Scully v. Nighthawk Radiology Holdings, Inc.: Court of Chancery Questions Potential Collusive Forum Shopping in Settlement of Stockholder Litigation

February 1, 2011

Publication| Corporate Transactions| Corporate & Chancery Litigation

At a status conference in Scully v. Nighthawk Radiology Holdings, Inc., C.A. No. 5890-VCL, Vice Chancellor Laster stated that there was prima facie evidence of collusive forum shopping in connection with a settlement of multi-jurisdictional, representative litigation challenging the fairness of a merger and announced that he would appoint special counsel to the Court to investigate these issues and possibly to recommend disciplinary action.

Following the announcement of the proposed merger of Nighthawk Radiology Holdings, Inc. and Virtual Radiologic Corporation, putative class actions challenging the deal were filed in the Delaware Court of Chancery and Arizona state court. The parties to the Delaware action briefed and argued a motion to expedite, during which (i) defendants expressed a strong preference for litigating the cases in Delaware; (ii) the Court signaled that plaintiffs’ disclosure claims were not colorable; and (iii) the Court signaled that the case presented meaningful, litigable process claims, which plaintiffs had ignored.

Shortly thereafter, the parties to the Delaware action notified the Court that they had entered into a memorandum of understanding that, subject to confirmatory discovery, would result in a global disclosure-only settlement. Further, the parties informed the Court that they intended to present the settlement for approval in Arizona, where there had been no litigation activity. In response, Vice Chancellor Laster immediately scheduled a status conference.

During the status conference, the Vice Chancellor expressed concern that the settlement consideration involved only disclosure claims that he already had said were not colorable and that there was no apparent effort to address the process claims, which he had expressed “had legs.” Further, the parties were seeking approval of the settlement from a court that had not yet looked at any of these issues and might never discover that the Court of Chancery had made preliminary determinations as to the merits.

According to the Vice Chancellor, it appeared that what took place was “the classic reverse auction . . . where defendants benefit and utilized multiple [fora] to force plaintiffs essentially to constructively reverse-bid for the lowest possible settlement.” Defendants could accomplish this goal by, for example, giving preferential access to documents, stipulating to consolidation and certification of a class, and threatening to cut certain plaintiffs’ counsel completely out of settlement negotiations.

The Vice Chancellor noted that historically plaintiffs’ lawyers have been criticized for suing on the announcement of every deal and then agreeing to disclosure-only settlements. “But what needs to be understood is that defense lawyers benefit from this game, too. They get to bill hours without any meaningful reputational risk from a loss. They then get to get a cheap settlement for their client.” The Vice Chancellor went on to explain that while many defense counsel rightly regard this dynamic as benefitting their clients, as he “tried to remind people in the Revlon case,1 you’re dealing with fiduciaries for a class. And when you knowingly induce a fiduciary breach, you’re an aider and abettor.”

Vice Chancellor Laster concluded that the Arizona court would determine whether or not to approve the settlement and that Delaware would give full faith and credit to its decision. However, he entered an order directing that the status conference transcript and the case files be sent to the Arizona court with a letter indicating that he was available to discuss his views.

He also indicated that he would appoint special counsel to the Court to investigate the prima facie case of collusion and forum shopping and will consider revocation of pro hac vice admissions and possible referrals to disciplinary counsel. All parties and their counsel were ordered to submit, by February 11, separate briefs and affidavits detailing every aspect of the settlement negotiations. The Vice Chancellor expressed that his mind was open to being convinced that what he has called collusive forum shopping “is a necessary part of the practice and should not be condemned,” but that he was deeply skeptical.

Gregory P. Williams, a director at Richards, Layton & Finger, has been appointed the special counsel to the Court for this matter to, inter alia, advise the Court as to potential changes to judicial procedures and rules pertaining to multi-forum litigation.

 1In In re Revlon, Inc. Shareholders Litigation, Consol. C.A. No. 4578-VCL (Del. Ch. Mar. 16, 2010), the Court of Chancery replaced lead representative plaintiffs and their counsel after concluding that the plaintiffs and their counsel failed to litigate the case adequately and exaggerated their litigation efforts in filings submitted to the Court. 
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