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

Opinion by: J. Anne Albright 

Holding:

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.

Facts:

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.

Analysis:

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.

Jesse Small v. Monty J. Bennett (Cir. Ct. Balto. City)

Filed:  February 5, 2018

Opinion by:  Pamela J. White

Holding:  Demand for attorney's fees and costs incurred prior to the mooting of a shareholder derivative suit (1) failed to satisfy the requirements of the "corporate benefit rule" because the suit was frivolous and causally unrelated to the corporate benefit in question, and (2) failed to meet the requirements for a discretionary award under Maryland Rule 2-703.

Facts:  Defendants are a Texas-based publicly traded real estate investment trust ("Company"), the management group that conducts Company's day-to-day business affairs ("Advisor"), and Company's managing board ("Directors").

Company became a publicly traded corporation in late 2013 and soon entered into an advisory agreement engaging Advisor to perform management functions.  In mid 2015, concerned about a hostile takeover, Directors adopted a poison pill in the form of an amended advisory agreement; one which would impose an onerous termination fee payable by Company to Advisor upon a change in control or termination of the agreement by either side.

Displeasure over the termination fee's size and triggering mechanism was swiftly communicated by a minority shareholder ("Minority") who commenced derivative suits in early 2016.   Minority sued first in Maryland and weeks later in Texas, alleging breach of fiduciary duty for failing to approve candidates for a proxy battle and adopting a termination fee that threatened to reduce the firm's current equity by 50% in the event of a change in control.  Minority was ultimately unable to overcome the business judgment rule presumption and suffered the dismissal of all claims in February 2016.

Though they prevailed in their suit against Minority, Directors were not deaf to the rising noise of discontent.  Between February and April 2016, Directors established a committee to explore negotiation of a termination fee reduction.  Insufficiently placated by the measure, Plaintiff, a separately situated shareholder ("Shareholder") entered the scene and served a demand letter on Directors in April mirroring the claims made by Minority and requesting an investigation and recommendation on the merits of litigation.  

By that time, the record confirmed much of Advisor's and Directors' energies to be centered on the termination fee provision.  Independent directors of Company and Advisor began negotiations and  drafted revisions to the advisory agreement.  An unsolicited takeover offer received Directors' favorable attention and protracted discussions regarding the import and impact of the termination fee.  Directors retained outside counsel to conduct Shareholder's demanded investigation and to report findings at the upcoming December 2016 board meeting.

Directors described these events in several letters to Shareholder between April and October, but Shareholder considered his demand as having been refused.  In October 2016, Shareholder filed a derivative complaint in the Circuit Court for Baltimore City largely regurgitating the content and form of Minority's prior suits: naming the same defendants (Company, Advisor, and Directors) and alleging breach of fiduciary duty with focus on the "unconscionable" fee provision.

Meanwhile, negotiations over the fee provision continued into 2017.  In January, Company's independent directors approved and recommended the amended advisory agreement.  In June 2017 at Company's annual shareholder meeting, shareholders approved the amended advisory agreement which softened its termination fee calculation and trigger mechanism.

That approval served to moot Shareholder's derivative suit; however, arguing that his litigation had led directly to substantial and valuable benefit for Company's shareholders, Shareholder moved for an award in the amount of attorneys' fees and expenses.

Analysis:  The court began by outlining the standard for an award of discretionary fees according to the corporate benefit doctrine, which required Shareholder to demonstrate three elements: (a) that his suit was meritorious when filed, (b) that Directors' action to benefit the corporation was taken prior to judicial resolution, and (c) that the corporate benefit was causally related to the suit.

To the first, the court examined whether Shareholder's suit would have survived the motion to dismiss - and were left wanting.  Shareholder neglected to allege sufficient facts in his complaint to show that Directors had failed to act in accordance with the Business Judgment Rule or made anything other than good faith, informed business decisions.

To the third, the court's examination of the chronology of events led to a finding that neither the termination fee negotiations nor subsequent approval had been causally related to Shareholder's demand letter or threat of litigation.  Instead, the train of activity as to challenging and rectifying the termination fee and trigger mechanisms had already left the station following Minority's suit - and months prior to Shareholder's involvement by demanding an investigation or filing the instant litigation.  Finding insufficient support for the required elements, the court determined Shareholder's litigation to have yielded no corporate benefit.

The court finally turned to Maryland Rule 2-703 which might have permitted a discretionary award in consideration of factors such as (a) time and labor required, (b) novelty and difficulty of questions raised, (c) legal skills required,... (e) customary fees for such services, (f) contingent or fixed fee agreement, (g) time-limiting circumstances,... or (i) experience and ability of counsel, among other factors.  Even had Shareholder been able to meet his burden to show a corporate benefit, his neglect to support the 2-703 showing with sufficient evidence about any of the recited factors and inability to explain or justify the difference between an initial demand for $565,000 and an amended demand for $272,347 were fatal to a request for a discretionary award.

Accordingly, the court denied Shareholder's motion for award of attorneys' fees and expenses.

The full opinion is available in PDF.

Oliveira v. Sugarman (Ct. of Appeals)

Filed: January 20, 2017

Opinion by J. Adkins

Holding:  (1) The traditional business judgment rule applies to a disinterested and independent board of directors' refusal of a stockholder litigation demand, not the modified business judgment rule established in Boland v. Boland, 423 Md. 296 (2011). (2) Conversion of a performance-based incentive plan approved by stockholders to a service-based incentive plan approved by a board of directors does not give rise to a direct stockholder claim. (3) An incentive plan approved by stockholders does not constitute a contract unless such plan contains language "indicating a clear offer and intent to be bound." (4) Even when a corporation owes a direct duty to its stockholders, a stockholder must have suffered an injury distinct from the corporation to bring a direct claim.

Facts:  The board of directors of a Maryland corporation (the "Company") granted performance-based restricted stock (the "Original Awards") to certain of its executives and employees; however, the Company did not have enough common stock authorized to pay these Original Awards if they vested. In a letter to stockholders from the CEO, accompanied by the annual proxy statement, the CEO asked stockholders to approve the proposed long-term incentive plan (the "Plan"). The mailing also included a copy of the Plan, which authorized the issuance of an additional eight million shares of common stock. The Plan was approved at the annual meeting. The Company, however, did not meet the performance metrics for the Original Awards to vest until eight trading days past when the Original Awards were to vest. The board of directors and its compensation committee, in consultation with its advisors, decided to convert the Original Awards to service-based awards (the "Modified Awards") to balance rewarding management’s performance and enforcing the terms of the Original Awards.

Plaintiffs, trustees of a stockholder of the Company, made a demand to the board of directors to investigate the Modified Awards and institute claims on behalf of the Company against "responsible persons." The board of directors appointed an outside, non-management director to serve as the demand response committee. After investigation that included assistance from outside counsel, the demand response committee recommended the board of directors refuse the stockholder demand, which it did after a unanimous vote. Plaintiffs filed suit against the members of the board of directors and senior management alleging breach of fiduciary duty, unjust enrichment, waste of corporate assets, breach of contract and promissory estoppel arising from the Modified Awards. The Court of Special Appeals affirmed the trial court’s dismissal of Plaintiffs’ claims, holding that the trial court correctly applied the business judgment rule and Plaintiffs’ failed to plead facts sufficient to overcome the presumption of the business judgment rule.

Analysis: The Court refused to expand the modified business judgment rule established in Boland to all board of director decisions refusing a stockholder litigation demand, regardless of whether a majority of the directors are disinterested or the board used a special litigation committee ("SLC"). After a discussion of the development of the business judgment rule in Maryland, the Court distinguished this case from Boland because a majority of the board of directors of the Company were disinterested and independent as only one of the six directors at the time the Amended Awards were made actually stood to financially benefit from the board's decision (even Plaintiffs agreed that the board consisted of a majority of disinterested and independent directors when it approved the Amended Awards). Plaintiffs argued that, by refusing to extend the modified business judgment rule to any denial by a board of directors of a stockholder litigation demand, enhanced scrutiny by the courts would be limited "to those rare instances when shareholders are not required to make a demand on the board before bringing suit" and thus the modified business judgment rule would be rarely applied. The Court explained that Boland was not concerned with the feasibility of stockholder derivative suits and was intended to address those situations where a board of directors does not have a disinterested majority and appoints an SLC because the courts wanted to ensure the SLC was not "serving as a puppet for the interested board."

Turning next to whether the claims asserted by Plaintiffs were direct or derivative, the Court held that Plaintiffs did not suffer "a 'distinct injury' separate from any harm suffered by the corporation." Plaintiffs claimed they suffered three harms giving rise to a direct claim. First, they claimed to have suffered harm when the Original Awards were converted to the Modified Awards because the Company could no longer take advantage of the tax exemption provided for under § 162(m)(4)(C) of the Internal Revenue Code because, unlike the Original Awards, the Modified Awards were no longer made in connection with a stockholder-approved performance plan. Even though the Court noted that this alleged increased tax cost actually resulted in damages to the Company, not Plaintiffs’, they maintained that the Plan granted them contact rights that they could enforce directly. Applying New York law (the Plan was approved in New York and expressly provided it was governed by New York law), the Court held that the Plan was not a contract because it contained no offer to stockholders. The Court also held that, under Maryland law, the Plan was not part of a larger "intra-corporate contract" between directors and stockholders.

Second, Plaintiffs claimed as a direct harm that the actions of the board of directors caused them to make an uninformed vote. Relying on the doctrine of promissory estoppel, Plaintiffs argued that the board promised them the Original Awards would vest only if the performance metrics outlined in the Plan were met and that this promise induced Plaintiffs to vote to approve the Plan. The Court acknowledged that the language in the letter to stockholders that accompanied the proxy statement did urge approval of the Plan and stated that the Original Awards would vest "only if performance conditions are achieved." The proxy statement contained the same assurance and, the Court found that "[t]his language could constitute a clear and definite promise on the part of the Board." The Court also found that the board of directors had a reasonable expectation that its promises to stockholders regarding the vesting of the Original Awards would induce stockholders to approve the Plan because, in language in the letter to stockholders, the board stated its belief that "the significant shareholder returns required in order to meet the performance hurdles of these proposed equity incentive awards…make the overall compensation strategy a compelling one for shareholders." Further, the stockholders did in fact approve the Plan. However, the Court held that Plaintiffs’ were unable to meet the fourth element of their promissory estoppel claim. Looking to Delaware law, the Court held that casting an uninformed vote in and of itself is not sufficient harm to support a claim for promissory estoppel – Plaintiffs’ would need to show individual damages resulting from their uninformed vote, which they had not done.

Plaintiffs next claimed that they suffered a direct harm because the Plan diluted the value of their shares in the Company. The Court agreed that, under certain circumstances, "financial harm due to stock dilution could support a direct shareholder claim"; however, the Court held that such a circumstance did not exist in this case. Plaintiffs had not alleged share dilution in their complaint and, while they argued dilution on appeal, they failed to allege any facts detailing the financial or other impact of the alleged dilution.

Finally, Plaintiffs claimed that, even if they had not suffered a distinct harm, the Plan created a direct duty owed to stockholders by the board of directors and thus they should be able to bring a direct claim. While the Court acknowledged that a stockholder may bring a direct action if the board of directors breached a duty owed to stockholders, it held that the breach of duty alone is not sufficient to bring a direct claim – there must be some separate harm suffered. Therefore, to bring a direct claim, a stockholder would have to show that it suffered a harm distinct from the corporation as a result of the breach of duty owed by directors to stockholders.

The full opinion is available in PDF.  The author of this post is an attorney at Venable LLP, which represented the Company.  

Oliveira v. Sugarman (Ct. of Special Appeals)

Filed:  January 28, 2016

Opinion by:  Stuart R. Berger

Holdings:  (1) A majority-disinterested and majority-independent board of directors’ unanimous decision to refuse a shareholder demand is not subject to the “special litigation committee” (“SLC”) exception but enjoys the protection of the business judgment rule.  (2) Absent a particularized rebuttal, statements made by a majority-disinterested and majority-independent board of directors within a letter refusing demand are presumed true and may properly be considered by the court. (3) In a derivative action, a shareholder’s right of discovery as to the issue of whether a board of directors acted appropriately in refusing demand is denied unless shareholder has met her burden of proof under the business judgment rule of showing bad faith, bad judgment, or lack of independence.

Facts:  Defendant-Appellees (“Appellees”) include a registered Maryland corporation and its current and former Board of Directors (“Board”) and members of senior management.  Appellants are two shareholders (“Shareholders”).

In 2009, Appellees sought and obtained shareholder approval of an executive compensation plan which issued additional shares of common stock to (1) ensure the ability to settle existing performance-based awards in shares instead of cash, and (2) thereby reduce Appellee’s tax burden.  Following a near-miss of share price performance targets in late 2010, Appellees became concerned that certain key employees might leave for better-paying opportunities with competitors.  After a 6-month review, the Board converted the performance-based awards to service-based awards.  The modification reduced the award amount by 25% and apportioned it into three installments over the years 2012 to 2014, so long as the employee remained employed.

In 2013, Shareholders issued a demand letter requesting Appellees to investigate and institute claims against responsible persons relating to the award modifications.  Shareholders demanded rescission of all shares issued under the 2009 plan, forbearance from issuing any additional shares-as-compensation, and any other appropriate relief due to damages sustained from the Board’s misconduct.

In response, the Board formed an investigative committee of a single, outside, non-management director.  The Board also retained outside counsel which was not then otherwise representing Appellee or its Board members.  After thorough review, the committee recommended refusal of Shareholders’ demand.  The Board unanimously voted to refuse the demand and informed Shareholders that the proposed litigation was not in the corporation’s best interest because Appellee would likely lose, suffer substantial harm, pay both sides’ legal fees, and incur substantial costs even in the event it won due to the millions of dollars required to generate new executive compensation awards.

In 2014, Shareholders began the instant litigation, alleging three derivative claims (breach of fiduciary duty, waste, and unjust enrichment) and two direct claims (breach of contract and promissory estoppel).  Appellees moved to dismiss, contending that because all five counts were essentially derivative claims and because Shareholders had failed to plead sufficient facts to overcome the presumption that the Board had acted in the best interest of the company, the Board was entitled to the protections of the business judgment rule.  Appellees further asserted that were the court to reach the merits, Shareholders had failed to state a claim on any of the five counts.  The circuit court agreed and dismissed Shareholders’ complaint in its entirety.  Shareholders timely appealed.

Analysis:  On appeal, Shareholders sought to establish that the circuit court had erred in two areas: first, by granting motion to dismiss the derivative claims, and secondly by dismissing those claims styled as direct claims. 

A derivative action requires the corporation’s board of directors to conduct an investigation into the shareholders’ allegations to determine whether pursuing the demanded litigation is in the best interests of the corporation.  Should the corporation fail to so litigate and the shareholder bring a “demand refused” action, the court is typically tasked with reviewing whether the board acted independently, in good faith, and with sound business judgment.  

On this point, Appellees sought the protections afforded by the presumption of business judgment rule.  Meanwhile, Shareholders argued that the court should apply an exception to the rule developed by the Court of Appeals in Boland v. Boland.  The Shareholders maintained that because the Boland court had established that a demand refusal was not entitled to business judgment rule protection, then Shareholders were entitled to discovery as to the process by which the Board had made its decision not to litigate leaving the burden to fall on Appellees to provide evidence of acting in good faith and reasonableness.  However, the court distinguished the instant case from Boland, noting that the demand refusal there was made by a special litigation committee (“SLC”) appointed in light of a minority of disinterested directors.  In this case, the decision to refuse demand was made unanimously by a board consisting of a majority of disinterested and independent directors.  As a result, the court found the business judgment rule to apply, and not the Boland exception.

So finding, the court placed the burden on Shareholders to establish sufficient facts that the directors had failed to act on an informed basis, in good faith, and with honest belief that actions taken were in the best interests of the corporation.  In each instance, the court found Shareholders’ arguments unpersuasive.  Shareholders’ allegation that the demand rejection was tainted by one director having received benefits under the contested executive compensation plan was insufficient because the other 5 directors remained disinterested.  Shareholders’ bald allegations of impropriety in the demand investigation were also insufficient in light of the committee’s 40 years of business experience and use of highly respected and experienced outside counsel.  Further, allegations of a mere personal friendship, outside business relationship, or compensation for services – standing alone – were insufficient to raise an inference of lack of independence.

The court was similarly unpersuaded by Shareholders’ next contention that the Board had acted in contravention of authority granted by shareholders in the 2009 plan.  Finding express discretionary language in the text of the 2009 plan, Appellees were clearly entitled to modify the 2008 executive compensation awards.  The court then doubled down: assuming arguendo that the compensation plan modification was improper, the Board acted properly because any remedy would have been detrimental to the best interests of the corporation by incurring considerable additional compensation or tax liabilities.

Shareholders next maintained the lower court had erred by considering facts contained within the Board’s letter refusing demand, arguing that the court should have permitted discovery or, at minimum, made independent factual determinations.  Finding no Maryland precedent, the court looked to Delaware law; pursuant to the business judgment rule, statements contained within a letter refusing demand are presumed true absent a particularized rebuttal.  Here again, the SLC exception did not apply because the demand refusal was approved by Appellee’s majority-disinterested and majority-independent Board.  Because a court’s decision to grant discovery in a demand-refused derivative action would undermine the business judgment rule by obviating the Board’s authority to decide whether litigation was pursuant to the corporation’s best interest, the lower court did not err by denying discovery.  Accordingly, Shareholders failed to meet their burden of establishing sufficient facts and the court held that the lower court did not err by granting motion to dismiss the derivative claims.

Finally, the court turned to the “direct” claims.  Here, the court noted that to maintain direct claims, shareholders must allege sufferance of an injury separate and distinct from that suffered directly by the corporation or derivatively by the shareholder due to injury to the corporation.  Because the injuries allegedly suffered would have been sustained by the corporation (by incurring compensation or tax liability), any claims would have properly been derivative.  The court further found no merit to either claim because the 2009 proxy statement did not constitute a contract, and because no detriment could have been avoided by its enforcement (nullifying a claim of promissory estoppel).  The remaining “direct” claims were therefore derivative and properly subject to dismissal.

The full opinion is available in PDF.

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.

Federal Deposit Insurance Corporation as received for Bradford Bank v. Arthur (Maryland U.S.D.C.)

Filed: March 2, 2015

Opinion by: Richard D. Bennett

Holding:  In a claim against officers and directors of a Maryland corporation, a plaintiff may only overcome the business judgment rule with a showing of gross negligence. 

Facts: Plaintiff was appointed receiver for a Bank and brought suit against four former officers of the Bank.  Plaintiff alleged Defendants were negligent, grossly negligent and breached fiduciary duties to the Bank by ignoring the Bank’s loan policy and failing to exercise due care in approving seven loan transactions. 

Analysis:  The Court first enforced a Tolling Agreement that was executed by and between the Plaintiff and each of the Defendants (and extended five times) to suspend operation of the statute of limitations under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”).  The Court noted that a defendant who enters into a contract while believing the contract is enforceable cannot be said to be acting in good faith. 

The Court then addressed the correct standard of liability for director and officer conduct under the FIRREA and Maryland law.  The Court stated that the FIRREA provides that a director or officer of an insured depository institution may be held personally liable for monetary damages for gross negligence, as such term is defined under applicable state law. 

Plaintiff argued that negligence applied to the conduct of corporate officers and directors under Maryland law due to the codification of the business judgment rule.  The Court disagreed and cited Parish v. Maryland & Virginia Milk Producers Ass’n and Billman v. State of Md. Deposit Ins. Fund Corp. as precedent from the Court of Appeals and the Court of Special Appeals, prior to and after codification of the business judgment rule, that applied a gross negligence standard.  

The opinion is available in PDF.

Boland v. Boland; Boland v. Boland Trane Associates, Inc. (Ct. of Appeals)

Filed: October 25, 2011
Opinion by Judge Sally D. Adkins.

Held:

Holding 1: After a motion to dismiss or for summary judgment against a derivative plaintiff, Maryland courts must review a special litigation committee's ("SLC") independence, and whether it made a reasonable investigation and principled, factually-based conclusions. In this inquiry, the SLC is not entitled to a presumption that it was sufficiently independent from a corporation's directors.

Holding 2: When a court grants summary judgment in a derivative suit based on an SLC's determination that continuing the lawsuit is not in the corporation’s best interest, that court decision is not a final adjudication on the merits so as to preclude a direct suit under the doctrine of res judicata. The court makes no determination of the merits of the allegations when reviewing an SLC's decision. Moreover, a direct action, which asserts individual rights, is an entirely different cause of action than a derivative action, which is brought on behalf of the corporation.

Facts: Two lawsuits arose when a family business, consisting of two corporations and owned primarily by eight siblings (collectively, the "Corporation"), attempted to repurchase the stock of one sister upon her death pursuant to a Stock Purchase Agreement. When the sister's estate refused to sell the stock, the Corporation filed a declaratory judgment action seeking enforcement of the Stock Purchase Agreement. Meanwhile, non-director siblings who had learned of earlier stock transactions that resulted in director siblings acquiring additional corporate stock for themselves, sent a demand for litigation to the Corporation and filed a derivative action in the Circuit Court alleging self-dealing and a breach of fiduciary duty. They also filed "direct" claims, as cross-claims in the declaratory judgment action.

In response, the corporations appointed an SLC consisting of two newly hired "independent directors" to examine the claims. The SLC determined that the stock transactions were legitimate and the Stock Purchase Agreement was enforceable.

The Circuit Court, applying the business judgment rule, deferred to the judgment of the SLC and granted summary judgment to the Corporation on the derivative action. The Circuit Court also dismissed the cross-claims relying on res judicata.

Analysis: On appeal in the Court of Appeals, the Court upheld the application of the business judgment rule by the Circuit Court and held that after a motion to dismiss or for summary judgment against a derivative plaintiff, Maryland courts must review the SLC’s independence, and whether it made a reasonable investigation and principled, factually-based conclusions. However, in this inquiry, the SLC is not entitled to a presumption that it was sufficiently independent from the directors. Because the Circuit Court presumed the independence and good faith of the SLC without requiring that the Corporation prove the SLC's independence, the Court of Appeals vacated the Circuit Court's judgment and remanded for further proceedings.

The Court referred to its holding as an "Auerbach enhanced" standard, in reference to Auerbach v. Bennett, 393 N.E.2d 994 (N.Y. 1979). In so holding, the Court rejected the so-called Zapata standard under which Delaware courts review a SLC’s recommendation on the merits, applying their “independent business judgment.”

The Court reasoned that "a procedural review under the business judgment rule, although clearly the more deferential standard [toward the Corporation], nonetheless provides for a thorough review of an SLC’s independence, good faith, and methodology, and such inquiry gives trial courts the ability to scrutinize SLC decisions and protect shareholders against collusive practices or inadequate investigations."

On the issue of whether the non-director siblings' "direct" claims, brought as cross-claims in the declaratory judgment action were precluded by res judicata, the Court held that the Circuit Court's grant of summary judgment in the derivative action, based on a recommendation of the SLC, does not form a basis for res judicata because it is not a determination on the merits. Accordingly, the Court held that a trial court's resolution of a derivative complaint, when based on the recommendation of an SLC, cannot be said to be a final judicial resolution on the merits of the claims.

The full opinion is available in PDF.

In re Nationwide Health Properties, Inc. S'holder Litig. (Cir. Ct. Balt. City)

Filed: May 25, 2011

Opinion by: Judge Stuart R. Berger

Held: When stating a claim for breach of fiduciary duty by the board of directors in a stock-for-stock merger, the duty of profit maximization under Shenker v. Laureate Education, Inc. does not apply.

Facts: The Board of Directors (the Board) of Nationwide, a publicly traded Maryland corporation and REIT with investments primarily in healthcare property in the United States, sought the advice of financial advisers on potential merger opportunities. Over a period of three months Nationwide actively pursued a deal with two of these opportunities. After some back-and-forth with the two potential acquiring companies the Board went with the company that offered them a firm, but slightly lower, price than the other.

Analysis: Plaintiffs attempted to use Shenker v. Laureate Education, Inc. to impose a duty of maximizing shareholder value on the Board. The Court distinguished the "cash-out" merger in Shenker as a different transaction from that of a "stock-for-stock" merger. In Shenker the duty of profit maximization was placed upon that board since the transaction was a "cash out" merger, where shareholders are given cash for their stocks, potentially forcing minority shareholders to accept a cash payment, effectively eliminating their interest in the target company and leaving them with no interest in the acquiring company. In a "stock-for-stock" merger, as is the case here, the current shareholder's equity is exchanged at a fixed conversion rate for shares in the acquiring company. The profit maximization standard may only be applied in a "cash-out" merger situation due to the finality of the decision by the board in such a merger as opposed to the current situation where shareholders will maintain an interest in the merged company. The Court noted that if it were to adopt the plaintiffs' reasoning, then there would be a duty of profit maximization in every merger, in direct opposition to existing case law.

The plaintiffs also argued the "stock-for-stock" purchase is effectively a change in control. The Court disagreed and cited the Delaware Supreme Court, which held where "control of both [companies] remains in a large, fluid, changeable and changing market, "directors do not have to obtain the highest possible value for shareholders since the asset remains liquid and easily sold or transferred in the broader market. A "stock-for-stock" merger is essentially a managerial function and there is no duty to maximize shareholder value, as opposed to a cash-out merger where this duty may be imposed. Further, Maryland corporation law reflects the same principle, "[A] stock-for-stock merger will not be a change of control..." (Hanks, Maryland Corporation Law § 6.6(b)). As the plaintiffs did not sufficiently plead facts supporting their change of control argument, the Court did not impose a duty of profit maximization on the Board.

The Court stated the proper analysis of the merger is under the Maryland Business Judgment Rule. To rebut the presumption, the plaintiffs needed to introduce evidence of director self-interest or self-dealing, or that the directors lacked good faith or failed to exercise due care. The allegations in the complaint did not allege a fraud, but rather self-dealing and negligence leading to substantially lower consideration for their shares. The plaintiffs did not show that interests such as early vesting of stock options influenced a majority of the Board in approving the transaction. The allegations of a breach of acting in the interest of the corporation must establish a link between the material benefit and the Board's decision to approve the merger transaction - absent this, allegations of self dealing are conclusory.

A breach of good faith is not met when the Board is presented with two rational options and chooses one that turns out to be less advantageous than the other. To succeed in showing a lack of care, the plaintiffs must show gross negligence was committed by the Board. Courts have held that boards are justified in accepting a lower but more firm offer over one that is higher but more speculative and that a board may act decisively to preserve an offer. The Court did not find such gross negligence was committed by the Board and the claim was dismissed with prejudice.

Lastly, the plaintiffs alleged a breach of the duty of candor. The Court found the complaint failed to state how any of the alleged omissions were material because the plaintiffs made no attempt to explain how the additional information they sought would alter the "total mix" of information made available in the lengthy report provided to shareholders. Accordingly, the plaintiff's disclosure claims were dismissed with prejudice.

The full opinion is available in pdf.