In re Countrywide Corporation Shareholders Litigation, Del. Ch., C.A. No 3464-VCN (March 31, 2009), read opinion here.
Kevin Brady, a respected Delaware litigator, provides us with the benefit of his following review of this case.
In this Chancery Court decision, Vice Chancellor Noble 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.
After the January 11, 2008, announcement of Countrywide’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.
Starting in the summer of 2007, in what has become an all-too-familiar scenario, 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% stake in Countrywide. The crisis continued to worsen. Countrywide’s stock price continued to fall and bankruptcy rumors surfaced. The situation was dire so Countrywide went back to BOA for a potential transaction and on January 11, 2008, Countrywide announced that it had entered into a merger agreement with BOA. 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: (i) agreeing to a merger which did not provide fair and adequate consideration; (ii) discouraging other bidders from making an offer; (iii) issuing a false and misleading preliminary proxy statement; (iv) 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 (v) 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 emphasing 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 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: (i) value the derivative claims pending against them at the time the merger was negotiated; and (ii) 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 Chairman, Chief Executive Officer, 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 plaintiffs application for class certification and approval of the settlement for now, he 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.