In the final days of 2012, the Delaware Supreme Court resolved an appeal arising out of class action litigation concerning the sale of Celera Corporation to Quest Diagnostics, Inc.1 The litigation was settled by agreement of the lead plaintiff and the defendants, and the settlement was approved by the Delaware Court of Chancery over the objection of Celera's largest single stockholder. In its en banc decision, the Delaware Supreme Court affirmed the Vice Chancellor's decision to approve the settlement and certify a non-opt-out class. But, because of "facts and circumstances" raising "due process concerns," the court held that the objector should have been allowed to opt out of the non-opt-out class. Though permitting a shareholder to opt out of a settlement resolving class action deal litigation is fundamentally at odds with the nature of a "non-opt-out" class—and undermines the rationale behind settling this sort of litigation—we do not believe that the court intended to dramatically alter the state of Delaware law on class actions. Instead, we believe that the court's decision was motivated by the extremely unusual facts in this case—in particular, the misdeeds of the lead plaintiff prior to the approval of the settlement.
Background
In 2009, Celera, a healthcare business, began exploring its strategic options. With the help of its advisors, Celera identified and reached out to several potential bidders, including Quest. The process was lengthy and troubled, with one potential transaction falling apart, disputes with Celera's CEO, and a financial restatement all contributing to delays and difficulties. In 2011, BVF Partners LP, one of Celera's largest stockholders, made public its disagreement with the board's strategy for selling the company. Ultimately, however, Celera's board agreed to a transaction with Quest at $8.00 per share.
Stockholder litigation, filed by the New Orleans Employees' Retirement System (NOERS), swiftly followed the announcement of the proposed transaction. Equally swift was BVF's public opposition to the deal. As NOERS conducted discovery, BVF bought more stock—eventually acquiring more than 20 percent of the company—and voiced concerns that the deal price was too low. In the litigation, NOERS also argued that the deal price was unreasonably low, but the bulk of its allegations—like the allegations in most cases challenging mergers—centered on the process that Celera's board employed and the terms to which it agreed. NOERS sought an injunction blocking the stockholder vote on the merger.
Before the court heard the injunction motion, NOERS and the defendants signed a memorandum of understanding (MOU) settling the case. In exchange for a full release of all claims against them—those asserted and those that could have been asserted, including potential claims for monetary damages—the defendants agreed to modify the deal terms and to issue more disclosures to Celera's stockholders. With the MOU in place, the merger closed on May 17, 2011. Days before, however, with rumors in the market that BVF's efforts to push for a better deal might succeed, the stock price of Celera exceeded the merger price. NOERS took advantage of this arbitrage opportunity, and sold all of its stock. Thus, NOERS was not a stockholder at the time the merger closed.
The Court of Chancery's Decision
Roughly 10 months later, when the settlement came to the Delaware Court of Chancery for approval, BVF objected. In particular, BVF argued that the settlement was unfair and that, in any event, NOERS was an inadequate representative of the stockholders because it sold its stock before the merger closed and the settlement was approved. BVF asked that, if the court did approve the settlement, it be permitted to opt out of the settlement class so that it could pursue its own money damages action against the defendants.
The Court of Chancery rejected BVF's arguments.2 It concluded that the settlement was fair to the stockholders, and it certified the class as defined in the settlement agreement: "[a]ny and all record holders and beneficial owners of share(s) of Celera common stock who held any such share(s) at any time [between February 3, 2010, and May 17, 2011, inclusive], but excluding the Defendants." As is customary in this sort of litigation, the Court of Chancery certified a non-opt-out class, meaning those within the class definition were not free to forego the settlement consideration in order to pursue individual claims. Correspondingly, the Court of Chancery refused to allow BVF to opt out of the non-opt-out class. The Vice Chancellor, however, criticized the "substandard behavior" of NOERS in its "careless and cavalier" sale of its stock before the merger. Despite this, the Court of Chancery concluded that "NOERS still satisfies, if only barely, the requirement for an appropriate class representative."
The Delaware Supreme Court's Decision
The Delaware Supreme Court largely affirmed the Vice Chancellor's decision. With respect to the adequacy of NOERS as the class representative, the court looked closely at the class definition and held that NOERS had standing because it met that definition—it owned stock at the time of the alleged wrongdoing. The court determined that the Vice Chancellor did not abuse his discretion in determining that NOERS could adequately represent the class.
The court also affirmed the Court of Chancery's certification of the class on a non-opt-out basis. Writing for the court, Justice Henry DuPont Ridgely reaffirmed the longstanding rule that "actions challenging the propriety of director conduct in carrying out corporate transactions are properly certifiable under both subdivisions (b)(1) and (b)(2)" of Rule 23—i.e., on a non-opt-out-basis—and his opinion stressed that the mere "availability of potential damages alone does not automatically require certification under Rule 23(b)(3)"—i.e., with an opt-out right.
Nevertheless, the Delaware Supreme Court did conclude that the Court of Chancery abused its discretion by refusing to allow BVF to opt out of the non-opt-out class in order to pursue its own individual damages action. Despite the absence of any textual basis in the class certification rule or other statute, the Delaware Supreme Court concluded that "the Court of Chancery has the discretionary power to grant opt-out rights to members of a [non-opt-out] class when fairness and equity demand it." Here, though the defendants argued strenuously that they only agreed to settle the case in exchange for the "complete peace" afforded by a non-opt-out class settlement, the court held that this interest was "outweighed by the due process concerns."
The Delaware Supreme Court seemed particularly troubled because by the time the settlement came to the Court of Chancery for approval, the only claims that remained to be released were those for monetary damages; the other claims—those seeking to stop the merger—were moot, as the merger already had been consummated. The court concluded that this, combined with other "facts and circumstances" such as a "barely adequate class representative" and an objector who was "a significant shareholder prepared independently to prosecute a clearly identified and supportable claim for substantial money damages," was enough to merit an exception to the non-opt-out class. Consequently, the court held that BVF must be permitted to pursue its individual claims.
Implications
The Delaware Supreme Court's decision to allow a stockholder to opt out of a non-opt-out class is deeply troubling. Delaware courts—and federal and state courts throughout the country—certify non-opt-out classes in situations where a case concerns conduct that affects all members of the class in precisely the same way. Where all plaintiffs are situated in exactly the same fashion, courts have reasoned that separate litigations would subject the defendants to the risk of different standards of conduct with respect to the same action and waste limited judicial resources. Non-opt-out classes prevent these risks from coming to fruition. Allowing opt-outs from non-opt-out classes quite obviously undermines the very point of the procedural device, rendering the path to settlements of litigation even more problematic.
We believe, however, that the Delaware Supreme Court's decision here will be limited to its unusual facts. For years, the Delaware Court of Chancery and the Delaware Supreme Court consistently and forcefully have held that litigation challenging the conduct of directors in connection with corporate mergers is properly certifiable on a non-opt-out class basis. The fact that stockholder plaintiffs may seek damages in addition to equitable relief does not change this conclusion, as the courts have held time and time again. As Chancellor Leo Strine previously has reasoned, unlike other types of tort class actions seeking damages, "[i]n challenges to corporate mergers brought on behalf of the stockholders not affiliated with the defendants, it is virtually never the case that there is any legitimate basis that a defendant might be found liable to some plaintiffs and not to others. Rather, the actions involve a challenge to a single course of conduct by the defendants that affects the stockholder class equally in proportion to their ownership interest in the enterprise."3
Nothing in the Delaware Supreme Court's decision in Celera challenges or disagrees with this well-established rule. To the contrary, the court expressly reaffirmed that challenges to corporate mergers should be litigated via non-opt-out classes. We believe that the court's decision to allow BVF an exception here was motivated by (a) the unusually large size of BVF's position in Celera and (b) the unusually bad pre-certification conduct of NOERS, the class representative. Barring repetition of these unusual facts, we expect the Court of Chancery and the Delaware Supreme Court to continue their venerable and established practice of certifying challenges to corporate mergers as non-opt-out class actions.
For additional information on the Delaware Supreme Court's decision in Celera or any related matter, please contact Chancellor William Chandler III, Ryan McLeod, Tamika Montgomery, Ian Liston, or another member of the firm's corporate law and governance practice.
