The Cox Communications case

In preparing the 2005 Supplement for Ribstein and Letsou, Business Associations (4th edition) I finally had time to read carefully Chancellor Strine's classic-to-be opinion in In re Cox Communications Inc. Shareholders Litigation, decided last month.  The case is so interesting for so many reasons that I thought I would spend some time and space on it here, for those who can tear themselves away from the Supreme Court.

Briefly, the case not only provides a very interesting analysis of the attorneys' fee and going private issues the case directly involved, but insights on the problems of the litigation process and what a very sophisticated judge can do about them.

In brief, Vice Chancellor Strine ruled on a fee request in a case arising out of a proposal by the Cox Family to take Cox Communications private. The Family proposed a merger on fully negotiable terms with an opening bid of $32. The proposal was immediately followed by the filing of class action lawsuits, as is typical in these types of transactions, The Family tentatively agreed with a special committee of independent directors to a price of $34.75 per share subject to approval by a majority of the minority stockholders and conditioned on settlement of the outstanding lawsuits, a final fairness opinion, and agreement on the terms of a final merger agreement. The Family then gave plaintiffs the $34.75 price as its "best and absolutely final offer," and plaintiffs settled with the Family. The Family agreed to pay the fee and to a stipulation that the litigation had contributed to their decision to increase the bid from the original offer price.  The court applied the “lodestar” factors in the Sugarland "lodestar" case, and awarded a fee of $1.275 million, as against a request of $4.95 million.

In a lengthy and detailed analysis, the court showed why it was skeptical in cases involving the filing of a lawsuit contemporaneous with the announcement of a going private proposal affected the final price separate from the work of the special committee. The problem is that the lawsuit comes right after an initial proposal that the controlling shareholder inevitably will increase as a normal part of the bargaining process.

Because the proposal is subject to further negotiation, the lawsuit almost certainly lacks real merit at the time it is filed.  Yet the defendant cannot get a dismissal because it is always possible at the pleading stage that there is some fairness issue with the merger price, and in controlling shareholder transactions the business judgment rule is never applied under Kahn v. Lynch Communications Systems, Inc.. Moreover, the plaintiff in these cases always settles at the price agreed on by the controlling shareholders and special litigation committee, suggesting that the lawsuit itself didn't contribute to the negotiations.

The court was not persuaded that the litigation was beneficial by an analysis by the plaintiff’s expert, Harvard professor Guhan Subramanian, to the effect that litigation ending in monetary settlements produced bigger merger premia than cases that didn't produce these settlements. The court suspected that the premium was attributable simply to the lawsuit’s being filed at an earlier stage, and there seemed to be nothing that the attorneys were doing differently in the two types of cases.

More generally, the opinion is sprinkled with language that disparages the wastefulness of the whole class action process and plaintiffs’ lawyers' contribution to it. For example, the Chancellor describes the initiation of the litigation as follows:

Beginning at 8:36 a.m. on August 2 [four and a half hours after the proposal was announced publicly], and continuing throughout the day, a flurry of hastily drafted complaints were filed with this court. The first of the complaints consisted of paragraphs cobbled together from public documents, and rested on the core premises that Cox was poised for growth, that the Family's Proposal undervalued the company, that the offer was timed to allow the Family to reap for itself Cox's expected profits from heavy capital investments made in recent years, and that the directors of Cox were acquiescing to the Family's wishes. At 9:28 a.m., the Abbey Gardy firm, which is lead counsel in this action, filed its initial complaint, the second complaint filed that morning. That complaint was even less meaty than the first filed complaint. It is exemplary of hastily-filed, first-day complaints that serve no purpose other than for a particular law firm and its client to get into the medal round of the filing speed (also formerly known as the lead counsel selection) Olympics. The complaint's allegations were entirely boilerplate, with no particular relevance to the situation facing Cox. Most notably, the complaint's strained accusations of wrongdoing reflected, but did not maturely and thoughtfully confront, the reality that the Family's Proposal was just that, a proposal, subject to the expected evaluation of a Special Committee of independent directors, which would soon be formed and have the chance to hire advisors.

Despite its skepticism that the plaintiffs’ lawyers were producing any benefit, the court declined to apply the rule of Chrysler v. Dann, 223 A. 2d 384 (Del. 1966), under which no fee would be awarded in a suit that could not survive a motion to dismiss when filed or where plaintiff has no factual basis for its claims.  The court did not want to essentially replicate a formal motion-to-dismiss type hearing where neither the objector nor any shareholders had been injured (since the Family was paying the fee and there was no contention that the suit resulted in less consideration paid to the shareholders). 

The court significantly reduced the fee request because of doubt concerning the benefit achieved and the risk and difficulty of the case.  But the court was willing to award some fee because of the sheer amount of money the additional negotiations produced and because the Family itself had negotiated the size of the fee.

The Chancellor concluded by addressing the substantive legal standards that had given rise to the litigation posture that itself led to the fee issue – namely the standards applied in the Lynch merger situation and the Siliconix tender offer-plus-merger situation.

The Chancellor criticized the lack of a role in the Lynch analysis for majority of minority shareholder approval, as well as the inapplicability of the business judgment rule to any of these transactions. He proposed applying the business judgment rule where the merger was approved both by an independent special committee and a majority of the minority vote, unless the plaintiff could show some specific process-related problem.

Chancellor Strine also proposed to reconcile the seeming tension  between Lynch and Siliconix by applying to the latter type of transaction a three-part test proposed by Gilson & Gordon, Controlling Controlling Stockholders, 152 U. Pa. L. Rev. 785 (2003) – a test that the court reasoned would afford the shareholders the same combination of a special committee and “non-coerced, fully informed approval by the minority stockholders” that was available in Lynch transactions.

One interesting aspect of this case is that the court was somewhat disturbed by the fact that the objection to the fee was being pressed as a matter of general policy by an otherwise disinterested objector – Professor Elliot J. Weiss, who had written on class action abuse in general, and on the specific abuse in this case. As just noted, the court refused to deny a fee despite its concern that the complaint was meritless because this would necessitate a detailed hearing, all on behalf of someone who hadn’t been injured.

Since the Chancellor was obviously sympathetic with the real world problem Weiss raised, it’s not clear why he was bothered that the challenge was academic rather than based on real injury.  The answer may be not because of Weiss’s role in this particular case, but out of a concern for the workload that might result from academic challenges on other issues.

At the same time, the court noted that no one else, including the defendant, had an incentive to challenge the underlying Lynch standard that gave rise to the fee issues in the case.  In order to do that, the defendant would have to turn down a settlement at the price recommended by the special committee and take a substantial risk of losing after much additional costly litigation.

The basic problem in this case is not necessarily that the defendant is paying more than it should, but that it has no way to get to a price without essentially bribing the plaintiff to go away. The defendant is forced to simply trade the plaintiff’s fee for the extra time and risk that a challenge would entail.  A less genteel judge might have labeled this extortion, though possibly of the gentler variety practiced by the squeegee men who used to haunt New York street corners.

In the absence of a way to resolve this sort of issue through the normal course of litigation, Chancellor Strine took matters in his own hands by looking through the fee issue to the underlying problem. In the course of doing so he demonstrated why there is currently no substitute for Delaware judging.  Not only did the Chancellor pierce through to the basic underlying problem, but he was able to sort out in a very sophisticated way the arguments presented by competing experts.

States that think they're going to be able to unseat Delaware simply by copying its laws and setting up business courts ought to look at this opinion and see if their judges can operate at this level.

At the same time, people should read this opinion to see why we cannot afford to delegate the power to decide corporate issues to the federal courts, including the Supreme Court -- at least until they get a lot more sophisticated in these issues than they are.  I don't mean just "sympathetic" with business, but knowledgeable and experienced.

Now I can't wait to see what Chancellor Chandler's going to do in Disney.

Comments

[Francis Pileggi]

Your insightful analysis of the Cox case is just as much a classic as the court's opinion. Concise and thoughtful summary of a very involved set of issues.
Best regards,
Francis Pileggi.