Sutton v. FedFirst Financial Corporation (Ct. of Special Appeals)

Filed:  October 29, 2015

Opinion by:  Graeff, J.

Holdings:  (1) The common-law fiduciary duties of candor and maximization of shareholder value articulated in Shenker v. Laureate Education, Inc. did not apply to a merger where shareholders received a mix of cash and stock consideration because the merger did not result in a sale or change of control of the target company.  (2)  Shareholder’s appeal is not moot even though rescission of merger would be impracticable, because shareholder could obtain rescissory damages in lieu of actual rescission if he were to prevail on his claims.

Facts:  Plaintiff, a shareholder of FedFirst Financial Corporation, sought to enjoin a merger between FedFirst and CB Financial Services, Inc., alleging that FedFirst’s directors breached fiduciary duties owed to FedFirst’s shareholders and that CB Financial aided and abetted the alleged breaches.

FedFirst began to explore a possible business combination with CB Financial in January 2013.  During the course of negotiations with CB Financial, FedFirst’s financial advisors were unsuccessful in soliciting other offers.  On April 14, 2014, after receiving a fairness opinion from its financial advisors, the FedFirst board unanimously approved the merger agreement with CB Financial, which was executed and announced that day.

The merger agreement provided that FedFirst shareholders would receive either  cash or shares of CB Financial common stock in exchange for each FedFirst share, at their election, subject to the requirement that 65% of the total shares of FedFirst would be exchanged for CB Financial stock and 35% would be exchanged for cash.  The agreement prohibited FedFirst from soliciting other acquisition proposals, but did not preclude it from considering unsolicited offers, as long as they were “superior proposals.”  If FedFirst terminated the agreement before consummating the merger it would pay CB Financial a termination fee.

On April 21, 2014, Plaintiff filed a class action lawsuit in the Circuit Court for Baltimore City against FedFirst, its seven individual directors and CB Financial, asserting both direct and derivative claims.  He later voluntarily dismissed the derivative claims, and on September 19, 2014, the Circuit Court dismissed the remainder of his claims with prejudice.  Plaintiff promptly noted his appeal, but did not move to stay the merger pending appeal, and on October 31, 2014, FedFirst and CB Financial completed the merger.

Analysis:  Plaintiff argued that FedFirst’s directors had breached common-law fiduciary duties of candor and maximization of shareholder value, as articulated in Shenker,, which held that directors owed such duties to shareholders in “cash out” mergers that effectively eliminated their interest in the target company without providing any interest in the acquiring company.  Shenker also established an exception to the general rule that a shareholder may only challenge a merger transaction in a derivative action (i.e., on behalf of the corporation), holding that a shareholder may bring direct claims when “the occurrence of appropriate events” triggers the aforementioned common-law duties to shareholder individually.  Plaintiff argued that  Shenker’s holding was not limited to “cash out” transactions, but that other “appropriate events” could give rise to fiduciary duties of candor and maximization of value to shareholders.

The Court conducted a detailed analysis of Shenker and agreed that its holding was not limited to “cash out” transactions, but that fiduciary duties of candor and maximization value are owed to shareholders when “the decision is made to sell the corporation,” the “sale of the corporation is a foregone conclusion,” or the sale involves “an inevitable or highly likely change-of-control situation.”  While the Court of Appeals declined to explain what factual scenarios may satisfy these triggering events, the Court looked to Delaware case law, which recognizes duties to shareholders only in the following scenarios:

(1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (3) when approval of a transaction results in a sale or change of control (internal quotations and citations omitted).

The Court found none of these scenarios present with respect to the FedFirst/CB Financial merger.  Plaintiff did not allege that FedFirst initiated an active bidding process or abandoned a long-term strategy to seek to break up the company. Rather, the FedFirst directors merely explored options for a potential merger, which they would then present to the stockholders for approval.  The facts did not indicate that the sale of the company was a foregone conclusion. And, perhaps most importantly, the Court found that the mixed cash and stock consideration did not result in a sale or change of control of the company, noting that, “Unlike the scenario involved in the cash-out merger transaction in  Shenker, FedFirst’s shareholders in this case, by virtue of the stock portion of the merger agreement, have a continuing interest, including voting power, in the combined company, and they can participate in the future successes of CB Financial.”

For these reasons, the Court found that the duties articulated in Shenker did not apply, , that FedFirst’s directors were subject only to the ordinary managerial duties set forth in C.A. § 2-405.1 and were protected by the business judgment rule, and that Plaintiff had no basis for his direct claims against FedFirst and its directors.  The Court also dismissed Plaintiff’s aiding and abetting claims against CB Financial because it had found no underlying breach of fiduciary duties.

While the Court ultimately affirmed dismissal of Plaintiff’s claims on the merits, it rejected Defendants’ threshold argument that Plaintiff’s claims were moot because he sought to prevent a merger that had been completed while the appeal was pending.  The Court recognized that unwinding a long-completed merger involving more than two million publicly traded shares and an integration of corporate management would not be practicable, but found that the possibility of rescissory damages (i.e., the fair value of Plaintiff’s shares) had Plaintiff prevailed on the merits of his claims precluded a finding of mootness.

The full opinion is available in PDF.