The United States District Court for the Southern District of New York recently issued a preliminary injunction modifying the terms of a merger agreement (the "Merger") because it appeared likely that representations made in the proxy statement (the "Proxy") issued to solicit shareholder approval for the Merger were misleading in violation of Section 14(a) of the Securities Exchange Act of 1934 (the "1934 Act").
The Merger Agreement
Seeking to offset substantial capital gains with a company experiencing tax losses, on November 23, 1998, defendant Besicorp Group, Inc. ("Besicorp") began merger negotiations with BGI Acquisition LLC ("Acquisition") and BGI Acquisition Corp. ("Merger Sub"). Under the terms of the Merger, a new company ("Newco") would spin-off from Besicorp, and Besicorp would then transfer its continuing business to Newco and distribute the common stock of Newco to the original Besicorp shareholders. Pursuant to a formula contained in the Merger, every shareholder of Besicorp would receive merger consideration of $37.09 per share, and all outstanding Besicorp shares would be canceled. After the Merger, Besicorp's shareholders would lose their equity interest in Besicorp, and Besicorp would become a wholly-owned subsidiary of Acquisition.
The Proxy Statement
On March 2, 1999, Besicorp issued the Proxy. On March 5, plaintiffs (shareholders in Besicorp) filed suit, seeking a preliminary injunction enjoining violations of the 1934 Act in connection with the Proxy. The plaintiffs alleged that the Proxy contained material misrepresentations concerning the effect of the Merger on two shareholder derivative suits pending in New York State Court. In one (the "Lichtenberg Action"), plaintiff Lichtenberg contended that several directors of Besicorp breached their fiduciary duties, as well as wasted corporate assets, by granting themselves 1.2 million shares of the company for little or no consideration. The plaintiff therein sought to return the shares to Besicorp. In the second suit (the "Bansbach Action"), plaintiff Bansbach sought to recover money spent by Besicorp in defending one of its directors, Zinn, for violations of the Internal Revenue Code and federal election laws.
Because the shareholders would have no equity interest in Besicorp after the Merger, the plaintiffs maintained that the Merger would put an end to the derivative suits. In support, the plaintiffs noted that under New York law, shareholders in a company involved in a cash-out merger who have no shares in the surviving company have no standing to maintain derivative actions. The plaintiffs asserted that this fact was not clearly divulged in the Proxy and therefore sought a preliminary injunction: (1) assigning Besicorp's interests in the pending derivative suits to Newco; and (2) placing the Merger consideration the Directors were to receive in exchange for the 1.2 million shares at issue in the Lichtenberg Action in escrow.
The Court's Ruling
On March 18, 1999, a day before the shareholder vote on the Merger was to take place, the court granted, in part, the plaintiffs' request for a preliminary injunction by ordering Besicorp to transfer its interest in the pending derivative actions to Newco. Although the court denied the plaintiffs' request to have the Merger consideration held in escrow, it ordered the defendants not to remove the Merger consideration from the jurisdictional reach of the court.
In reaching its decision, the court held that the plaintiffs had demonstrated a substantial likelihood of success on their claim that the Proxy was misleading. To maintain a claim under Section 14(a) of the 1934 Act, the court noted that a party must demonstrate that a proxy statement contained a "material misrepresentation, either in the form of an affirmative statement or an omission." An omission or statement is material if a reasonable shareholder would consider the information important in deciding how to vote. The court found that the Proxy could be materially misleading in four respects:
- First, the Proxy lacked specificity in the description of the derivative suits. The primary deficiency was the failure to disclose the value of the claims which would be extinguished by the Merger. The plaintiffs argued that successful adjudication of the Lichtenberg Action could make an additional $44.5 million ($25 per share) available as Merger consideration, while the Bansbach Action could result in the recoupment of $1 million. According to the court, these figures were neither speculative nor trivial, and should have been included in the Proxy.
- Second, the court held that the statement in the Proxy that "[t]he Plaintiffs . . . may not [be] able to maintain their actions as shareholder derivative suits if the merger is consummated" was "extremely misleading, if not plainly false." As the court noted, the use of the word "may" in the Proxy was misleading because it suggested that there was a possibility that the plaintiffs could maintain their suits after the Merger, although the law was clear that they could not.
- Third, the court held that the Proxy "trivialize[d] the financial windfall to the officers and directors." The Proxy stated only that "certain of Besicorp's executive officers and directors who are defendants in such [derivative] suits, . . . may benefit." The court held that the Proxy should have disclosed that the Merger saved the directors from potential liability of $45.5 million dollars.
- Fourth, the Proxy stated that the directors believed that the Merger would be in the best interests of the Besicorp shareholders and would "maximiz[e] the return to Besicorp's shareholders." However, the court held that it was "preposterous" for the directors to claim this given their knowledge that elimination of the derivative suits would also eliminate $45.5 million in Merger consideration.
In granting the preliminary injunction, the court also found that the plaintiffs would suffer an irreparable harm without an adequate legal remedy, i.e., not compensable by monetary damages, if the Merger were allowed to go forward without the modifications sought by plaintiffs. *
Lichtenberg v. Besicorp Group Inc., - F. Supp. 2d, No. 99 Civ. 1638, 1999 WL 178796 (S.D.N.Y. Mar. 26, 1999).