Multi-Forum Merger Litigation and the “Market for Preclusion”

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday February 22, 2013 at 9:15 am
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Editor’s Note: The following post comes to us from Sean J. Griffith, T.J. Maloney Chair in Business Law at Fordham University School of Law. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

The recent discovery that corporate law litigation very often takes place in courts outside of Delaware has rattled the academic consensus that Delaware won the corporate law “race” by providing a well-managed forum staffed with expert judges willing to decide complex deal cases quickly. In an apparent affront to this settled understanding, recent research shows that more cases are filed against Delaware corporations in other states than in Delaware itself. [1] As a forum for corporate litigation, in other words, Delaware no longer dominates.

Shaken from their settled understandings, commentators have sounded the alarm that fewer cases decided in Delaware could, over time, reduce the expertise of the Delaware judiciary in corporate law matters. Worse, the decisions reached by non-Delaware “dilettantes” threaten to adulterate and degrade the basic Delaware product. In sum, prior commentary on the out-of-Delaware trend has treated it as very bad for corporate defendants, very bad for shareholder plaintiffs, and very bad for Delaware.

My co-author, Alexi Lahav, and I don’t see it that way. In our current article, The Market for Preclusion in Merger Litigation, forthcoming in the Vanderbilt Law Review, we argue that the out-of-Delaware trend has awakened an active “market for preclusion” in which parties seek to trade the preclusive effect of a judgment in exchange for compensation. [2] Multi-jurisdictional litigation is essential to making this market work since related claims filed in a single jurisdiction can be consolidated, but related claims filed in different jurisdictions cannot. Multi-jurisdictional litigation thus creates a market of multiple sellers—that is, competing plaintiffs’ counsel in each jurisdiction, each of whom has the power to settle. Moreover, thanks to the operation of the Full Faith and Credit clause of the U.S. Constitution, the first settlement approved by a court precludes all other claims relating to the same underlying matter.

The preclusive effect of settlement is enormously valuable to transaction planners. Without it, planned transactions will be burdened by potentially large contingent liabilities and may even be enjoined. With a preclusive settlement resolving all shareholder claims, the transaction can move forward to closing. Multi-jurisdictional litigation enables this market for preclusion. In one of our more provocative claims, we argue that the market for preclusion, when it works well, may provide a reliable price discovery mechanism for shareholder claims, allowing low value claims to settle quickly and cheaply while higher value claims are litigated more aggressively.

Prior commentators remarking on similar phenomena in other areas of law have warned that such a settlement structure may produce a “reverse auction,” resulting in under-compensation of the plaintiffs’ class. [3] While we acknowledge that risk—the market for preclusion is not always a well-working market and we address several areas of potential market failure—we argue that ultimately the best means of managing it is through a more robust understanding of judicial comity.

Comity is typically understood to require that states respect each other’s laws. In the Article, we propose a reconceptualization of comity that would also require cross-jurisdictional communications. Through these inter-state “comity communications,” judges can monitor cases during the initial trial stages and determine the novelty and complexity of the legal issues involved. Judges can then collaboratively decide where the case should proceed and how carefully it should be managed through the settlement stage. Comity communications would thus serve to regulate the market for preclusion while also allowing it to operate, producing potentially significant benefits for all involved.

The full paper can be downloaded here.

Endnotes:

[1] John Armour, Bernard S. Black & Brian R. Cheffins, Is Delaware Losing Its Cases? 9 J. Empirical Legal Stud. 605 (2012).
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[2] Sean J. Griffith & Alexandra D. Lahav, The Market for Preclusion in Merger Litigation, 66 Vanderbilt L. Rev. ___ (forthcoming 2013), available at SSRN: http://ssrn.com/abstract=2155809
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[3] See generally John C. Coffee, Jr., Class Wars: The Dilemma of the Mass Tort Class Action, 95 Colum. L. Rev. 1343 (1995).
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