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The Delaware Supreme Court recently held that a “quasi-appraisal” remedy is an appropriate remedy in a short form merger where the greater than 90 percent stockholder breached its duty to disclose material information to the minority stockholders.

In its en banc decision in Barbara Berger v. Pubco Corporation and Robert H. Kanner¹, the Delaware Supreme Court reversed the Delaware Court of Chancery’s form of “quasi-appraisal” remedy and instructed the Court of Chancery to enter a quasi-appraisal remedy that includes all minority stockholders (except those that opt out) and to not require any minority stockholders to escrow a portion of their previously received merger consideration.

Key Facts and Procedural Background

The facts in this case were undisputed by the parties, and the Delaware Supreme Court drew them all from the Court of Chancery’s opinion deciding cross motions for summary judgment. Pubco Corporation (Pubco or the company) is a Delaware corporation whose shares of common stock were not publicly traded. More than 90 percent of Pubco’s shares were owned by defendant Robert H. Kanner, who was Pubco’s president and sole director. The plaintiff, Barbara Berger, was a Pubco minority stockholder.

Prior to October 12, 2007, Kanner decided that Pubco should go private via a “short form” merger under Section 253 of the Delaware General Corporation Law (the DGCL). Because that short form procedure is available only to corporate controlling stockholders, Kanner formed a wholly owned subsidiary, Pubco Acquisition, Inc. (Acquisition) and transferred his Pubco shares to that entity to effect the merger. When the merger took place, on October 12, 2007, Pubco’s minority stockholders received $20 cash per share. The only relevant corporate action required to effect a short term merger under Section 253 is for the board of directors of the parent corporation, in this case Acquisition, to adopt a resolution approving a certificate of merger and to furnish the minority stockholders with a notice advising that the merger has occurred and that they are entitled to seek an appraisal under Section 262 of the DGCL. Section 253 required that the notice include a copy of the appraisal statute, and Delaware case law required that Acquisition disclose in the notice of merger all information material to stockholders deciding whether or not to seek appraisal.

In November 2007, Berger received a written notice (the Notice), from Pubco advising that Pubco’s controlling stockholder had effected a short form merger and that Berger and the other minority stockholders were being cashed out for $20 per share. The Notice explained that stockholder approval was not required for the merger to become effective and that the minority stockholders had the right to seek an appraisal. The Notice disclosed some information about the nature of Pubco’s business, the names of its officers and directors, the number of its shares and classes of stock, a description of related business transactions and copies of Pubco’s most recent interim and annual unaudited financial statements. The Notice also disclosed that Pubco’s stock, although not publicly traded, was sporadically traded over the counter, and that in the nearly two years preceding the merger there were 30 open market trades that ranged in price from $12.55 to $16 per share, at an average price of $13.32. Finally, the Notice provided telephone, fax and e-mail contact information so that stockholders could request and obtain additional information.

In its summary judgment opinion, the Court of Chancery found that the disclosures in the Notice provided no significant detail regarding Pubco, its future or the determination of the merger price, with the exception of the financial statements. In this regard, as noted by the Delaware Supreme Court, the Notice included a description of the Company and its business, which was only five sentences long and featured otherwise vague statements—for instance, that “[t]he Company owns other income producing assets.”² The Delaware Supreme Court further noted that the Notice did not include any disclosure regarding Pubco’s plans or prospects, nor any “meaningful” disclosure regarding Pubco’s actual operations or of its finances by division or line of business. Finally, the Delaware Supreme Court noted that the financial statements indicated that Pubco held a sizeable amount of cash and securities but failed to explain to the minority stockholders how those assets were, or would be, utilized.

The Delaware Supreme Court also noted that the Notice did not disclose how Kanner had determined the $20-per-share merger price. As required by law, the Notice did attach a copy of the appraisal statute, but the copy attached was outdated and, therefore, incorrect and Pubco never sent a corrected copy of the updated appraisal statute to its former minority stockholders.

On December 14, 2007, Berger initiated a lawsuit as a class action on behalf of all Pubco minority stockholders, claiming that the class was entitled to receive the difference between the $20 per share paid to each class member and the fair value of the Pubco shares, whether or not any class member had properly demanded appraisal. Pubco and Kanner then filed a motion to dismiss the complaint. Berger responded to that motion and simultaneously filed a brief in support of her counter-motion for summary judgment. Thereafter, the defendants abandoned their motion to dismiss and filed a cross-motion for summary judgment. The Court of Chancery handed down its opinion on May 30, 2008, granting the cross-motions in part and denying them in part.

In its decision the Court of Chancery found two disclosure violations: (1) the wrong version of the appraisal statute was attached to the Notice; and (2) the Notice did not disclose how Kanner set the per-share merger price. Based on these two disclosure violations, the Court of Chancery held that the appropriate remedy was one of quasi-appraisal. The Court of Chancery then held that the form of quasi-appraisal should be the same form as was awarded in another quasi-appraisal case, Gilliland v. Motorola, Inc,³ because that remedy mirrored, as best as possible, the statutory appraisal remedy. As a result, the Court of Chancery held that: (1) Pubco needed to make supplemental disclosures to the minority stockholders to remedy the disclosure violations; (2) the minority stockholders needed to affirmatively opt in to the quasi-appraisal action; (3) the minority stockholders that elected to opt in to the quasi-appraisal action needed to escrow a portion of their merger consideration proceeds; and (4) a valuation of the Pubco shares as of the merger date should be conducted using the method prescribed by the appraisal statute.

Delaware Supreme Court Decision and Analysis

The only issue before the Delaware Supreme Court on appeal, but one of first impression, was the nature of the appropriate remedy for minority stockholders in a short form merger when a fiduciary fails to meet its duty of full disclosure. Berger, on appeal, argued that all of the minority stockholders should have been treated as members of a class entitled to seek the quasi-appraisal recovery, without being burdened by any precondition or requirement that they opt in to the quasi-appraisal proceeding or escrow any portion of the merger proceeds paid to them. In its opinion, the Court of Chancery had paraphrased the decision in Gilliland, stating that the purpose of the requirement that minority stockholders who opt in to a quasi-appraisal remedy escrow a portion of their merger consideration proceeds is to replicate a “modicum of the risk” that would be present if such minority stockholders were pursuing an actual appraisal.

The Delaware Supreme Court noted that, pursuant to the decision in Glassman v. Unocal Exploration Corporation,⁴ the exclusive remedy for minority stockholders who challenge a short form merger is a statutory appraisal, provided that there is no fraud or illegality, and that all facts are disclosed that would enable the stockholders to decide whether to accept the merger price or seek appraisal. The Delaware Supreme Court held that where, as in this case, the material facts are not disclosed, the controlling stockholder forfeits the benefit of that limited review and exclusive remedy, and the minority stockholders become entitled to participate in a quasi-appraisal class action to recover the difference between fair value and the merger price without having to opt in to that proceeding or to escrow any merger proceeds that they received. As a result, the Delaware Supreme Court reversed the Court of Chancery’s remedy and ordered that the quasi-appraisal remedy for a violation of the fiduciary disclosure obligation should not be restricted by opt-in or escrow requirements for the minority stockholders.

The Delaware Supreme Court noted that, before making its decision, it needed to choose which analytical standard to use in determining the most appropriate remedy. The optimal alternative, the court said, would be the remedy that best effectuates the policies underlying the short form merger statute (Section 253), the appraisal statute (Section 262) and the Glassman decision, taking into account considerations of practicality of implementation and fairness to the litigants.

In its analysis, the Delaware Supreme Court examined four alternative remedies for the disclosure violations in the Notice. Two of the remedies were advocated by the parties in this case and two were not. The two remedies that were not advocated by either party were a “replicated” appraisal proceeding and a remedy for a breach of fiduciary claim based on the “entire fairness” standard of review used in long form cash-out mergers.

Based on this standard of review, the Delaware Supreme Court decided that the last alternative (entire fairness review) was not the most appropriate remedy because it would deprive a majority stockholder of the benefit of Glassman’s decision regarding a limited review and exclusive remedy in a challenge to a short form merger. While noting that there was some logic to this remedy, the Delaware Supreme Court found that, if awarded, this remedy would ignore the legislative intent that the only remedy for minority stockholders in a non-fraudulent, legally valid short form merger is appraisal.

In reviewing the replicated appraisal proceeding remedy, the Delaware Supreme Court found that this remedy would give “maximum effect” to the legislative intent that was recognized in Glassman. However, the court determined that this remedy would effect the legislative intent at an “unacceptable cost” in terms of both practicality of its application and fairness to the minority stockholders. The Delaware Supreme Court held that the Gilliland court implicitly acknowledged this in its decision by refusing to order a replicated appraisal remedy.

It further noted that a “remedy limited to awarding a second statutory appraisal would deny the minority any credit for that expense and effort, after having been forced to prosecute that litigation solely because the controlling stockholder had violated its fiduciary duty. A replicated appraisal remedy would also give controlling stockholders little incentive to observe their disclosure duty in future cases, since the cost of the remedy to the controllers would be negligible.”

This analysis left the Delaware Supreme Court to choose between the two types of quasi-appraisal remedies advocated by each party in this case. The court noted that the principal differences between the two parties’ positions on the appropriate remedy was that the defendants advocated an opt-in and escrow requirement for minority stockholders and the plaintiff argued that neither of these requirements should apply to the minority stockholders in this case. The court found for reasons of “utility and fairness” that the plaintiff’s position was the more appropriate remedy and analyzed both the opt-in requirement and the escrow requirement separately.

The opt-in requirement was more burdensome to minority stockholders, the court found, and imposed no burden to the corporation, whereas the opt-out requirement was less burdensome to minority stockholders and again imposed no burden on the corporation. The Delaware Supreme Court determined that the latter approach was the optimal alternative for this part of the remedy.

With respect to the escrow requirement, the Delaware Supreme Court noted that the defendant argued that without this requirement the minority stockholders would have the “dual benefit” of retaining their merger consideration proceeds while litigating for a higher value, something that they would not have had in the case of a statutory appraisal proceeding. The Delaware Supreme Court found that this dual benefit was not inequitable to the fiduciary that breached its duty of disclosure, noting that the law allows minority stockholders to enjoy this dual benefit in a long form cash-out merger being challenged on fiduciary duty grounds.

Finally, the Delaware Supreme Court noted that the corporation should be held to the same strict compliance to the appraisal statute as minority stockholders. In this regard, the court reasoned that minority stockholders who did not strictly adhere to the technical requirements of the appraisal statute lose their right to pursue an appraisal remedy and, therefore, allow a corporation to keep the difference between the fair value of their shares and the merger consideration paid by the corporation. The Delaware Supreme Court held that the “appraisal statute should be construed evenhandedly, not as a one-way street … In fairness, majority stockholders that deprive their minority stockholders of material information should forfeit their statutory right to retain the merger proceeds payable to stockholders who, if fully informed, would have elected appraisal.”

Key Takeaways from Pubco

The most obvious point to observe from this decision is one that corporate law practitioners have historically espoused: majority stockholders, notwithstanding their own technical compliance with the statute, must respect the statutory and other legal rights of minority stockholders, including the fiduciary duties owed to minority stockholders, or otherwise face legal and equitable results that they did not intend. It is clear from this and other decisions that the Delaware courts are willing to look to equitable solutions to remedy breaches of fiduciary duties owed to minority stockholders by majority stockholders. The quasi-appraisal remedy is just such an equitable solution.

In an additional point, the Delaware Supreme Court noted that if the only disclosure violation was distribution of an out-of-date copy of the appraisal statute, the quasi-appraisal remedy may have been different. The court did not explain what differences there would have been in such a case. Also, the Delaware Supreme Court commented that the appraisal statute contemplates that a corporation will negotiate and attempt to settle with stockholders who perfect their rights to appraisal, prior to filing an appraisal petition. While made in dictum, this is an interesting comment regarding the court’s view of the way the appraisal statute should work.