In an important decision released on July 24, 2012, the Pennsylvania Supreme Court held, in Mitchell Partners v. Irex Corp., that under Pennsylvania law, minority shareholders who oppose a merger have no post-merger recourse, absent fraud or fundamental unfairness, other than to seek judicial appraisal of the value of their shares. This ruling has great importance for Pennsylvania corporations and their shareholders, as it substantially restricts the availability of post-merger common law claims for breach of fiduciary duty or other alleged corporate misfeasance, unless such conduct rises to the level of fraud or fundamental unfairness. Accordingly, business decisions made by Pennsylvania corporations and their directors are better protected against the specter of possible post-merger shareholder lawsuits.
Despite its possible broad-reaching implications on the acquisition and sale of Pennsylvania corporations, the case reached the court in an unusual manner – via a certified question from the Court of Appeals for the Third Circuit. Mitchell Partners, a minority shareholder of Irex, a privately-held Pennsylvania corporation, challenged a merger that had the effect of cashing out minority stockholders at a price Mitchell Partners considered unfair. Mitchell Partners pursued post-merger appraisal proceedings in Pennsylvania state court while concurrently pursuing common law claims for breach of fiduciary duty and unjust enrichment in federal court in the Eastern District of Pennsylvania, seeking non-appraisal remedies for wrongs allegedly committed by Irex.
The district court dismissed the claims, ruling that, under Section 1105 of the Pennsylvania Business Corporation Law, appraisal is the sole post-merger remedy available to dissenting stockholders. Section 1105, entitled “Restriction on equitable relief,” provides that, “in the absence of fraud or fundamental unfairness,” stockholders in Pennsylvania corporations do not have the right to seek an injunction against a proposed merger, or to seek a judicial determination of the fair value of their shares before a proposed merger takes place. When a proposed merger is to be submitted to a shareholder vote, Subchapter D of the Business Corporation Law gives dissenting shareholders the right to submit written notices of their intention to demand appraisal if the proposed merger is completed. If they do not vote in favor of the merger, and if they retain ownership of their shares until the merger is completed, they may be entitled to post-merger appraisal. Section 1105 also provides that the rights and remedies provided to dissenters under Subchapter D are “exclusive” in the absence of fraud or fundamental unfairness.
Mitchell Partners appealed, and a panel of the Third Circuit reversed the district court’s judgment, holding that, while Section 1105 makes appraisal the exclusive pre-merger remedy, the statutory appraisal remedy “coexists” post-merger with common law causes of action, including actions against corporate directors to recover damages for breaches of fiduciary duty. The Court of Appeals later agreed to rehear the case, and it certified the following question to the Pennsylvania Supreme Court:
Does 15 Pa.[C.S.] §1105, providing for appraisal of the value of the shares of minority shareholders who are “squeezed out” in a cash-out merger[,] preclude all other post-merger remedies including claims of fraud, breach of fiduciary duty, and other common law claims[?]
In a decision by Justice Saylor, the Supreme Court unanimously (6-0, Justice Orie Melvin not participating) rejected Mitchell Partners’ arguments and the Court of Appeals’ rationale. The court concluded that in the ordinary case, the Pennsylvania General Assembly’s intent in enacting Section 1105 was to limit post-merger relief to appraisal actions and to preclude other claims for damages. The court determined that the General Assembly specifically intended, in enacting Section 1105, to limit post-merger relief to the recovery of fair value of a minority shareholder’s shares in an appraisal proceeding. The court rejected arguments that its 1980 decision in In re Jones & Laughlin Steel Corporation, interpreting the predecessor statute to Section 1105, supported an alternate interpretation of the statute, distinguishing the case on its facts and conclusively determining that Section 1105 precludes common law post-merger claims for relief, absent the exceptional case of fraud or fundamental unfairness. Although the court observed that the exceptions for fraud and fundamental unfairness “may not be invoked lightly,” it did not attempt to define or describe the circumstances that would give rise to the exceptions, other than to say that inadequacy of price is insufficient to bring the exceptions into play.
The court also rejected arguments that Pennsylvania should adopt procedures employed in other jurisdictions, including Delaware, which permit separate suits for breach of fiduciary duty even in a post-merger context. The court recognized that Pennsylvania’s corporate law jurisprudence differs from those of other jurisdictions, that the intent of the General Assembly was of foremost consideration in interpreting statutory provisions, and that Section 1105 was clearly intended to be an exclusive remedy, in the absence of extraordinary circumstances.
Justice Baer, in a concurring opinion, expanded on the court’s conclusions that “mere inadequacy in price is not sufficient to implicate the fraud or fundamental unfairness exception contained in Section 1105” and that the exceptions are “not to be invoked lightly.” Specifically, Justice Baer stated that the exceptions should “not ... be invoked to compensate financial unfairness,” as concerns of financial fairness are properly addressed and remedied in an appraisal proceeding. He concluded that due to the narrow nature of the exceptions, litigants seeking to invoke them must demonstrate that the harm they allege results from fraud or fundamental unfairness and that compensation through the appraisal process would be inadequate to remedy the alleged wrong.
Mitchell Partners reminds litigants that Pennsylvania courts, in undertaking statutory interpretation, will look first and foremost to legislative intent for a proper reading of a given statute. As applied in this case, the General Assembly clearly sought to limit minority shareholders’ potential avenues for recourse should they dissent from a proposed merger. Corporations in merger negotiations or in the process of consummating a business combination should take appropriate steps to ensure that no conduct of the corporation or its officers or directors could be construed to rise to the level of fraud or fundamental unfairness.
M. Duncan Grant, James H. S. Levine and James G. McMillan, III