Dexter v. ZAIS Financial Corp. (Cir. Ct. Balto. City)

Filed: December 8, 2016

Opinion by: Judge Audrey J.S. Carrion

Holding:

The Wittman standard of awarding attorneys’ fees is not met in a cash-stock merger suit alleging inadequate information in the registration statement because (1) directors do not owe shareholders a common law duty of candor in that type of transaction, and therefore the claim cannot be “meritorious” when filed, and (2) the corporate benefit was not casually related to the suit when the information in published disclosures was in accordance with previous public filings filed before the suit.

Facts:

On April 7, 2016, a merger agreement was announced between ZAIS, the Defendant, and another party, the Second Defendant, in which shareholders could elect to receive all cash or all stock.  The Second Defendant would be merged into a subsidiary of Defendant, ZAIS would issue its shares to the Second Defendant’s shareholders, and ZAIS would make a pre-merger tender offer to its shareholders who would not like to own shares in the resulting company.

The registration statement was filed on May 10 and amended on June 20 and August 5, 19 and 26, 2016 (the “August Registration Statement”).   On August 24, 2016, Dexter, the Plaintiff, an individual shareholder of Defendant, filed a complaint alleging inadequate information about the shareholder vote.  Plaintiff argued that details about the final exchange ratio, the per share tender offer price and conflicts of interest were missing from the registration statement.

Dexter then filed a Motion for Preliminary Injunction.  On September 12, 2016, ZAIS filed supplemental disclosures with the SEC.  On September 19, 2016, Dexter withdrew the Injunction Motion as moot and it was granted.  On September 30, 2016, Dexter filed a request for attorneys’ fees.  Defendants argue that the supplemental disclosures were disclosed not due to Plaintiff’s demand letter, but rather in accordance with the registration statement.

Analysis:

The “corporate benefit” doctrine is an exception to the American Rule, which states that litigants bear the cost of their own attorneys’ fees and expenses.  In re First Interstate Bancorp, 756 A.2d 357, 756 A.2d 353, 357 (Del. Ch. 1999).  It should be noted that attorneys’ fees can be awarded even when a defendant moots a claim by satisfying a plaintiff’s demands.  Tandycrafts v. Initio Partners, 562 A.2d 1162, 1164 (Del. 1966) citing Chrysler Corp. v. Dann, 223 A.2 384, 386 (Del. 1966).

The Court required the Plaintiff to satisfy the three conditions of the Wittman standard: the suit was meritorious when filed; the action producing the corporate benefit was taken by the Defendant prior to a judicial resolution; and the resulting corporate benefit was causally related to the lawsuit.  Wittman v. Crooke, 120 Md. app. 369, 379, 707 A.2d 422, 426 (1998).

1. The Suit was not meritorious when filed.

A suit is “meritorious” when it can “withstand a motion to dismiss on the pleadings.”  The Court held that Plaintiff’s claim that the Defendant’s directors breached the duty of candor and the Second Defendants aided and abetted that breach could not have been meritorious.

The Court disagreed with Plaintiff that Shenker applied to this case.  The transaction in Shenker v. Laureate Education, Inc., 411 Md. 317, 338, 983 A.2d 408, 420 (2009), involved a cash-out merger after the decision to sell the corporation had already been made and that Court “determined the common law duties are triggered when the decision is made to sell the corporation, the sale of the corporation is a foregone conclusion, or the sale involved an inevitable or highly likely change-of-control situation.”

In this case, the Court agreed with Defendant that Revlon duties do not apply in a cash-stock election merger, similar to this merger.  Therefore, individual shareholders like the Plaintiff may not bring direct claims against the directors for a breach of common law duties.  ZAIS also referred to Sutton v. FedFirst Financial Corp., 226 Md. App. 46, 85, 126 A.3d 765, 788 (2015), which involved a stock-for-stock transaction, and the Court of Special Appeals did not apply Revlon.

2. The corporate benefit was not causally related to the Suit.

The September 12 Supplemental Disclosures were made in accordance with the August Registration Statement, which included a prospectus with a calculation of the exchange ratio, that was to be publicly announced at least five days before the shareholder meetings.

The Court found that the benefit to the Defendant’s shareholders – the disclosure of the Exchange Ratio and Tender Offer price – was not caused by the Plaintiff’s lawsuit; it was “mere happenstance” (Wittman).

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.

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.