CANADIAN CLASS ACTION LAWSUITS
D&O liability exposure is far greater in the United States than in any other country because, among other things, U.S. law authorizes class action litigation. Effective January 1, 1993, the Class Proceedings Act, 1992, now authorizes class action litigation in Canada. Depending upon the willingness to Canadian judges to reward, financially, plaintiff lawyers who prosecute class actions, this new legislation may result in a quantum increase in Canadian D&O liability exposure.
The Canadian legislation is quite similar to U.S. laws authorizing class actions. Any person may commence a proceeding as a representative of a class of injured persons if the claims of the class members raise common but not identical issues of fact or common but not identical issues of law that arise from common facts. Upon motion by the representative plaintiff, the court must certify the class proceeding as such if (1) the claims of the class members raise sufficient common issues, (2) the named plaintiff will fairly and adequately represent the class free of conflicts of interest, and (3) the class proceeding is the preferable procedure for resolution of the common issues. The court may not refuse to certify the class solely because each class member may have separate issues of proof or because the number and identity of class members is not known.
Most importantly, the Canadian legislation authorizes the payment of a contingent fee award to plaintiffs counsel, unlike general Canadian law which prohibits contingent fee awards. The contingent fee may be set forth in a court approved agreement between the representative plaintiff and the attorney or may be awarded by the court following resolution of the class action. The legislation expressly authorizes a court to increase the plaintiff attorney's "base fee" (i.e., the fee determined by multiplying the attorney's time devoted to the lawsuit by an hourly rate) by a multiplier that results in a "fair and reasonable compensation" to the attorney for the risk incurred in prosecuting the lawsuit under a contingent fee arrangement.
In the United States, a small fraternity of highly sophisticated professional plaintiff lawyers instigate and prosecute class actions and recover enormous contingent fee awards. The awards are typically determined primarily based upon the perceived benefits realized by the class rather than the amount of work performed and risks incurred by the plaintiff lawyer. Absent the incentive to reap enormous attorney fee awards, many believe the frequency of class action litigation would be curtailed substantially.
Therefore, the magnitude of increased liability exposure in Canada as a result of this new class action legislation largely depends upon the generosity of Canadian courts in approving plaintiff attorney fee awards. A multiplier methodology, as authorized by the new legislation, may be viewed as resulting in a lesser fee than under other alternative methodologies which focus on the benefit to the class rather than the work performed by the attorney. However, any method can result in lucrative compensation and can serve as a strong incentive for knowledgeable plaintiff attorneys instigating and prosecuting class actions.
To date, no Canadian class action has been resolved through settlement or judgment and therefore the Canadian courts have not yet demonstrated their inclinations concerning plaintiff fee awards. During the last year, at least eight class action proceedings were filed under this new legislation, alleging a variety of wrongdoing including securities fraud, product liability, consumer fraud and defamation. Some of these proceedings named directors and officers as defendants, while others named only the target corporation.
Partly in response to this new liability exposure and partly in recognition of the increasing exposure under U.S. laws for Canadian corporations, many Canadian companies are now increasing the amount of their directors and officers liability insurance coverage. Based upon the development of class action litigation in the United States, that response appears justified.
PARAMOUNT: HAVE THE RULES CHANGED?
In 1989, Paramount Communications, Inc. made a tender offer for Time, Inc. In response, Time agreed to a stock-for-stock merger with Warner Communications. Paramount alleged that the Time directors breached their fiduciary duties in agreeing to the merger without adequately "shopping" the sale of the company. The Delaware Supreme Court ruled against Paramount and held that the proposed merger was a "strategic alliance", not a change in control which would invoke that duty to conduct an auction sale of the company.
In 1993, Paramount sought to invoke the protections of that earlier decision by agreeing to a merger with Viacom without "shopping" Paramount in an auction. QVC commenced a competing tender offer for Paramount, which the Paramount board essentially rejected without serious consideration. QVC alleged that the Paramount directors breached their fiduciary duties by not adequately investigating alternative proposals. In December 1993, the Delaware Supreme Court again ruled against Paramount, this time ruling that the proposed Paramount/Viacom merger constituted a change in control which necessitated an auction sale of Paramount.
Directors and their advisors have considered the 1990 Paramount v. Time opinion as providing significant protection to directors of a target company since the Court ruled, among other things, that "generally speaking and without excluding other possibilities" directors are not under any per se duty to maximize shareholder value in the short term and are not obligated to conduct an auction of their company when presented with a hostile takeover bid unless (1) the company initiates an active bidding process seeking to sell itself or to affect a business reorganization involving a clear break-up of the company, or (2) in response to a hostile offer, the company abandons its long-term strategy and seeks an alternative transaction also involving the break-up of the company. Because the Time/Warner merger was a stock-for-stock transaction, the shareholders of each company became the collective shareholders of the merged company and therefore the Court found no change in control which would justify the Court's interference with the directors' business judgment that the alliance with Warner furthered the long-term strategic plan for the company.
The Delaware Supreme Court's December 1993 decision in Paramount v. QVC, which was amplified by the Court in its February 4, 1994 written opinion, on its face may appear to substantially dilute the protection afforded to target company directors by virtue of the 1990 Paramount v. Time opinion. However, a careful analysis of the recent Paramount decision reveals that it will not likely cause greater director liability exposure in most "strategic" takeovers.
Apparently critical to the Court's decision was the fact that Viacom, which under the proposed merger would acquire Paramount, was 90% owned by one individual, Sumner Redstone. The Court found that the effect of the proposed merger would be to shift control of Paramount from the public stockholders to a controlling stockholder. Unlike the Time/Warner merger, where the surviving company would remain publicly owned, the Paramount/Viacom merger would supplant the authority of the current Paramount board and thus prohibit the current board from continuing to maintain and implement their long-term strategic vision for the company:
Irrespective of the present Paramount board's vision of a long-term strategic alliance with Viacom, the proposed sale of control would provide the new controlling stockholder with the power to alter that vision.
Thus, the proposed merger with Viacom was not simply a "strategic alliance", but a change in control which triggered the long-recognized duty of the directors in a change-in-control situation to auction the company and to obtain the best terms for the Paramount shareholders. The Court strongly suggested in a footnote that it was not expanding the directors' general duties in a takeover context and that directors could still "just say no" to an unsolicited hostile takeover bid.
It appears likely that the Court continues to endorse the broad discretion and protection afforded to directors by virtue of the 1990 Paramount v. Time opinion if the directors' conduct allows them to continue in their selection and implementation of a long-term strategic plan for the company. Instead of lamenting this recent opinion, directors generally should be grateful that Paramount, through two judicial losses, afforded to the Delaware Supreme Court the opportunity to articulate and refine rather protective rules for directors in implementing strategic long-term goals notwithstanding the opportunity to maximize shareholder value in the short term through one or more takeover proposals.
NEW YORK DERIVATIVE SUIT LEGISLATION
New York legislature appears poised to enact legislation intended to curb unwarranted shareholder derivative lawsuits against directors and officers of New York corporations. The proposed legislation, which has passed one chamber of the New York legislature and is supported by the Governor, is designed to grant to the corporation greater control over the selection of suits brought by shareholders on behalf of the corporation. According to the preamble to the proposed legislation, the legislature finds:
Meritless derivative litigation jeopardizes the economic health of New York corporations, and thereby the economic health of New York State, by causing these corporations to expend significant resources to defend themselves against meritless claims.
The primary provision of the legislation is the adoption of the so-called "universal demand" rule. Under existing law, shareholders who wish to commence a derivative claim on behalf of the corporation against directors or officers must first make demand upon the corporation's board to commence the action directly against the defendants. However, courts will frequently excuse shareholders from making this demand if shareholders can demonstrate the futility of such a demand due to the directors' conflict of interest with respect to the proposed litigation.
Whether a demand on the board is required or excused can be critical to the prosecution of the claim. If demand is required, the board of directors, through a Special Litigation Committee which is composed to independent directors who utilize independent legal counsel and other advisors, can determine whether prosecution of the proposed claim is in the best interests of the corporation. If the board's investigation into the proposed claim is thorough and independent, a decision by the board that prosecution of the proposed claim would be against the best interests of the corporation can serve as a basis for the court to dismiss the shareholder derivative claim. However, if shareholder-plaintiffs are excused from making a demand on the board, the corporation has no opportunity to terminate litigation on its behalf.
By adopting a universal demand requirement, the proposed New York legislation would require shareholders in every case to seek the approval of the corporation before filing the derivative suit. The proposed law would also provide that a shareholder may maintain a derivative suit over the objection of the corporation only if the plaintiff shows, through a preponderance to the evidence, that the board's decision in rejecting the demand lacked independence, was not made in good faith, or was not an adequately informed decision. In addition, in an attempt to discourage professional plaintiff lawyers from filing meritless derivative suits which are then settled through a payment of plaintiff attorney fees, the proposed legislation authorizes the payment of reasonable plaintiff attorney fees in the settlement of a derivative lawsuit only if the court finds that the derivative suit has resulted in "significant benefit" to the corporation.
Proponents and critics of the legislation disagree greatly on the effect of the new law. Supporters contend that the vast majority of derivative suits simply result in unnecessary management distraction and corporate expense, and have little economic benefit to the company (on whose behalf the suit is ostensibly prosecuted). Thus, the only people who really benefit are the shareholder-plaintiff lawyers who invariably receive a large fee award in exchange for settling the litigation.
Critics of the legislation, though, argue that derivative litigation would effectively be killed, thereby permitting the worst types of managers to get away with the most serious kinds of misconduct.
In reality, this legislation probably will reduce some what but not eliminate the number of litigated derivative suits for New York corporations. Ironically, though, the legislation will probably increase the corporations' costs with respect to shareholder derivative demands.
The new law should not materially affect valid claims on behalf of the corporation against its directors and officers. In evaluating a shareholder demand, the board is subject to a strict duty of diligence to carefully investigate and analyze the proposed claim. If the board's investigation and analysis is flawed, additional personal liability exposure may be created for the directors who participate in the demand evaluation process. In addition, shareholders will be able to circumvent an unreasonable refusal to com- menace suit if they can demonstrate to the court that prosecution of the proposed claim is merited and appropriate under the circumstances. Thus, valid shareholder demands will likely continue to result in claims against directors and officers.
In summary, the new legislation should not enable directors to avoid the ramifications of wrongful conduct, but will help corporations and their management in fending off meritless litigation.
It seems probable that at least some additional states will seek similar legislation in the coming months and years. The New York proposal is largely tailored after the American Law Institute's "Principles of Corporate Governance," which were recently finalized and frequently serve as a model for state legislation.