Friday, January 18, 2019

Penchuk v. Grant (Cir. Ct. Mont. Co.)

Opinion by: J. Anne Albright 


Shareholders’ ratification of a board’s merger decision is valid where the shareholders were informed of the deal provisions at issue, and where the Plaintiff failed to explain how disclosing certain pieces of financial information would have altered the “total mix” of information available to shareholders.


Plaintiff Walter Penchuk is a common stockholder of CYS Investments, Inc., a Maryland publicly-traded corporation that invests in residential mortgage pass-through certifications (the "Corporation"). In June 2018, the Corporation announced a proposed merger with Two Harbors Corporation, a real estate investment trust and also a publicly-traded Maryland corporation (the "REIT"). The Corporation and the REIT filed a joint proxy statement and two supplementary Form 8-Ks. In July, on the recommendation of the Board and by a majority vote of the shareholders of Corporation, the merger was consummated, and the Corporation became a wholly owned subsidiary of the REIT.

The Corporation's board had formed a special committee comprised of several of its directors to evaluate the merger proposals  — five bids in total, including the REIT's. As they narrowed down the bids to that of REIT, they negotiated the following conditions with REIT: an exclusivity period in exchange for three director appointments; that the transaction be taxable to the Corporation's shareholders; a non-solicitation provision; access to nonpublic information about competing proposals; a right to amend or match the offer; and a $43.2 million dollar termination fee.

Plaintiff filed a class action lawsuit against the Corporation (later dropped) and eight of its Directors (collectively, the "Defendants"), claiming a breach of fiduciary duty. The Plaintiff argued that these provisions amounted to onerous deal protections and a conflict of interest for the directors, and yielded inadequate consideration for the transaction, especially when considered in light of the Corporation's past financial performance. 

Defendants filed a motion to dismiss, and Plaintiff filed a second amended complaint, claiming failure to disclose one pro forma projection and two distributable cash flow projections, thus preventing the shareholders from making an informed decision about the merger. In their motion to dismiss, Defendants claimed, first, that venue is improper under the Corporation's amended bylaws and, second, that the business judgment rule protects their decision, as does the subsequent ratification of their decision by a majority of the shareholders.


First, Defendants argued that the Corporation's bylaws were amended to limit venue to Baltimore courts. The Court held that the amendment was invalid, citing Maryland Code Ann. Corps & Ass'ns section 2–110(a), which provides that a Corporation may not enact a provision that is inconsistent with Maryland law. Under Maryland law, a claimant may bring a claim against non-resident defendants in any county in Maryland. Md. Cts. & Jud. Proc. section 6–202(11).  Here, Defendants are non-Maryland residents, and its bylaws are inconsistent with the venue statute.  Defendants had argued that a change in the Corporations & Associations article permitted limiting shareholder claims to a particular venue in Maryland, but the Court's review of Maryland Corporations & Associations Article section 2-113 concluded that the statute permitted limitation on jurisdiction to a particular court system, but not as to venue of a specific court location within a jurisdiction.  The Court concluded that the legislative history for the section did not support an interpretation of it as permitting a limitation on venue.

Next, a shareholder's a valid claim for breach of fiduciary duty is extinguished when a majority of informed, disinterested shareholders vote to ratify a merger. In support, the Court cited long-held Maryland case law and Corwyn v. KKR Financial Holdings LLC, 125 A.3d (2015), which emphasized the requirement of “fully informed, uncoerced votes”. Maryland applies a materiality standard to disclosures to shareholders in advance of a merger (as does Delaware, and as is used in federal securities laws). A fact is considered a material only if there is a substantial likelihood that its disclosure would be viewed by a reasonable investor as significantly altering the total mix of information; for example, facts that would affect decisions to buy, sell or hold a company’s securities or affect a company‘s value. The burden is on a plaintiff to meet the materiality standard and explain how the facts at issue would have affected the total mix. Here, Plaintiff failed to meet the burden. First, the “onerous deal protections“ were disclosed to the shareholders. Second, as for the projections that were not disclosed, Plaintiff failed to specify how they would have significantly altered the total mix. Mere conclusory allegations are insufficient.

The Court therefore denied the Defendants' motion to change the venue, but granted its motion to dismiss with prejudice Count I of the Plaintiff's Complaint.

A pdf of the opinion is available here.

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