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
State of New York
IN RE KENNETH COLE PRODUCTIONS, INC.
ERIE COUNTY EMPLOYEES RETIREMENT SYSTEM,
– 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.,
REPLY BRIEF FOR LEAD PLAINTIFF-APPELLANT
KESSLER TOPAZ MELTZER
& CHECK, LLP
280 King of Prussia Road
Radnor, Pennsylvania 19087
Tel.: (610) 667-7706
Fax: (610) 667-7056
JEROEN VAN KWAWEGEN
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
Date Completed: October 8, 2015
TABLE OF CONTENTS
I. INTRODUCTION ..................................................................................... 1
II. NEW YORK LAW HOLDS THAT BECAUSE COLE HAD
AN "INHERENT CONFLICT," THE TRANSACTION MUST
BE REVIEWED FOR ITS ENTIRE FAIRNESS ..................................... 5
A. Defendants Cite No New York Law Holding That
Conflicted Fiduciary Conduct Gets Reviewed Under
The Business Judgment Rule Just Because A Transaction
Is Subject To Procedural Protections .............................................. 7
B. Defendants Cite No New York Law Holding That
Conflicted Fiduciary Conduct Gets Reviewed Without
Discovery ....................................................................................... 1 0
C. Appellant's Claims Against Cole And Against The
Special Committee Defendants Are Distinct; Allegations
Against The Special Committee Serve Two Distinct
Purposes ......................................................................................... 14
III. A NEW,MFW-TYPE STANDARD IN NEW YORK WILL
CAUSE MERITORIOUS CASES TO BE DISMISSED SIMPLY
IF DEFENDANTS "CHECK THE RIGHT BOXES" ............................ 18
A. Two Recent Trials Involving Controlling Stockholder
Transactions Demonstrate That MFW's Procedural
Safeguards Cannot Fully Protect Stockholders ............................. 19
B. MFWEncourages Defendants To Check Boxes, Rather
Than Treat Minority Stockholders Fairly ...................................... 22
C. Defendants' Argument That New York Should Adopt
The MFW Standard To Promote "Consistency" With
Delaware Is Both Wrong And Irrelevant ...................................... 23
IV. EVEN IF THE COURT ADOPTS AN MFW-TYPE STANDARD,
THIS ACTION WOULD SURVIVE A MOTION TO DISMISS .......... 25
V. CONCLUSION ........................................................................................ 28
TABLE OF AUTHORITIES
Ackerman v. 305 East 40th Owners Corp.,
189 A.D.2d 665 (1st Dep't 1993) ........................................................... 10, 16
Alpert v. 28 Williams St. Corp.,
63 N.Y.2d 557 (1984) ............................................................................ passim
Auerbach v. Bennett,
47 N.Y.2d 619 (1979) ................................................................................... 16
Brody v. Catell,
16 Misc. 3d 1105(A) (Sup. Ct. Kings Cnty. 2007) ................................. 11, 12
Chelrob, Inc. v. Barrett,
293 N.Y. 442 (1944) ....................................................................................... 8
Cohen v. Seward Park Hous. Corp.,
7 Misc. 3d 1015(A) (Sup. Ct. N.Y. Cnty. 2005) ........................................... 17
In re Cox Commc'ns, Inc. S'holders Litig.,
879 A.2d 604 (Del. Ch. 2005) ............................................................. 2, 24, 25
In re Dole Food Co., Stockholder Litig.,
Consol. C.A. No. 8703-VCL, 2015 Del. Ch. LEXIS 223 (Del. Ch. Aug. 27,
2015) ....................................................................................................... passim
Kahn v. M&F Worldwide Corp.,
88 A.3d 635 (Del. 2014) ........................................................................ passim
Kahn v. Tremont,
694 A.2d 422 (Del. 1997) ............................................................................. 22
Kimeldorfv. First Union Real Estate Equity & Mortg. Invs.,
309 A.D.2d 151 (1st Dep't 2003) ..................................................... 11, 12, 19
Limmer v. Medallion Grp., Inc.,
75 A.D.2d 299 (1st Dep't 1980) ............................................................... 8, 10
Lyondell Chemical Co. v. Ryan,
970 A.2d 235 (Del. 2009) ............................................................................. 18
Minzer v. Keegan,
No. CV-97-4077 (CPS), 1997 WL 34842191 (E.D.N.Y. Sept. 22, 1997) ... 18
Owen v. Hamilton,
44 A.D.3d 452 (1st Dep't 2007) ....................................................... 11, 12, 13
In re Rural Metro Corp. S'holders Litig.,
No. 6350-VCL, 2013 Del. Ch. LEXIS 302 (Del. Ch. Dec. 17, 2013) ............ 9
In reS. Peru Copper Corp., S'holder Derivative Litig.,
52 A.3d 761,819 (Del. Ch. 2011) .......................................................... passim
Saito v. McKesson HBOC, Inc.,
806 A.2d 113 (Del. 2002) ............................................................................. 24
Stilwell Value Partners, IV, L.P. v. Cavanaugh,
41 Misc. 3d 1216(A) (Sup. Ct. N.Y. Cnty. 2013), aff'd, 118 A.D.3d 518 (1st
Dep't 2014) ................................................................................................... 10
In re Viacom Inc. S'holder Derivative Litig.,
Case No. 602527/05, 2006 N.Y. Misc. LEXIS 2891 (Sup. Ct. N.Y. Cnty.
2006) .............................................................................................................. 25
Weinberger v. Quinn,
264 A.D. 405 (1st Dep't 1942), aff'd, 290 N.Y. 635 (1943) ........................ 14
Youlu Zheng v. Icahn,
38 Misc. 3d 1217(A) (Sup. Ct. N.Y. Cnty. 2006) ......................................... 25
8 Del. C. § 220 .................................................................................................... 24
N.Y. Bus. Corp. L. § 624 ................................................................................... 24
Jeffrey J. Clark, Recent Developments in Delaware Corporate Law: Kahn v.
Lynch Commn 'c Sys., Inc.: A Major Step Toward Clarifying the Role of
Independent Committees, 20 Del. J. Corp. L. 564 (1995) ...................... 15, 22
Appellant submits this Reply brief to address three points raised by
Defendants in their Opposition Brief.
First, Defendants argue that the Transaction1 is not a "self-interested"
transaction that warrants entire fairness review under Alpert and the other
precedents Appellant cited in its Opening Brief. New York law is clear,
however, that when a controller buys out the public shareholders, that defendant
has an "inherent conflict," and the resulting transaction must be reviewed for its
entire fairness. Cole's inherent conflict here was not cured by the Company's
independent directors approving the Transaction, or by the minority
stockholders voting in favor of it. No New York case supports Defendants'
argument to the contrary. Nor did any "longstanding precedents" allow the
courts to dismiss this litigation on the pleadings. Def. Br. at 24. New York
courts refuse to dismiss cases alleging bad faith conduct without first affording
the plaintiff access to discovery, and none of the cases in Defendants' brief hold
Under well-established entire fairness law, Cole's conditioning the
Transaction on approval by the Special Committee and a majority-minority vote
can be offered by Cole as proof that the Transaction was the result of "fair
1 Capitalized terms have the meanings defined in the Brief for Lead Plaintiff-Appellant. The
Joint Brieffor Defendants-Respondents is referred to herein as "Def. Br."
dealing." Alpert v. 28 Williams St. Corp., 63 N.Y.2d 557, 570-71 (1984) ("an
independent negotiating committee" and "how the necessary approvals were
obtained" are proof of "fair dealing"). These protections, however, do not
change the fundamental nature of this conflicted transaction. Cole still faces an
"inherent conflict," and strict judicial scrutiny is still required. Unlike
transactions with non-conflicted boards of directors, these sort of cases are
where the greatest "danger exists" of exploitation and abuse. Id. at 567 n.2; see
also In re Cox Commc 'ns, Inc. S 'holders Litig., 879 A.2d 604, 617 (Del. Ch.
2005) ("mergers with controlling stockholders involve an extraordinary
potential for exploitation by powerful insiders"). Courts should not be blindly
deferring to directors' business judgment in approving them.
Second, Defendants urge this Court to adopt a brand new standard of
review for litigation challenging controlling-stockholder mergers. Specifically,
Defendants say that this Court should borrow the Delaware Supreme Court's
standard from Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014)
("MFW''), and adopt it wholesale (and even more strictly) in New York.
Otherwise, Defendants argue, New York courts will be overrun with a flood of
meritless litigation that they will be ill-equipped to handle. As explained
below, the sky is not falling in New York, and requiring conflicted fiduciaries
to prove the entire fairness of self-interested transactions poses no risk of undue
burden on New York courts.
Adopting MFW in New York would also be poor public policy. MFW
does nothing to reduce the overall volume of merger litigation referenced by
Defendants, see Def. Br. at 4 n.l. Rather, business judgment review would only
make a very specific subset of merger cases - those proposed by controlling
stockholders - easier to dismiss. That specific type of merger case, meanwhile,
targets inherently conflicted deals and, thus, has resulted in some of the largest
judgments in history for stockholders. See, e.g., In reS. Peru Copper Corp.,
S'holder Derivative Litig., 52 A.3d 761, 819 (Del. Ch. 2011) ($2 billion
judgment); In re Dole Food Co., Stockholder Litig., Consol. C.A. No. 8703-
VCL, 2015 Del. Ch. LEXIS 223, at *158 (Del. Ch. Aug. 27, 2015) ($148
million judgment). Controlling-stockholder merger cases are also relatively
uncommon in New York,2 so making them easier to dismiss will do little, as
Defendants propose (Def. Br. 26-27) to ease the burden on New York courts.
Third, even if this Court were to adopt MFW as the new legal standard
governing cases such as this (which it should not), Appellant's case still should
not have been dismissed on the pleadings. MFW was decided after summary
judgment. Discovery in MFW demonstrated not only that the deal had been
2 The study cited by Defendants, Def. Br. at 4 n.1, reflects that only 1 0 out of approximately
135 challenged mergers in 2014 (of all types) were litigated in New York.
conditioned on a special committee's approval and a majority-minority vote,
but that those procedural protections had been "effective." MFW, 88 A.3d at
646-47. This analysis cannot be undertaken on the pleadings, especially where
Appellant has pled facts to suggest that the Special Committee failed to
"exercise real bargaining power 'at an arms-length."' Id. at 646. These facts
would prevent dismissal of the case on the pleadings, even under MFW, as the
Delaware Supreme Court specifically explained. Id. at 645 n.14 ("The .. .
Complaint would have survived a motion to dismiss under this new standard .. .
These allegations . . . call into question the adequacy of the Special
Committee's negotiations, thereby necessitating discovery").
* * *
Appellant asks that the Court reverse the courts below, reaffirm the
longstanding New York law of Alpert, Chelrob, and Limmer, and continue to
require conflicted fiduciaries to prove the entire fairness of self-interested
transactions. Under controlling New York precedents, well pled complaints
challenging such transactions cannot be dismissed without discovery. New
York already has a workable and policy-driven standard for addressing
challenges to conflicted transactions, which have a high risk of abuse to
minority stockholders. The courts below should be reversed, and the case
should proceed into discovery.
II. NEW YORK LAW HOLDS THAT BECAUSE COLE HAD AN
"INHERENT CONFLICT," THE TRANSACTION MUST BE
REVIEWED FOR ITS ENTIRE FAIRNESS
Defendants' position is that under New York law, a public company's
controlling shareholder, with 89% of its voting power, can stand on the opposite
side of the minority shareholders in a going-private transaction, and New York
law will apply the deferential business judgment rule the same way that it
would for a truly arm's-length transaction. Defendants unsurprisingly cannot
cite a single New York case supporting this proposition, because courts refuse
to defer to the "business judgment" of directors in approving such inherently
conflicted transactions, for good reason.
Cole was KCP's majority stockholder, and in the Transaction he sought
to buy the minority KCP shares he did not own for the lowest possible price.
These two facts alone establish that Cole was "conflicted" and the Transaction
requires entire fairness review. See, e.g., Alpert, 63 N.Y.2d at 570 (in
transactions involving "majority ownership, the inherent conflict of interest and
the potential for self-dealing requires careful scrutiny of the transaction," and
therefore "the burden shifts to the interested directors or shareholders to prove
good faith and ... entire faimess'V
3 Unless otherwise noted, all emphasis is supplied and all internal citations omitted.
Defendants argue that this statement in Alpert was limited only to a
particular type of controlling shareholder merger ("two-step mergers"), Def.
Br. at 5-6, 20-24, but Appellant's Opening Brief, at 21-26, explained at length
why this is wrong. Alpert explained that while different facts might suffice to
prove the entire fairness of different types of controlling shareholder merger
cases, all such transactions are "freeze-outs." 63 N.Y.2d at 567 n.3. And "in
freeze-outs the danger exists that 'a self-interested majority stockholder ... has
ruled unfairly' thus necessitating the need for 'safeguards' ... " Id. at 567 n.2.
Nowhere in Alpert (nor in Chelrob, nor in Limmer) does the court say that if the
self-interested transactions at issue had been conditioned on a special
committee or majority-minority vote, that the entire fairness standard would
have given way to business judgment deference.
In fact no New York precedent supports Defendants' bald assertion that
by subjecting the Transaction to Special Committee approval and a majority-
minority vote, entire fairness review is abandoned in favor of lenient business
judgment review. No New York law holds that a conflicted fiduciary can get
litigation challenging his conduct dismissed on the pleadings without discovery.
Rather, decades of case law, including the very cases Defendants cite, say the
It is important, however, to distinguish between Appellant's claims
against Cole and its claims against the Special Committee members. Cole must
prove that the Transaction was entirely fair, both in price and process. As proof
of "fair process," Cole will seek to prove, among other things, that the Special
Committee acted properly and protected the interests of minority stockholders.
See, e.g., Alpert, 63 N.Y.2d at 570-71. The Special Committee Defendants bear
no such burden of proof. Rather, to support its claim against the Special
Committee members, Appellant must plead that they acted in bad faith.
Allegations that the Special Committee members failed adequately to negotiate
with Cole therefore serve two distinct purposes: first, they state a claim that
these Defendants breached their fiduciary duties of good faith; and second, they
rebut Cole's claim (which he must prove) that the Transaction was the result of
"fair dealing." See id. at 570-71.
A. Defendants Cite No New York Law Holding That Conflicted
Fiduciary Conduct Gets Reviewed Under The Business
Judgment Rule Just Because A Transaction Is Subject To
Defendants concede, as they must, that Cole had a conflict. Def. Br. at
27 ("It is of course beyond dispute that Mr. Cole had an interest in paying [KCP
shareholders] as little as possible for the public stock"). They also concede that
"when corporate officials . . . engage in fraud or self-dealing or . . . make
decisions affected by inherent conflict of interest, the burden shifts to
defendants to prove the fairness of the challenged acts." Def. Br. at 28, citing
Wolfv. Rand, 258 A.D.2d 401, 404 (1st Dep't 1999).
Under New York law, it follows that the Transaction should be reviewed
for its entire fairness. See Alpert, 63 N.Y.2d at 570 ("When, however, there is
. . . majority ownership, the inherent conflict of interest and the potential for
self-dealing requires careful scrutiny of the transaction."); Chelrob, Inc. v.
Barrett, 293 N.Y. 442, 461-62 (1944) (requiring directors serving on boards of
both parent and subsidiary to prove entire fairness of transaction between the
two); Limmer v. Medallion Grp., Inc., 75 A.D.2d 299, 303 (1st Dep't 1980)
(requiring controlling shareholders to demonstrate entire fairness of sale-
leaseback arrangement with the company).
Defendants disagree. They posit, without a single New York authority,
that Cole's "inherent conflict" can be presumptively and definitively cleansed
by conditioning the Transaction on two procedural protections. By
conditioning the Transaction on Special Committee approval and a majority-
minority vote, they say, Cole was no longer engaging in "self-dealing," and his
"inherent conflict of interest" was effectively immunized. Def. Br. at 27-28.
Putting aside the fact that Defendants cannot cite a single New York case
supporting this argument, this logic effectively turns the entire fairness doctrine
on its head. The entire fairness analysis requires a conflicted defendant to
present proof of fair dealing and fair price. Alpert, 63 N.Y.2d at 569. Alpert
specifically lists special committees and minority votes as evidence of "fair
dealing." See id. at 569-70 (conflicted fiduciary may "introduc[ e] evidence of
efforts taken to simulate arm's length negotiations," such as "the appointment
of an independent negotiating committee made up of neutral directors or of an
independent board to evaluate the merger proposal and to oversee the process of
its approval..."); id. at 570-71 ("disclosure to the independent directors and
shareholders, and how the necessary approvals were obtained," is also part of
the "fair dealing" analysis). If the mere presence of these procedural
protections were enough to cause a transaction to be viewed under the business
judgment rule, Alpert's description of how these facts could be offered to prove
fair dealing under the entire fairness analysis would make no sense.
Appellant agrees that the two procedural safeguards on which Cole
conditioned his offer - Special Committee approval and a majority-minority
vote- are important protections for stockholders.4 As Alpert specifically holds,
4 Without discovery, however, Appellant does not concede that the Special Committee
functioned properly, or that the vote was conducted fairly on full information to stockholders.
Contrary to Defendants' representation, Appellant has never conceded the truth of
Defendants' SEC filings, Def. Br. at 10 n.4. In fact, Appellant specifically alleged in its
Complaint that the Proxy was materially misleading. R. 585-86. Nor should this Court
accept the contents of Defendants' self-interested proxy materials for their truth. See, e.g., In
re Rural Metro Corp. S'holders Litig., No. 6350-VCL, 2013 Del. Ch. LEXIS 302, at *23
(Del. Ch. Dec. 17, 2013) (explaining that a court could take judicial notice of a proxy
statement to establish when it was filed or identify its statements, but not for its truth).
Defendants also criticize Appellant for failing to "inform the Court" that the Transaction
those protections are relevant to the Transaction's procedural fairness. But
nothing in New York law suggests that a conflicted transaction which employs
these two procedural devices can avoid entire fairness review. New York law
consistently recognizes that the business judgment rule does not insulate
conflicted fiduciaries who benefit from self-interested transactions. Rather, as
described above, courts are always asked to review conflicted transactions, on
an evidentiary record, for their entire fairness.
B. Defendants Cite No New York Law Holding That Conflicted
Fiduciary Conduct Gets Reviewed Without Discovery
Under clear New York law, conflicted fiduciary conduct is always
reviewed on a discovery record. See, e.g., Stilwell Value Partners, IV, L.P. v.
Cavanaugh, 41 Misc. 3d 1216(A) (Sup. Ct. N.Y. Cnty. 2013), aff'd, 118 A.D.3d
518 (1st Dep't 2014) ("the entire fairness of the Directors' decision ... cannot
be made at this stage of the litigation and is more appropriately reserved for ...
after there has been discovery on these issues"); Limmer, 75 A.D.2d at 303 ("in
cases of fraud [and "self dealing"] such detail[s] ... are peculiarly within the
knowledge of the other party"). This is even true regardless of whether the
challenged transaction is subject to entire fairness. Ackerman v. 305 East 40th
Owners Corp., 189 A.D.2d 665, 667 (1st Dep't 1993) ("Pre-discovery dismissal
received "overwhelming support" in the stockholder vote. Def. Br. at 3. But the vote tally
and the proper administration of the vote are facts outside the pleadings, and Appellant has
no obligation to accept them as true.
of pleadings in the name of the business judgment rule is inappropriate where
those pleadings suggest that the directors did not act in good faith").
Defendants cannot cite a single case for the proposition that New York
law allows for pre-discovery dismissal of conflicted fiduciary conduct under the
business judgment rule. Def. Br. at 19. Rather, in each of Defendants' three
cases,5 none of which were subject to entire fairness review, the court still only
deferred to directors' business judgment after discovery.
Defendants describe Kimeldorf as holding that "the business judgment
rule was held to apply even though the defendant merger partner was
'principally owned' by its largest shareholder and managed by the former
chairman of its board." Def. Br. at 19. First, the buyer in Kimeldorfwas not
the target company's controlling shareholder. Kimeldorf, 309 A.D.2d at 156
("Defendants' holdings, collectively, do not comprise a controlling interest in
First Union"). Second, while no party contests here that Cole owed fiduciary
duties to KCP's common shareholders,6 the Kimeldorf court noted that "there is
some doubt that a fiduciary duty is even owed to the preferred share owners
under these circumstances." Id. at 160. Third, the Kimeldorf court was
5 See Def. Br. at 19-20 (citing Kimeldorfv. First Union Real Estate Equity & Mortg. Invs.,
309 A.D.2d 151 (1st Dep't 2003); Brody v. Catell, 16 Misc. 3d 1105(A) (Sup. Ct. Kings
Cnty. 2007); and Owen v. Hamilton, 44 A.D.3d 452 (1st Dep't 2007)).
6 See Alpert, 63 N.Y.2d at 568 ("majority shareholders ... are cast in the fiduciary role of
'guardians of the corporate welfare"').
reviewing a factual record developed through discovery in which defendants
were deposed. ld. at 159. That record revealed that the special committee had
shopped the company for sale to "some 90 prospective strategic partners," id.,
and the court found that "Plaintiffs real grievance is with First Union's
management and the course that it has charted for the company." Id. at 156.
Thus, Kimeldorf actually undermines Defendants' argument that business
judgment review should apply to this self-interested controlling shareholder
buyout at the motion to dismiss stage.
Neither Brody nor Owen were decided on a pre-discovery motion to
dismiss. Nor did either of those decisions involve buyouts of minority
shareholders by controlling shareholders. Brody simply approved, on a
discovery record, a settlement of merger litigation challenging a third-party
merger between two companies with independent boards. That discovery
record allowed the plaintiffs and the Court to fully evaluate the case and
determine that the fiduciary duty claims in the case did not have a strong chance
of success. Owen did not involve the buyout of minority shareholders either.
There, a shareholder brought suit against the board of directors because it had
given permission to two members of the board to buy a competitor company,
thereby foregoing a corporate opportunity. Discovery showed that the directors
who approved that personal acquisition were truly independent and, moreover,
that their consent to the acquisition was "taken in furtherance of [the
company's] interests, was within the scope of the board's authority and was
taken in good faith." Owen, 44 A.D.3d at 456. Notably, in Owen, it was those
independent directors - not the controllers - who proposed the transaction. !d.
The discovery records were critical to the outcomes of each of these cases; they
cannot be compared to a motion to dismiss, on the pleadings, an action that
challenges the kind of self-dealing transaction that raises the greatest threat of
abuse to minority stockholders.
Even MFW, which Defendants ask this Court to adopt, precludes
summary dismissal of challenges to transactions just because they employ both
a special committee and a majority-minority vote. See infra Section IV.
Rather, MFW requires that those procedural protections be "effective." MFW,
88 A.3d at 645-46. "If, after discovery, triable issues of fact remain about
whether either or both of the dual procedural protections were established, or if
established were effective, the case will proceed to a trial in which the court will
conduct an entire fairness review." Id. 7
When a controller stands on both sides of a transaction, and particularly
when there are credible factual allegations of breaches of fiduciary duty,
7 Defendants can only cite a single unreported Delaware trial court opinion dismissing a
controlling-stockholder case under MFW on the pleadings. Def. Br. at 26 n.7. To
Appellant's knowledge, the facts of that case are markedly different from those here.
judicial oversight is necessary to ensure that minority shareholders were treated
fairly. Whether there was a fair process by which director defendants
sufficiently approximated an arm's-length process and thereby protected the
interests of minority shareholders is a factual determination to be made after
discovery. Otherwise, abusive and conflicted directors could simply "check
boxes" by creating merely the appearance of fairness, and courts would be
obliged to dismiss such cases, regardless of whether the deals were in fact fair
or whether reasonable discovery would uncover serious, abusive conduct.
C. Appellant's Claims Against Cole And Against The Special
Committee Defendants Are Distinct; Allegations Against The
Special Committee Serve Two Distinct Purposes
While Appellant alleges that all of the Defendants breached their
fiduciary duties to KCP's stockholders, only Cole is required to prove the entire
fairness of the Transaction. This is because the Special Committee Defendants
did not have an "inherent conflict" in negotiating the Transaction. While
Appellant's claims against Cole cannot be dismissed without Cole proving
(with evidence) that the Transaction was entirely fair, its claims against the
Special Committee members require Appellant to allege sufficiently that these
Defendants acted in bad faith. See Weinberger v. Quinn, 264 A.D. 405, 408
(1st Dep't 1942), aff'd, 290 N.Y. 635 (1943) (holding that "[f]acts showing bad
faith or other breach of duty must be alleged" against directors who were not
Thus Appellant must plead with greater particularity its claims against
the Special Committee than its claims against Cole. As one commentator
Notably, the two standards of review are often applied differently
to different defendants. One standard may apply to one fiduciary
while another fiduciary in the same transaction is subject to a
different standard. Accordingly, a corporation's majority
shareholder would often be subject to the entire fairness standard,
while the directors' actions would be critiqued under the business
Jeffrey J. Clark, Recent Developments in Delaware Corporate Law: Kahn v.
Lynch Commn 'c Sys., Inc.: A Major Step Toward Clarifying the Role of
Independent Committees, 20 Del. J. Corp. L. 564, 567 (1995); see also S. Peru,
52 A.3d at 787 n.72 (The entire fairness standard "ill suits the inquiry whether
disinterested directors ... can be held liable for breach of fiduciary duties ...
[T]he more stringent, strict liability standard applicable to interested parties
such as [the controller] is critically different than that which must be used to
address directors such as those on the Special Committee.") (emphasis in
Appellant's allegations regarding the Special Committee's conduct are
therefore relevant in two distinct ways. First, these allegations support
Appellant's claims against the Special Committee Defendants for their bad faith
conduct in approving the Transaction. Second, these same allegations of the
Committee's ineptitude counter Cole's argument (for which he has the burden
of proof) that the Transaction was the result of "fair dealing." These two
purposes should not be confused.
Appellant has adequately alleged that the Special Committee members
breached their fiduciary duties of good faith and loyalty by approving the
Transaction. Among other things, the Special Committee made no meaningful
attempt to extract a better price from Cole in the Transaction, inexplicably
rejected positive internal Company financial projections, and insisted on
justifying Cole's inadequate offer price behind negative projections. R. 578-79.
It ignored the value of tax benefits and the Company's real estate holdings. R.
583; 578. It allowed Cole to walk away from his $16 per share offer on the
flimsiest of excuses, and failed to perform any form of a market check. R. 577,
These allegations were more than sufficient to survlVe the Special
Committee members' motion to dismiss. See, e.g., Ackerman, 189 A.D.2d 665
at 667 ("Pre-discovery dismissal of pleadings in the name of the business
judgment rule is inappropriate where those pleadings suggest that the directors
did not act in good faith"); Auerbach v. Bennett, 41 N.Y.2d 619, 629, 635
(1979) (describing good faith actions of corporate directors as being "in the
exercise of honest judgment in the lawful and legitimate furtherance of
corporate purposes" and noting that "questions of good faith ... would never be
shielded by" the business judgment rule); Cohen v. Seward Park Hous. Corp., 7
Misc. 3d 1015(A) (Sup. Ct. N.Y. Cnty. 2005) (holding that "it is inappropriate
to dismiss a claim by invoking the 'business judgment rule,' given that
plaintiffs have set forth more than conclusory allegations concemmg
defendants' fiduciary duties.").
But even if Appellant's claims against the Special Committee members
fail, either on the pleadings or at summary judgment, its allegations that the
Special Committee failed to act reasonably would still be relevant to its claims
against Cole. Cole would still need to prove that the Transaction was entirely
fair, and these facts would be relevant to rebut Cole's arguments. The Court's
analysis of whether Appellant has stated a claim against the Special Committee
defendants is distinct from the analysis of whether Cole can prove that the
Transaction was the result of a fair process.
As but one example, the special committee members in Southern Peru
were dismissed from the litigation at the summary judgment stage. S. Peru, 52
A.3d at 785-86.8 After dismissing these individuals as defendants, however, the
Southern Peru decision went on to hold that they had failed to negotiate
effectively with the controller. Thus the controller was held liable because it
was unable to prove that the deal was entirely fair. Id. at 797-98, 813.
III. A NEW, MFW-TYPE STANDARD IN NEW YORK WILL CAUSE
MERITORIOUS CASES TO BE DISMISSED SIMPLY IF
DEFENDANTS "CHECK THE RIGHT BOXES"
Defendants argue that that "if Appellant's arguments are accepted, [class
action merger] litigation will proliferate because there will be no judicial
mechanism to dismiss such claims, no matter how meritless or flimsy the
allegations." Def. Br. at 3-4. But that argument conflates litigation challenging
third-party, non-conflicted mergers with litigation challenging controlling-
stockholder mergers.9 Third-party mergers are not typically "self-dealing"
transactions. These lawsuits are therefore already properly reviewed - and
typically dismissed- under the business judgment rule. 10
New York's courts have struck an appropriate balance that allows third-
party merger litigation to be dismissed on the pleadings where appropriate,
8 After discovery, the court held that the special committee defendants had not breached their
duties of good faith or loyalty, but were at most careless, which conduct was exculpated
under the company's charter. See id.
9 The study cited by Defendants, Def. Br. at 4 n.l reflects that most merger litigation
challenges third-party mergers. None of the nine most litigated M&A deals in the study
(accounting for 129 out of 608 lawsuits filed) were controlling-stockholder transactions.
10 See Minzer v. Keegan, No. CV-97-4077 (CPS), 1997 WL 34842191, at *10-12 (E.D.N.Y.
Sept. 22, 1997); Lyondell Chemical Co. v. Ryan, 970 A.2d 235,242-43 (Del. 2009).
while properly requiring careful post-discovery judicial scrutiny of conflicted
transactions. See Kimeldorf, 309 A.D.2d at 156 (applying business judgment
rule review to a transaction that it determined to be a third-party merger). This
balance needs no adjustment. Adopting a more lenient standard of review for
controlling-stockholder merger cases - and allowing them to be dismissed on
the pleadings as Defendants propose- would make New York a decidedly anti-
shareholder jurisdiction, and would undoubtedly result in dismissal of
meritorious cases. As recent trial victories for stockholders in Delaware
demonstrate, controlling-stockholder transactions are rife with the potential for
abuse. SeeS. Peru, 52 A.3d at 819; Dole, 2015 Del. Ch. LEXIS 223, at *158.
These trials also show that even when such deals are negotiated by special
committees, and endorsed by a majority of the minority stockholders, they can
still be massively unfair.
A. Two Recent Trials Involving Controlling Stockholder
Transactions Demonstrate That MFW's Procedural
Safeguards Cannot Fully Protect Stockholders
Lest there be any doubt, two recent trials challenging controlling-
shareholder mergers - Southern Peru and Dole - are certainly "examples of
situations when a plaintiff's attack on a [controlling-stockholder merger] has,
by actual litigation, added actual value." See contra Def. Br. at 42 (citing Cox,
879 A.2d at 630-31 ). 11 Both deals were conditioned on the approval of special
committees, and both were approved by a majority of the company's minority
stockholders. Under Defendants' proposed new legal standard, both cases
would have been dismissed on the pleadings.
Defendants miss the point when they contend that "where a plaintiff can
plead facts as egregious as those alleged in Southern Peru, he might well be
able to ... defeat a motion to dismiss." Def. Br. at 35. The plaintiff in
Southern Peru himself could not have pleaded the "egregious" facts that led to
a $2 billion plaintiffs' verdict, because those facts came out only in discovery.
Prior to discovery, the plaintiff in Southern Peru only knew what the company
had included in its proxy materials and other public filings: that while the price
may have looked unfair, it had been reached after a months'-long negotiation
with an independent special committee, and that "[ m ]ore than 90% of the
stockholders" voted to approve it. S. Peru, 52 A.3d at 778 n.44, 785.12 All of
the facts that eventually showed how Southern Peru's special committee had
been dominated and controlled by its majority shareholder were developed in
11 There have also been numerous settlements in recent years in which litigation challenging
a negotiated deal with a special committee resulted in significantly increased consideration to
minority stockholders. The study referenced by Defendants, Def. Br. at 4 n.l, in fact, lists
$280.5 million in M&A litigation settlements plus one $76 million trial victory just in 2014.
12 The shares voted by the controller and a large stockholder who had pledged its support for
the merger, Def. Br. at 37-38, only added up to 68.4% of the vote. S. Peru, 52 AJd at 778
n.44, n.45. To get 90% of the votes, therefore, 68% of the company's remaining minority
stockholders (21.6% + 31.6%) still needed to vote yes.
discovery. Under Defendants' proposed pleading standard, Southern Peru
would never have seen the inside of a courtroom.
The Dole trial challenged a going-private merger where the controlling
stockholder was found, just six weeks ago, to have underpaid stockholders by
$148 million. Dole, 2015 Del. Ch. LEXIS 223, at *158. Like Southern Peru,
the Dole case would have been dismissed on the pleadings under Defendants'
proposed new standard, because it was explicitly conditioned on the approval
by a special committee and a majority of the minority stockholders. The trial
proved, however, that while the special committee did its best, it was defrauded
by the controlling stockholder and management during the negotiations. Dole,
2015 Del. Ch. LEXIS 223, at *123-24 ("by engaging in fraud, [management]
deprived the Committee of its ability to obtain a better result on behalf of the
stockholders"). The Dole trial in particular highlights the danger of dismissing
controlling stockholder cases on the pleadings. The trial opinion noted that
while the controlling shareholder's offer "mimick[ed] MFW's form," it "did not
adhere to its substance," as the controller sought "to undermine the Committee
from the start." !d., at *3. These facts were only clear after discovery.
The Dole decision should definitively disprove Defendants' contention
that simply by employing a special committee and majority-minority vote, "the
transaction replicates a genuine third-party, arm's-length merger, and the
concerns for abuse warranting 'entire fairness' review disappear." Def. Br. at 7.
If the Dole court's concerns had "disappeared" at the pleading stage upon
learning that the transaction was subject to both procedural protections, the
company's stockholders would not be poised to receive an extra $148 million in
B. MFWEncourages Defendants To Check Boxes, Rather Than
Treat Minority Stockholders Fairly
MFW encourages controlling stockholders to condition deals on special
committee and minority stockholder approvals. But if controllers know that the
deals will not be subject to judicial review if they simply "check the boxes,"
then that checklist will take the place of making sure that the deal is actually
fair, and shareholders will have absolutely no way to ensure that either
procedural protection was actually effective in protecting their interests. See,
e.g., Clark, supra Section C, at 580-81 (noting that special committees can be
flawed as a procedural protection); Kahn v. Tremont, 694 A.2d 422, 428 (Del.
1997) (discussing how minority shareholder votes can be coercive due to the
possibility of retaliation by the controlling stockholder). The effect on the
negotiation of controller buyouts would be serious. Like in Dole, controlling
stockholders may withhold critical information from special committees,
knowing that they will not be held accountable. Special committees will know
that their conduct will not be scrutinized, which will leave them with little
incentive or leverage to push back against an aggressive controller, even ifthey
know the proposed deal is unfair.
C. Defendants' Argument That New York Should Adopt The
MFWStandard To Promote "Consistency" With Delaware Is
Both Wrong And Irrelevant
Defendants argue that "[h]aving New York adopt a fundamentally
different rule than Delaware on an important issue of corporate law would
create needless inconsistency across jurisdictions and encourage forum
shopping." Def. Br. at 26. That analysis is wrong in three ways, and ultimately
First, Appellant is not advocating that New York "adopt" a different
standard than Delaware's. New York law is already different from Delaware
law. One needs only to compare Alpert with MFW to make this point plain.
Defendants, not Appellant, are arguing that New York law needs to change to
become "consistent" with Delaware.
Second, adopting an MFW standard in New York as Defendants urge
would not create consistency between the corporate law of New York and
Delaware. New York law already differs from Delaware law in important
ways. For example, Delaware law provides shareholders with much broader
access to nonpublic documents before filing a lawsuit, making it substantially
more realistic for a Delaware shareholder to plead facts necessary to challenge
the MFW factors. 13 In fact, MFW specifically encourages Delaware
stockholders to use the "tools at hand," including "inspection of the
corporation's books and records" in order to plead such facts. MFW, 88 A.3d at
645 n.15. Without such "tools," New York stockholders cannot be expected to
plead complaints with the same level of specificity.
New York law also does not give dissatisfied stockholders the right to
seek appraisal for their shares. Indeed, if Plaintiff had wanted to seek appraisal
for its shares rather than file this litigation, it would not have been able to do so
under the plain terms of the Transaction. R. 58. When advocating for the
standard the Delaware Supreme Court ultimately endorsed in MFW, the
Delaware judge who authored Cox in fact considered the ability to seek
appraisal to be important if Delaware law was to be modified to make lawsuits
harder to bring:
Importantly, a revlSlon along these lines would leave in place
another remedial option that is viable for stockholders who believe
that the ultimate price paid in a negotiated merger is unfair -
appraisal. Appraisal permits a stockholder to receive a fair value
determination regardless of the procedural fairness leading to a
merger. Particularly for institutional investors with large stakes,
13 Compare 8 Del. C. § 220 (broadly providing for the inspection of corporate books and
records by stockholders) with N.Y. Bus. Corp. L. § 624 (stockholders only entitled to
"minutes of the proceedings of its shareholders and record of shareholders"); see also Saito v.
McKesson HBOC, Inc., 806 A.2d 113, 115 (Del. 2002) ("A stockholder who demands
inspection for a proper purpose [under the Delaware statute] should be given access to all of
the documents in the corporation's possession, custody or control, that are necessary to
satisfy that proper purpose.").
appraisal can be a potent remedy, as certain recent cases have
879 A.2d at 645.
Third, different standards of review for controlling stockholder
transactions m New York and Delaware would not "encourage forum
shopping." Def. Br. at 26. MFW is a substantive rule of Delaware law, and will
apply whether litigation challenging the buyout of a Delaware corporation is
filed in Delaware or elsewhere.14 The only "forum shopping" that could result
from this appeal is a migration of controlled companies looking to incorporate
in New York if they perceive that they will be better able to perpetrate abusive
transactions against their minority stockholders without facing judicial scrutiny.
IV. EVEN IF THE COURT ADOPTS AN MFW-TYPE STANDARD,
THIS ACTION WOULD SURVIVE A MOTION TO DISMISS
Finally, even if the MFW standard were to become New York law, that
would hardly mean that Appellant's case was properly dismissed below. MFW
was decided on a full discovery record, only after which the court was able to
conclude that the six MFW factors were met. MFW requires that the procedural
protections be not only adopted, but be "effective." 88 A.3d at 645-46. This
analysis can typically only be undertaken after discovery. I d. ("If a plaintiff
14 See, e.g., In re Viacom Inc. S'holder Derivative Litig., Case No. 602527/05, 2006 N.Y.
Misc. LEXIS 2891, at *8 (Sup. Ct. N.Y. Cnty. 2006) (applying Delaware law in derivative
lawsuit challenging entire fairness of compensation decision at Delaware corporation); Youlu
Zheng v. Icahn, 38 Misc. 3d 1217(A) (Sup. Ct. N.Y. Cnty. 2006) (applying Delaware law to
challenged corporate transaction involving Delaware corporation).
can plead a reasonably conceivable set of facts showing that any or all of [the
MFW factors] did not exist, that complaint would state a claim for relief that
would entitle the plaintiff to proceed and conduct discovery."). Appellant has
pled a "reasonably conceivable set of facts" to cast doubt that the Special
Committee "[met] its duty of care in negotiating a fair price." Id. at 645.
The Delaware Supreme Court took pains to note that the complaint in
MFWitselfwould have survived a motion to dismiss. MFW, 88 A.3d 645 n.l4.
The MFW court explained that because of the plaintiffs' allegations regarding
the special committee's price negotiations, the MFW complaint "would have
survived a motion to dismiss under this new standard." I d. The court reasoned:
"These 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." I d.
The same is true here. Even under an MFW standard, Appellant more
than adequately pled facts to entitle it to discovery. The Special Committee
negotiations show that it was "trapped in [a] controlled mindset," see S. Peru,
52 A.3d at 800, rather than truly negotiating at arm's-length. The Special
Committee basically begged Cole to improve his offer by any amount, rather
than ever countering his offer with a price that the Committee thought would
actually be fair. It downwardly adjusted the Company's financial projections.
R. 578. The Special Committee let Cole walk away from his $16 per share
offer for plainly pretextual reasons. R. 577-78. It also ignored the effect of
significant tax benefits that should have been passed along to the stockholders
in the Transaction. R. 583.
These were not the actions of the kind of special committee described by
Defendants, one "with general business acumen and a fair amount of company
specific knowledge, with wily advisors who know how to pull the levers in
merger transactions in order to extract economic advantage," Def. Br. at 43
(quoting Cox, 879 A.2d at 618). Would directors with "business acumen" and
"company specific knowledge" fail to ever counter Cole's offer with a price
that they believed fairly captured KCP's true value? Would the Special
Committee and its "wily advisors" reasonably let Cole offer $16 per share and
then withdraw the offer only days later on the premise that the entire world had
apparently just changed?15 Of course not. Appellant suggests rather that this
was the conduct of an anemic special committee with a long history of
acqmescmg to Cole's wishes regarding everything from executive
15 The Proxy states that Cole said he was withdrawing his $16 per share offer (made just days
earlier) on account of a "slowdown in the Company's operations, the problems in the
European economy that ... threatened to spread to the United States, the disappointing report
on unemployment and job growth issued by the U.S. government on the prior Friday, and the
significant decline in the U.S. stock market in the prior week." R. 26.
compensation to self-interested transactions. R. 567-69. Appellant argues that
the Special Committee simply continued its longstanding tradition of rolling
over to Cole's wishes when they negotiated the Transaction with him. R. 579-
81. But even under MFW, whether Appellant is right or not in making this
assertion should be decided after discovery, not on the pleadings.
It is not disputed that Cole faced an "inherent conflict" when he stood
opposite KCP stockholders and paid them $15.25 per share for their stock in his
Company. Under Alpert, Chelrob and Limmer, such a conflict requires Cole to
prove the entire fairness of the Transaction, both in price and process.
Defendants' argument that New York law properly reviews Cole's conduct
under the deferential business judgment rule is not only unsupported by a single
New York decision, it would also be bad policy. The Southern Peru and Dole
trials make clear that conflicted transactions approved by special committees
and a majority of the company's minority shares can still be massively unfair.
Cole's conditioning the Transaction on these procedural devices will help him
to argue, after discovery, that the Transaction was entirely fair. But even MFW
notes that without knowing whether they were "effective," these procedural
mechanisms cannot presumptively allow Cole to escape any judicial scrutiny.
The courts below should be reversed, and discovery should proceed.
Dated: New York, New York
October 8, 2015
MELTZER & CHECK, LLP
280 King of Prussia Road
Radnor, PA 19087
Tel: (610) 667-7706
Fax: (610) 667-7056
Co-Lead Counsel for Plaintiff-
BERGER & GROSSMANN LLP
Jeroen van Kwawegen
1285 Avenue of the Americas
New York, NY 10019
Tel: (212) 554-1400
Fax: (212) 554-1444
Co-Lead Counsel for Plaintiff-