Berger v. Pubco: An Introduction

Some corporate cases scream out their importance from the get go, but Berger v Pubco wasn’t one of them. Now we know better. The Supreme Court, en banc, has just (this July, 2009) reversed the Court of Chancery, holding not only that the fiduciary duty of disclosure remains alive and well in §253 short form mergers; but also that a more minority-friendly, more practicable and affordable “quasi-appraisal” process will be available, in equity, to give it force. Given the newly defined contours of this equitable appraisal process, controllers will have more incentive to be attentive to providing minorities a full and fair account of the information material to their choosing between the (controller-determined) merger consideration and a judicial appraisal of their shares’ worth.

The facts, as described by the Court of Chancery’s and Supreme Court’s decisions, on the litigants’ cross motions for summary judgment. Perhaps the most important fact here is that Pubco was not a reporting company – there were no SEC periodic reports or federally mandated (e.g. SEC Rule 13e-3) going private disclosures the minority could use to evaluate Pubco’s condition and prospects. Of course, the Delaware statute is mostly silent about shareholders’ informational rights, in short form mergers as elsewhere, but §262 dictates that in short form mergers the exiting shareholders must be given a copy of the appraisal statute and notified of their right to go this route. Beyond the Delaware statute (and leaving aside federally mandated disclosures which were inapplicable here), Delaware fiduciary law provides that boards and controllers have a duty to provide shareholders all the information material to their responding to mergers, tender offers, and recourse to appraisals.

In Pubco the controlling shareholder, Robert H. Kanner, was a consummate corporate insider. He owned over 90% of Pubco, and was also the company’s CEO and sole director/chairman of the board. Seemingly unimpressed by equity’s deterrent force, he delivered a notice of merger that was a virtual guarantee of litigation (assuming, that is, that the minority fund it -- was that the bet, especially since institutional holders were likely few?) Unfortunately for Kanner, the Notice of Merger included a stale (inaccurate) copy of the appraisal statute, which had been amended months earlier. (Aren’t you relieved you’re not the lawyer who forgot to check that!) So the controller had already failed to live up to the letter of the law.

Leaving aside that defect, beyond a set of unaudited financial statements, the company-specific information Kanner provided was so brief (five sentences) and vague as to be virtually meaningless to the minorities’ decision making. Nothing was said about the company’s plans and prospects, its actual operations and business segments or anticipated use of its vast horde of cash (as evident from the financials). Given that appraisal’s fair value encompasses paying shareholders the full value of what they’ve been forced to surrender in the merger, such forward- looking information would seem to be vital (vital to the minority in evaluating the adequacy of the offered price and vital, later, in any appraisal proceedings). The Supreme Court was deeply alarmed by this overall disclosure shortfall, but it’s not what sunk the controller before the Court of Chancery.

Court of Chancery’s Holding on Disclosure. The Court of Chancery held that in the context of a nonreporting company (at least), controllers must describe the valuation process undertaken by the controller in arriving at the price offered the minority -- however methodical or arbitrary. The court cited statements from the defendants’ briefs that since no fair price duty applies in short form mergers (true), so that a controller could set a price even by a “roll of the dice” (true), what was there to discuss?  “No way,” said the court, holding that while the Notice of Merger need not contain all the details necessary for the minority to do an independent valuation, controllers must provide sufficient description of the valuation process for minorities to get a feel for its soundness. Such information, the court held, is essential – material --  to minorities’ determination of whether they should “trust the price” or suffer appraisal’s slings and arrows. Less fortunately for minorities, the court assumed (without discussion), that the plaintiffs possessed the burden of proving the materiality of the controller’s misrepresentation or omission, though this is arguably at odds with the self-dealing nature of the freezeout.

In many respects this “tell them about the valuation process you followed” approach reminds me of the Supreme Court’s opinion in Smith v. Van Gorkom. In Van Gorkom the board was held to have breached its fiduciary disclosure duty in failing to advise the shareholders of how they’d arrived at the $55 per share merger price. (The directors were also, famously, held to have breached their duty of care in neglecting to inform themselves about the value of the company before approving its sale via merger.) In Van Gorkom the Supreme Court said it did not intend to require boards’ hiring of independent financial advisors (to give fairness opinions). However, after Van Gorkom you’d prefer to avoid being on a board that had to announce it didn’t have an independent financial advisors to opine about the fairness of the merger. Analogously, I wonder: will Pubco result in pressure for controllers to hire and defend their offered price by way of “independent” financial advisors? And to what effect?

Court of Chancery’s Holding on Remedies. Having resolved that Kanner breached his fiduciary disclosure duty in the short form merger, the Court of Chancery had to figure out what remedy was appropriate. The defendant argued that the minority, in essence, should merely get a do-over vis a vis deciding whether or not to elect appraisal -- complete with their having to opt-in individually to the proceedings and deposit a portion of the merger proceeds into an escrow account (so they’d bear some of the financial risk of the appraisal coming in under the merger price). The defendant’s logic was that minorities cannot block their expulsion via a §253 merger – hence the disclosure was relevant merely to their choosing an appraisal or not, a logic the Court of Chancery found compelling. Nevertheless, the quasi-appraisal do-over ordered by the Court of Chancery would hardly keep controllers from thumbing their noses at “fiduciary” disclosure duties.

The Supreme Court on Remedies. Hence it was this remedy issue where the courts divided. The Supreme Court held that where the disclosure defects are “only technical and non-prejudicial,” a different remedy might be warranted; however, where the controller-as-fiduciary (who obviously has the requisite information about the deal and company at hand) provides “no significant detail” for the minorities’ contemplation, the balance of the equities mandates dropping the individual opt-in and escrow requirements.

The Supreme Court’s remedy analysis was sweeping: it surveyed the merits of a closely replicated, fully formal appraisal; the more liberal and more conservative quasi-appraisal proceedings considered below; and fourthly, a full scale proceeding where the controller would be required to prove the entire fairness of the short form merger. Despite it’s having affirmed the controller’s fiduciary (disclosure) breach, in order to avoid running afoul of its decision in Glassman, the Supreme Court ruled against the propriety of a full, fiduciary entire fairness proceeding. (The logic that even in a short form merger a material fiduciary disclosure breach by a controller should occasion full, fiduciary entire fairness review is explored, with some zeal, in the Supreme Court’s footnote 23.) In conclusion, the Supreme Court remanded the case to the Court of Chancery to conduct a class-based, quasi-appraisal proceeding unrestricted by opt in or escrow requirements.