a punctuational quirk]

(The Manhattan Institute did not participate in the suit, and is not affiliated with the Center for Class Action Fairness.)

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Isaac Gorodetski
Project Manager,
Center for Legal Policy at the
Manhattan Institute
igorodetski@manhattan-institute.org

Katherine Lazarski
Press Officer,
Manhattan Institute
klazarski@manhattan-institute.org

 

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The Manhattan Insitute's Center for Legal Policy.