“No Better than a Racket”: Seventh Circuit Cracks Down on Merger Objection Strike Suits

In a recent decision, the United States Court of Appeals for the Seventh Circuit outlined a mechanism by which shareholders can object to mootness fees paid to plaintiffs’ attorneys in merger objection suits. See Alcarez v. Akorn, Inc., 99 F.4th 368 (7th Cir. 2024). By allowing a shareholder to intervene and inviting the district court to scrutinize the propriety of the suit, the Seventh Circuit took a further step in its battle against the frivolous strike suits that have plagued M&A transactions for many years.

Background

The case addresses a controversial practice in which plaintiffs file class action suits seeking additional proxy disclosures without alleging that any of the existing disclosures is false or materially misleading. After the defendant company agrees to amend its proxy statement, the plaintiffs voluntarily dismiss the suit, and the plaintiffs’ attorneys collect mootness fees from the company. By settling the cases before moving for class certification, the plaintiffs circumvent Rule 23(e) of the Federal Rules of Civil Procedure, which requires judicial approval of settlements or voluntary dismissals of class actions. In a 2016 case, Judge Richard Posner of the Seventh Circuit described these suits as “no better than a racket,” explaining that they “yield[] fees for class counsel but nothing for the class.” In re Walgreen Co. Stockholder Litigation, 832 F.3d 718, 724 (7th Cir. 2016).

Historically, most suits seeking supplemental disclosures were filed in Delaware; but in 2016, the Delaware Court of Chancery held that such suits would be subject to “disfavor in the future unless the supplemental disclosures address a plainly material misrepresentation or omission.” Trulia, Inc. Stockholder Litigation, 129 A.3d 884, 898 (Del. Ch. 2016). The suits have continued, but plaintiffs’ attorneys have changed their strategy to filing in federal court, thereby dodging the “plainly material” standard that would defeat their claims in state court.

The Case

Alcarez v. Akorn involves six suits challenging Akorn, Inc.’s (Akorn) proposed merger with Fresenius Kabi AG, which alleged that the proxy statement required additional disclosures. Akorn agreed to amend its proxy statement but maintained that none of the additions was legally required. Plaintiffs then dismissed their suits on the basis that Akorn’s acquiescence rendered their claims moot, and plaintiffs’ attorneys collected a $322,500 payment from Akorn.

An Akorn shareholder named Theodore Frank filed a motion to intervene in the case, seeking, among other things, disgorgement of the mootness fees as unjust enrichment. The district court denied Frank’s motion but reopened the suits, citing its “inherent powers to police potential abuse of the judicial process.” The court ultimately concluded that the complaints were frivolous and ordered plaintiffs’ counsel to return the mootness fees to Akorn.

On appeal, the Seventh Circuit held that the district court did not have inherent authority to reopen the suit following voluntary dismissal; rather, it could do so only after the filing of a Rule 60(b) motion. Importantly, however, the Seventh Circuit also held that the district court erred in denying Frank’s motion to intervene. Recognizing that Frank could have filed a Rule 60(b) motion if he were a party to the suit, the Seventh Circuit remanded the case and instructed the district court to treat Frank as an intervenor, permit him to file a Rule 60(b) motion, and decide what relief is appropriate.

The court reasoned that the suit is subject to the Private Securities Litigation Reform Act of 1995 (PSLRA), explaining that the PSLRA “applies to all securities suits ‘brought’ as class actions, whether or not they are so certified.” See 15 U.S.C. § 78u–4. Under the PSLRA, upon final adjudication of such actions, courts must conduct a mandatory review of compliance with Rule 11(b), which prohibits lawsuits “presented for any improper purpose, such as…needlessly increas[ing] the cost of litigation,” among other things. The Seventh Circuit noted the district court may order counsel to return the mootness fees under Rule 11(c)(4), which gives the district judge discretion to impose sanctions.

Key Takeaways

Alcarez v. Akorn solidifies the Seventh Circuit’s disfavor of frivolous merger objection suits in which “money moves from corporate treasuries to plaintiffs’ lawyers,” yet “the investors get nothing.” Such litigation is precisely the type of abuse of the judicial system that the Federal Rules of Civil Procedure and the PSLRA seek to eradicate. By permitting shareholder intervention, the Seventh Circuit has fashioned a potential remedy for the current status quo, under which companies frequently opt to settle rather than deal with the nuisance of litigating the matter. Perhaps other jurisdictions will follow the Seventh Circuit’s lead in promoting efficiency in M&A transactions by deterring unnecessary disruptions.

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