IN RE: PHC, INC. SHAREHOLDER LITIGATION; PETER BLAKESLEE v. PHC, INC., ET AL. (D. Mass., March 30, 2012)
This case arises out of the merger of PHC, Inc. with Acadia Healthcare Company, Inc. (Acadia) and its wholly owned subsidiary, Acadia Merger Sub, LLC (Acadia Sub). After the merger, Acadia stockholders would own 77.5 percent of the new company and PHC stockholders would own 22.5 percent. PHC stockholders included both Class A and B shareholders, the latter class having enhanced voting rights. Each share of PHC Class A stock would be exchangeable for one quarter of a share of Acadia common stock. Class B shares would also be exchangeable for one quarter of one share of Acadia stock, plus consideration in the amount of $5 million. Pursuant to the terms of the merger, defendants Shear and Grieco (both Class B shareholders) were also given seats on Acadia’s new Board of Directors. Finally, all outstanding PHC stock options and outstanding warrants to purchase PHC common stock would be assumed by Acadia, and Acadia shareholders would be paid a dividend of $90 million prior to the merger.
Peter Blakesee, a PHC Class A shareholder, commenced suit individually and on behalf of others similarly situated against PHC, Acadia, and Acadia Sub as well as several individual executives, alleging breach of fiduciary duty and violations of Section 14(a) of the Securities Exchange Act of 1934. In addition, the plaintiff asserted a claim against Acadia and Acadia Sub for aiding and abetting the other defendants’ breach of fiduciary duties. Specifically, the plaintiffs alleged that the defendants breached their fiduciary duties by abusing control of PHC to secure cash compensation for Class B shareholders and obtain positions on the Board of Directors at the expense of Class A shareholders. In addition, the plaintiffs alleged that defendants agreed to the merger through an unfair process and failed to maximize the consideration which Class A shareholders would receive in the merger.
The defendants moved to dismiss the complaint pursuant to Rule 12(b) on multiple grounds. First, the defendants alleged that the plaintiffs failed to make the required written demand on the corporation which is a condition precedent to a shareholder derivative action. In response, the plaintiffs argued that their claims were direct, not derivative, and therefore this requirement did not apply. In considering the issue and applying Massachusetts law (where PHC was incorporated), the court noted that the determination as to whether a claim is direct or derivative depends on whether the party which is ultimately injured is the corporation. If the claims allege injury to the corporation as a whole, the claims are merely derivative. However, where the plaintiffs allege breach of a duty distinct to that owed to other shareholders, the claim is direct. Here, because the complaint essentially alleged that the merger afforded disparate treatment to Class A and Class B shareholders, the court determined that the claims were direct.
The defendants argued next that the business judgment rule constituted a complete defense to the plaintiffs’ complaint. In rejecting this defense, the court noted that the business judgment rule requires a showing that defendants were acting in good faith in the interests of the corporation and had diligently investigated the merger. Here the plaintiffs accused defendants of acting in bad faith and self-dealing. These allegations rendered the business judgment rule inapplicable. Employing the same rationale, the court rejected the defendants’ argument that the complaint must be dismissed because plaintiffs’ exclusive remedy was appraisal. Under Mass. Gen. Laws ch. 156D, §13.02, a shareholder’s sole remedy when he objects to fundamental corporate transactions is to receive “fair value” for their shares as determined by appraisal. However, the statute does not apply where the shareholder can demonstrate that the transaction was violative of fiduciary duties, unlawful, or fraudulent.
Impact: This case highlights the distinction between a shareholder’s direct claims as distinct from claims which are solely derivative. Many of the defenses available to directors and officers against derivative actions are simply inapplicable to direct actions.