First Department reverses Supreme Court decision on”holdback”provision in stock purchase agreement.

In a rare reversal, the Court in Golden Tech. Mgt., LLC v. NextGen Acquisition, Inc., 138 AD3d 625 (2016) granted defendant’s motion for summary judgment dismissing a breach of contract cause of action.

As part of the terms of a stock purchase agreement, the defendants were to make an initial cash deposit at the time of closing.  In addition, they were also to deposit a “holdback” amount in an escrow account of non-party NextGen Fuels, Inc.   The deposit would then be returned to the plaintiffs after one year.

Plaintiffs filed a cause of action for breach of contract approximately seven years after the closing date, but within six years of the time that the deposit should be disbursed to the plaintiffs.

The Court delineated the contract provision to include two obligations: (1) a deposit to be made into an escrow account and (2) the payment obligation whereby the plaintiffs would receive the amount deposited after one year.

Here, the plaintiff intended to enforce the payment obligation and the Court noted that while it was not time-barred under CPLR  213(2), nevertheless the defendants were “not responsible for the breach” and the correct party was non-party NextGen Fuels, Inc.



Court dismisses cross-complaint based on defective UCC-1 filing.

In 1380 Hous. Dev. Fund v. Carlin, 138 A.D3d 613 (2016), the First Department dismissed defendant’s cross-complaint based on a defective UCC-1 fixture filing.

In order to perfect a lien against real property, the UCC-1 financing statement needs to be filed with the local property records pursuant to UCC 9-334.  Here, the defendant filed  UCC-1 with the Secretary of State in 2005.  The second fixture filing filed in 2010 fails to satisfy the criteria set forth in UCC 9-502(b).  There was no description of the collateral, specifically the fixtures it needed to cover; there was no explicit intention to cover fixtures on the property; the filing lacked the description of the property including block and lot numbers.

The defendant also failed to meet the requirement under UCC 9-108 in that the description was not sufficient to identify the collateral subject to the lien.  While there was a stipulation and pledge agreement, it only referred to the borrower’s 50% share certificates and not the real property itself.  The UCC-1 financing statement referred to the stipulation agreement, but did not reasonably identify the assets.  Thus, in the Court’s view, the defendant failed to perfect a lien established by a security agreement under UCC 9-102.



NY Court of Appeals applies additional scrutiny to opt-out of clauses in mergers.

The Court of Appeals recently held in Jiannaris v. Alfant, 2016 Slip Op 03548 (May 5th, 2016) that a settlement that would deprive out-of-state class members of a cognizable property interest to opt-out should be rejected.

On August 4th, 2009, Google and On2 entered into a merger agreement.  A class action was commenced by plaintiff alleging that the On2’s board of directors had breached its fiduciary duty to its shareholders.  Another group of shareholders commenced similar actions in the Delaware Court of Chancery.

A settlement was reached between plaintiffs in both actions with the directors of On2.  The stipulation of settlement was filed in Supreme Court that provided for, inter alia, “the dismissal of the New York and Delaware actions in their entirety with prejudice” and a “release of of any and all merger related claims.” However, the settlement failed to state any opt-out rights.  The Supreme Court certified the proposed class pursuant to CPLR Article 9 subject to a fairness hearing.

The Supreme Court found the settlement to be fair ,but rejected it ultimately as there was no opt-out clause for out of state class members.  The Appellate Divison upheld the Supreme Court’s judgment, see 124 A.D.3d 582 (2nd Dep., 2015).  Leave of appeal was granted by the Court of Appeals.

The Court began its analysis with a review of the Philips Petroleum Co. v. Shutts, 472 US 797 (1985), which held that due process requires opt-out rights in actions “wholly or predominately for monetary damages.”  The Court of Appeals affirmed this decision in Matter of Colt Indus. Shareholder Litig., 77 N.Y.2d 185 (1991).  In Matter of Colt, a Missouri corporation wanted to opt-out of a New York class action that seeked equitable relief.  The Court held that “there was no due process right to opt out of a class that seeks…equitable relief.”   Nevertheless, the settlement still violated due process since it precluded class members to pursue an action for damages in another jurisdiction (internal citations omitted).  

Similarly, the settlement proposed between Google and On2 also contained a provision whereby out-of-state class members could not pursue non-equitable claims.  The defendants distinguished Colt by stating that the scope of the release was different in that Colt also related to claims prior to the buyout in addition to the merger-related claims.  However, the Court emphasized that the holding based on the damage claims that could not be pursued because of the merger.  Thus, for the purpose of the opt-out analysis, the case was not distinguishable.

In addition, the defendants sought to distinguish the different types of damages claims such as incidental damages and individualized damage claims.  To this effect, the defendants cited Wal-Mart Stores, Inc. v. Dukes, 131 S.Ct.  2541 (2014) where the Supreme Court held that legal damage claims incidental to equitable relief may be bound on out-of-class members.

The Court distinguished Wal-mart by indicating that it applies to federal class actions whereas the current case is a New York class action suit.   Under FRCP 23(b)(2), there is no right to opt out of class actions where equitbale relief is sought.

Since the current class action was brought under CPLR 9, the Court stated that Wal-Mart did not apply here.  Furthermore, pursuant to Colt, a judge has discretion “to permit a class member to opt out of a class”, particularly where a settlement may violate due process rights.

The takeaway from this case is the differentiation of right of out-of-state class members in New York state class actions versus federal ones.  The lack of opt-out clauses for out-of-state class members are likely to be scrutinized further in New York state class actions.

New York Court of Appeals adopts Delaware Standard of Review in Private Mergers.

In a recent decision, Matter of Kenneth Cole Prods., Inc. Shareholder Liig., (2016 N.Y. Slip Op 354, May 5th, 2016), the New Court of Appeals adopted the standard of review decided in Kahn v. M&F Worldwide Corp., 88 A.3d. 635 (MFW) with respect to going private mergers.  The Court went on to affirm the application of the business judgment rule where shareholder-protective conditions are present.  In contrast, the Court further held that in the absence of such conditions, the entire fairness standard shall apply, drawing from MFW standard.

Kenneth Cole Productions, Inc. (KCP) had two classes of common stock: (1) Class A stock which was traded on the New York stock exchange and (2) Class B stock, which was held entirely by  the defendant Kenneth Cole himself.  There were 10,706,723 outstanding shares of Class A stock and each shareholder was entitled to one vote.  Kenneth Cole owned 46% of Class A stock.  With respect to Class B, there were 7,890,497 shares and each share was entitled ten votes.  The overall voting structure meant that Kenneth Cole had 89% of the voting power of KCP.

In February 2012, Cole had informed the Board that he wished to proceed with a going private merger and intended to submit an offer to purchase the remaining Class A shares.  The Board established a special committee consisting of Michael J. Blitzer, Philip R. Peller, Denis F. Kelly, and Robert Grayson to review the proposal and negotiate the merger.  Kenneth Cole was not present when the committee was formed.

On February 23rd, 2012, Kenneth Cole proposed to to buy the Class A shares at $15 per share.  Among the conditions of the offer, (1) the special committee had to approve the offer and (2) in addition, the majority of the minority shareholders need to approve the offer as well.  On a rather personal note, Kenneth Cole also stated that if the offer was not approved, “his relationship with KCP would not adversely be affected”.

After the announcement of Cole’s offer, various shareholders commenced class actions  against Cole and KCP.  During their review, the special committee asked Cole to increase his offer and Cole ultimately raised his offer to $15.50 and then $16.  However, Cole reduced his offer back to $15 stating the issues with the company and general economy.  Further negotiations ultimately settled for a price of $15.25 for each outstanding share of Class A stock.  A shareholder vote was held and 99.8% of minority shareholders voted in favor of the merger.

Plaintiffs in an amended complaint alleged: (1) Cole and the directors breached their fiduciary duty they owed to minority shareholders; (2) award of damages to the class; and (3) a judgment enjoining the merger.  The defendants filed a motion to dismiss the complaint on the grounds that it failed to state a cause of action.

The Supreme Court granted defendants’ motion to dismiss the complaint citing that complaint failed to “demonstrate a lack of independence on the part of any of the…individual defendants.”  The Supreme Court also pointed out that the directors engaged in negotiations with Cole over the period of months and the the price offered was a premium over the last selling price of the stock.  Furthermore, the plaintiffs had failed to show any specific unfair conduct by the committee and thus, there was no reason to second guess the committee’s business decisions.

Upon appeal, the Appellate Division affirmed the Supreme Court holding that the “the motion court was not required to apply the “entire fairness’ standard to the transaction”(internal citations omitted).  The Appellate Division distinguished this case from the seminal case, Alpert v. 28 Williams St. Corp., 63 N.Y.2d 557 (1984) in that the current merger required the “approval of the majority of the minority shareholders.”  Furthermore, the Appellate division pointed that Cole himself did not participate in the board’s vote on the merger and the plaintiffs failed to demonstrate any self-interest on the part of the remaining board members.

The Court of Appeals adopted a “middle ground” with respect to the standard that should be applied to a going private merger.  Plaintiff had argued that an entire fairness standard should be used which places a burden on the directors that they “engaged in a fair process and obtained a fair price.”  On the other hand, the defendants argued that the business judgment rule should apply.

The Court began to re-affirm the principle that “courts should…avoid interfering with the internal management of business corporations”.  Thus, in the application of the business judgment rule, as long as the directors and officers of a company exercise unbiased judgment in good faith, the courts will defer to those determinations.  40 W. 67th St. v. Pullman, 100 N.Y.2d 147, 153 (2003).  In expounding the business judgment rule, the Court also observed that courts are ill equipped to evaluate business judgments and there was no objective standard by which one could evaluate any corporate decisions.  Auerbach v. Bennett, 47 N.Y.2d 619 (1979).  The Court further emphasized that under the business judgment rule, “courts may inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee” citing Auerbach at 623-624.

The opinion also distinguished the different types of freeze-out mergers: (1) two-step mergers whereby an investor purchases the majority of the shares of the company and then uses said control to merge the target with a second company, compromising minority shareholders; (2)  parent-subsidiary mergers and (3) going-private mergers, whereby the majority shareholder of a public company buys the shares of the remaining investors.

In the  Court’s analysis, the leading case in freeze-out mergers is Alpert v. 28 Williams St. Corp., 63 N.Y.2d. 557 (1984).  With respect to a two step merger, in the event of an “inherent conflict of interest and the potential for self-dealing, careful scrutiny of the transaction is required.” citing Alpert, 570.   The burden falls on the interested directors or shareholders to prove good faith and the entire fairness of the merger citing Chelrob, Inc. v. Barrett, 293 N.Y 442, 461 (1944).

Under Alpert, In order to determine fairness, two elements must be considered: (1) fair process and (2) fair price.  The fair process is comprised of factors such as “timing, structure, disclosure of information to independent directors and shareholders, how approvals were obtained” (internal citation omitted).   In contrast, the fair price can be determined whether “independent advisors rendered an opinion or other bids were considered in order to determine an arms-length negotiation.  These two elements are then considered as a whole to determine fairness to the minority shareholders.

Despite reiterating the standard used in Alpert, the Court nevertheless distinguished the case by stating that in Alpert there was no independent committee formed or a minority shareholder vote.  The question still remained whether the fiduciary standard set above would apply to mergers other than a two-step merger.

The Court considered the holding in the Delaware case of Kahn v. M&F Worldwide Corp., 88 A.3d. 635 (MFW) where a controlling shareholder proposed to purchase all outstanding shares of stock and thus, take the company private.   Similar to the current case, the shareholder also made the proposal contingent on: (1) approval from a special independent committee and (2) approval of the majority of the shareholders not associated with the controlling shareholder (internal citations omitted).  Furthermore, if the merger was not approved, the controlling shareholder would not bear an adverse relations with the corporation.

The Delaware court preferred the business judgement rule over the entire fairness standard because of the structure it created i.e. (1) an independent special committee and (2) uncoerced, informed vote of the majority of the minority shareholders.  The reasoning behind the adoption of the business judgment rule is that inter alia there are arms-length negotiations; the protection offered to minority shareholders in controller buyouts; there is a deference to the informed decisions of the independent directors and the incentive to protect minority shareholders.

The standard is defined as follows: (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”.  (internal citation omitted).

The Court reasoned that the adoption of the Delaware standard “reinforces the business judgement rule.”  Furthermore, there remains a continued to deference to the disinterested board of directors consistent with Auerbach, and the interests of the minority shareholders are protected sufficiently.

In order to prevail in a complaint for breach of fiduciary duty, the plaintiff may proceed to discovery if it alleges “a reasonably conceivable set of facts” showing that one if the six elements does not exist.  Neither conclusory statements or speculation may support a cause of action for breach of fiduciary duty.  In the event that one of six elements does not exist, the business judgment rule no longer applies, and in its place, the entire fairness standard should be applied instead.

In applying the MFW standard, the Court affirmed the lower courts’ decision granting defendant’s motion to dismiss.  First, the plaintiffs did not allege with any sufficiency or specificity that any of the six elements were absent.  The first element had already been fulfilled as Kenneth Cole had established a special committee of independent directors and in addition, the majority of the minority shareholders.

Although the plaintiffs challenged the independence of some of the directors, the Court applied the MFW standard in that the ties must be “material in the sense that they could affect partiality.  MFW, 69.  Thus, the plaintiffs had failed to provide any evidence of fraud, conflict of interest or that the members lacked the capability of reaching an unbiased decision.

With respect to the third element, the plaintiffs only made speculative allegations that the directors acceded to Kenneth Cole’s demands.  The Court focused on the Cole’s conduct whereby he stated that his relationship with the company would not be adversely affected if the committee or the minority shareholders failed to vote for the transaction.

The plaintiffs also failed to fulfill the fourth condition.  The Court pointed out that mere cursory allegations that the committee failed to meet its duty of care in negotiating a fair price was not sufficient.  The plaintiffs failed to provide substantive instances where the committee engaged in any unfair conduct.  The Court noted that the final offer was higher than the original offer, which in itself was determined by a panel of independent analysts.

With respect to the fifth and sixth elements, the plaintiff failed to plead with any specificity that the minority shareholders were less than informed when they voted for the transaction or that they were coerced in any manner.

Essentially, the Court has held that unless the six conditions are met, the Court will continue to apply the business judgment rule.  The case stands as a re-affirmation to the deference to the board of directors with respect to corporate decisions to mergers.