Berger v. Pubco Corp., et al., Del. Supr., No. 509, 2008 (July 9, 2009), read opinion here.
Kevin Brady, a highly regarded Delaware litigator, provides the following synopsis of the case:
In a case of first impression, Justice Jacobs writing for the Delaware Supreme Court en banc resolved the differences between two Court of Chancery decisions addressing the appropriate remedy in a short form merger under 8 Del. C. § 253 where the controlling stockholder fails to disclose the facts material to an informed shareholder’s decision whether or not to elect the exclusive appraisal remedy available under section 253.
In the Court of Chancery action, 2008 WL 2224107 (Del. Ch. 2008), the Court decided that because the notice of merger did not disclose certain material facts, “the minority shareholders were entitled to a ‘quasi-appraisal’ remedy, wherein those shareholders who elect appraisal must ‘opt in’ to the proceeding and escrow a portion of the merger proceeds they received.” The Supreme Court, while it agreed with the Court of Chancery’s decision “that the majority stockholder had violated its disclosure duty,” found that the Court of Chancery “erred as a matter of law” in prescribing that specific form of remedy. The Supreme Court further found that the “quasi-appraisal” remedy did not require the minority stockholders to “opt-in” (they would automatically become members of the class) or escrow a portion of the merger proceeds they received.
Defendant Robert H. Kanner, Pubco’s president and sole Director, owned over 90 percent of Pubco’s shares. The plaintiff, Barbara Berger, was a Pubco minority shareholder. After Kanner decided that Pubco should “go private” Kanner effected a “short form” merger under 8 Del. C. § 253 in October 2007, where Pubco’s minority stockholders received $20 cash per share. In November 2007, the plaintiff received a written notice from Pubco, advising that Kanner had effected a short form merger and that the minority stockholders were being cashed out for $20 per share.
Disclosure Issues and the Appraisal Statute
The notice disclosed: (i) that shareholder approval was not required for the merger to become effective; (ii) that minority stockholders had the right to seek an appraisal; (iii) information about the nature of Pubco’s business; (iv) Pubco’s most recent unaudited financial statements; (v) that in the 22 months preceding the merger the open market trades in Pubco’s stock averaged a price of $13.32 per share; and (vi) the contact information where shareholders could request and obtain additional information. Pubco also attached to the notice an out-of-date copy of the appraisal statute.
“On December 14, 2007, the plaintiff initiated this lawsuit as a class action on behalf of all Pubco minority stockholders, claiming that the class is entitled to receive the difference between the $20 per share paid to each class member and the fair value of his or her shares, irrespective of whether any class member demanded appraisal.” The parties ultimately filed cross-motions for summary judgment.
Disclosure Violations Found
The Court of Chancery addressed two issues: (i) whether the notice contained disclosure violations, and (ii) if so, what was the appropriate remedy. There were two disclosure violations: distributing the wrong version of the appraisal statute, and the failure to disclose any significant details about how Kanner unilaterally determined the $20 per share merger price. The defendants argued that because this is a short-form merger, Kanner can basically do whatever he wants in terms of the price. The Court of Chancery was unpersuaded by this argument because:
the issue . . . is about materiality. In the context of Pubco, an unregistered company that made no public filings and whose Notice was relatively terse and short on details, the method by which Kanner set the merger consideration is a fact that is substantially likely to alter the total mix of information available to the minority stockholders…this does not mean that Kanner should have provided picayune details about the process he used to set the price; it simply means he should have disclosed in a broad sense what the process was, assuming he followed a process at all and did not simply choose a number randomly.
Remedy Options– Opt-in or Opt-out
The plaintiff relied upon Nebel v. Southwest Bancorp., Inc., 1995 WL 405750 (Del. Ch. July 5, 1995), where the court found that the minority shareholders should receive the difference between the merger consideration and the fair value of their shares, to be determined in a parallel appraisal proceeding in which the shareholders were not required to “opt in.” The defendants argued for the more-recent Gilliland v. Motorola, Inc., 873 A.2d 305 (Del. Ch. 2005), where the court required the minority shareholders seeking that remedy to “opt in” and to escrow a portion of the merger consideration they received.
The Court of Chancery followed Gilliland requiring: (i) supplemental disclosures to address the violations found by the court; (ii) a requirement that the minority stockholders follow “opt-in” procedures by providing “proof of beneficial ownership of the [Pubco] shares on the merger date; (iii) a procedure that would “replicate a modicum of the risk that would inhere if this were an actual appraisal action, i.e., the risk that the Court will appraise [Pubco] at less than [$20] per share and the dissenting stockholders will receive less than the merger consideration”; and (iv) valuation of the Pubco shares as of the date of the merger using the method prescribed by the appraisal statute.
Supreme Court Appeal
On appeal, while the plaintiff Berger did not contest the supplemental disclosure requirement, she did contest the “opt in” and escrow features, claiming that “as a matter of law, all minority shareholders should have been treated as members of a class entitled to seek the quasi-appraisal recovery, without being burdened by any precondition or requirement that they opt in or escrow any portion of the merger proceeds paid to them. Defendants Pubco and Kanner argued that the Supreme Court should follow Gilliland.
Standard of Review – Abuse of Discretion or De Novo
The Court of Chancery has broad discretion to craft an appropriate remedy for a fiduciary violation, which is normally reviewed on an “abuse of discretion” standard. However, the Supreme Court reviewed the matter de novo because Berger claimed that the Court of Chancery erred as a matter of law . . . “in formulating and applying legal principles” and granting summary judgment for the defendants.
Supreme Court’s Analysis
Under Glassman v. Unocal Exploration Corp., 777 A.2d 242 (Del. 2001), the Delaware Supreme Court found that where there is no fraud or illegality, the exclusive remedy for minority shareholders who challenge a short form merger is a statutory appraisal, with no “entire fairness” review. The Supreme Court noted, however, that the critical issue in this case, which was not addressed in Glassman, is the consequence for the majority stockholder’s failure to meet its full disclosure obligations.
The Remedial Alternatives
The Court discussed four possible alternative remedies – the two “quasi-appraisal” proposals made by the parties and two proposals not mentioned. The ones proposed by the parties were the “opt-in” and escrow standard and the no “opt-in” or escrow standard where the minority stockholders are automatically members. Both forms would entitle the minority stockholders to supplemental disclosure enabling them to make an informed decision whether to participate in the lawsuit or to retain the merger proceeds. Both forms would entitle those who elect to participate to seek a recovery of the difference between the fair value of their shares and the merger consideration they received, without having to establish the controlling shareholders’ personal liability for breach of fiduciary duty. The difference between the two quasi-appraisal approaches is that under the defendants’ approach (which the Court of Chancery approved), the minority shareholders who elect to participate would be required to “opt in” and to escrow a prescribed portion of the merger proceeds they received. Under the plaintiff’s approach, all minority stockholders would automatically become members of the class without being required to “opt in” or to escrow any portion of the merger proceeds.
The third alternative was the “replicated appraisal” under which the minority shareholders would receive (in a supplemental disclosure) all information material to making an informed decision whether to elect appraisal and then follow the appraisal procedures. The fourth alternative would involve no remedial appraisal proceeding and instead it would be the same as in a “long form” cash out merger under 8 Del. C. § 251, “where the legality of the merger (and the liability of the controlling stockholder fiduciaries) are determined under the traditional ‘entire fairness’ review standard.”
The Remedy – No “Opt-in” or Escrow Requirement
The Supreme Court was looking to select the remedy that “best effectuates the policies underlying the short form merger statute (Section 253), the appraisal statute (Section 262) and the Glassman decision, taking into account considerations of practicality of implementation and fairness to the litigants.” After a very detailed analysis, the decision came down to the two forms of “quasi-appraisal.” The Court noted that:
As between an opt in requirement that would potentially burden shareholders desiring to seek an appraisal recovery but would impose no burden on the corporation, and an opt out requirement that would impose a lesser burden on the shareholders but again no burden on the corporation, the latter alternative is superior and is the remedy that the trial court should have ordered.
In next holding that there was no requirement to deposit part of the merger consideration in escrow, the Court noted that:
The defendants-appellees argue that it is fair and equitable to require the minority shareholders to escrow some portion of the merger proceeds. Otherwise (defendants say), the shareholders would have it both ways: they could retain the merger proceeds they received and at the same time litigate to recover a higher amount―a dual benefit they would not have in an actual appraisal. It is true that the minority shareholders would enjoy that “dual benefit.” But, does that make it inequitable from the fiduciary’s standpoint? We think not. No positive rule of law cited to us requires replicating the burdens imposed in an actual statutory appraisal. Indeed, our law allows the minority to enjoy that dual benefit in the related setting of a class action challenging a long form merger on fiduciary duty grounds. In that setting the shareholder class members may retain the merger proceeds and simultaneously pursue the class action remedy.
The appraisal statute should be construed evenhandedly, not as a one-way street. Minority shareholders who fail to observe the appraisal statute’s technical requirements risk forfeiting their statutory entitlement to recover the fair value of their shares. In fairness, majority stockholders that deprive their minority shareholders of material information should forfeit their statutory right to retain the merger proceeds payable to shareholders who, if fully informed, would have elected appraisal.
In cases where the corporation does not comply with the disclosure requirement mandated by Glassman, the quasi-appraisal remedy that operates in the fairest and most balanced way and that best effectuates the legislative intent underlying Section 253, is the one that does not require the minority shareholders seeking a recovery of fair value to escrow a portion of the merger proceeds they received.