Week 4 Discussion Questions 1 & 2 - Jamie Acker

Case: Countrywide Corporation Shareholder Litigation (Mintz and Morris 2011)

Background

On March 31, 2009, Vice Chancellor Noble in In re Countrywide Corporation

Shareholders Litigation, C.A. No 3464-VCN (Del. Ch.),1 denied “for the time being” an

application to certify a class and approve a stipulated settlement because the settlement

would have improperly eliminated some investors’ claims for common-law fraud.

1Available at www.delawarelitigation.com/2009/08/articles/chancery-court-

updates/chancery-court-approves-class-action-settlement-involving-countrywide-and-

attorneys-fees-for-plaintiffs-attorneys-based-on-therapeutic-disclosures/print.html.

After the January 11, 2008, announcement of Country-wide’s proposed merger with

Bank of America Corporation (BOA), Countrywide stockholders brought an action

seeking to enjoin the merger, alleging breach of fiduciary duties by the individual

director-defendants of Countrywide and aiding and abetting charges against BOA.

Ultimately, a settlement was negotiated whereby the class claims would be dismissed in

return for additional disclosures; there was no additional monetary consideration.

In the summer of 2007, Countrywide started experiencing financial difficulties due to,

among other things, increased rates of loan defaults on residential mortgages,

foreclosures due to subprime mortgages, and the need for capital and liquidity.

Countrywide entered into an agreement in August 2007 with BOA to secure additional

funding. BOA invested $2 billion in Countrywide and in return BOA received numerous

benefits in addition to a 16 percent stake in Countrywide. The crisis continued to

worsen. Countrywide’s stock price continued to fall and bankruptcy rumors surfaced.

The situation was so dire that Countrywide went back to BOA and on January 11, 2008,

Countrywide announced that it had entered into a merger agreement. On June 25,

2008, Countrywide’s shareholders voted to approve the merger, which closed on July 1,

2008.

Class Action Allegations and Settlement

After the merger announcement, stockholder actions were filed alleging that the

Countrywide board had breached its fiduciary duties by (1) agreeing to a merger that did

not provide fair and adequate consideration, (2) discouraging other bidders from making

an offer, (3) issuing a false and misleading preliminary proxy statement, (4) agreeing to

provisions in the merger agreement that allegedly insulated Countrywide’s directors and

officers from liability for breaches of fiduciary duty raised in pending derivative actions,

and (5) entering into the merger agreement without adequately valuing certain pending

derivative claims. Within days of the plaintiffs’ moving for a preliminary injunction, the

parties reached an agreement to settle the consolidated actions by providing additional

disclosures, which occurred on May 28, 2008, and releasing the defendants from a wide

range of potential claims. A Stipulation of Settlement was filed on June 13, 2008,

requesting court approval. The parties also stipulated to the propriety of certifying a non-

opt-out class pursuant to Court of Chancery Rules 23(a) and 23(b)(1) or (b)(2). Several

shareholders objected with respect to the limited benefits of the proposed settlement to

the shareholders and the broad release of claims. In addition, one objector challenged

the appropriateness of a certification without an opportunity for shareholders to opt out.

The Federal Objectors and “Two Novel Theories”

Objections to the settlement were raised by five former Countrywide shareholders (the

Federal Objectors) who were plaintiffs in a federal court action brought in California

against Countrywide. The Federal Objectors lost standing in California federal court to

pursue the derivative claims after the close of the merger because under Delaware law,

“a merger which eliminates a derivative plaintiff’s ownership of shares of the corporation

for whose benefit she has sued terminates her standing to pursue those derivative

claims.”

To avoid the impact of Delaware law, the Federal Objectors raised what the vice

chancellor called “two novel theories of direct liability, both of which they argue have

value equal to that of the derivative claims and, thereby, render the proposed settlement

fundamentally unfair.” Without any supporting case law, the Federal Objectors argued

that the Countrywide directors had a fiduciary duty to (1) value the derivative claims

pending against them at the time the merger was negotiated, and (2) preserve that

value “either by extracting additional consideration from BOA or by assigning the

derivative claims to a litigation trust that could pursue the claims for the benefit of

Countrywide’s shareholders.” The vice chancellor, however, was not persuaded.

In discussing the applicable law, the vice chancellor noted that because this merger was

a stock-for-stock transaction of two widely held corporations, the Countrywide board’s

decisions surrounding the merger were subject to the protections of the business

judgment rule. Moreover, the court noted that the presumption protects a board-

approved transaction unless the plaintiff can show that a majority of the directors were

self-interested, lacked independence, were grossly negligent in failing to inform

themselves, or that the transaction can be attributed to no rational business purpose.

The court concluded that the Federal Objectors had failed to demonstrate “any facts

suggesting their claims could overcome the insulating effects of the business judgment

rule.” Therefore, the court overruled the Federal Objectors’ objections.

The SRM Objectors

SRM Global Fund Limited Partnership (SRM) challenged the propriety of class

certification by arguing that its common-law fraud claims for money damages were

individual and thus “predominate over the equitable relief found in the Delaware

Complaint.” SRM also argued that “to foreclose the individual common-law fraud claims

of SRM by virtue of certification of a class action and approval of the Proposed

Settlement would violate due process.”

For factual support, SRM pointed to January 14, 2008, when, just days after the merger

was announced, Kenneth Lewis, the chair, CEO, and president of BOA, in a speech to

the Delaware State Chamber of Commerce, dismissed rumors of Countrywide’s

impending bankruptcy and asserted that Countrywide “had a very impressive liquidity

plan [and] backup lines in place.” SRM claimed that these Lewis Statements were false

and that this misrepresentation induced SRM to hold, rather than sell, its shares of

Countrywide which resulted in losses of $80 million. As a result, SRM alleged that its

common-law fraud claims arising out of the Lewis Statements were uniquely individual,

not shared by the named plaintiffs and the plaintiffs could not adequately raise them so

they should not be dismissed. Vice Chancellor Noble agreed, finding that it was

“improper to include SRM’s individual claims based on the Lewis Statements within the

reach of the class action and the scope of the proposed release precludes both class

certification and approval of the proposed settlement.”

Almost Approved but Denied for Now—with Options

Vice Chancellor Noble found that “except for the matters raised in the SRM Objections

related to the Lewis Statements, the Court would certify the defined class of former

Countrywide stockholders.” Moreover, the court found that except for “the problems with

the scope of the release, the settlement ... would be approved.” While the court denied

the plaintiff’s application for class certification and approval of the settlement for now,

Vice Chancellor Noble did note that the parties had a number of options including (1)

amending the class structure to allow for opt-out rights, (2) amending the release

contained in the proposed settlement to carve out the common-law fraud claims with

respect to the Lewis Statements, or (3) abandoning their efforts to settle this litigation

altogether.

Legal Reasoning

In a follow-up to its original ruling, the Chancery Court reviewed its decision and

affirmed it to be correct. What follows is the court’s legal reasoning in this regard.

The prior decision of the Chancery Court in which the court refused to approve the class

action settlement in this case was reviewed as a result of the shareholder’s objections

to the release of potential federal securities laws violations based on the statements of

Ken Lewis. The duty of the court is to apply various factors to make an independent

determination about whether the proposed settlement was fair and reasonable.

Additional considerations include:

Rule 23(a) and Rule 23(b) must also be satisfied before the court will conclude that this

case should be certified as a class action—which must precede the court’s approval of

the proposed class action settlement.

In certifying this case as a class action, the court did not require an opt-out right for

class members.

The court rejected the objections to the settlement and approved the settlement based

on the following rulings and reasoning:

The absence of a monetary benefit “is not fatal to a settlement which, almost by

definition, confers only a therapeutic benefit.” The court found the merger price fair and

that there were no other potential buyers—and that the shareholders would have done

worse without the merger.

The court reviewed the elements that must be established for a successful fraud action

based on the federal securities laws (which the objector argued should not be released),

and found that those claims “possess no obvious value” (based on the unlikely success

in pursuing them on the facts of this case). Thus, the court reasoned it was fair and

reasonable to release them.

The federal securities laws claims based on the Lewis Statements did not predominate

over the equitable claims.

The release provision in the settlement proposal is not overbroad. In reaching this

conclusion, the court evaluated not only the claims in the complaint but also those that

might be barred due to the release. In the case of In Re Philadelphia Stock Exchange,2

the court ruled that a settlement can release claims not specifically asserted in a settled

action only if those claims are “based on the same factual predicate or the same set of

operative facts as the underlying action.”

2In Re Philadelphia Stock Exchange, 945 A.2d at 1145-46 (Del Ch. 2008).

There is no requirement that a specific claim be included in a lawsuit in order for it to be

released.

An objector is not required to present its common-law fraud claims (that it wants carved

out of the settlement) with the same specificity as would be needed when pleading in a

complaint.

Approval of a class action settlement by the Court of Chancery requires only a cursory

scrutiny of the issues presented, but the Court’s consideration must be the product of a

logical and deductive process.

The court concluded that the class treatment was proper, the case was certified as a

class action, and the proposed settlement was approved.