On July 24, 2012, in response to a question of law from the Third Circuit, the Supreme Court of Pennsylvania held that Section 1105 of Pennsylvania’s Business Corporation Law (“BCL”) “precludes postmerger remedies other than appraisal [for dissenting shareholders] only in the absence of fraud or fundamental unfairness.” Mitchell Partners, L.P. v. Irex Corp., 2012 WL 3007224, at *8 (Pa. July 24, 2012) (Saylor, J.) (Mitchell III). The court emphasized that “the fraud or fundamental unfairness exception may not be invoked lightly” and explained that “appraisal is intended as the usual remedy in the absence of exceptional circumstances.” Id. at *7.
“Mitchell Partners, L.P., was a minority shareholder of Irex Corporation, a privately-held Pennsylvania business corporation.” Id. at *1. “In 2006, Irex participated in a merger transaction structured so that some minority shareholders would be ‘cashed out’ and would not receive an equity interest in the surviving corporation, a wholly owned subsidiary of North Lime Holdings Corporation.” Id. “Mitchell objected to the acquisition, as it viewed the transaction as a ‘squeeze out’ of minority interests at an unfair price.” Id. “The merger proceeded nonetheless[.]” Id.
“Irex commenced valuation proceedings in state court, per Section 1579 of the BCL, to address the dispute with Mitchell.” Id. At the same time, Mitchell brought a diversity action in federal court against Irex, its directors, most of its officers, and North Lime, and asserted common law claims for breach of fiduciary duties, aiding and abetting breach of fiduciary duties and unjust enrichment. The defendants moved to dismiss the federal action, arguing that “under Section 1105 of the BCL, judicial valuation is the sole remedy available to dissenting shareholders in the post-merger timeframe.” Id.
Section 1105 provides, in relevant part, as follows: A shareholder of a business corporation shall not have any right to obtain, in the absence of fraud or fundamental unfairness, an injunction against any proposed plan … except that he may dissent and claim such payment if and to the extent provided in [the statutory provisions of the BCL relating to dissenters’ rights]. … Absent fraud or fundamental unfairness, the rights and remedies so provided shall be exclusive.
15 Pa. C.S. § 1105 (emphasis added). The Eastern District of Pennsylvania Finds That Section 1105 Precludes the Plaintiff’s Common Law Claims
On September 29, 2010, the Eastern District of Pennsylvania found that under In re Jones & Laughlin Steel Corporation, 488 Pa. 524 (1980) (Nix, J.), the plaintiff’s “‘post-merger remedies were limited to the appraisal of the fair market value of their stock.’” Mitchell Partners, L.P. v. Irex Corp., 2010 WL 3825719, at *5 (E.D. Pa. Sept. 29, 2010) (Gardner, J.) (Mitchell I) (quoting Jones, 488 Pa. at 533-34). “While the district court appreciated that several decisions of the Third Circuit Court of Appeals and the Pennsylvania Superior Court sanctioned remedies beyond appraisal,” the Mitchell I court “distinguished these [cases] on the ground that they involved separate litigation that was filed before the consummation of merger transactions.” Mitchell III, 2012 WL 3007224, at *2 (internal citations omitted).
The Third Circuit Reverses the District Court’s Decision
On August 31, 2011, “a divided three-judge panel of the Third Circuit reversed” the district court’s decision. Id. The Third Circuit “disagreed … with the district court’s position that [Section 1105] precludes all other remedies” besides appraisal. Id. “Acknowledging that some of the broader language from Jones supported the defendants’ position,” the Third Circuit distinguished Jones on the grounds that it “arose in the context of a statutory valuation proceeding, such that ‘the narrow issue of whether a suit for damages based on breach of fiduciary duties may be brought post-merger was not directly presented to the Supreme Court.’” Id. (quoting Mitchell Partners, L.P. v. Irex Corp., 656 F.3d 201, 212 (3d Cir. 2011) (Sloviter, J) (Mitchell II)).
The Third Circuit “predict[ed] that the Supreme Court of Pennsylvania would hold that Pennsylvania’s appraisal statute does not exclude separate, postmerger suits for damages alleging that majority shareholders breached their fiduciary duties to minority shareholders in the process of consummating a freeze out merger.” Mitchell II, 656 F.3d at 216. The Mitchell II court held:
[I]t is a clear holding in Pennsylvania [that] the statutory appraisal cause of action coexists with common law causes of action. Indeed, no other rule makes sense, for the appraisal remedy is available even absent misconduct of corporate officials. It was hardly intended to provide a shield for misconduct.
Id. (quoting Herkowitz v. Nutri-System, Inc., 857 F.2d 179, 187 (3d Cir. 1988) (Gibbons, J.)).
The Third Circuit Petitions the Pennsylvania Supreme Court for Certification of the Section 1105 Issue
The defendants sought rehearing of the Third Circuit’s decision, and the Governor of Pennsylvania moved for leave to file a supportive amicus brief. The Governor “expressed particular concern that the Third Circuit had interpreted the BCL’s provisions relating to dissenting shareholders’ rights in a manner inconsistent with Jones” and “found it troubling that resolution of this significant corporate law issue might depend on whether a litigant seeks redress in federal or state court.” Mitchell III, 2012 WL 3007224, at *4. “Accordingly, he urged the Third Circuit to grant rehearing and certify a question of law to [the Supreme Court of Pennsylvania].” Id.
The Third Circuit petitioned the Pennsylvania Supreme Court for certification of the following issue:
Does [Section 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[?]
Id. (quoting Petition for Certification of Question of Law, at 7). On February 28, 2012, the Pennsylvania Supreme Court granted certification.
The Pennsylvania Supreme Court Holds That Section 1105 Does Not Preclude Other Remedies But Only in the Event of Fraud or Fundamental Unfairness
The Supreme Court of Pennsylvania explained at the outset that “[t]his matter presents an issue of statutory interpretation[.]” Id. at *6. “Section 1105 indicates that the remedies it provides shall be exclusive ‘[a]bsent fraud or fundamental unfairness.’” Id. (quoting 15 Pa.C.S. § 1105). “By straightforward implication,” the Pennsylvania Supreme Court found that “this language conveys that, where fraud or fundamental unfairness are present, the statutory remedies are not made to be exclusive.” Id.
The court noted that “[e]xceptions to exclusivity of the appraisal remedy based on fraud, illegality or fundamental unfairness are common in the state corporate law of many jurisdictions and, indeed, are reflected in the Model Business Corporations Act[.]” Id. “Such exceptions obviously reflect a policy concern that, despite the desire to authorize and streamline fundamental changes beneficial to majoritarian interests, the appraisal remedy may be inadequate to vindicate the essential interests of minority shareholders where they encounter wrongful conduct.” Id. “Their application is also consistent with the scrutiny usually required, under corporate law, with respect to conflict transactions.” Id.
The Pennsylvania Supreme Court stated that this was “not to say … that Section 1105 does not serve as a restriction on non-appraisal proceedings.” Id. at *7. The court explained that “the General Assembly did intend for the notion of exclusivity—as modified by the exception for fraud or fundamental unfairness—to curtail actions outside the appraisal context.” Id. “Such qualified preclusion is suggested by the language of exclusivity appearing in Section 1105 and is supported by the general policy of reducing the burdensomeness of fundamental corporate changes.” Id. “In light of such purposes,” the Pennsylvania Supreme Court underscored that “the fraud or fundamental unfairness exception may not be invoked lightly.” Id. “For example, the Legislature has made clear that the exception does not apply merely by virtue of the character of a cash-out transaction.” Id. (citing 15 Pa.C.S. § 1105).3 “Plainly, appraisal is … the usual remedy in the absence of exceptional circumstances.” Id.