On January 7, 2015, Justice Kornreich of the New York County Commercial Division issued a decision in City Trading Fund v. Nye, 2015 NY Slip Op. 50008(U), refusing to approve a class action settlement.
In a decision reminiscent of Justice Schweitzer’s recent decision in Gordon v. Verizon Communications, Inc., 2014 NY Slip Op. 33367(U), the City Trading Fund court refused to approve the settlement of a class action challenging the disclosures made in connection with a merger.
The court’s lengthy decision should be read in its entirety. It thoughtfully (if forcefully) addresses systematic problems with merger-related class action litigation. We quote here only the decision’s conclusion:
In merger litigation — unlike other class action litigation (e.g., securities fraud) where, if the case is frivolous, the court can dispose of it on a motion to dismiss — the time crunch incentivizes a payout to plaintiffs to settle all cases, even frivolous ones. Thus, extra scrutiny is warranted when it appears that the incentives of the purported class representatives diverge from those of the shareholders. Such a divergence of incentives may exist, as is the case here, where it appears that the original plaintiff, CTF — essentially a fictitious entity — seeks to obfuscate what it really is. When a proposed class representative appears to be a fiction, there is the concern that it has no accountability, either to the class or to the court. As noted earlier, such entities have a troubling history of litigating deceptively. Additionally, when a plaintiff and its counsel have identical incentives, that is, litigation to obtain attorneys’ fees, such plaintiffs are improper class representatives because it is the function of the class action representative to act as a check on the attorneys in order to provide an additional assurance that in any settlement or other disposition the interests of the members of the class will take precedence over those of the attorneys.
Simply put, the secretive nature in which plaintiffs and their counsel choose to litigate, both here and in Delaware, along with the frivolity of their claims, is a strong indication that they are ill suited to represent the class. Given the inability of plaintiffs to identify any actual material omission in the definitive proxy, perhaps the only reasonable inference is that the defendant directors have, to their credit, lived up to the very aspirational fiduciary duties merger class actions are supposed to incentivize. It, therefore, is somewhat unfortunate that they still find themselves as defendants in a lawsuit. If all mergers will spawn disclosure lawsuits, regardless of the sufficiency of the actual disclosures, a board may well be incentivized not to care so much if the initial disclosures are adequate. This would be unfortunate. As some commentators have observed, if directors worry that plaintiffs will not settle unless they can proffer some additional, material disclosure, an even more perverse incentive may exist to intentionally withhold some material disclosure so the directors have a bone to throw plaintiffs’ counsel when it comes time to settle.
That being said, the incentives surrounding mergers can never be fully perfected, and mergers taxes may simply be a reality, an inevitable cost of doing business. However, even if that is the case, this court sees no reason to countenance frivolous litigation.
(Internal quotations and citations omitted).