To be Argued by:
LEE D. RUDY
(Time Requested: 30 Minutes)
APL No. 2015-00155
New York County Clerk’s Index No. 650571/12
Court of Appeals
of the
State of New York
IN RE KENNETH COLE PRODUCTIONS, INC.
SHAREHOLDER LITIGATION
––––––––––––––––––––––––––
ERIE COUNTY EMPLOYEES RETIREMENT SYSTEM,
Lead Plaintiff-Appellant,
– against –
MICHAEL J. BLITZER, ROBERT C. GRAYSON, DENIS F. KELLY, PHILIP
R. PELLER, PAUL BLUM, KENNETH D. COLE, KCP HOLDCO, INC.
and KCP MERGERCO, INC.,
Defendants-Respondents.
BRIEF FOR LEAD PLAINTIFF-APPELLANT
LEE RUDY
MICHAEL WAGNER
LEAH HEIFETZ
KESSLER TOPAZ MELTZER
& CHECK, LLP
280 King of Prussia Road
Radnor, Pennsylvania 19087
Tel.: (610) 667-7706
Fax: (610) 667-7056
MARK LEBOVITCH
JEROEN VAN KWAWEGEN
ADAM HOLLANDER
BERNSTEIN LITOWITZ BERGER
& GROSSMANN LLP
1285 Avenue of the Americas, 38th Floor
New York, New York 10019
Tel.: (212) 554-1400
Fax: (212) 554-1444
Attorneys for Lead Plaintiff-Appellant
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TABLE OF CONTENTS
Page
I. PRELIMINARY STATEMENT.......................................................... 1
II. QUESTION PRESENTED .................................................................. 6
III. PROCEDURAL HISTORY ................................................................. 7
IV. JURISDICTIONAL BASIS FOR APPEAL ........................................ 8
V. STATEMENT OF FACTS................................................................... 9
A. Background ................................................................................ 9
B. Cole Moves to Take the Company Private .............................. 11
C. The Special Committee’s Ineffective Negotiations
with Cole .................................................................................. 13
D. The Going Private Transaction Price Provided
Inadequate Consideration to the Company’s
Minority Shareholders.............................................................. 15
VI. ARGUMENT...................................................................................... 16
A. Transactions with Controllers Require Post-Discovery
Judicial Review Because Of Their High Potential
for Abuse .................................................................................. 16
B. The Court of Appeals Held in Alpert That Controller
Buyouts Are Subject to Entire Fairness Review...................... 19
C. Pure Going Private Transactions Especially Call
for Strict Judicial Scrutiny ....................................................... 21
D. Neither Special Committees Nor Majority-Minority
Votes Can Fully Protect Minority Shareholders...................... 26
E. New York Courts Favor Discovery and Frown on
Pre-Discovery Dismissal.......................................................... 29
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F. Abandoning Alpert in Favor of Business Judgment
Rule Protection of Conflicted Freeze-Out Mergers
Would Be Bad Policy............................................................... 31
G. While New York May Look to Delaware Law
for Guidance, The Court Should Maintain the Clear
Alpert Standard of Review for Controller Buyouts ................. 32
VII. CONCLUSION .................................................................................. 38
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TABLE OF AUTHORITIES
Page(s)
Cases
Matter of Allion Healthcare, Inc.,
28 Misc. 3d 1228(A) (Sup. Ct. Suffolk Cty. 2010) ................................. 28
Alpert v. 28 Williams St. Corp.,
63 N.Y.2d 557 (1984)....................................................................... passim
Ams. Mining Corp. v. Theriault,
51 A.3d 1213 (Del. 2012).................................................................. 18, 33
Chelrob, Inc. v. Barrett,
293 N.Y. 442 (1944)................................................................................ 19
Citron v. E.I. du Pont de Nemours & Co.,
584 A.2d 490 (Del. Ch. 1990) ................................................................. 28
Coggins v. New England Patriots Football Club, Inc.,
397 Mass. 525, 492 N.E.2d 1112 (Mass. 1986) ...................................... 17
Cohen v. Seward Park Hous. Corp.,
7 Misc. 3d 1015(A) (Sup. Ct. N.Y. Cty. 2005) ....................................... 30
In re Cox Commc’ns, Inc. S’holders Litig.,
879 A.2d 604 (Del. Ch. 2005) ................................................................. 16
Foley v. D’Agostino,
21 A.D.2d 60 (1st Dep’t 1964) ................................................................ 29
Gesoff v. IIC Indus., Inc.,
902 A.2d 1130 (Del. Ch. 2006) ............................................................... 16
Jones v. H.F. Ahmanson & Co.,
1 Cal. 3d 93, 460 P.2d 464 (Cal. 1969) ................................................... 17
Kahn v. Lynch Commc’n Sys., Inc.,
638 A.2d 1110 (Del. 1994)...................................................................... 18
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Kahn v. M&F Worldwide,
88 A.3d 635 (Del. 2014)................................................................... passim
Kahn v. Tremont Corp.,
694 A.2d 422 (Del. 1997)................................................................. passim
Matter of Kenneth Cole Prods., Inc.,
122 A.D.3d 500 (1st Dep’t 2014) ........................................................ 7, 21
Matter of Kenneth Cole Prods., Inc.,
Index No. 650571/2012, 2013 N.Y. Misc. LEXIS 4026 (Sup. Ct. N.Y.
Cty. Sept. 3, 2013) ......................................................................................7
Leon v. Martinez,
84 N.Y.2d 83 (1994)................................................................................ 30
Limmer v. Medallion Group, Inc.,
75 A.D.2d 299 (1st Dep’t 1980) ........................................................ 19, 29
Marcus v. Jewish Nat’l Fund,
158 A.D.2d 101 (1st Dep’t 1990) ............................................................ 30
Palladino v. CNY Centro, Inc.,
70 A.D.3d 1450 (4th Dep’t 2010)............................................................ 30
In re Rural/Metro Corp. Stockholders Litig.,
102 A.3d 205 (Del. Ch. 2014) ................................................................. 29
In re S. Peru Copper Corp., S’holder Derivative Litig.,
52 A.3d 761 (Del. Ch. 2011) ............................................................ passim
Stilwell Value Partners, IV, L.P. v. Cavanaugh,
41 Misc. 3d 1216(A) (Sup. Ct. N.Y. Cty. 2013), aff’d, 118 A.D.3d 518
(1st Dep’t 2014)....................................................................................... 19
Swomley v. Schlecht,
No. 9355-VCL, 2014 WL 4470947 (Del. Ch. Aug. 27, 2014) ............... 34
Weinberger v. UOP, Inc.,
457 A.2d 701 (Del. 1983)...................................................... 20, 24, 29, 33
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Weinberger v. UOP, Inc.,
Civ. Action No. 5642, 1985 Del. Ch. LEXIS 378
(Del. Ch. Jan. 30, 1985)........................................................................... 29
Wolf v. Rand,
258 A.D.2d 401 (1st Dep’t 1999) ............................................................ 19
Rules and Statutes
CPLR § 3016(b)............................................................................................ 29
CPLR § 5501(b)...............................................................................................9
CPLR § 5513(b)...............................................................................................8
CPLR § 5513(d)...............................................................................................8
CPLR § 5602(a)(1)(i).......................................................................................8
8 Del. C. § 220 .............................................................................................. 37
22 N.Y.C.R.R. § 500.11................................................................................ 37
N.Y. Bus. Corp. L. § 624.............................................................................. 37
N.Y. Bus. Corp. L. § 910.............................................................................. 37
Other Authorities
Arthur M. Borden & Joel A. Yunis, Going Private (2015).......................... 23
Edward F. Greene, Corporate Freezeout Mergers: A Proposed Analysis, 28
STAN. L. REV. 487 (1976) ........................................................................ 23
Louis Lowenstein, Management Buyouts, 85 COLUM. L. REV. 730 (1985) . 17
Victor Brudney & Marvin A. Chirelstein, A Restatement of Corporate
Freezeouts 87 YALE L.J. 1354 (1978).............................................. passim
I. PRELIMINARY STATEMENT
This shareholder class action arises from a controlling shareholder’s
buyout of the minority investors in a New York corporation. In September
2012, Defendant Kenneth D. Cole (“Cole”), the controlling shareholder of
Kenneth Cole Productions, Inc. (“KCP” or the “Company”), acquired all of
the Company’s minority-held stock for $15.25 per share (the “Going Private
Transaction” or “Transaction”). Plaintiff, a pension fund that owned stock
in KCP, alleges that the Going Private Transaction resulted from an unfair
process and paid KCP shareholders an unfair price. Plaintiff seeks damages
on behalf of a putative class of similarly situated shareholders.
A transaction in which the majority shareholder squeezes out the
minority shareholders involves an inherent conflict of interest, because “the
danger exists that ‘a self-interested majority stockholder or control group has
ruled unfairly.’” Alpert v. 28 Williams St. Corp., 63 N.Y.2d 557, 566 n.2
(1984) (quoting Victor Brudney & Marvin A. Chirelstein, A Restatement of
Corporate Freezeouts, 87 YALE L.J. 1354, 1358 (1978) (“Brudney &
Chirelstein”)). In accord with almost seven decades of case law, New York
courts have consistently recognized that inherent conflict of interest. Due to
that inherent conflict, before the trial court and Appellate Division opinions
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in this case, no New York court had applied the deferential business
judgment standard of review to litigation challenging a controller-sponsored
squeeze-out. To the contrary, and consistent with the case law of virtually
every other state that has considered the issue, New York courts had
uniformly held that the controller-proponent of such a conflicted transaction
bears the burden of proving its “entire fairness” to the minority stockholders.
If the lower court opinions at issue here are upheld, New York will be at the
far extreme of anti-stockholder rights jurisdictions.
On September 5, 2013, the trial court in New York County (Marks, J.)
granted Defendants’ motion to dismiss this action. The trial court held that
Cole was entitled to act in his own economic self-interest in proposing the
Transaction, and that the decision by the committee of KCP directors tasked
with simulating an arm’s-length negotiation with Cole (the “Special
Committee”) to approve the Transaction was protected by the “business
judgment rule.” Both of those holdings were wrong, and inconsistent with
New York law and longstanding policy protecting the rights of minority
investors.
The business judgment rule protects only disinterested and non-
conflicted board decisions. The Going Private Transaction, by contrast,
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pitted Cole’s interest in buying the Company for as little as he could against
the common stockholders’ interest in maximizing the value of their shares.
New York law is clear that, having put himself in this conflicted position by
proposing the Going Private Transaction, Cole breached his fiduciary duty if
he does not prove that the Going Private Transaction was entirely fair to the
minority shareholders. Alpert, 63 N.Y.2d at 569-70 (“In reviewing a freeze-
out merger, the essence of the judicial inquiry is to determine whether the
transaction, viewed as a whole, was ‘fair’ as to all concerned.”). This
analysis requires Cole to prove, on an evidentiary record, both “fair dealing”
and “fair price.” Id. The trial court erred by granting Defendants’ pre-
discovery motion to dismiss on the basis of the business judgment rule.
The Appellate Division affirmed, in a decision that is inconsistent
with both Alpert and the sound policies that require entire fairness review of
conflicted transactions. The Appellate Division read Alpert to say that entire
fairness review applies to only a specific type of conflicted merger
transaction (“two-step” mergers), and held that entire-fairness scrutiny
should not apply to the Going Private Transaction because it was a “going
private” merger. The distinction drawn by the First Department contravenes
both Alpert and a long line of other precedents that require controlling
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shareholders to prove that conflicted transactions are entirely fair to the
minority shareholders. The First Department’s distinction between “two-
step” and “going-private” mergers also ignores the authorities cited by
Alpert, which argued that going private freeze-outs warranted the greatest
level of judicial skepticism. Alpert, 63 N.Y.2d at 567 n.2 & n.3 (citing
Brudney & Chirelstein, 87 YALE L.J. at 1368 arguing that “[g]iven the
absence of social benefit, the strength of fiduciary obligation, and the danger
of unnoticeable abuse, the simplest and the best response the corporate law
can make to going-private transactions is a flat prohibition.”).
The Appellate Division emphasized that unlike the merger in Alpert,
the Going Private Transaction was approved by a vote of KCP’s minority
stockholders. But nothing in Alpert justified that distinction: whether the
transaction in Alpert was subject to a stockholder vote had nothing to do
with Alpert’s holding that controller freeze-outs require entire fairness
review. The First Department was wrong to discard Alpert’s reasoning on
such a narrow basis. Instead, the fact that Cole subjected the Transaction to
a vote of the minority shareholders should have been considered as part of
the “fair dealing” analysis under entire fairness review. Alpert specifically
instructed courts to consider “how the necessary approvals were obtained”
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(i.e., the vote) as part of the “fair dealing” prong of the entire fairness
analysis. Alpert, 63 N.Y.2d at 570-71. The fact that KCP minority
shareholders approved the Going Private Transaction also cannot justify a
lower standard of review because, as several courts have held, minority
shareholders in controlled companies often agree to transactions proposed by
a controlling shareholder rather than risk the controller’s “retaliation.” See,
e.g., Kahn v. Tremont Corp., 694 A.2d 422, 428 (Del. 1997).
The Appellate Division strayed far from Alpert and created new law
that is unfair to minority shareholders of controlled New York corporations.
While Alpert held that the “inherent conflict of interest and the potential for
self-dealing” in freeze-out mergers requires “careful scrutiny,” 63 N.Y.2d at
570, the First Department held that controlling shareholders can avoid
judicial scrutiny altogether simply by subjecting the transaction to a vote of
the minority stockholders. Such votes can be procured by soft, inadequate
disclosures, or by other means that can be assessed appropriately only
against the backdrop of a developed evidentiary record. Such votes cannot
serve as a substitute for the sunshine of entire fairness review.
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This Court should reverse the opinion below to protect the rights of
New York shareholders facing potentially oppressive transactions proposed
by controlling shareholders. The case should proceed to discovery.
II. QUESTION PRESENTED
Does New York law require that courts strictly scrutinize, based on an
evidentiary record, whether going private mergers proposed by controlling
shareholders are “entirely fair” to the company’s minority shareholders?
The Appellate Division answered this question in the negative,
holding that the more deferential “business judgment rule” governs such
transactions as long as they are approved by the majority of the company’s
minority shareholders (a “majority-minority vote”). The Appellate
Division’s decision allows controlling shareholders to obtain pre-discovery
dismissal of any lawsuit challenging a conflicted transaction, even where the
process and terms are unfair, as long as the controller can procure a
majority-minority vote to approve the deal. This decision carved out an
unwarranted exception from New York courts’ consistent application of
entire fairness review to all conflicted corporate transactions, including but
certainly not limited to, going private mergers led by controlling
shareholders.
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III. PROCEDURAL HISTORY
On July 12, 2012, the trial court entered an order consolidating six
cases challenging Defendants’ conduct in proposing and approving the
Going Private Transaction. Plaintiff and its counsel were appointed to lead
the litigation on behalf of the putative class.
The trial court heard oral argument on Defendants’ motions to dismiss
on February 4, 2013. On September 5, 2013, the trial court entered an order
and decision dismissing the Complaint, holding that pre-discovery
adjudication was proper under the business judgment rule. Matter of
Kenneth Cole Prods., Inc., Index No. 650571/2012, 2013 N.Y. Misc. LEXIS
4026, at *10-13 (Sup. Ct. N.Y. Cty. Sept. 3, 2013).
Plaintiff appealed from that judgment to the Appellate Division, First
Department. On November 20, 2014, the Appellate Division affirmed the
dismissal, holding that entire fairness was not the appropriate standard of
review for conflicted going private transactions that are approved by a
majority of the company’s minority shareholders. See Matter of Kenneth
Cole Prods., Inc., 122 A.D.3d 500 (1st Dep’t 2014) (“the motion court was
not required to apply the ‘entire fairness’ standard to the transaction”).
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On November 20 and 21, 2014, Defendants served notice of entry of
the Appellate Division’s order by e-filing it with the court. On December
19, 2014, Plaintiff timely served a motion with the Appellate Division,
pursuant to CPLR § 5602(a)(1)(i), for permission to appeal to this Court. On
March 16, 2015, Defendants each served by e-filing notice of entry of the
Appellate Division’s order (dated March 12, 2015) denying leave to appeal.
On April 15, 2015, Plaintiff moved for leave to appeal to the Court of
Appeals pursuant to CPLR §§ 5513(b), (d) and 5602(a)(1)(i), and § 500.11
of this Court’s Rules of Practice, which motion was granted by Order dated
June 10, 2015.
IV. JURISDICTIONAL BASIS FOR APPEAL
This Court has jurisdiction over this appeal pursuant to CPLR §
5602(a)(1)(i). This case originated in the Supreme Court of New York
County. The Appellate Division’s November 20, 2014 decision and order,
which upheld the IAS Court’s dismissal of this action, constituted a final
determination of the action as it completely disposed of the case. This Court
granted Plaintiff’s motion for leave to appeal the Appellate Division’s
November 20, 2014 decision and order by Order dated June 10, 2015. This
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Court has jurisdiction to review the questions of law presented herein
pursuant to CPLR § 5501(b).
V. STATEMENT OF FACTS
A. Background
It would be difficult to overstate the power that Cole held as the
controlling shareholder, founder, Chairman, and Chief Creative Officer of
his namesake Company. Prior to the Going Private Transaction, KCP had
two classes of common stock: (i) Class A common stock, which was entitled
to one vote per share; and (ii) Class B common stock, which was entitled to
ten votes per share. R. 564. Cole owned 1.6 million shares of the
Company’s Class A common stock, and all 8,010,497 outstanding shares of
the super-voting Class B common stock, giving him 89% of KCP’s voting
power. Id. As KCP’s controlling shareholder and Chairman of the Board,
Cole owed fiduciary duties to KCP and its minority shareholders.
As a result of his voting power, Cole personally elected four of the six
members of the Company’s board of directors, including two of the
members of the Special Committee of directors appointed to “negotiate”
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with Cole.1 R. 564-66. Over the years, all of the KCP directors consistently
acted to serve Cole’s personal interests, even when doing so came at the
expense of KCP and its minority investors, demonstrating those directors’
primary loyalty to Cole. R. 567-69. A good example is the board’s
consistently rewarding Cole with outsized executive compensation. KCP’s
executive compensation was consistently criticized by Glass Lewis & Co.
(“Glass Lewis”), a leading national shareholder advisory firm, which gave
KCP an “F” grade for pay-for-performance in each year from 2007 through
2009, and a “D” grade in 2010. R. 567. The compensation committee that
set those practices had four members, including three members of the
Special Committee: defendants Grayson, Kelly, and Blitzer. Id. Glass
Lewis even recommended that shareholders withhold votes from Grayson,
Kelly, and Blitzer for failing to link compensation of the Company’s
executives with performance. Id. In addition, the Board routinely provided
lucrative licensing agreements to Cole’s brother, Neil Cole, R. 568-69, and
approved payments to Cole’s aviation company to allow him to travel in his
own private jet. R. 567-68. When Cole appointed these directors to serve
1 The Special Committee consisted of defendants Robert C. Grayson (“Grayson”), Denis
F. Kelly (“Kelly”), Michael J. Blitzer (“Blitzer”), and Philip R. Peller (“Peller”) (the
“Special Committee Defendants”).
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on the Special Committee and “negotiate” against him, Cole could be fairly
certain that he would get what he wanted.
B. Cole Moves to Take the Company Private
After several years of financial losses, KCP took steps in 2011 that
placed the Company on a much more positive trajectory. Defendant Paul
Blum (“Blum”) rejoined the Company as CEO and Vice Chairman, and
worked with Cole to implement a new strategic plan. R. 583. Prior to
Cole’s initial $15 per share lowball offer for the Company, in the
approximately two months since the end of 2011, KCP’s stock price had
increased by more than 20%. R. 573. Indeed, the Company reported
significant increases in net revenues, operating income, and net income per
share in the third quarter of 2011 and first quarter of 2012. R. 583-84. Cole
himself stated in a November 2011 press release that he was “pleased that
we are making steady progress in many areas and . . . confident in our
management team’s ability to move the business forward.” R. 583.
Cole’s opportunistic offer just three months later failed to account for
the Company’s historical success or the improvement that KCP was already
experiencing. Instead, Cole decided that the Company’s deflated share price
as a result of its previous poor performance, coupled with its anticipated
-12-
upward trajectory, presented the perfect opportunity to take it private.
Private ownership would allow Cole to enjoy the full upside of the
Company’s successful restructuring, while minority investors had borne the
brunt of financing the turnaround.
On February 2, 2012, Cole told Blum, KCP’s Chief Financial Officer
David Edelman, and KCP’s General Counsel Michael Colosi about his plans
to squeeze out the Company’s minority shareholders. Those senior officers
spent the following three weeks assisting Cole to prepare his offer, including
collecting financial data and helping in discussions with potential lenders
regarding financing for his bid. R. 570. Then, between February 4 and
February 16, 2012, Cole separately told directors Blitzer, Kelly, and Peller
that he was considering making an offer to take KCP private. Id. But rather
than taking some kind of action to protect the interests of the Company or its
minority shareholders, such as calling a special Board meeting to discuss the
appropriate next steps or ensuring that Cole did not improperly use
Company resources (i.e., senior management) to further his proposal,
Blitzer, Peller, and Kelly simply waited for Cole’s next move. R. 570-71.
Finally, at a regularly scheduled Board meeting held on February 23,
2012, Cole formally offered to buy all of the KCP Class A stock that he did
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not already own for $15.00 per share. R. 571. Cole made clear that he
planned to continue the Company’s existing strategic plan, which had
already been implemented, demonstrating Cole’s well-founded belief that
the Company’s performance would continue to improve. R. 572.
Unsurprisingly, analysts called the offer an “opportunistic play” by Cole to
acquire KCP on the cheap, estimating the Company’s actual value at
approximately $20 per share. R. 573.
C. The Special Committee’s Ineffective Negotiations with Cole
In response to Cole’s offer, the Board formed the Special Committee,
consisting of four directors – Blitzer, Grayson, Kelly, and Peller – to
evaluate his proposal and negotiate with him on behalf of the Company’s
minority shareholders. R. 575. Defendant Kelly, the Special Committee
chairman, and defendant Grayson had served on KCP’s board for 18 years
and 16 years, respectively. R. 565. All four directors had participated in the
Board’s previous decisions to approve policies and transactions that
benefited Cole, and had been given failing grades by Glass Lewis for
awarding Cole windfall compensation. Cole could be confident that the
Special Committee Defendants would not bargain particularly hard with him
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in light of their long history of granting Cole whatever he wanted at his
namesake Company. R. 567-69.
The Special Committee did not disappoint Cole. While Cole told the
Special Committee that he would not be interested in selling his shares to an
alternative bidder, R. 577, the Special Committee should have tested the
market to see what other bidders might have been willing to pay. Doing so
would have provided valuable leverage and information in a negotiation
with Cole even with his stated opposition to any other transaction. Id.
Instead, the Special Committee accepted as a foregone conclusion that a deal
would get done, on terms favorable to Cole. R. 577-81.
While KCP’s internal financial forecasts reflected management’s
belief that the Company was headed for brighter days, the Special
Committee failed to use on those forecasts during their negotiations in order
to secure more value for minority stockholders. Instead, the Special
Committee oddly undermined that key source of leverage, and directed
management to downwardly revise the Company’s financial projections,
effectively negotiating against itself (and, more importantly, against the
minority shareholders) by making a lower price appear more reasonable. R.
578.
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The Special Committee’s anemic dealings with Cole undermine any
notion of an effective arm’s-length negotiation. On May 23, 2013, in
response to Cole’s $15-per-share offer, the Special Committee requested
feebly that he offer something “higher than $15 per share.” R. 579. Cole
raised his offer to $16 per share on May 27, but then inexplicably reverted to
his original $15 per share offer on June 4. R. 579-80. While a reasonable
arm’s-length negotiator would have at least threatened to walk away at that
point, the Special Committee essentially begged Cole to offer anything
higher than $15 per share. R. 580. Cole offered an additional $0.25 per
share the following day, which the full Board (excluding Cole but including
CEO Blum) immediately accepted. Id. On June 6, 2012, the Company
announced that it had signed a merger agreement with Cole, under which he
would buy all of the KCP Class A stock that he did not already own for
$15.25 per share, freezing out the Company’s minority shareholders. R.
581.
D. The Going Private Transaction Price Provided Inadequate
Consideration to the Company’s Minority Shareholders
Cole succeeded in his plan to buy out the minority shareholders for
inadequate consideration. The $15.25 per share price was well below
market analysts’ estimates of a $20 per share value for the Company, as well
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as the market’s expectations set in post-offer trading. R. 573. The price
paid failed to account for the Company’s significant real estate and other
assets that were not reflected in the Company’s trading price, including $55
million in net operating loss carryforwards. R. 578. Nevertheless, after the
Company solicited its minority shareholders’ votes on the basis of materially
misleading and incomplete proxy materials, R. 585-86, the Going Private
Transaction was approved and consummated on September 24, 2012.
Accordingly, Plaintiff’s Complaint in this action pled that the $15.25 per
share price, agreed upon following an inherently flawed and unfair process,
was inadequate and not fair to the Company’s minority shareholders.
VI. ARGUMENT
A. Transactions with Controllers Require Post-Discovery
Judicial Review Because Of Their High Potential for Abuse
Freeze-out mergers present an inherent conflict of interest for
controlling shareholders and create a strong potential for abuse. Alpert, 63
N.Y.2d at 567 n.3. See also Gesoff v. IIC Indus., Inc., 902 A.2d 1130, 1144
(Del. Ch. 2006) (holding that in a controller buyout, “the self-interested
directors have an interest that diverges from that of the minority
stockholders, and, to the extent that the minority resists, the process is
entirely suffused with the parent’s coercive power”); In re Cox Commc’ns,
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Inc. S’holders Litig., 879 A.2d 604, 617 (Del. Ch. 2005) (recognizing that
“mergers with controlling stockholders involve an extraordinary potential
for the exploitation by powerful insiders of their informational advantages
and their voting clout”); Coggins v. New England Patriots Football Club,
Inc., 397 Mass. 525, 532-33, 492 N.E.2d 1112, 1117 (Mass. 1986) (“The
dangers of self-dealing and abuse of fiduciary duty are greatest in freeze-out
situations [], where a controlling stockholder and corporate director chooses
to eliminate public ownership”); Jones v. H.F. Ahmanson & Co., 1 Cal. 3d
93, 111-12, 460 P.2d 464, 474 (Cal. 1969) (recognizing “potential for injury
to minority shareholders from majority dealings in its control power”).
Indeed, as going private transactions became more common in large
public corporations in the 1980s, an influential corporate law scholar warned
that even as “the extensive literature on the subject has by now catalogued
the opportunities for and forms of abuse . . . [t]he only certainty is that even
our considerable knowledge of such abuses will always be incomplete, and
that the risks to shareholders in [management buyouts] are limited in
substantial measure only by the imagination of the management group and
its potential lack of scruples.” Louis Lowenstein, Management Buyouts, 85
COLUM. L. REV. 730, 740 (1985).
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Brudney and Chirelstein, who were repeatedly cited by this Court in
Alpert, list a number of inherent advantages that create strong risks of
coercion and abuse in a take-private transaction. Only insiders have access
to corporate proxy machinery, and using it to take a company private rather
than simply buying shares on the open market may be seen as inherently
coercive. 87 YALE L.J. at 1366. Brudney and Chirelstein also identify the
exact scenario at issue in this case – “first sucking in the public’s money,
and then squeezing out the public’s participation. . . .” Id.
Accordingly, courts guard against the potential for abuse in controller
buyouts by carefully reviewing such transactions for their entire fairness.
See, e.g., Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110, 1117 (Del.
1994) (holding that “the exclusive standard of judicial review in examining
the propriety of an interested cash-out merger transaction by a controlling or
dominating shareholder is entire fairness”); Ams. Mining Corp. v. Theriault,
51 A.3d 1213, 1239 (Del. 2012) (“When a transaction involving self-dealing
by a controlling shareholder is challenged, the applicable standard of judicial
review is entire fairness, with the defendants having the burden of
persuasion.”).
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B. The Court of Appeals Held in Alpert That Controller
Buyouts Are Subject to Entire Fairness Review
This Court decided Alpert in 1984. Before Alpert, decades of settled
New York law already required conflicted fiduciaries to establish that self-
interested transactions are “entirely fair.” See, e.g., Chelrob, Inc. v. Barrett,
293 N.Y. 442, 461-62 (1944) (requiring directors serving on boards of both a
parent and subsidiary corporation to prove the entire fairness of a transaction
between the two); Limmer v. Medallion Group, Inc., 75 A.D.2d 299, 303
(1st Dep’t 1980) (requiring controlling shareholders to demonstrate the
entire fairness of a sale and leaseback arrangement between the company
and themselves); Wolf v. Rand, 258 A.D.2d 401, 404 (1st Dep’t 1999)
(requiring shareholders of a close corporation to demonstrate the entire
fairness of expense reimbursements); Stilwell Value Partners, IV, L.P. v.
Cavanaugh, 41 Misc. 3d 1216(A) (Sup. Ct. N.Y. Cty. 2013), aff’d, 118
A.D.3d 518 (1st Dep’t 2014).
Alpert unsurprisingly applied the entire fairness doctrine to a
controlling shareholder freeze-out transaction. Alpert held that in
transactions involving “majority ownership, the inherent conflict of interest
and the potential for self-dealing requires careful scrutiny of the
transaction.” 63 N.Y.2d at 570. For those transactions, “the burden shifts to
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the interested directors or shareholders to prove good faith and the entire
fairness of the merger.” Id.
Alpert is clear that proving the entire fairness of a merger with a
controlling shareholder requires the court to weigh evidence. Id. at 570-72.
“The interested parties may attempt to establish . . . fair dealing by
introducing evidence of efforts taken to simulate arm’s length negotiations.”
Id. at 570. That includes the examination of evidence regarding whether
members of a special committee are independent, as well questions the
procedural fairness of the deal, including “its timing, initiation, structure,
financing, development, disclosure to the independent directors and
shareholders, and how the necessary approvals were obtained.” Id. at 570-
71 (quoting Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983)). And
“[i]n determining whether there was a fair price,” the trial court should
consider, for example, “net asset value, book value, earnings, market value,
and investment value.” Alpert, 63 N.Y.2d at 571. As a result, under Alpert,
well-pled allegations that a controller buyout is not fair to the minority
shareholders requires that the court scrutinize the fairness of the transaction
on an evidentiary record. The trial court and the Appellate Division ran
afoul of Alpert by dismissing this case pre-discovery.
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C. Pure Going Private Transactions Especially Call for Strict
Judicial Scrutiny
Alpert identified three types of conflicted merger transactions: “(1)
two-step mergers, (2) parent/subsidiary mergers, and (3) ‘going-private’
mergers.” Alpert, 63 N.Y.2d at 567 n.3. The merger at issue in Alpert was a
two-step merger, not a “going private transaction” like the Transaction here.
The First Department decided in this case that because the Going Private
Transaction was not a two-step merger, there was no need to subject it to
entire fairness review. The First Department reasoned that when Alpert
stated, “This court does not now decide if the circumstances which will
satisfy the fiduciary duties owed in this two-step merger will be the same for
the other categories,” id., that Alpert meant that going private transactions
(or parent/subsidiary mergers) were not necessarily subject to entire fairness
review. The First Department then decided that, because the Going Private
Transaction was subject to a majority-minority vote, it should not be subject
to strict judicial scrutiny like the two-step merger in Alpert. Kenneth Cole,
122 A.D.3d 500.
The First Department’s analysis on this point was demonstrably
wrong in a number of ways. First, all three types of merger transactions
listed in Alpert, 63 N.Y.2d at 567 n.3, are what Alpert called “freeze-out”
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mergers. Id. And Alpert held that “[i]n reviewing a freeze-out merger, the
essence of the judicial inquiry is to determine whether the transaction,
viewed as a whole, was ‘fair’ as to all concerned.” Id. at 569; see also id. at
567 n.2 (“in freeze-outs the danger exists that ‘a self-interested majority
stockholder or control group has ruled unfairly’ thus necessitating the need
for ‘safeguards to ensure that minority stockholders receive equal though not
identical treatment’”). Alpert did not limit its holding to “two-step mergers.”
Thus when Alpert reserved deciding “if the circumstances which will satisfy
the fiduciary duties owed in this two-step merger will be the same for the
other categories,” Alpert was not reserving the question whether entire
fairness review applied to the other categories. Rather, Alpert simply left
open what facts might suffice to demonstrate that one of the other categories
of “freeze-out” mergers was entirely fair.
Second, a review of the authorities on which Alpert relied
demonstrates that that the First Department wrongly interpreted Alpert.
Alpert relied on Brudney and Chirelstein’s A Restatement of Corporate
Freezeouts, 87 YALE L.J. 1354 (1978), for the propositions that (1) “freeze-
outs of minority interests by mergers occur principally in three distinct
manners,” Alpert, 63 N.Y.2d at 567 n.3; and (2) “in freeze-outs the danger
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exists that ‘a self-interested majority stockholder or control group has ruled
unfairly’ . . . ,” id. at 567 n.2.
The First Department below interpreted Alpert to mean that the two-
step merger in Alpert was subject to entire fairness review, but the Going
Private Transaction was not. But Brudney and Chirelstein actually wrote
that two-step mergers generally present the least risk of abuse by controlling
shareholder.2 By contrast, the authors posited that going private transactions
present a much higher risk of abuse. Indeed, the authors suggested that the
risk of unfair coercion inherent in going private transactions is so great that
they are of “small value and high risk and hence should be prohibited.”
Brudney & Chirelstein, 87 YALE L.J. at 1359.3 Alpert’s heavy reliance on
Brudney and Chirelstein, which suggested barring going private transactions
altogether, makes it clear that Alpert did not intend for a more lenient
standard of review to apply to going private transactions than two-step
2 Brudney and Chirelstein wrote that “mergers representing merely a second step in the
take-over of a target firm by a previously unrelated company present the least need for
protective regulation and can be dealt with largely through the familiar medium of
advance disclosure.” 87 YALE L.J. at 1359; see also Edward F. Greene, Corporate
Freezeout Mergers: A Proposed Analysis, 28 STAN. L. REV. 487, 518 (1976); Arthur M.
Borden & Joel A. Yunis, Going Private § 1.07 (2015).
3 Unless otherwise noted, all emphasis is added and internal citations are omitted.
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mergers. If anything, Alpert left for another day the question whether going
private transactions should be prohibited altogether.
Alpert also relied heavily on the seminal Delaware case of
Weinberger, 457 A.2d 701. Alpert cited Weinberger for the proposition that
“when there is an inherent conflict of interest, the burden shifts to the
interested directors” to prove the transaction’s entire fairness, Alpert, 63
N.Y.2d at 570; and also in describing what evidence is relevant to proving
“fair dealing” and “fair price.” Id. at 570-71. But nowhere in Weinberger
does the Delaware Supreme Court limit its holding to “two-step” mergers.
Rather, Weinberger held:
When directors of a Delaware corporation are on both sides of a
transaction, they are required to demonstrate their utmost good
faith and the most scrupulous inherent fairness of the bargain.
The requirement of fairness is unflinching in its demand that
where one stands on both sides of a transaction, he has the
burden of establishing its entire fairness, sufficient to pass the
test of careful scrutiny by the courts.
457 A.2d at 710. This Court’s heavy reliance on Weinberger in deciding
Alpert also makes clear that Alpert requires that all freeze-out mergers be
scrutinized by courts for their entire fairness, not just “two step” mergers.
Third and finally, the facts here show that the risks of abuse to
minority shareholders were in fact greater in the Going Private Transaction
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than in the transaction in Alpert. The defendants in Alpert first negotiated at
arm’s-length to buy the controlling interest held by the corporation’s prior
majority shareholders (the “first” step). The prior majority shareholder had
no reason to sell unless the price offered was fair, and their arm’s-length
negotiation was real, rather than “simulated.” After purchasing majority
control of the corporation, the defendants then fulfilled their promise to pay
the minority shareholders the same price they had negotiated to pay for the
majority shares (the “second” step). The price paid to the minority
shareholders in Alpert was therefore the result of true arm’s-length
negotiating between an actual buyer and a seller, and had all of the
hallmarks of fairness. Still, however, Alpert required that the defendants
prove, with evidence, that the transaction was in fact entirely fair to the
minority.
Far from being reached through the rigors of the marketplace, the
price paid in the Going Private Transaction here resulted from a simulated
negotiation between Cole and his longtime directors. Those directors had
been appointed by Cole and, unlike the first-step negotiations in Alpert, were
not negotiating on their own behalf. The Special Committee directors had
little to lose or to gain in the deal negotiations, which they also demonstrated
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through their anemic negotiating style. Judicial scrutiny of the price and
process here is plainly warranted.
D. Neither Special Committees Nor Majority-Minority Votes
Can Fully Protect Minority Shareholders
The special committee’s conduct in In re S. Peru Copper Corp.,
S’holder Derivative Litig., 52 A.3d 761 (Del. Ch. 2011) is instructive. In
Southern Peru, the special committee consisted of independent directors
with impeccable pedigrees. Id. at 769-70. They hired reputable financial
and legal advisors, id. at 770, and met dozens of times over eight months of
negotiations with the company’s controlling stockholder. Id. at 770-82. On
the surface, the process appeared fair, and the proxy disclosures gave little
hint that anything was untoward. But after trial, the court found that the
special committee had knowingly overpaid its controlling stockholder by
manipulating the financial analyses to make the transaction appear fair. Id.
at 811-13. The committee failed to make reasonable counter-proposals or to
maximize its negotiating leverage because its members were trapped in a
controlled mindset that “too often afflicts even good faith fiduciaries trying
to address a controller.” Id. at 763.4 Rather than act like true arm’s-length
4 Tremont had previously counseled that “the controlling shareholder must do more than
establish a perfunctory special committee of outside directors. Rather, the committee
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negotiators, the special committee members sought “comfort” by making the
controller’s proposed deal look fair. Id. at 773-74. Ultimately, the
committee agreed to a deal that massively overvalued the controller’s
interest, and the trial court awarded damages of $1.3 billion ($2.03 billion
with interest). Id. at 819. Importantly, the Southern Peru transaction was
approved by a majority of the company’s minority shares, id. at 785, and
only after discovery did the special committee’s total abdication of its
responsibilities become clear.
Courts have also consistently acknowledged that majority-minority
votes can be subtly coerced by controllers, because minority shareholders
may fear the controller’s “retaliation” if they fail to accede to his wishes.
Tremont, 694 A.2d at 428. In Tremont, the Supreme Court of Delaware
explained:
Entire fairness remains applicable even when an independent
committee is utilized because the underlying factors which raise
the specter of impropriety can never be completely eradicated
and still require careful judicial scrutiny. This policy reflects
the reality that in a transaction such as the one considered in
this appeal, the controlling shareholder will continue to
dominate the company regardless of the outcome of the
transaction. The risk is thus created that those who pass upon
must function in a manner which indicates that the controlling shareholder did not dictate
the terms of the transaction and that the committee exercised real bargaining power ‘at an
arms-length.’” 694 A.2d at 429.
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the propriety of the transaction might perceive that disapproval
may result in retaliation by the controlling shareholder.
Consequently, even when the transaction is negotiated by a
special committee of independent directors no court could be
certain whether the transaction fully approximated what truly
independent parties would have achieved in an arm’s length
negotiation. Cognizant of this fact, we have chosen to apply the
entire fairness standard to “interested transactions” in order to
ensure that all parties to the transaction have fulfilled their
fiduciary duties to the corporation and all its shareholders.
694 A.2d at 428-29.
The court in Citron v. E.I. du Pont de Nemours & Co., similarly held
that entire fairness applied to a controlling-shareholder parent-subsidiary
merger:
Even where no coercion is intended, shareholders voting on a
parent subsidiary merger might perceive that their disapproval
could risk retaliation of some kind by the controlling
stockholder. For example, the controlling stockholder might
decide to stop dividend payments or to effect a subsequent cash
out merger at a less favorable price, for which the remedy
would be time consuming and costly litigation. At the very
least, the potential for that perception, and its possible impact
upon a shareholder vote, could never be fully eliminated.
584 A.2d 490, 502 (Del. Ch. 1990).
As a result, approval by the minority shareholders has never been
considered a sufficient reason to avoid entire fairness review of a transaction
with a controller. See also, e.g., Matter of Allion Healthcare, Inc., 28 Misc.
3d 1228(A) (Sup. Ct. Suffolk Cty. 2010) (refusing to dismiss shareholder
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complaint challenging merger approved by 99.18% of the voting
shareholders).
In fact, when courts scrutinize such transactions based on a full record
at trial (after the minority shareholders have voted in favor of them), courts
frequently find that the transactions were unfair to the minority. This is
exactly what happened in Weinberger, where 92% of the minority
shareholders approved a freeze-out merger that the court later found
underpaid the minority stockholders by millions of dollars.5 See also, e.g.,
S. Peru, 52 A.3d at 819; In re Rural/Metro Corp. Stockholders Litig., 102
A.3d 205, 263 (Del. Ch. 2014).
E. New York Courts Favor Discovery and Frown on Pre-
Discovery Dismissal
Alpert’s requirement that freeze-out merger transactions be reviewed
for their entire fairness on an evidentiary record is also consistent with New
York’s broad policy favoring discovery. CPLR § 3016(b) requires plaintiffs
to plead complaints with “sufficient detail” so as “to inform the defendants
of the substance of the claims.” Limmer, 75 A.D.2d at 302; see also Foley v.
5 See Weinberger, 457 A.2d at 708 (2,953,812 of the 3,208,652 minority shares cast
voted to approve the merger); Weinberger v. UOP, Inc., Civ. Action No. 5642, 1985 Del.
Ch. LEXIS 378, at *3 (Del. Ch. Jan. 30, 1985) (on remand, awarding $1 per share
additional consideration for each of the company’s 5,688,502 minority shares).
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D’Agostino, 21 A.D.2d 60, 64 (1st Dep’t 1964). In the corporate law
context, this means that “it is inappropriate to dismiss a claim by invoking
the ‘business judgment rule,’ given that plaintiffs have set forth more than
conclusory allegations concerning defendants’ fiduciary duties.” Cohen v.
Seward Park Hous. Corp., 7 Misc. 3d 1015(A) (Sup. Ct. N.Y. Cty. 2005)
(citing Ackerman v. 305 E. 40th Owners Corp., 189 A.D.2d 665 (1st Dep’t
1993)); see also Marcus v. Jewish Nat’l Fund, 158 A.D.2d 101, 106 (1st
Dep’t 1990).
The Complaint fully meets this standard. It makes detailed and
extensive allegations describing the unfairness of the merger, which must be
accepted as true and afforded the benefit of every favorable inference at the
motion to dismiss stage. See Leon v. Martinez, 84 N.Y.2d 83, 87-88 (1994);
Palladino v. CNY Centro, Inc., 70 A.D.3d 1450 (4th Dep’t 2010). Plaintiff
adequately pled that the Going Private Transaction was unfair both as a
matter of price and process, including the Special Committee Defendants’
failure to meaningfully negotiate with Cole. The Special Committee never
considering rejecting Cole’s proposal, even when Cole reneged on his
improved $16-per-share offer. R. 577-80. Instead, the Special Committee
directed management to downwardly revise positive projections in order to
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justify accepting a lower bid. R. 578-79. It also failed to account for
significant real estate and tax assets that justified a much higher valuation
for the Company. Id. In other words, like in Southern Peru, the Special
Committee approached the negotiations with Cole under the controlled
mindset that “too often afflicts even good faith fiduciaries trying to address a
controller.” 52 A.3d at 763.
Plaintiff’s well-pled allegations entitled Plaintiff to discovery before
the case was dismissed.
F. Abandoning Alpert in Favor of Business Judgment Rule
Protection of Conflicted Freeze-Out Mergers Would Be Bad
Policy
As discussed above, Alpert and other relevant New York precedent
provide for entire fairness review in all controller buyouts. There is no basis
to subject the Going Private Transaction to deferential business judgment
review absent discovery and given well-pled allegations of unfair price and
process. Allowing for pre-discovery application of the business judgment
rule where, as here, minority investors are vulnerable to significant coercion
and harm from conflicted fiduciaries, would make New York law far less
protective of public investors, and would thereby threaten to drive those
investors to companies incorporated elsewhere.
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Here, both the Supreme Court and the Appellate Division decisions
rewarded conflicted, unscrupulous fiduciaries by insulating the Going
Private Transaction with deferential business judgment review. By
declining to evaluate the Transaction’s entire fairness, the First Department
departed from decades of sound, reasoned New York corporate law.
Left undisturbed, the First Department’s decision would establish
precedent in the First Department that would empower feckless fiduciaries
to pursue personal gain regardless of the cost to their companies and public
investors. Controlling stockholders would have a roadmap of how to “check
the boxes” to obtain pre-discovery dismissals of lawsuits challenging
conflicted transactions, even where process and terms are unfair. Just as
important, if they know that their conduct will never be scrutinized,
independent directors attempting to negotiate fair deals on behalf of minority
stockholders will have no effective recourse against controllers who seek to
force through unfair transactions.
G. While New York May Look to Delaware Law for Guidance,
The Court Should Maintain the Clear Alpert Standard of
Review for Controller Buyouts
New York courts have often looked to Delaware for guidance on
corporate law matters, especially on the entire fairness standard. See, e.g.,
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Alpert, 63 N.Y.2d at 570-71. In the decades since Weinberger and Alpert,
the Delaware courts, like the New York courts, have consistently applied the
entire fairness standard to controlling shareholder transactions. Tremont,
694 A.2d at 428-29; Ams. Mining, 51 A.3d at 1239.
In 2014, however, after the trial court below had already wrongly
dismissed this case, the Supreme Court of Delaware decided Kahn v. M&F
Worldwide, 88 A.3d 635 (Del. 2014) (“MFW”), which carved out a limited
exception to the bright-line entire fairness test. While MFW was a summary
judgment decision, it theoretically allows for controlling-shareholder cases
to be dismissed on the pleadings, “if and only if” the court finds that six
specific procedural protections are in place and were “effective.” Id. at 645-
46. New York and Delaware law have largely been consistent for decades
regarding the scrutiny to be applied to controlling shareholder transactions.
However, this Court should not follow MFW’s reasoning that if a controlling
shareholder complies with a series of superficial requirements, he can evade
entire fairness scrutiny. Application of an MFW-like standard in New York
would create serious risks of abuse and coercion for minority shareholders of
New York companies.
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MFW reiterated Delaware’s historical standard that “[w]here a
transaction involving self-dealing by a controlling stockholder is challenged,
the applicable standard of judicial review is ‘entire fairness,’ with the
defendants having the burden of persuasion.” 88 A.3d at 642. However, for
the first time, the Delaware Supreme Court also held that controller buyouts
may be reviewed under the business judgment rule rather than entire
fairness, “if and only if”:
(i) the controller conditions the procession of the transaction on
the approval of both a Special Committee and a majority of the
minority stockholders; (ii) the Special Committee is
independent; (iii) the Special Committee is empowered to
freely select its own advisors and to say no definitively; (iv) the
Special Committee meets its duty of care in negotiating a fair
price; (v) the vote of the minority is informed; and (vi) there is
no coercion of the minority.
Id. at 645 (emphasis in original). For the burden shift to happen on the
pleadings before discovery, the shareholder plaintiff must fail to plead any
“reasonably conceivable set of facts” challenging any of those six factors.
Id.
MFW’s six specific pre-conditions are exceedingly difficult to
evaluate pre-discovery. Indeed, since MFW was decided, to Plaintiff’s
knowledge only one case has been dismissed on the pleadings under MFW’s
new pleading standard: Swomley v. Schlecht, No. 9355-VCL, 2014 WL
-35-
4470947 (Del. Ch. Aug. 27, 2014), a transcript ruling that is currently on
appeal. Even in MFW itself, which granted summary judgment to
defendants, the court held that the complaint would have survived a pre-
discovery motion to dismiss. 88 A.3d at 645 n.14. Similarly, here,
Plaintiff’s complaint would survive MFW scrutiny on the pleadings because
Plaintiff’s “allegations about the sufficiency of the price call into question
the adequacy of the Special Committee’s negotiations, thereby necessitating
discovery on all of the new prerequisites to the application of the business
judgment rule.” Id.
Nevertheless, even though MFW appears to have limited application
in pre-discovery motions to dismiss, the Delaware Supreme Court’s decision
is surprising in light of Delaware’s historic skepticism of controller buyouts
due to their inherent risk of abuse. Several of the MFW factors are very
difficult for plaintiffs to plead before getting discovery, which may lead to
meritorious cases – where controlling shareholders took advantage of the
minority shareholders – getting dismissed.
Instead, the Court should continue to endorse Alpert’s bright-line
entire fairness test. Special committees and majority-minority votes are not
adequate protections against abuse by controlling shareholders. Southern
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Peru serves as a good example of a special committee negotiation where the
process appeared pristine on the surface, but was wholly corrupt underneath.
The Southern Peru court concluded that the special committee members
were “competent businessmen [who] may have had the best of intentions . . .
[but] allowed themselves to be hemmed in by the controlling stockholder’s
demands.” 52 A.3d at 800-01.
Similarly, majority-minority votes are inadequate protection against
unfair conduct by a controlling shareholder. Such votes can been coerced by
fear of “retaliation,” and “even when the transaction is negotiated by a
special committee of independent directors no court could be certain
whether the transaction fully approximated what truly independent parties
would have achieved in an arm’s length negotiation.” Tremont, 694 A.2d at
428. Under MFW, therefore, challenges to interested transactions that may
very well be unfair will likely be dismissed before plaintiffs, and courts, can
ever inquire into whether the process was indeed fair. That is bad policy in
Delaware, and would be bad policy in New York.
Appellant therefore respectfully submits that the clear standard under
Alpert, which requires conflicted fiduciaries to prove the fairness of a freeze-
out merger, needs no further caveats. Alpert protects shareholders from
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coercion in a way that even well-intended procedural protections
demonstrably cannot.
In addition, New York shareholders have less access to corporate
information or alternative recourse than do shareholders in Delaware,
making an MFW-like standard even more potentially dangerous in this state.
For example, unlike New York, Delaware law grants shareholders the right
to inspect corporate books and records before filing a complaint.
Shareholders therefore have access to nonpublic documents before filing
suit, which helps protect against meritorious cases being dismissed.6 Also,
unlike New York, in Delaware if a shareholder cannot plead that a controller
failed to comply with MFW, the shareholder can still seek appraisal – in
which the shareholder asks a court to set the “fair value” for the shares –
rather than file a class action. Under N.Y. Bus. Corp. L. § 910, however,
shareholders of New York corporations cannot seek appraisal for their
shares if the shares are listed on a national exchange like the New York
Stock Exchange, as KCP shares were prior to the Going Private Transaction.
6 Compare 8 Del. C. § 220 with N.Y. Bus. Corp. L. § 624 (shareholders of a New York
corporation are entitled only to examine the minutes of the proceedings of the company’s
shareholders and record of shareholders).
Thus even if MFW were good policy in Delaware (which Plaintiff
respectfully submits it is not), this Court should not adopt a similar standard
here. MFW rests on the premises that independent special committees and
majority-minority votes can ensure that controlling shareholder freeze-out
transactions are fair. Those premises have frequently been proven wrong.
New York courts should not adopt a new set of caveats to the clear Alpert
standard, which would need to be interpreted and applied across New York's
broad and diverse court system. Rather than exposing shareholders in New
York companies to potential abuse by conflicted insiders, the Court should
re-affirm Alpert's clear standard- that controlling shareholders must prove
that conflicted freeze-out transactions are entirely fair to the minority.
VII. CONCLUSION
The order of the Appellate Division should be reversed. Defendants'
motion to dismiss should be denied, and the case remanded for discovery to
proceed. Defendants should thereafter bear the burden of proving that the
Transaction was entirely fair to the Company's minority shareholders.
Dated: New York, New York
August 7, 2015
BERNSTEIN LITOWITZ
BERGER & GROSSMANN LLP
-38-
KESSLER TOPAZ
MELTZER & CHECK, LLP
Lee Rudy
Michael Wagner
Leah Heifetz
280 King of Prussia Road
Radnor, PA 19087
Tel: (610) 667-7706
Fax: (610) 667-7056
Co-Lead Counsel for Plaintiff-
Appellant
Adam Hollander
1285 A venue of the Americas
New York, NY 10019
Tel: (212) 554-1400
Fax: (212) 554-1444
Co-Lead Counsel for Plaintiff-
Appellant
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