Opinion
Civil Action No. 16836
Date Submitted: June 25, 1999
Date Decided: September 27, 1999
Ronald A. Brown, Jr., Esquire, of PRICKETT, JONES, ELLIOTT KIRISTOL, Wilmington, Delaware; Attorneys for Respondents
Allen M. Terrell, Jr., Srinivas M. Raju, and Michael D. Allen, Esquires, of RICHARDS, LAYTON FINGER, Wilmington, Delaware; and David J. Hooker, Keith L. Carson and Lisa R. Battaglia, Esquires, of THOMPSON HINE FLORY LLP, Cleveland, Ohio; Attorneys for Defendants
MEMORANDUM OPINION
The plaintiffs, who are former shareholders of House of Fabrics, Inc. ("HF"), brought this class action against HF and its seven former directors, claiming that those directors (i) breached their fiduciary duty of disclosure by omitting material facts from an Information Statement disseminated in connection with a proposed merger and (ii) violated 8 Del. C. § 251 and 262 by not mailing to the shareholders in timely fashion the Information Statement and the Notice of meeting at which HF shareholders would vote on that merger.
The defendants moved to dismiss all claims on the grounds that the plaintiffs lack standing and that the complaint fails to state a claim upon which relief can be granted. In response, the plaintiffs filed a cross-motion for the entry of summary judgment on four of their disclosure claims. I conclude, for the following reasons, that all the claims alleged in the complaint are legally insufficient. Accordingly, the motion to dismiss will be granted and the crossmotion for summary judgment will be denied.
I. BACKGROUND
The pertinent facts are derived from the complaint. HF, a Delaware corporation headquartered in Sherman Oaks, California, is one of the largest home sewing and craft retailers in the United States. As of March 31, 1998, the record date for the April 21, 1998 shareholder meeting, HF had issued and outstanding 1,216,817 shares of common stock that were owned by thousands of public shareholders located throughout the country. At the time of the merger, HF's board of directors consisted of seven members, all of whom are named as defendants.
On February 1, 1998, two years after HF had emerged from bankruptcy, HF and FCA Acquisition Corp., a wholly-owned subsidiary of Fabri-Centers of America, Inc. ("FCA"), entered into a merger agreement (the "Merger Agreement") which provided for a two-step acquisition of HF by FCA for $4.25 per share. The $4.25 acquisition price was approximately 20% below HF's February 28, 1998 book value of $5.35 per share. The first step would consist of a tender offer to acquire a majority or all of HF's outstanding shares for $4.25 per share cash (the "tender offer"). The second step would consist of a "back-end" merger, in which each remaining share would be converted into a right to receive $4.25 in cash (the "Merger").
As a result of the tender offer, which commenced on February 6, 1998 and closed on March 6, 1998, FCA acquired 4,115,013 HF shares, representing 77.2% of HF's outstanding stock. The remaining 1,216,817 shares, representing about 22.8% of HF's outstanding shares, were not tendered. The plaintiffs, who were the beneficial owners of 3,000 HF shares held in street name, did not tender their shares or the 300 HF shares of which they were the record owners.
The day after FCA acquired 77.2% of HF in the tender offer, five of HF's seven directors resigned and were replaced by five FCA designees, all of whom were FCA senior officers. Mr. Alan Rosskam, FCA's Chairman and President, was named HF's CEO and a director. On March 10, 1996, the new HF board of directors announced that HF's headquarters would be relocated from Sherman Oaks, California to FCA's headquarters in Ohio. Two days later, FCA advanced funds to HF to repay HF's outstanding indebtedness to CIT Group/Business Credit, Inc. (approximately $43 million against a $65 million line of credit), and as a result, FCA became HF's largest creditor.
On or about April 1, 1998 the HF board of directors caused to be mailed an Information Statement together with a Notice (the "Notice") of a special shareholders meeting to be held on April 21, 1998, to consider and vote upon the Merger Agreement. Both the Notice and the Information Statement were dated April 1, 1998. The Information Statement disclosed that it "is dated April 1, 1998 and is first being mailed to stockholders on or about April 1, 1998." The HF shareholders voted to approve the Merger, which was consummated on April 21, 1998. The named plaintiffs accepted the $4.25 per share Merger consideration.
II. THE CONTENTIONS
In their complaint the plaintiffs assert two claims. The first is that HF directors breached their fiduciary duty of disclosure by omitting to disclose material facts to HF shareholders in the Notice and Information Statement. Specifically, plaintiffs claim that six material facts should have been, but were not, disclosed: (i) the omission of FCA's business plan concerning how HF would be treated post-acquisition; (ii) the reason why HF's board had decided to sell the company to FCA; (iii) the HF investment banker's fairness opinion; (iv) the company's earnings projections through 2003; (v) the most up-to-date available financial information; and (vi) the information concerning other offers to acquire HF.
The plaintiffs' second claim is that the mailing of the Notice and the Information Statement were untimely under 8 Del. C. § 251 and 262, which requires the mailing to be completed twenty days before the shareholders meeting, in this case (plaintiffs say) by April 1, 1998. The disclosure in the Information Statement that the mailing occurred "on or about" April 1, 1998, is claimed to be a tacit admission that the mailing had not been completed by April 1, 1998.
On their Rule 12(b)(6) motion, the defendants seek dismissal of both claims on four grounds. First, the defendants argue that the representative plaintiffs lack standing to assert their claims. Second, the defendants contend that the disclosure allegations fail to state claims upon which relief may be granted.Third, the defendants assert that even if the Information Statement omitted to disclose material facts, the exculpatory clause found in HF's Certificate of Incorporation bars the plaintiffs from recovering money damages. Fourth, the defendants argue that the complaint fails to state a cognizable claim for violations of 8 Del. C. § 251 and 262.
On their cross-motion the plaintiffs seek summary judgment on four of their six omitted disclosure claims.
The motion to dismiss and the cross-motion for summary judgment frame four issues: (1) Do the named plaintiffs have standing to maintain this class action? (2) Were any or all of the six disclosure omissions material to HF shareholders deciding how to vote on the merger? (3) If any of those omissions was material, does the exculpatory clause in HF's Certificate of Incorporation bar a recovery of money damages? (4) Did the disclosure that the HF board began mailing the Notice and Information Statement "on or about April 1, 1998" constitute an admission that defendants failed to notify shareholders in a timely way?
Only issues 1, 2, and 4 are addressed in this Opinion, because the Court's determination that the disclosure omissions are legally insufficient, obviates the need to address the plaintiffs' cross-motion for summary judgment or the defense that the exculpatory clause bars money damages.
III. ANALYSIS
A. The Applicable Standards
The two motions before the Court — the defendants' motion to dismiss and the plaintiffs' cross motion for summary judgment — involve different standards. Each motion must be independently addressed, and the Court must apply the standard applicable to each.
See Continental Airlines Corp. v. American Gen'l Corp., Del. Supr., 575 A.2d 1160, 1164 n. 5 (1990).
The standard on a motion under Rule 12(b)(6) is that a claim will be dismissed where it is clear from the allegations of the complaint that the plaintiffs would not be entitled to relief under any set of facts that could be proven to support the claim. All well-pleaded facts alleged in the complaint will be accepted as true, but inferences and conclusions that are unsupported by specific factual allegations will not be. In this regard the Court will consider on a Rule 12(b)(6) motion any documents that are incorporated into the complaint by reference.
In re Tn-Star Pictures. Inc. Litig., Del. Supr., 634 A.2d 319, 326 (1993); see also Loudon v. Archer-Daniels-Midland Co., Del. Supr. 700 A.2d 135, 140 (1997).
See supra note 2; see also In re Wheelabrator Technologies Inc. Shareholders Litin., Del. Ch. , C.A. No. 11495, mem. op. at 4, Jacobs, V.C. (September 1, 1992) (citing Grobow v. Perot, Del. Supr., 539 A.2d 180, 187 n. 6 (1988)); see also Weinberger v. UOP. Inc., Del. Ch. , 409 A.2d 1262, 1264 (1979).
See Vanderbilt Income and Growth Assocs. L.L.C. v. Arvida/JMB Managers. Inc., Del. Supr., 691 A.2d 609, 613 (1996).
To succeed on the motion under Rule 56 for summary judgment, the plaintiffs must show that there are no genuine issues of material fact and that the moving party is entitled to judgment as a matter of law. All facts will be viewed in the light most favorable to the non-moving party, and summary judgment will be denied "if there is any reasonable hypothesis by which the opposing party may recover, or if there is a dispute as to a material fact or inferences to be drawn therefrom." B. The Standing Defense
Emerald Partners v. Berlin, Del. Ch. , C.A. No. 9700, Steele, V.C. (September 22, 1995), rev'd on other grounds, Del. Supr., 676 A.2d 902 (1995); see also Brown v. Ocean Drilling Exploration Co., Del. Supr., 403 A.2d 1114, 1115 (1979).
Gilbert v. The El Paso Co., Del. Supr., 575 A.2d 1131, 1142 (1990).
Seagraves v. Urstadt Property Co. Inc., Del. Ch. , C.A. No. 10307, mem. op. at 7, Jacobs, V.C. (April 1, 1996).
The defendants first contend that the complaint must be dismissed because the representative plaintiff shareholders lack standing by reason of their having accepted the cash merger consideration. The plaintiffs respond that under clearly established Delaware law, shareholders who are misled into casting an uninformed vote retain the right to challenge a merger, even if they accept the consideration. The plaintiffs here claim that they were so misled.
The plaintiffs' position is correct. Only fully informed shareholders waive their right to challenge a merger by tendering their shares and accepting the merger consideration. Where, as here, the plaintiff shareholders claim that their approving vote was induced by misleading disclosures, their acceptance of the merger consideration will not bar a challenge to the transaction voted on. Specifically, because the plaintiffs claim that the directors breached their fiduciary duties by omitting to disclose material facts in the Information Statement, their acceptance of the Merger consideration will not bar their claim.
Bershad v. Curtiss-Wright Corp., Del. Supr., 535 A.2d 840, 848 (1987).
Iseman v. Liquid Air Corp., Del. Ch. , C.A. No. 9694, Berger, V.C. (February 11, 1992); see also Seigman v. Columbia Pictures Entertainment. Inc., Del. Ch. , C.A. No. 11152, Hamett, V.C. (January 12, 1993).
Having determined that the plaintiffs have standing to assert their claims, the Court next considers the legal sufficiency of those claims.
C. The Legal Sufficiency of the Claims
1. The Claim That Defendants' Mailing "On or About April 1, 1998" Constitutes Untimely Disclosure Under §§ 251 and 262
The defendants contend that the plaintiffs' "untimely mailing" claim based on 8 Del. C. § 251 and 262 must be dismissed as legally insufficient. The only factual basis for this claim (defendants argue) is an inference that the phrase in the Information Statement that the mailing occurred "on or about April 1, 1998," admits that not all of the notifications were mailed by April 1, 1998. The defendants respond that "on or about April 1, 1998" does not mean after April 1, 1998, and contend that this claim must be dismissed because the complaint pleads no facts that would support it.
The plaintiffs respond that it may be inferred from the phrase mailed "on or about April 1, 1998," that not all of the mailings had been completed by April 1, 1998 as was legally required. They further contend that on this motion all they need do to satisfy the requirements of notice pleading is inform the defendants that they are charged with failing to mail the Notice to all HF stockholders in a timely manner.
The defendants' position is, in my view, meritorious. The plaintiffs have not alleged that they or any other member of the class received an Information Statement postmarked after April 1, 1998. The use of the phrase "on or about April 1, 1998" may be inelegant, but that alone does not fairly permit an inference that the mailing of the Information Statements had not been completed by April 1, 1998.
2. The Disclosure Claims
The defendants next argue that the disclosure claims must be dismissed, because none of the omitted facts complained of was material. The defendants contend that the Information Statement disclosed facts that were adequate to enable HF shareholders to make a fully informed voting decision. The plaintiffs disagree. They argue that the omitted information was material, and further, that summary judgment should be granted in their favor on four of their disclosure claims.
It is well established that directors have a fiduciary duty to disclose fully and fairly all material facts within their control that would have a significant effect upon a stockholder vote. An omitted fact is material if a reasonable shareholder would consider it important in deciding how to vote. To say it differently, it must be substantially likely that the information would have been viewed by a reasonable investor as altering the "total mix" of available information. Determining materiality requires an assessment of what a "reasonable investor" would consider when making a decision to vote or exercise appraisal rights.
Stroud v. Grace, Del. Supr., 606 A.2d 75, 85 (1992).
Ibid.
Ibid.
The duty to disclose, though highly important, is not all encompassing. "Some information is of such dubious significance that insistence on its disclosure may accomplish more harm than good." Balanced against the requirement of complete disclosure is the pragmatic consideration that creating a lenient standard for materiality poses the risk that corporations will "bury the shareholders in an avalanche of trivial information a result that is hardly conducive to informed decisionmaking."
TSC Industries. Inc. v. Northway, Inc., 426 U.S. 438, 448 (1976).
Ibid.
The disclosure claims are assessed in light of these standards.
a) The Omitted Disclosure of FCA Changes and FCA Plans
The plaintiffs first contend that HF's directors failed to disclose a full explanation of (i) the changes made by FCA to HF after the tender offer closed and (ii) FCA's business plan regarding how HF would be treated after it was acquired. More specifically, the plaintiffs claim that the business reasons for replacing five of HF's directors with five FCA officers, for relocating HF headquarters from California to Ohio, and for FCA repaying the entire amount HF had borrowed from CIT Group, were not — but should have been — fully disclosed. The plaintiffs rely on Cede Co. v. Technicolor. Inc. as support for their view that HF's stockholders needed that information, first to determine the going concern value of HF as of the Merger date, and then to compare that going concern value with the Merger price.
Cede Co. v. Technicolor. Inc., Del. Ch. , C.A. No. 7129, slip op. at 35-36, 57, Allen, C. (October 19, 1990), rev'd on other grounds, Del. Supr., 684 A.2d 289 (1996).
The defendants argue that the plaintiffs have failed to plead facts that support a conclusion that FCA added value to HF before the Merger was consummated. The defendants contend that FCA's plan and a summary of its effects would be of no use to shareholders seeking to calculate the going concern of HF for the purposes of a later appraisal proceeding, because the values generated would have included synergies arising from the Merger, which cannot be considered in an appraisal.
I conclude that the plaintiffs have failed to plead facts showing why the omitted information would have been material to the stockholders' decision concerning how to vote. To establish materiality, it is not enough for plaintiffs to assert conclusorily that the omitted information might perhaps have been useful to shareholders. Rather, the plaintiffs must plead facts showing that the omitted information would have altered the "total mix" of information available to shareholders and would have been considered important to a reasonable shareholder deciding how to vote. The plaintiffs have not done that in connection with this claim.
b) The Omitted Disclosure of the Reasons for the Merger
The plaintiffs next claim that the nine reasons recited in the Information Statement for why the HF board was recommending the Merger, were incomplete because the board's "true" — but undisclosed — rationale for approving the Merger would have been material to shareholders deciding how to vote.
The Information Statement recited the following nine reasons why the Merger was approved:
(1) The financial condition and results of operations of the Company.
(2) The projected financial results, prospects and strategic objectives of the Company, as well as the risks involved in achieving those results, prospects and objectives, including certain liquidity constraints which the Company may face in the absence of any new financing.
(3) The fact that the $4.25 per Share to be received by the Company's stockholders in both the Offer and Merger represents a substantial premium (approximately 33%) over the closing market price of $3.19 per Share on January 30, 1998 (the last trading day prior to the Board's approval of the Offer and the Merger); and the fact that the $4.25 per Share to be received by the Company's stockholders in both the Offer and the Merger represents a substantial premium (110%) over the average market price per Share during the 60-day period prior to the Board's approval of the Offer and the Merger.
(4) The Board's view, after consultation with the management and F.M. Roberts, regarding the likelihood of the existence of other viable buyers on terms as favorable as those in the Offer and the Merger.
(5) The presentation to the Company's Board of Directors by representatives of DLJ and the opinion of DLJ that the $4.25 per Share in cash to be received by the stockholders of the Company pursuant to the Merger Agreement is fair to such stockholders from a financial point of view. The full text of the written opinion of DLJ, which sets forth assumptions made, procedures followed, matters considered and limits on the review undertaken, is attached as Annex E to this Information Statement. THE COMPANY'S STOCKHOLDERS ARE URGED TO READ THIS OPINION IN ITS ENTIRETY
(6) The availability of appraisal rights under Section 262 of Delaware Law for dissenting Shares.
(7) The terms and conditions of the Merger Agreement and the course of the negotiations resulting in the execution thereof.
(8) The possible alternatives to the Offer and the Merger, including the prospects of the Company going forward as an independent entity, the range of possible benefits to the Company's stockholders of such alternatives and the timing and the likelihood of actually accomplishing any of such alternatives.
(9) The likelihood that the proposed acquisition would be consummated, including the likelihood of obtaining the regulatory approvals required pursuant to, and satisfying the other conditions to, the Offer and the Merger contained in the Merger Agreement, the experience, reputation and financial condition of the Parent and the risks to the Company if the acquisition were not consummated.
The plaintiffs do not claim that any of these disclosed reasons was false. Instead, they imply that the HF board had some other hidden reason for agreeing to the Merger, but they allege no facts to support that implicit, but conclusory, claim. Accordingly, the plaintiffs have failed to support their claim that the reasons disclosed in the Information Statement were "misleading and incomplete boilerplate."
c) The Omitted Disclosure Concerning DLJ's Fairness Analysis
The plaintiffs next claim that the Information Statement should have disclosed the methodologies and analyses that Donaldson, Lufkin Jenrette ("DLJ") used in arriving at its fairness opinion. The plaintiffs concede that the "disclosure of methodologies and analyses used by an investment banker have generally been held by the Court of Chancery not to be material." The plaintiffs argue, however, that the fact that HF was sold for 20% less than its book value is a circumstance so unusual that it required the disclosure of DLJ's methodologies and valuation analysis in this case.
In re Dataproducts Corp. Shareholders Litig., Del. Ch. , C.A. No. 11164, slip op. at 16-17, Jacobs, V.C. (August 22, 1991).
Again, I find this disclosure claim to be without factual or legal support. The plaintiffs cite no authority, nor proffer any logical reason to support their ipse dixit. The Information Statement included a summary of DLJ's fairness opinion. It also attached a copy of that opinion, which disclosed DLJ's assumptions and procedures and the matters it considered. Delaware law did not require further disclosures on that subject.
d) The Omitted Disclosure of HF Management's Five Year Projections
Based on similar reasoning, the plaintiffs claim that the board was legally required to disclose the five year projections that HF management had provided to DLJ in connection with DLJ's fairness opinion. The plaintiffs argue that those projections would have formed the basis for a discounted cash flow valuation that a reasonable stockholder could have used to evaluate whether or not to pursue a statutory appraisal.
I conclude that the plaintiffs have not alleged facts sufficient to support an inference that the projections would have been material to stockholders deciding how to vote. All the plaintiffs allege are conclusory statements that the projections might help explain why the Company was sold for 20% below book value, and would also be useful in a discounted cash flow valuation. Those bare assertions fall short of showing that the projections would alter the information mix already available to shareholders and become important to a reasonable shareholder's voting decision.
e) The Omitted Disclosure Concerning Up-to-Date Financial Information
The plaintiffs next claim that the defendants did not, but should have, disclosed the most up-to-date financial statements available. The plaintiffs concede that the Information Statement did disclose all that which was required by SEC Regulations. They contend, however, that because the financials were for the fiscal year ending January 31, 1998, and because the Information Statement was dated April 1, 1998, HF could and should have disclosed more recent financial information.
The plaintiffs cite no support for their position that with respect to this subject Delaware should impose more stringent financial disclosure requirements than those presently mandated by the SEC under federal law. It also appears that the defendants did disclose the most up-to-date financials that were available to it. Those disclosures, in the circumstances, were sufficient. The plaintiffs have presented no persuasive authority or argument why this Court should expand Delaware disclosure requirements beyond those presently mandated by Federal law.
As defendants point out, the Company's next quarter ended on April 30, 1998. Therefore, the January 31, 1998 financial statement was the most recent available statement for inclusion in the Information Statement that was issued on April 1, 1998, almost I month before.
f) The Omitted Disclosure Regarding The Other Offers HF Received
Lastly, the plaintiffs claim that the Information Statement failed to adequately disclose other offers HF received during the year preceding the Merger. The Information Statement disclosed that "[t]he entity that had expressed interest prior to DLJ's engagement ultimately declined to make an offer for the Company . . . Other parties contacted by DLJ did not return with proposals the Company wished to pursue." [n these circumstances, the defendants argue, nothing more had to be disclosed.
I concur. Where an expression of interest does not lead to a firm offer, the board has no obligation to disclose the specifics of the expression. Moreover, shareholders are not entitled to a "play-by-play" description of merger negotiations. Under Delaware law, efforts by public corporations to explore a possible merger do not become a subject of mandated disclosure unless and until the firms have agreed on the price and structure of the transaction.
In re KDI Corp. Shareholders Litig., Del. Ch. Consol. C.A. No. 10278, slip op. at 18, Berger, V.C. (November 1, 1988).
TCG Sec. Inc. v. Southern Union Co., Del. Ch. , C.A. No. 11282, slip op. at 17, Chandler, V.C.(January 31, 1990); Arnold v. Society For Sav. Bancorp. Inc., Del. Ch. C.A. No. 12883, slip op. at 17, Chandler, V.C. (December 15, 1993), aff'd in part, Del. Supr., 650 A.2d 1270 (1994).
Bershad supra note 8 (citing Rosenblatt v. Getty Oil Co., Del. Supr., 493 A.2d 929, 944 (1985).
In this case, the entity that originally expressed an interest in acquiring HF declined to make an offer. Because no firm offer was made, the board had no duty to disclose any of the specifics of HF's negotiations with that entity. The other companies did not make any proposals that HF wished to pursue, and defendants were under no duty to disclose those proposals either.
* * *
Because the Court concludes that the disclosure claims are legally insufficient and must be dismissed, it is unnecessary to address the plaintiffs' motion for summary judgment respecting those claims, or the defense that the exculpatory clause in HF's charter bars a recovery of money damages with respect to these claims.
IV. CONCLUSION
For the foregoing reasons, defendants' motion to dismiss is granted and plaintiffs' motion for summary judgment is denied. IT IS SO ORDERED.