Opinion
Civil Action No. 16281-NC.
Date Submitted: April 20, 1999.
Date Decided: July 9, 1999.
R. Bruce McNew, of TAYLOR, GRUVER MCNEW, Greenville, Delaware, Attorney for Plaintiffs and The Class.
A. Gilchrist Sparks, III, Alan J. Stone and David J. Teklits, of MORRIS, NICHOLS, ARSHT AND TUNNELL, Wilmington, Delaware; OF COUNSEL: Robert T. Markowski and David M. Kroeger, of JENNER BLOCK, Chicago, Illinois, Attorneys for Defendants.
MEMORANDUM OPINION
This suit involves allegations of breach of fiduciary duty in connection with the cash-out of the minority shareholders in three related corporations: Best Lock Corporation ("BLC"), Best Universal Lock Co. ("BUL") and Frank E. Best, Inc. ("FEB") (collectively, the "three companies"). According to the complaint, each plaintiff was a shareholder in one or more of the three companies. On March 23, 1998 the companies were all merged into Walter E. Best Company, Inc. ("WEBCO") and its subsidiaries, and the shareholders were cashed out. The complaint alleges that FEB was a holding company with no operating assets which held a controlling interest in BUL. BUL in turn was a holding company without operating assets which held a "substantial" interest in BLC. BLC was a manufacturer of locks and components. The complaint alleges that the individual defendants, Russell C. and Mariea Best, held a controlling interest in FEB and, therefore, controlled BLC and BUL as well; they also constituted the boards of directors of BLC, BUL and FEB at the time of the cash-out merger. The individual defendants own all the stock in WEBCO, the surviving entity and, thus, stood on both sides of the merger. The plaintiffs allege that the terms and timing of the merger were unfair to the minority stockholders and, accordingly, that the individual defendants breached their fiduciary duty to the shareholders. The defendants have moved to dismiss the complaint on grounds of laches and failure to state a claim. This is my decision on that motion.
The complaint refers at times to actions taken by Russell C. Best and at times to actions taken by Russell C. Best together with Mariea Best, his wife. For clarity's sake, I have used the term "the individual defendants" to refer to Russell C. Best and/or Mariea Best.
I.
On a motion to dismiss, I consider, as I must, all well-plead facts as true and draw all inferences in a light most favorable to the non-moving party. A motion to dismiss will be granted only if it appears to a reasonable degree of certainty that the plaintiffs would not be entitled to relief under any set of facts which they could prove in support of the claim. The following recitation of alleged facts is taken from the complaint, except where stated otherwise.
James River-Pennington, Inc. v. CRSS Capital, Inc., Del.Ch., C.A. No. 13870, Steele, V.C. (Mar. 6, 1995), Mem.Op. at 10; Grobow v. Perot, Del.Supr., 539 A.2d 180, 186 n. 6 (1988).
Rabkin v. Philip A. Hunt Chemical Corp., Del.Supr., 498 A.2d 1099, 1104 (1985); In re USACafes, L.P. Litigation, Del.Ch., 600 A.2d 43, 47 (1991).
II.
In May 1994, the individual defendants acquired majority control of FEB by purchasing shares from Russell C. Best's father, Frank Best. The entirety of the purchase price was financed by a loan made by one of the companies, apparently BLC, to Russell C. Best. While this transaction gave the individual defendants effective control of the three related companies, the complaint further alleges that they enhanced their voting control through a number of transactions after May, 1994. On February 27, 1998, the individual defendants, by written consent and by causing the defendant corporations to act by written consent, merged each of the three companies into an entity owned by the individual defendants, WEBCO. As a result of that transaction, the minority shareholders, including the plaintiffs, were "cashed out." The cash value per share was determined in consultation with Piper Jaffray, Inc., which was retained by the defendants as a financial advisor to establish the merger price. Although the plaintiffs bring this claim as a single cause of action, the allegation breaks down logically into two parts: plaintiffs' claim that the acquisition of voting control over the three companies constitutes an actionable breach of fiduciary duty, and plaintiffs' contention that the merger was unfair to the minority shareholders.
The complaint does not specify which company made the loan, but the defendants concede that the purchase money loan was made to Russell C. Best by BLC.
A) Acquisition of Voting Control of the Three Companies
The initial complaint in this matter was filed in March 1998. The defendants obtained voting control of the three companies in May 1994. The complaint alleges that this acquisition of control, via a loan from the companies, constituted misuse of corporate assets and was a breach of the individual defendants' fiduciary duty. As the defendants point out, a claim for breach of fiduciary duty is subject by analogy to a three-year statute of limitations, and where the complaint itself discloses that the matter was not timely filed, the case is subject to a motion to dismiss. The statute applies only by analogy, however, and the plaintiffs' claims are not based by laches where they can demonstrate that the limitations period should be tolled because the plaintiff through reasonable diligence was unable to discover his injury. As the defendants point out, the financial disclosures made in connection with the loan and the purchase of stock by Russell C. Best referred to in paragraph 16 of the complaint disclosed the terms of the loan to Russell C. Best, that the purpose of the loan was to enable Russell C. Best to purchase stock in FEB and that the purchase would result in control of the three companies by the individual defendants. Although the plaintiffs now claim that these papers did not disclose that the loan repayment would result in periods of "negative amortization", they do not dispute the fact that the schedule of repayment, including principal and interest, could be derived from the disclosures. Therefore, to the extent that any aspects of the 1994 transactions were actionable, they were disclosed to the companies and their shareholders at that time and the statute of limitations by analogy bars action upon them now.
See, Kahn v. Seaboard Corp., Del.Ch., 625 A.2d 269, 277 (1993); 10 Del. C. § 8106.
See In re Dean Witter Partnership Litigation, Del.Ch., C.A. No. 14816, Chandler, C. (Jul. 17, 1998), Mem.Op. at 16.
It is appropriate for me to consider documents referred to in the complaint in determining this motion to dismiss. See In re Santa Fe Pacific Corp. Shareholder Litigation, Del.Supr., 669 A.2d 59, 69 (1995).
The plaintiffs argue that the limitations period should be tolled because until the time of the merger they could not know of the individual defendants' "secret" plan to use their voting control to cash-out the public shareholders of the three companies. What was fully apparent at the time of the 1994 transaction, however, was that the individual defendants were acquiring voting control of the three companies, which would give them the ability to consummate the merger, subject to their fiduciary duties to the shareholders. The plaintiffs, therefore, cannot obtain relief from the statute of limitations by claiming that they did not know that the individual defendants would exercise the capabilities which they plainly acquired in the 1994 transaction.
The plaintiffs' argument is akin to a claim that I would have brought a timely conversion action for theft of my shotgun, if only I had known that you intended to shoot me with it.
See Sanders v Devine, Del.Ch., C.A. No. 14679, Lamb, V.C. (Sept. 24, 1997), Mem.Op. at 9.
Although the complaint alleges that voting control was complete as of the May, 1994 transaction, the plaintiffs also point out that the defendants caused the three corporations to acquire stock, which allegedly "facilitated" (presumably, that is, made more profitable) the cash-out merger. Some of these transactions appear to have taken place within the three-year period before suit was filed. To the extent the actions taken by the corporations at the direction of the individual defendants were improper, however, these actions did not confer upon the individual defendants the power to effect these mergers: the complaint discloses that they had that ability as of May 1994. While the complaint alleges that these acquisitions were not in the best interests of the corporation and thus represented breaches of fiduciary duty, such claims, if any, belong not to the individual plaintiffs but to the corporations themselves.
As former shareholders of the three companies, the plaintiffs have no standing to bring derivative actions on the companies' behalf. E.g., Kramer v. Western Pacific Industries, Inc., Del.Supr., 546 A.2d 348, 354 (1988).
B) Claims Arising from the Merger
On February 27, 1998, the individual defendants, by written consent of shareholders, caused a merger to be approved between the three companies and WEBCO after which WEBCO and its subsidiaries were the survivors of the merger and the public shareholders were cashed-out at a price of $55.61 per share of FEB commnon stock, $120.69 per share BUL class A common stock, $118.12 per BUL class B common stock and $525.43 per share of BLC common stock. These prices were set through consultation with Piper Jaffray, Inc., the financial advisor engaged by the three companies in connection with the merger.
First Amended Complaint at ¶¶ 34-35.
The plaintiffs claim the defendants breached fiduciary duties in a number of ways in connection with the merger. They claim that the three companies and Piper Jaffray failed to consider the market value of the controlling interest of BUL and BLC, which were corporate assets held by FEB at the time of the merger; that the three companies and Piper Jaffray failed to place any value on the outstanding debt owed by Russell C. Best to BLC, which was an asset of the companies and resulted from a loan which had been used to purchase a controlling share in the companies; and that the timing of the merger was chosen to take advantage of the "negative amortization" of the loan, resulting in a benefit to the individual defendants at the expense of the public shareholders. The plaintiffs point out that the merger did not require an approval of the majority of the minority stockholders; that it proceeded in the absence of any input from the minority into the process of the merger; that it lacked an independent advisor or board member whose interest was to protect the minority stockholders; and that the board failed to engage a truly independent financial advisor to authenticate the merger price. As a result, the plaintiffs allege that the merger was unfair to the minority.
First Amended Complaint at 45.
The defendants move to dismiss, arguing that the plaintiffs have failed to state a claim beyond that for which the statutory appraisal remedy would provide complete relief.
The statutory remedy of appraisal is available where the merger eliminates the minority shareholders for cash and the sole dispute involves the value of stock. A suit for breach of fiduciary duty in connection with a merger, however, may be brought where the appraisal remedy is inadequate to redress the damages claimed such as "where fraud, misrepresentation, self-dealing, deliberate waste of corporate assets, or gross and palpable over-reaching are involved." Here, the plaintiffs have alleged not only unfair price but claims that arise from the self-dealing nature of the transaction. Defendant Russell Best and his wife were the sole directors of the three corporations. Russell Best obtained voting control of FEB by a purchase of stock with the proceeds of a loan to him from BLC. The initial loan amount was for $3.4 million. Because of the terms of the loan, the amount of interest due the corporation together with the outstanding principal was greater than $3.4 million at the time of the merger. According to the complaint, the timing of the merger was a result of a desire on behalf of the individual defendants to minimize their liability under the loan agreement at the expense of the corporation. The complaint alleges that Piper Jaffray placed no value on the loan as an asset of the corporation. The individual defendants own all outstanding stock in the surviving entity, WEBCO, and thus controlled both sides in the merger. Against this claim of self-dealing, as the plaintiffs point out, there was no vote of the minority in favor of the merger, independent analysis of stock value, or independent advisor or board member who could act on behalf of the minority stockholders. While it may be true, as the defendants argue, that the lack of a vote of the minority and the lack of an independent advisor or financial analyst acting on the minority's behalf do not state a claim for breach of fiduciary duty, lack of these safeguards means that there is nothing in the record at this stage of the proceedings to indicate that the merger was fair to the public shareholders.
Weinberger v. UOP, Inc., Del.Supr., 457 A.2d 701, 703-04 (1983).
Weinberger, 457 A.2d at 714; see Rabkin v. Philip A. Hunt Chemical Corp., Del.Supr., 498 A.2d 1099, 1106 (1985).
See Bershad v. Curtiss-Wright Corp., Del.Supr., 535 A.2d 840, 845-46 (1987).
The defendants argue that any breach of fiduciary duty was remediable by the statutory appraisal remedy, and that plaintiffs should be limited to that remedy. Defendants' argument is not unpersuasive. All of the allegations of breach of duty ultimately relate to the plaintiffs' claim that the price they received was unfair. Moreover, there is no allegation of deception which might have mislead the shareholders as to whether to pursue their appraisal rights at the time of the merger. The fact that the shareholders were subject to a cash-out merger in which the board of directors and majority shareholders stood on both sides of the transaction, with no independent determination of fairness, was obvious to the shareholders at the time of the merger. Thus, argue defendants, shareholders dissatisfied with the merger terms could have elected appraisal (as, indeed, some did) and the plaintiffs should be limited to that form of action.
Plaintiffs claim that the timing of the merger, in light of the outstanding debt owed by the individual defendants to the corporations, was chosen to minimize the price and that Piper Jaffray assigned no value to this debt; that Piper Jaffray and the board did not properly compute the merger price; and that no procedures were put in place by the defendants to insure that the minority was treated fairly. Ultimately, all these claims address the adequacy of the compensation received by the minority.
See Weinberger, 417 A.2d at 714.
Unfortunately for the defendants' position, however, our Supreme Court has addressed this issue, in a slightly different context. In Cede v. Technicolor, this Court had determined that the plaintiffs could not proceed in an action for breach of fiduciary duty because, although the defendant board of directors had breached its duty to shareholders, the price paid in that merger had been determined in an appraisal action to be higher than the fair value. Reversing this decision, the Delaware Supreme Court noted that "under Weinberger's entire fairness standard of review, a party may have a legally cognizable injury regardless of whether the tender offer and cash out price is greater than the stock's fair value as determined for statutory appraisal purposes." The Supreme Court noted that "we emphasized that the measure of any recoverable loss by [the plaintiff] under an entire fairness standard of review is not necessarily limited to the difference between the price offered and the `true' value as determined under appraisal proceedings. Under Weinberger, the Chancellor may `fashion any form of equitable and monetary relief as may be appropriate, including rescissory damages.' . . . The Chancellor may incorporate elements of rescissory damages into his determination of fair price, if he considers such elements: (1) susceptible to proof; and (2) appropriate under the circumstances."
Cede, 634 A.2d at 367 (citations omitted).
Quoting Weinberger, 457 A.2d at 714.
Cede, 634 A.2d at 371.
As the defendants point out, in Weinberger, the Delaware Supreme Court expanded the appraisal remedy to allow a broader methodology to determine fair value, and noted that appraisal was generally to be the exclusive remedy for dissenting stockholders in cash-out mergers. By 1985, however, in Rabkin the Court addressed a situation where appraisal was not a sufficient remedy because the plaintiffs claim went beyond value. Rather than restricting its decision to the narrow facts of that case, however, the Supreme Court ruled broadly, noting that a:
Rabkin v. Philip A. Hunt Chemical Corp., 498 A.2d 1099 (1995).
In Rabkin, the plaintiffs sought not the value of their shares, but a minimum price determined by an agreement entered by the controlling shareholder, which the plaintiffs claimed an equitable right to enforce. This contractual claim, by definition, would not have been captured in the "fair value of the entity as a going concern" analysis of an appraisal action.
. . . narrow interpretation of Weinberger would render meaningless our extensive discussion of fair dealing found in that opinion. In Weinberger we defined fair dealing as embracing `questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.' . . . While this duty of fairness certainly incorporates the principle that a cash-out merger must be free of fraud or misrepresentation, Weinberger's mandate of fair dealing does not turn solely on issues of deception. We particularly noted broader concerns respecting the matter of procedural fairness.
498 A.2d at 1104-05 (citations omitted).
The plaintiffs have alleged that the individual defendants stood on both sides of the cash out merger, timed the merger so as to minimize cost to themselves at the expense of the shareholders, and failed to provide any method for determining whether the merger was entirely fair to the shareholders independent of the defendants themselves or their financial advisors whom they had hired. They claim that the resulting price was unfair, and that they were damaged as a result. Under Cede and Rabkin this states a claim sufficient to survive a motion to dismiss, and sufficient to put the defendants to proof that the transaction was entirely fair.
The defendants argue that, in addition to alleging breach of fiduciary duty, to survive a motion to dismiss the plaintiffs must demonstrate that appraisal is an inadequate remedy, either because deception or fraud misled shareholders into failing to pursue appraisal, or because damages available in an appraisal would be inadequate. It is defendants' view that a demonstration of the inadequacy of an appraisal action is the hurdle which plaintiffs must clear before pursuing this equitable remedy. For good or ill, however, as Cede makes clear, a colorable allegation of breach of entire fairness is sufficient to proceed with an equitable entire fairness action, despite the availability of appraisal as an alternative remedy. I need not determine at this stage, therefore, whether appraisal would constitute an adequate remedy in this case.
See Weinberger, 457 A.2d at 701.
There are some factors indicating that fair value of the shares may not represent an adequate measure of damages in this case. The individual defendants purchased their controlling interest in the corporation with a loan from one of the corporations. The amount of debt outstanding under the loan agreement, including interest, is greater than the original loan amount. It is possible that the fair value of this asset is substantially below its face amount, although the individual defendants have an equitable as well as a legal obligation to repay the debt. This factor may indicate that rescissory damages are required. Similarly, allegations of the timing of the merger as well as claims based on the individual defendants' duties as directors of corporations which they controlled through corporate structure but in which they were not shareholders may indicate that rescissory damages are appropriate.
This Court recently addressed a motion to dismiss under similar circumstances in Nebel v. Southwest Bancorp, Inc. In Nebel, the defendants also stood on both sides of a cash-out merger. The merger was consummated without an independent committee of directors to represent the interests of the minority. The merger in that case was a short-form merger under § 253. Noting that in that context "the absence of a negotiating committee of independent directors, without more, does not constitute unfair dealing as a matter of law," the Vice Chancellor in Nebel noted that the absence of such a committee was evidence which, taken together with other allegations of unfair dealing, put the defendants to the burden of demonstrating entire fairness.
Del.Ch., C.A. No. 13618, Jacobs, V.C. (Mar. 9, 1999) Mem. Op.
Id., at 7.
At oral argument in this matter, the defendants claimed that a crucial distinction exists between this case and Nebel. They point out that in Nebel, the price per share had been demonstrated through an appraisal action to have been inadequate. While the Vice Chancellor in Nebel indeed noted the outcome of the appraisal action, I do not find the distinction to be an important one. The plaintiffs here have alleged inadequate price. For purposes of this motion, I must assume that the plaintiffs will be able to demonstrate inadequate price at trial. An appraisal action is currently pending in this matter. The fact that inadequate price remains an allegation here, unlike the situation in Nebel, cannot determine the outcome of the motion to dismiss. The current state of our corporation law is that where, as here, cashed out minority shareholders have plead facts sufficient to indicate a breach of fiduciary duty, which they seek to bring against not only the surviving corporation but against individual directors or majority shareholders as well, the plaintiffs need not demonstrate inadequacy of the appraisal remedy to survive a motion to dismiss.
Of course, even a determination in an appraisal action that the merger price was adequate would not necessarily lead to a finding of fair price in this equitable action. See Cede, 634 A.2d at 367.
In Rabkin, the Supreme Court recognized that its holding encouraged litigants to forgo appraisal, with its associated risks and opportunity costs, in favor of an equitable action. The Rabkin court placed the burden on this Court to strike a balance "between sustaining complaints averring faithless acts, which taken as true would constitute breaches of fiduciary duties that are reasonably related to and have a substantial impact upon the price offered, and properly dismissing those allegations questioning judgmental factors of valuation." 498 A.2d at 1107-08. While the Court took comfort that this Court's "degree of sophistication" in such matters would allow performance of such a winnowing, it failed to explain how such a process could proceed in cases involving allegations of self-dealing in connection with a cash-out merger.