Class Action Litigation Uncertainty: The M&A Killer
It is no secret that class action lawsuits can have disastrous effects on mergers and acquisitions. One need look no further than the news to meet this point.
In 2003, for example, famed environmental activist Erin Brockovich filed a class action lawsuit against Wainoco, a subsidiary of Frontier Oil Corp. At the time, Frontier was a party to a merger agreement with Holly Corp. worth $450 million. When news of the class action broke, Holly Corp. backed out of the merger, citing concern over the impact the suit would have on Frontier’s stock prices and overall financial condition.
That situation is not unusual. Just this year, Tribune Media backed out of a planned merger with Sinclair Broadcast Group. Though that merger fell apart for several reasons, the fact that Sinclair was defending three class action lawsuits played a role in the deal’s demise.
The truth is, class action lawsuits form a giant wall of uncertainty around a company. Unfortunately, with the U.S. economy on the rise, class action lawsuits are also on the rise. This article examines the myriad of ways a class action lawsuit can be a deal-killer. It also explores a relatively new way to bring certainty and finality to the financial aspects of a class action, even in the early stages of litigation.
How Class Action Litigation Kills M&A Deals
Anytime one company seeks to merge with or acquire another, the acquiring company is looking for a few critical factors within the target – strong financial potential, predictable expenses, and an absence of risk are just a few of the most positive indicators. Having only one class action lawsuit filed against the target organization, however, can throw each of those positive indicators into a tailspin.
The first problem is the sheer level of legal expenses that accompany class action lawsuit defense. The cases take years to resolve and require more filings and hearings than a regular action. While that may be great news for outside law firms, it can wreak havoc on a company’s balance sheet. And, with no predictable end date to the litigation, it is impossible to gauge the extent and magnitude of legal bills.
Of course, the biggest risk of class action litigation is the outcome of the lawsuit itself. Especially in cases involving consumer protection issues, where there is no way to predict how large the class will become. This is particularly true given the viral class response that can result from social media attention and various class action promotion websites. The company’s liquidity or enterprise value can evaporate as reserves are set to cover legal fees or potential exposure. Given the varying outcomes and massive potential exposure, Buyers simply don’t want to inherit a financial risk emanating from known, threatened or pending class action litigation.
Lifting the Cloud of Uncertainty
So, what happens if your organization is sued in the middle of M&A negotiations? In light of the risk and uncertainty that stems from class action litigation, is there any way to salvage the deal? In recent years, viable solutions have emerged.
Specifically, one such product, known as Class Action Settlement Insurance is an insurance product that may go a long way toward preserving the value and executability of M&A deals. Known as “CASI”, it transfers the financial risk of pending class action litigation away from the organization. Importantly, CASI is unlike traditional business policies such as CGL or D&O. It doesn’t have to be purchased before the class action is filed. To the contrary, CASI policies are purchased while the class action litigation is underway. A company can purchase traditional CASI coverage after dispositive motions have been filed and overruled.
Alternatively, early in a case, companies can purchase Litigation Buyout (LBO) Insurance coverage. With LBO Insurance, the organization pays one fixed premium in exchange for a complete transfer of the litigation risk. This includes fees for plaintiffs’ counsel, defense counsel, as well as all costs of settlement, class notice, and payout administration. With an LBO Insurance policy, 100% of the settlement risk is transferred to the insurance company in exchange for a one-time premium. The insurance company then takes over settlement negotiations, structures a settlement agreement, and sees that it is carried out.
These options can salvage an M&A deal which is faltering due to a class action lawsuit. Ultimately, these solutions provide predictability to an otherwise chaotic and uncertain process. With risk transfer, the parties can proceed with the transaction, having ring fenced the class action liability and costs.